Question

Section C 30 45 60 Important: - Each answer should have minimum 100 words, if data or table used to support your answer, must give proper reference The economic glance data for 2012 is given below. The aggregate demand is equal to the national disposable income. (5 Marks Months Disposable income (In million) Aggregate supply January 50 February March 60 70 April 75 80 May 90 90 June 105 100 July August 135 September 150 130 October 165 140 November 180 150 December 195 160 120 110 120 8. Suppose there is 10% increase in disposable income in each month in subsequent year where supply remains same. Draw the diagram and explain the inflationary or deflationary situation arises in the economy. [2.5+2.5 = 5 Marks]

Answer 1

8. With rise of 10% in disposable income, aggregate demand curve shifts to the right. As a result, equilibrium real GDP and price level both rises. However, if the economy was already at its potential level, real GDP remains unchanged with only increase in price level. Thus, inflationary situation arises in the economy. In the diagram below, we have shown the effects of increase in disposable income. Equilibrium real GDP increases from Q1 to Q2 , whereas, price level rises from P1 to P2.

Price level AS P2 P1 AD2 AD1 Real GDP Q1 Q2

9. With the increase in 10% of disposable income, real GDP/income increases.

Now, Y=C+(mpc*DI)+I+G+NX (where, Y=income, C=autonomous consumption, I=investment, G=government expenditure, NX=net exports)

Thus, change in Y = mpc*increase in disposable income

10. Due to current economic crisis, there has been a decrease in aggregate demand, resulting in the fall in both income and price levels.

Now, in order to come out of the situation government can take following steps:

a. Expansionary monetary policy : If government increases money supply (by decreasing interest rates) , supply of loanable funds will increase in the economy. Again, this will lead to rise in investment and aggregate demand. This will help to increase both price level and income level.

b. Expansionary fiscal policy : If government increases government expenditure or reduces tax rate, aggregate demand will increase. As a result, both equilibrium price level and equilibrium income level will rise.