Question

1. What impact would an increase in AD, in the vertical range of AS, will have on GDP and the price level according to the AD/AS model? Explain the reasons to score high marks.

2..  If the economy is operating in the short run AS curve and aggregate demand falls, what is likely to happen to real GDP, Price level, Unemployment and why? Would you suggest the economy will face a recessionary gap or inflationary gap?

Answer 1

Q.1

Ans.

Although both fiscal and monetary policy can alter aggregate demand, they do so through differing channels with differing impact on the composition of aggregate demand.

- If the rising aggregate demand is accompanies with no monetary accommodation, rising aggregate demand leads to higher interest rates immediately , higher prices and lower real GDP

- Government spending increases have a much bigger effect on GDP than similar size social transfers because the latter are not considered permanent, although real interest rates rise as monetary authorities react to rises in aggregate demand and inflation.

- If the rising aggregate demand is with monetary accommodation , the larger multiplier effects with monetary accommodation result from rises in aggregate demand and inflation, leading to falls in real interest rates and additional private sector spending and GDP.