Concept explainers
In the Keynesian framework, which of the following events might cause a recession? Which might cause inflation? Sketch AD/AS diagrams to illustrate your answers.
- A large Increase In the price of the homes people own.
- Rapid growth in the economy of a major trading partner.
- The development of a major new technology offers profitable opportunities for business.
- The Interest rate rises.
- The good imported from a major trading partner become much less expensive.
(a)
Whether “A large increase in the price of the homes that people own” will cause inflation or recession is to be determined.
Answer to Problem 1SCQ
Inflation is the persistent increase in general price level over a period of time in an economy.
Recession is the general slowdown of economic activity.
Explanation of Solution
Large increase in the home prices leads to inflation in economy. As output remains same, demand is higher, which leads to rightward shift of AD, this will lead to increase in price level and inflation.
(b)
Whether “Rapid growth of major trading partner” will cause inflation or recession is to be determined.
Answer to Problem 1SCQ
Inflation is the persistent increase in general price level over a period of time in an economy.
Recession is the general slowdown of economic activity.
Explanation of Solution
As there is growth in trading company, it means our exports will decline, this will lead to fall in aggregate demand which will lead to fall in income, output and price level. It will lead to recession.
(c)
Whether “The development of a major new technology offers profitable opportunities for business” will cause inflation or recession is to be determined.
Answer to Problem 1SCQ
Inflation is the persistent increase in general price level over a period of time in an economy.
Recession is the general slowdown of economic activity.
Explanation of Solution
New technology means increase in productivity growth, which induces business man to invest in economy. As investment increases, aggregate demand will increase, leading to increase in output, price level. It will mitigate recession.
(d)
Whether “the interest rate rises” will cause inflation or recession is to be determined.
Answer to Problem 1SCQ
Inflation is the persistent increase in general price level over a period of time in an economy.
Recession is the general slowdown of economic activity.
Explanation of Solution
As interest rate increases, it becomes costlier for firms to invest as cost of borrowing increases. This will lead to more recession in an economy.
(e)
Whether “the goods imported from a major trading partner become much less expensive” will cause inflation or recession is to be determined.
Answer to Problem 1SCQ
Inflation is the persistent increase in general price level over a period of time in an economy.
Recession is the general slowdown of economic activity.
Explanation of Solution
As imports become cheaper, it leads to more demand of imports, thereby declining aggregate demand. As AD falls, it will lead to less output, it will increase recession.
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