Answer to Question #132484 in Macroeconomics for Johan

Question

4.1 Assume the aggregate demand of an economy is rising at 3%, but its productive capacity is
only rising at 2%. Discuss the type of inflation this would lead to. Use a diagram to motivate
your answer. (20)
4.2 Explain how fiscal policy can be implemented if an economy is in the downswing of a business
cycle. (15)

Answer 1

4.1 If the aggregate demand of an economy is rising at 3%, but its productive capacity is

only rising at 2%, then the demand-pull inflation occurs, because the economy demands more goods and services than are available.

4.2 During a recession, the government may employ expansionary fiscal policy by lowering tax rates or increasing government spending to increase aggregate demand and fuel economic growth.