Question

With the components of nominal Gross Domestic Product (GDP), inflation rate, output ratio.

a.using examples, discuss the relationship between inflation rate and output ratio.

b. By using an appropriate diagram, examine the effects of an acceleration in nominal Gross Domestic Product (GDP) growth on inflation rates and output ratio in the long run.

c. Discuss the effects of the Three(3) possible policy responses to an adverse supply shock on inflation rate, output ratio and nominal GDP.

Answer 1

a)The relationship between inflation ratio and output usually can be described by phillips curve where inflation rate and output ratio are positively correlated.higher inflation reduces the average real wealth thus it increases employment and thus output increases but if the inflation is due to cost push inflation then Short run Aggregate supply curve will shift due to adverse supply shock thus though inflation will increase it will decrease the output level; if the inflation is due to demand push then increase in demand will shift the short run aggregate demand curve thus along with increasing inflation output will increase.

b) In long run Economic growth or accelerations in GDP and inflation has some delicate relationship. if increase in GDP due to increase in AD more than productivity capacity means more than long run aggregate supply then increase in GDP will have increase in inflation, but if Increase in GDP is due to increase in long run productivity then maybe inflation will not increase.

c) There is no proper policy than can deal with adverse supply shock on inflation rate output ratio and nominal GDP altogether.

But in adverse supply shock situation we can keep AD constant thus output and employment rate will be lower than natural rate after sometime price will fall to original level but there will a recession

or, we should increase AD by expansionary monetary policy or fiscal policy mainly known as accommodating policies to bring back the output level to its original point but here a permanent inflation will be the result