Question

1.If you wanted to increase aggregate demand, what kind of policy would you use? Why?

2.If you wanted to increase aggregate supply, what kind of policy would use? Why?

Answer 1

Solution-

1.If you wanted to increase aggregate demand, what kind of policy would you use? Why?

If I wanted to increase aggregate demand, I can use Expansionary Monetary Policy.

An expansionary policy is a macroeconomic policythat seeks to expand the money supply to encourage economic growth or combat inflationary price increases. One form of expansionary policy is fiscal policy, which comes in the form of tax cuts, transfer payments, rebates and increased government spending,

Increase in aggregate demand can be achieved through expansionary fiscal policy where an increase in government purchases, decrease in net taxes, or a combination of the two aimed at increasing aggregate demand enough to reduce unemployment and return the economy to its potential output where fiscal policy is used to close a recessionary gap.

Second Policy is Changes in the money supply, An increase in the money supply will lead to in increase in the amount of money that people and firms will hold and they will spend more. Therefore aggregate demand will increase.

2.If you wanted to increase aggregate supply, what kind of policy would use? Why?

To increase aggregate supply, mostly use Supply- side Policies,

Supply-side policies are government attempts to increase productivity and shift aggregate supply (AS) to the right.

1. Free-market supply-side policies involve policies to increase competitiveness and competition. For example, privatisation, deregulation, lower income tax rates, and reduced power of trade unions.

2. Interventionist supply-side policies involve government intervention to overcome market failure. For example, higher government spending on transport and communication.

In theory, supply-side policies should increase productivity and shift long-run aggregate supply (LRAS) to the right.

1. Lower Inflation - Shifting AS to the right will cause a lower price level. By making the economy more efficient, supply-side policies will help reduce cost push inflation.

2. Lower Unemployment - Supply-side policies can contribute to reducing structural, frictional and real wage unemployment and therefore help reduce the natural rate of unemployment. See: Supply-side policies for reducing unemployment.

3. Improved economic growth - Supply-side policies will increase the sustainable rate of economic growth by increasing LRAS; this enables a higher rate of economic growth without causing inflation.

4. Improved trade and Balance of Payments. - By making firms more productive and competitive, they will be able to export more. This is important in light of the increased competition from an increasingly globalised marketplace.