To understand the economy in the short run (over a few years), we can use either...

To understand the economy in the short run (over a few years), we can use either the static or dynamic version of AD-SRAS. In which of the following situations would you use dynamic AD-SRAS? As far as this question goes, If dynamic AD-SRAS is not appropriate, then static AD-SRAS is appropriate.

A. If Government spending grows, does Y grow or decline.

B. The economy is in an expansion. The FOMC lowers the federal funds rate -- does growth pick up or does it slow down?

C. Does P rise or fall if taxes decline?

D. The current inflation rate is about 2%. If taxes fell, would the inflation rate rise?

Expert Solution

We can use the dynamic AD-AS model for the option C, that is when the FOMC lowers the federal funds rate.

The dynamic AD-AS model is used when the output and respond over time to exogenous changes in the enviornment.

a). If the government spends more in the economy means people have more money than the before. This induces the people to spend more so there should be an increase in the aggregate demand in the economy. So the real GDP increases and the inflation increases. Here the economy will definitely grow.The aggregate demand curve will shift to the right

b). The economic growth picks up- When the FOMC lowers the federal fund rate the banks can easily borrow from other depository institutions to maintain their reserve requirement. This means the banks has an increased excess reserves so they can lend out more money so this will increase the money supply in the economy and inturn result in the growth of the economy.

c). The P rises when the taxes decline- The decrease in the taxes will increases the disposable income of the economy leading to an increased consumption. This increases the aggregate demand and the AD curve shifts to the right. So there will be rise in the general price level.

d). The inflation rate will increase- The disposable income will increase and the AD increases.

Rahul Sunny answered 2 years ago

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