Answer to Question #150506 in Macroeconomics for kent chin

Question

Assume that millennials, who spend an average of RM100 a day, are expected to spend at a higher rate in the next ten to fifteen years. 37 percent of millennials report higher spending today than a year ago, while 42 percent of millennials say they are spending more. Furthermore, millennials are spending more on rent or mortgages and leisure activities than they were spending a year ago. Graphically illustrate the macroeconomic equilibrium after the change in spending by millennials:

Answer 1

a) If Malaysia’s economy operates below full employment equilibrium before the change in spending

When Millenials start spending, by that time the economy in Malaysia is at E. Due to increased levels of spending, the AD curve shifts to the AD1, and the potential output level is achieved at E1 as a new long-run equilibrium. Though it increases the price level to P1 and potential output Qp is achieved.

b) If Malaysia’s economy operates at full employment before the change in spending

In this scenario, the economy is already at the potential output level at E. Now, the increase in spending at this point, causes demand-pull inflation to take place and the AD curve shifts to the AD1 at E1 equilibrium. It is the condition of overheating of the economy at the increased price level of P1.

Now, it is important for the government of Malaysia to take action in terms of fiscal and monetary policy to help the economy achieve long-run equilibrium again.