Question

The following events have occurred at times in the history of​ Canada:

  

1. The world economy goes into an expansion.

2. Canadian businesses expect future profits to rise.

3. The government increases its expenditure on goods and services in a time of increased international tension.

Explain the separate effects of each event on Canadian real GDP and the price​ level, starting from a position of​ long-run equilibrium.

Starting from a position of​ long-run equilibrium, a world expansion​ ______, and an increase in expected future profits​ ______.

A.

decreases real GDP and raises the price​ level; decreases real GDP and raises the price level

B.

increases real GDP and raises the price​ level;

increases real GDP and raises the price level

C.

increases real GDP and raises the price​ level; increases real GDP and lowers the price level

D.

increases real GDP and lowers the price​ level; increases real GDP and raises the price level

Starting from a position of​ long-run equilibrium, an increase in government expenditures​ ______ real GDP and​ ______ the price level.

A.

​increases; real GDP and lowers the price level

B.

decreases real GDP and raises the price level

C.

increases real GDP and raises the price level

D.

decreases real GDP and lowers the price level

Answer 1

Event 1

The world economy goes into expansion.

This will result in an increase in income around the world which would increase the demand for Canadian exports.

As Canadian exports will increase, net exports of Canada will increase. This will lead to increase in aggregate demand.

Given the aggregate supply, increase in aggregate demand will lead to increase in price level and real GDP.

Event 2

Canadian businesses expect future profits to rise.

This expectation of rise in future profits will induce the businesses to expand their productive capacity and thereby the investment by businesses will increase.

Investment is a component of aggregate demand. So, this increase in investment will lead to increase in aggregate demand.

Given the aggregate supply, this increase in aggregate demand will lead to increase in the price level and real GDP.

So,

Starting from a position of​ long-run equilibrium, a world expansion increases real GDP and raises the price​ level​ , and an increase in expected future profits increases real GDP and raises the price​ level.

Hence, the correct answer is the option (B).

Event 3

Government expenditure or purchases is a component of aggregate demand.

So, an increase in government expenditure will result in an increase in aggregate demand.

Given the aggregate supply, this increase in aggregate demand will result in an increase in price level and real GDP.

So,

Starting from a position of​ long-run equilibrium, an increase in government expenditures​ increases real GDP and​ increases the price level.

Hence, the correct answer is the option (C).