Refer to the table below. Suppose that aggregate demand increases such that the
ID: 1208717 • Letter: R
Question
Refer to the table below.
Suppose that aggregate demand increases such that the amount of real output demanded rises by $17 billion at each price level.
Instructions: Enter your answers as whole numbers.
a. By what percentage will the price level increase? percent.
Will this inflation be demand-pull inflation or will it be cost-push inflation? (Click to select)Cost-push inflation or Demand-pull inflation.
b. If potential real GDP (that is, full-employment GDP) is $510 billion, what will be the size of the positive GDP gap after the change in aggregate demand? $ billion.
c. If the government wants to use fiscal policy to counter the resulting inflation without changing tax rates, would it increase government spending or decrease it? (Click to select)Decrease or Increase.
Explanation / Answer
Aggregate demand is equal to aggregate supply at a level of $510 billion when the price level is $100.
Suppose that aggregate demand increases such that the amount of real output demanded rises by $17 billion at each price level. This will increase the AD curve and shift it to the right by $17 billion. New AD and old AS are now equal at a level of $515 when the price level has risen to $114.
a. Since the price level increases from 100 to 114, there is an increase of 14 percent.
It is demand-pull inflation when the inflation results in keeping the unemployment rate below the natural rate of unemployment. It is cost-push inflation when the inflation causes the unemployment rate to surpass the natural rate of unemployment.
This is Demand-pull inflation as there is a positive GDP gap that implies lower unemployment.
b. If potential real GDP (that is, full-employment GDP) is $510 billion, the size of the positive GDP gap after the change in aggregate demand is $5 billion.
c. Since there is a positive GDP gap, the government wants to use a contractionary fiscal policy to counter the resulting inflation without changing tax rates, by decreasing government spending.
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