Question

I only need 4 and 5

1) Define Aggregate Demand.

Aggregate demand is a schedule or curve that shows the various amounts of real domestic output that domestic and foreign buyers will desire to purchase at each possible price level.

2) Give three reasons why the Aggregate Demand curve slopes downward.

Real balances effect: When the price level falls, the purchasing power of existing financial balances rises, which can increase spending.

Interest‑rate effect: A decline in the price level means lower interest rates that can increase levels of certain types of spending.

Foreign purchases effect: When the price level falls, other things being equal, U.S. prices will fall relative to foreign prices, which will tend to increase spending on U.S. exports and also decrease import spending in favor of the U.S. products that compete with imports.

3) Using the Expenditure Model (GDP = C + G + I + NX), draw a graph that depicts Demand-Pull inflation.

For the GDP be , we have the representative AD and AS curve, and the initial equilibrium at X. Now, in case of demand-pull inflation, the AD increases to AD' due to an increase in consumption and/or government spending and/or NX, ie for , the representative AD is AD'. The new equilibrium would be at Y, where the price has increased.

Hence, inflation in case of demand-pull inflation would happen in the framework of expenditure model when

• C: consumer expenditure increases for some reason, such as an increase in the price of a group of products (which may happen as a significant factor like oil prices spikes up).

• G: government spending increases as a part of the expansionary fiscal policy.

• NX: domestic currency depreciates and that change in exchange rate causes export to increase, ie net export increases.

4) What factors cause Demand-Pull inflation?

5) Using the Expenditure Model (GDP = C + G + I + NX), what needs to be done to get back to equilibrium when an economy experiences Demand-Pull inflation?

Answer 1

4)

As name indicates Demand pull inflation happens due to the high demand for goods and services.Usually sellers raise their supply to meet this demand. Even this supply cannot meet their demand for commodity or service,sellers compell to raise their price.That results in demand pull inflation.

The major causes for demand pull in flation are as given below.

1.growing economy:

In a growing economy ,families spend more and save less in expecting to get better jobs and better salries .They willl borrow more .All this will create demandpull inflation inflation.

2.Expectation of inflation

Sometimes people buy more in the expectation of higher future prices.It also will cause demand pull inflation.

3.Over expansion of money supply

When government prints too much money to overcome government debt, the supply of money will increase in the economy.Too much money will chase too few goods.It is anothe cause for demand pull inflation.

4.Discretionary fiscal policy

Some government policies raise the descretionary income of the people.Eg:Government spending like military spending rice prices of that equipments,If Government reduce the taxes it also raise the demand.Raise in  descretionary income raise demand and leads to demand pull inflation.

5.Strong brand

Some products brand will create high demand.So they charge high prices and causes inflation

6.Technological innovation

People demand commodities with new technologies that will really help them in their daily life.Some companies make innovataions in commodities whose demand will raise heavily.It owns the market untill other companies begin to copy it.Heavy demand cause a rise in price and slowly leads to demand pull inflation.

5)Real GDP and price leve make an imbalance at inflation

AE,Aggregatr expenditure is the total expenditure that firms and households plans to spend on goods and services at various income levels.It iHelps to calculate the total sum of all economic activity,GDP

AE=C+G+I+NX

At equilibrium Aggregate Demand=aggregate Supply

When an economy experience demand pull inflation,Aggregate demand>Aggregate supply,So a raise in price To reduce demand state , local federal governments have to reduce their expenditure like borrowing(G),it will reduce the money supply in economy and help to reduce too much demand for too few goods.

Goverment have to adjust with direct and indirect taxes, so that so that over consumption(C) can be controlled so can reach to the equilibrium level.

NX is the difference between total export -total import.Tarrif and quota can be used to reduce over monesupply in the economy by export promotion.

Investment should regulated in such a way that it will not cause any inflation