North South University

Department of Economics
School of Business and Economics
Introduction to Macroeconomics (ECO 104)
Final Assignment
Total Marks: 45
Deadline: 04 May, 2020

Instructions
Read the questions carefully. Answer all the questions.  You have to type out the assignment completely in MS
Word, along with diagrams and boxes. You may use the drawing options of MS Word or Paint or anything you
are comfortable with.

1. “The Bangladesh Bank has created additional money worth Tk70,794 crore through various
refinance schemes and easing regulatory requirements after the Covid-19 outbreak in March
for stimulating demand to revive the declining economy.” (link:
https://tbsnews.net/economy/banking/bangladesh-bank-creates-money-worth-over-
tk70000cr-revive-economy-76435?
fbclid=IwAR108OXKcbXq6JjZj6v9FbULrDtys_QsZySUTKeAmauoqTjppgnLqU89muw#.Xq5kdXh
gRqq.facebook).
a. If government increases money supply do you think if will affect product market? How it
will affect i. the price level, value of money, and ii. loanable fund market? Use the
relevant diagrams. 05+05+05

b. According to Monetarism, when does an increase in money supply change both Real
GDP and price level? In the short run or in the long run? Explain your answer using a
diagram.
05+05

c. Do you think creating this additional money will lead to inflation? What type of inflation,
demand-induced or supply-induced? Do you think it will be continued inflation? Why?
Draw a relevant diagram to explain your answer. 02+04+02

2. Suppose recent wave of pessimism engulfs consumers and firms, causing them to reduce
their expenditures.
a. Demonstrate this event using the model of aggregate demand and aggregate supply and
assuming that the economy was originally in long-run equilibrium. 03

b. What is the appropriate activist Fiscal policy response in this regard? In which direction
would the activist policy shift aggregate demand? Use Diagram. 03

c. Did the activist fiscal policy destabilize the economy? Explain and Use diagram. 04+02
 Assignment
Course Code :ECO 104

Section : 3

Submitted To
Nazneen Imam

Department of Economics

North South University

Submitted By

Md. Rezwan Hossain

Id: 1711977630

1. a)(i) If government increases money supply it will certainly have an impact on the product
market. As we know if money supply increases then the aggregate demand increases as a
result and AD curve shifts rightwards. As a result, price level will also increase. Here in this
case as government has increased money supply. As a result, the aggregate demand and
price level will also increase. In the long run the price level and the GDP will also increase. As
price level increases the wages will also increase which will lead to less aggregate supply and
as a result SRAS curve will shift backwards and the price level will increase even higher and
real GDP will decrease. As the prices have increased there will be an inflation and thus the
value of money will decrease as the increase in price level indicates more price for less
goods which means that the value of money has decreased.

Here, the vertical axis shows the price level and the horizontal axis shows the real GDP.
From the diagram we can see that as money supply has increased the aggregate demand
has increased and AD shifted rightwards. As a result, both price level and real GDP increased
from P1 and Qn to P2 and Q1 in the short run. But as a result, the prices and wages has
increased and the supply of products in the market decreased from SRAS1 to SRAS2. So, in
the long run the GDP has come back to its original place but the price has increased further

(ii) if the government increases money supply then the supply for loanable funds in the
market will increase. As a result, the supply curve will shift rightwards. As the supply has
increased the interest rates will decrease which will eventually lead to an increase in the
demand of loanable money supply.
Here the vertical axis shows the interest rate and the horizontal axis shows the quantity. If
money supply increases the supply for loanable fund also increases and supply curve shifts
rightwards from SLF1 to SLF2. Which decreases the interest rate from i1 to i2 and increases
the demand for loanable money .

1.(b) According to monetarism in the short run the increase in money supply will change
both real GDP and price level. If the velocity and money supply changes in the economy the
price level and real GDP both will change. But as according to monetarism the economy is
self-regulating, so in the long run only the price level will be changed.
 Here from the diagram we can see that as money supply has increased the aggregate demand has
increased and AD shifted rightwards. As a result, both price level and real GDP increased from P1
and Qn to P2 and Q1 in the short run. But as a result, the prices and wages has increased and the
supply of products in the market decreased from SRAS1 to SRAS2. So, in the long run the GDP has
come back to its original place but the price has increased further. So, it can be said that the increase
in money supply change both real GDP and price level in the short run.

