Answer to Question #125813 in Economics of Enterprise for Ayanda

Question

4.1 Assume the aggregate demand of an economy is arising at 3%,but its productive capacity is only rising at 2%. Discuss the type of inflation this would lead to. Use diagram to motivate your answer.
4.2 explain how fiscal policy can be implemented if an economy is in the downswing of a business cycle.

Answer 1

A) Demand-pull inflation refers to a period of inflation which arises from rapid growth in aggregate demand. It occurs when economy of a country is growing too fast.

If aggregate demand is rising at 3%, but productive capacity is only rising at 2%; firms will see demand outstripping supply. This means that firms will only respond by increasing prices.

As firms produce more goods and services they will employ more workers, creating a rise in employment and fall in unemployment.

Increased demand for workers leads to a more demand on wages, leading to wage-push inflation. Higher wages increase the disposable income of workers leading to a rise in consumer spending

B) Fiscal policy refers to the changes in the taxing and spending of the federal government for purposes of expanding or contracting the level of aggregate demand. For instance in a recession, an expansionary fiscal policy will involve lowering taxes and increasing government spending

A downswing is a downward turn in the level of economic or business activities. It is usually caused by fluctuations in the business cycle. When used in the context of securities