Answer to Question #283719 in Macroeconomics for ABEX

Question

20. The Great Depression of the 1930s was characterized by deflation and significant involuntary unemployment, and a decline in output. The recession that has been observed in 1970s and early 1980s was characterized by increase in both prices and unemployment, and a decline in output. How does the AS-AD model explain this? What are the most

likely policy remedies that could be applied in each case?

Answer 1

Due to decrease in output, the Aggregate supply(AS) would shift to left indicating shortage while the aggregate demand(AD) would shift to the right indicating increase in demand. Fiscal policies such as decrease in taxes and increase in government spending into the economy would be the most crucial policy that could stir economic growth. This would increase aggregate consumption, pushing output to increase and thus prices to decline.