Question

1. Suppose that goverment spending is raised at the same time that money supply is lowered. What will happen to the position of aggregate demand(AD). Explain

Answer 1

Aggregate demand refers to demand for all goods and services produced in the economy during a period of time. It consists of the following elements : household consumption expenditure (C), private investment expenditure (I), Government expenditure (G), net exports (X-M).

Of the government spending is increased and money supply is decreased all together it can create three scenarios.

1. The Increase in government spending is equal to decrease in money supply. Decrease in money supply means that there will be a decrease in consumer spending. If they both are equal then there will be no effect on the AD curve. It will remain as it is.

2. The Increase in government spending is more than the decrease in money supply. In this case, the AD will increase all together as the net effect will be an increase in the AD. So, the AD curve will shift to the right.

3. The Increase in government spending is less than the decrease in money supply. In this case the AD will decrease as the net effect of the situation will lower the AD. So, the AD curve sill shift to the left.

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