Answer to Question #209653 in Macroeconomics for Gouri

Question

By using aggregate supply and aggregate demand curves to illustrate your

points, discuss the impacts of the following events on the price level and on equilibrium GDP (Y) in

the short run:

a) An increase in the money supply with the economy operating at near full capacity.

b) A decrease in taxes and increase in government spending supported by a cooperative Fed acting

to keep output from rising.

Answer 1

Solution:

a.). An increase in the money supply with the economy operating at near full capacity will increase both the price level and equilibrium GDP due to an increase in output levels.

This is because an increase in money supply will increase consumption levels and investment, shifting the aggregate demand curve to the right causing price level and national output to increase.

 

b.). A decrease in taxes and increase in government spending supported by a cooperative Fed acting to keep output from rising will increase aggregate demand and shift the curve to the right causing price level and national output to increase. This is because of the increase in consumption, government purchases, and investments.

 

This is demonstrated by the below two graphs: