Question

Assume an economy operates in the intermediate range of its aggregate supply curve. For each of the following changes in conditions, state the direction of the effect on: aggregate demand, aggregate supply, price level, real GDP.

a) An increase in government expenditure in infrastructure

b) A severe recession occurs in a country which has been a major importer of the nations exports.

c) The federal government reduces business taxes

Answer 1

The intermediate range of the Aggregate supply curve is when it is upward sloping.

a) an increase in government expenditure in infrastructure would lead to an increase in aggregate demand. Aggregate Supply will remain unchanged. This will lead to to an increase in price level and real GDP.

b) it was severe decision occurs in a country which has been a major importers of the nation's Exports then that country's income would go down. This will lead to a reduction in the demand for its Imported goods. Therefore, our nation's exports would Decrease. This will lead to a Decrease in Aggregate Demand. The aggregate supply would remain unchanged. There would be a Decrease in the price level and the real GDP.

c) if the Federal government producers business Taxes then the investment spending in the economy would increase full stop this will lead to an increase in aggregate demand in the economy. Moreover, Decrease in Taxes would increase the incentive to work more. Thus, Aggregate Supply would also Increase. However, the Increase in work hours is very small due to the tax cut. Hence, Increase in Aggregate Demand is greater than Increase in Aggregate Supply. As a result of this, Real GDP Increases and Price level also Increases.

Hence, if the Federal government reduces business taxes then the aggregate demand will increase, aggregate supply will increase, real GDP will increase and the price level also increases.