Question

We have discussed stagflation in this course. Explain how stagflation can be caused in an economy. Include an explanation of the shift in the AD-AS diagram that could cause stagflation, and possible reasons for such a shift. Please do not draw graphs - a written explanation is all that is required.  

(b) Recall our class discussion on the money market, money demand and money supply. Suppose you are studying the money market in an open economy. You now see that the money demand in the money market decreases. How might this change in the money market affect the economy? Explain with respect to each of the elements of the AD equation (the expenditure equation), which is Y = C + I + G + NX. Please do not draw graphs - a written explanation is all that is required.

Answer 1

Answer to the first question is provided :

1) When unemployment is high in an economy , total spending declines because people have no jobs and they do not have money to spend on goods and services . So due to lack of demand the prices of commodities fall in the economy . But in case of stagflation prices of goods rise while unemployment increases and spending declines . It is a situation of slow economic growth with inflation and stagnation and rising unemployment in the economy . This can occur due to sudden increase in the price of oil or poor economic policies etc .

When the price of oil suddenly increases , the cost of production increases . The Short Run Supply Curve shifts left . The price level rises and and output falls . So inflation occurs and production falls which causes rise in unemployment at the same time .