Fig. 1 shows aggregate demand curves for an economy. The government has announced a temporary increase in spending on rail construction. Price level is show...

Assessment: Economics 9214 | Paper 1 Mock 01 | Written Paper 1 Subject: Economics - 9214

Question 1 Report

Fig. 1 shows aggregate demand curves for an economy. The government has announced a temporary increase in spending on rail construction. Price level is shown on the vertical axis and real output on the horizontal axis.

Real outputPrice levelAD1AD2© EAGLE BEACON GLOBAL

(a) Which curve, AD1 or AD2, is most likely to show the effect of the higher government spending? [1]
(b) Explain the likely effect on real output, assuming spare capacity exists. [2]
(c) Analyse one reason why this policy could cause inflation instead. [3]

Answer Details

(a) The higher government spending shifts aggregate demand to the right, shown by AD2. [1]

(b) Rail construction is government expenditure, so the temporary spending increase raises aggregate demand. If spare capacity exists, firms can employ unused workers and other resources to produce more. Therefore real output rises. [2]

(c) The spending raises aggregate demand. However, if workers, raw materials and machinery are already fully used, firms cannot increase output much further. Excess demand and rising production costs then lead firms to raise prices. This is demand-pull inflation. [3]

Key distinction: With spare capacity, higher demand mainly raises output. Close to full capacity, higher demand is more likely to raise the price level.

Download The App On Google Playstore

Everything you need to excel in your exams

Green Bridge CBT Mobile App
Personalized AI Learning Chat Assistant
200,000+ Exam Questions Across IGCSE, JAMB, WAEC & NECO
Over 3,900 Lesson Notes
Offline Support - Learn Anytime, Anywhere
Green Bridge Timetable
Literature Summaries & Potential Questions
Track Your Performance & Progress
In-depth Explanations for Comprehensive Learning