Assume that wages and prices are sticky and that we start at a long-run equilibr
ID: 1227815 • Letter: A
Question
Assume that wages and prices are sticky and that we start at a long-run equilibrium. Assume that at this initial point, the growth rate of the money supply is 4%, the growth rate of the velocity of money is 3% and that the real economic growth rate is 5%. Now assume that there is a negative real shock. After the negative real shock, the inflation rate in the economy is 7%. Now assume that the federal government decides to increase government spending in order to combat the situation resulting from the rise in oil prices. After the increase in government spending, the growth rate of the velocity of money is 8%.
Q1. After the negative real shock (Point 2), what is the the real economic growth rate?
Q2. When the federal government decides to increase government spending, the ______ curve shifts ______.
Explanation / Answer
Question 2) When the government decides to increase the government spending, the Aggregate Demand Curve will shifts Rightward.
Explanation:- Aggregate Demand (AD) = Household Consumption expenditure + Investment expenditure + Government spending + Net Exports.
Thus, Aggregate Demand (AD) has Four Components namely:-
i) Household Consumption expenditure (C)
ii) Investment expenditure (I)
iii) Government spending (G)
iv) Net Exports (X - M) [ X denotes Exports and M denotes Imports.]
If there is increase in any of the four components mentioned above, then the aggregate demand in the economy will increase and thus, aggregate curve will shift to right. Accordingly, increase in government spending will shift aggregate demand to rightward.
Conclusion:- When the government decides to increase the government spending, the Aggregate Demand Curve will shifts Rightward.