Question

In the year 2000, the Chinese economy’s growth was not as fast as the government expected....

In the year 2000, the Chinese economy’s growth was not as fast as the government expected. The Chinese government prolonged the Labour Day vacation (in May) to 7 days so that people could spend more.

a. Explain this decision, using the model of aggregate demand and aggregate supply. (6%)

b. Why did the Chinese government not wait until the economy adjusted back to its expected long-run position of high economic growth? (2%)

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Answer #1

In the year when the Chinese economic growth was not growing according to government expectations . It reveals that there was difference in actual and potential output. Actual output was less than the potential output. In order to eliminate the output gap, Chinese government follow expansionary policy and increase government sending to enhance the aggregate demand and due to government step of labor day vacation for seven days, aggregate demand was increased and shifts to AD1 and due to that prices and real GDP was increased and government expectations related to income and output rise was fulfilled.

Answer B) The Chinese government could not wait to have adjustments in the long run because low aggregate demand may signaled businesses of low profits. This can reduce production and economy can again be in the trap of recession.

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