Problem 161 Algo Refer to the table glven below Sup ppose th

Problem 16-1 (Algo) Refer to the table glven below. Sup ppose that aggregate demand increases such that the amount of real output demanded rises by $11 bilion at each price leve eal Output upplied 515 eal Output Demanded Price ina 504 108 96 By what percentage will the price level increase? Will this inflation be demand-pull inflation or will it be cost-push inflation? (Click to select) If potential real GDP that is, full-employmen If the gover percent t GDP) is $510 billion, what will be the size of the positive GDP gap after the change in aggregate demand? s wants to use fiscal policy to counter the resuiting inflation without changing tax rates, would it increase government spending or decrease it select) v nment eBook &Resources;

Solution

a) Current equilibrium is attained at a point where Real output demanded = real output supplied.

Thus, current price level = 100

If real output demanded increases by 11 billion at each price level, new equilibrium will be attained at a level where P =108.

Thus, percentage incraese in price level = 8%

b) This inflation will be demand pull inflation.

c) Given, full employment GDP = 510 billion, size of the positive GDP gap after change in aggregate demand = $11 billion.

d) Inorder to counter the increase in inflation rate with the help of a fiscal policy, the government should decrease its spending. This will result in a fall in aggregate demand and hence the economy will come back to its original full employment equlibrium.