Question

Suppose a closed economy (an economy that does not engage in international trade) is described by the following table.

Year	Potential GDP	Real GDP	Price Level
1	$1200 billion	$1200 billion	100
2	$1250 billion	$1270 billion	109

(a) What problem will occur in the economy in Year 2 if no policy is pursued?

(b) Describe the fiscal policy tools that could be used to combat the problem. Carefully explain all steps in the link between policy and outcomes. What impact will this policy have on the various components of the aggregate expenditures? What will happen to the real GDP and Price level as a result of these policies?

(c) Describe the monetary policy tools that could be used to combat the problem. Carefully explain all steps in the link between policy and outcomes. What impact will this policy have on the various components of the aggregate expenditures? What will happen to the real GDP and Price level as a result of these policies?

Answer 1

(a) :-

In the event that no policy is sought after, swelling will rise further as the price level has just crept up in light of the fact that the real GDP is over the possible GDP. It essentially implies demand is higher as creation is in deficit since individuals are acquiring more and spending more and there is by and large work in the economy.

On the off chance that the expansion inches significantly higher, then wages will begin to expand which will prompt stagflation which is portrayed by higher swelling and higher joblessness levels.

b) :-

To battle the issue the government can build the duty rates and lower government use, which will lessen the demand as joblessness will begin to rise and demand will get together creation levels, more elevated levels of joblessness will prompt decrease in the price level as buyers begin to spend and demand less.

Aggregate use comprises of family unit utilization which will begin to fall in light of the fact that there are less occupations.

Speculations will begin to decrease as government begins burdening corporates, wherein their venture potential diminishes.

Government spending decreases.

Consequently real GDP will fall as yield will begin declining and the price level will decrease.

c) :-

Monetary policy device of increment in the loan fees could be utilized to battle the issue as because of increment in financing costs, assuming praise will end up being costly, and individuals will begin sparing as opposed to spending which will lessen aggregate demand for products and enterprises.

Family utilization will begin to fall as purchasers will spare progressively because of higher loan fees and store the money in banks.

Ventures will decay as it will turn costly for organizations and people to search out credits as a result of higher loan costs.

Government spending will likewise decay as their income will be spent on reimbursing higher intrigue installments.

Real GDP will decrease and the price level will likewise fall on account of decrease in aggregate demand.