Question

Compare the effects of an aggregate-demand-induced recession with an aggregate-supply-induced recession. How would you recognize that a recession is induced by demand or supply? What policies would be appropriate in the first case and what in the second?

Answer 1

The effects of an aggregate demand induced recession and the aggregate supply induced recession are different in the way they affect the price level.
An aggregate demand induced recession leads to a decrease in both the price level and the output in the economy. An aggregate supply induced recession leads to an increase in the price level but a decrease in the output in the economy.
We would be able to recognise that a recession is induced by demand or supply by looking at the trend of the prices. If the prices are going up then the recession is caused by the supply and if the prices are going down then the recession is caused by the demand.
The policies that would be appropriate in the first case is that government should increase its spending and lower the taxes.
The policies that would be appropriate in the second case are lowering of taxes that affect business, policies that increase deregulation and the policies that increase the competition in the Economy.