Question

2. What is the classical view of money’s role in economic fluctuations? Do most economists agree with the classical view?

3. Illustrate a graph with aggregate demand, short-run aggregate supply and long-run aggregate supply all intersecting. Then, show what happens in the short-run when the government increases taxes. What happens to the price level and output in the short-run? Finally, adjust the short-run aggregate supply curve so that we are back in long-run equilibrium. What is the long-run effect of the increased taxation on output and the price level? Be sure to include your illustrations.

4. What is stagflation? What causes stagflation in the AD/AS model?

Answer 1

1) Classical economist says that supply creates its own demand and money only affect price and real wages in long run while having no impact on output level produced. They believe that supply curve is vertical and any change in price does not affect output level. Not all economist agree with Classical theories because leftist say that demand creates its own supply and supply curve is upward sloping.

2) If government increases taxes, people will be left with less disposable income in short run which will reduce the level of consumption that takes place in short run and shift aggregate demand curve to its left from AD to AD1 which will reduce price level as well as level of output.

Due to decrease in short run, there is increase in real wage of labor which induce them to accept a cut in their nominal wages which result in fall in cost of production and force producers to raise their supply and shift supply curve to its right which take economy to its long run output level.

3) A leftward shift in short rin supply curve from SRAS to SRAS1 show stagfation which result in increase in inflation and a rise in unemployment rate due to fall in equilibrium level of GDP.