The diagram shows aggregate demand, AD, and short-run aggregate supply, SRAS, for Bellora. A cut in income tax has increased household disposable income, mo...
Question 1 Report
The diagram shows aggregate demand, AD, and short-run aggregate supply, SRAS, for Bellora. A cut in income tax has increased household disposable income, moving aggregate demand from AD1 to AD2. Bellora currently has low unemployment, but its central bank has an inflation target of 3%. Firms report that they are already using most available labour and machinery. The government must decide whether rapid economic growth should be its main objective in the following year.
(a) Identify the direction of the change in real GDP from X to Y. [1]
(b) Explain why the tax cut is likely to increase aggregate demand. [3]
(c) Describe one conflict between Bellora's economic growth objective and its inflation objective in this situation. [4]
Answer Details
(a) Real GDP increases from X to Y, since the equilibrium moves rightwards on the real-GDP axis. [1]
(b) A cut in income tax increases households' disposable income. [1] Households can therefore increase consumption spending. [1] Consumption is a component of aggregate demand, so aggregate demand shifts right from AD1 to AD2. [1]
(c) The higher aggregate demand raises real output, so it supports economic growth. [1] However, Bellora has little spare capacity because most labour and machinery are already in use. [1] Firms may bid up wages and other input costs, or raise prices when they cannot readily expand output. [1] Inflation may therefore rise above the 3% target. [1] The conflict is that policies to produce rapid growth can create demand-pull inflation when capacity is constrained.
Download The App On Google Playstore
Everything you need to excel in your exams
