Question

1. Inflation and unemployment often move in opposite directions. (6 pts.)
   1. If the government implements an expansionary policy during a recession, what happens to prices and unemployment?

2. If the government implements a contractionary policy during an inflationary period, what happens to prices and unemployment?

3. Are people more willing or less willing to agree with an expansionary period during a recession, or a contractionary policy during an inflationary period? Briefly explain your answer.

2. Briefly explain how spending money on infrastructure or human capital can expand the economy without causing prices to increase. (1 pt.)

Answer 1

a) During recessioary period, potential output (Y1) is more than current output level (Y). If expansionary policy is adopted which will raise government expenditure and reduce tax in the economy. Both of the factors will raise aggregate demand in the economy and shift current demand curve to New demand which raise output level to its potential leveland raise price from P0 to P1. It will reduce unemployment level in the economy as it tends to raise output level.

b) During inflationary period, potential output (Y1) is less than current output level (Y). Contractionary fiscal policy will reduce government expenditure and raise tax wich tends to reduce aggregate demand in the economy and shifts demand curve to new demand. It reduce the price level from P0 to P1 and reduce output level from Y0 to Y1. It will raise unemployment level in the economy as less goods are produced in the economy.

c) People will be more wiling to accepy contractionary policy during expansionary gap because it tends to reduce the price level in the economy. On the other hand, expansionary fiscal policy during recessionary gap raises the price. Consumers are more happy to get a price cut of goods.

Human capital help producers in producing more goods in the economy which shift supply curve to its right. Infrastructure growth and human capital tends to rise without causing price to increase, demand curve must be perfectly elastic. A rise in supply curve will raise only output level and does not change price level.