Answer to Question #136722 in Macroeconomics for Saket Jaiswal

Question

Which condition is reason for deflation and why?
AD < AS
AD >AS

Higher the MPC will be cause of higher national income?
True or False

Answer 1

ANSWER:

AD < AS

There are three reasons:

i) wealth effect- as price rises wealth consumers are holding decreases because of constant money supply. Decrease in wealth makes buyers poorer which makes them reduce their demand for goods and services.

ii) interest rate effect- as the price rises buyers need more money to buy goods which leads to increase demand for money. Because money supply is constant, interest rate rises. Interest rate is the return on bonds buyers can earn. So they reduce their demand.

iii) Net exports effect- as price level rises, foreign goods become cheaper which leads to increase in demand for imports which compensates for domestic goods. Thus demand for domestic goods decreases

An equal increase in money supply will lead to higher national income in Keynesian view and lower national income in Monetarist view.

- False.

Reason - Monetarist believe that increase in money supply will lead to a higher national income. As money supply increases, the interest rates decrease, which facilities investments and leads to economic growth. Thus, according to monetarist view the supply of money is directly related to the economic growth.