Question

In: Economics

Suppose the economy is suffering in a recessionary period. Firms are facing increasing inventories and individual...

Suppose the economy is suffering in a recessionary period. Firms are facing increasing inventories and individual consumers are increasing their saving to prepare for hard times ahead. What is likely to happen to the economy and can it correct itself and grow toward full employment in the short run? How is this different and how is it similar to the impact of the COVID-19 in the economy?

Solutions

Expert Solution

As economiy is suffering a recessionary period, demand is falling in the economy which is reducing the price of all goods constantly. There occurs a recessionary gap (Ql - Qs) in the eceonomy where economy is operating where full potential output level is Ql and current production level is Qs.

If government have funds with them and adopts expansionary fiscal policy such that they raise government spending in the economy and reduces tax which will raise the overall spending on goods and services by raising disposable income. It will shift the demand curve to its right from AD to AD1 in short run which will raise the price level and take economy to its potential level of output.

It is quite similar to COVID-19 where many businesses have to shut their businesses temporarily and many job employees lost their jobs which reduced the aggregate demand in the economy.


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