1. c) yes, I think creating this additional money will lead to inflation. As the government has created
additional money worth Tk.70,794 crore. This money will increase aggregate demand and as a result
demand induced inflation will be created. If money supply is increased in an economy it generally
increases the aggregate demand.
Here in the graph we can see that the aggregate demand has increased from AD1 to AD2 because of
the increase of money supply. As a result, price and real GDP has increased from P1 and Q1 to P2
and Q2. As the wages have increased the supplies have decreased from SRAS1 to SRAS2 resulting in
the price of products to increase even more to P3. Thus because of the increase in money supply in
the economy demand induced inflation is incurred.

But this inflation is one shot inflation. I don’t think this inflation will be a continued inflation.
Because an inflation to be a continued demand-pull inflation there needs to be a continued ongoing
increasing supply of money. But in this economy the government has increased money one time
only. So we can’t surely say that it will be a continued inflation which would look like the graph
below and would have a continuous increase in demand and price level.
2.a)

If the consumers decrease their expenditure it would mean that there will be less consumer
spending and if the firms stop expenditure it would mean that the investment will be decreased. In
both cases the aggregate demand will be decreased. So the aggregate demand curve will be shifted
leftwards because of the less demand on the market. As a result the price level and quantity will also
decrease. So in the long run the wages will fall and the prices of resources will fall. So the aggregate
supply will shift rightward from SRAS1 to SRAS2 while putting the economy back into full
employment.

Here, the vertical axis shows the price level and the horizontal axis shows the price level. Here the
AD is aggregate demand and SRAS is short term aggregate supply. The LRAS is the long term
aggregate supply. At the point of o the equilibrium is achieved where the price level is Po and the
Real GDP is Yo. Here because of the reduction of expenditures the AD curve shifts leftwards from
AD1 to AD2. As a result the price level and real GDP decreases from Po and Yo to P1 and Y1. In the
long run this leads to the reduction of wages and cost of resources and as a result supply increases
from SRAS1 to SRAS2 and as a result the price level is reduced even more to P2 and the GDP is
increases and comes back to the previous position of Yo.

2.b) The appropriate Fiscal policy in this regard will be the expansionary fiscal policy as the economy
is currently in recession.
 In an expansionary fiscal policy the government applies two methods. They increase the
government spending which increases aggregate demand and they decrease taxes which increases
people’s disposable income and thus increases the consumer spending and eventually increases the
aggregate demand. So the expansionary fiscal policy would shift the aggregate demand rightwards.

Here, the vertical axis shows the price level and the horizontal axis shows the price level. Here the
AD is aggregate demand and SRAS is short term aggregate supply. The LRAS is the long term
aggregate supply. Here if the expansionary fiscal policy is followed then the AD is increased and is
shifted rightwards from AD1 to AD2. As a result the price level and real GDP increases from P1 and
Y1 to P2 and Y2.

2.c) Yes, the expansionary fiscal policy destabilized the economy. Normally the expansionary fiscal
policy destabilize an economy if it overheats the economy. This happens if the economy is already
expanding on its own. Here the economy is assumed to be in long term equilibrium. So it is assumed
that the economy would expand itself on its own and come back to the full employment and the
previous real GDP. So when the expansionary fiscal policy has been applied as the economy is
expanding itself it would only fuel the demand pull inflation. The tax cuts and spending increases will
move the AD curve to the right. So in such a case the expansionary fiscal policy destabilized the
economy.

Here, the vertical axis shows the price level and the horizontal axis shows the price level. Here the
AD is aggregate demand and SRAS is short term aggregate supply. The LRAS is the long-term
aggregate supply. At the point of o the equilibrium is achieved where price is Po and the real GDP is
Yo. If expansionary fiscal policy is applied it would shift the AD curve from AD1 to AD2. So the price
will increase from Po to P1 and real GDP from Yo to Y1 which would cause demand pull inflation and
would destabilize the economy.