Answer to Question #203262 in Microeconomics for Haider

Question

Q: 03: Suppose that when everyone wakes up tomorrow, they discover that the government has given them an additional amount of money equal to the amount they already had. Explain what effect this doubling of the money supply will likely have on the following:

a. the total amount spent on goods and services

b. the quantity of goods and services purchased if prices are sticky

c. the prices of goods and services if prices can adjust

Answer 1

Solution:

a.). The total amount spent on goods and services – Doubling the money supply will increase the personal disposable income to consumers and if people have more money, they are probably going to spend more on goods and services.

 

b.). The quantity of goods and services purchased if prices are sticky – If prices are sticky which means that the price of the goods and services does not change immediately or readily due to the new market price when there are shifts in the demand and supply curve, the quantity of goods and services will still increase. This is because despite the demand increase for the goods and services, the prices will remain constant and therefore, people will still spend more on goods and services. As a result, output demanded will increase and producers will increase output to meet the increased demand rather than raising prices.

c.). The prices of goods and services if prices can adjust – If the prices can adjust as demand rises, then the higher consumer spending will result in to increase in prices to match the increased demand and quantity demanded will decrease as a result of the price increases.