BAKRIE UNIVERSITY INDIVIDUAL ASSIGNMENT 3 MACROECONOMICS

ECONOMICS FOR BUSINESS

Wednesday June 21 2023

1. Do it by yourself, no discussions with other people, other students, or other classmates.

2. Answer all questions in detail and clearly to get higer score
3. show graphs completely and clearly.
4. support your answer by using curves.
5. Submit your answers to my email: uhsyah21@gmail.com the latest is on Tuesday June 27
2023 at 21:00

QUESTION:

1.(100 marks), Would decreasing government spending solve the problem of inflation in the current
economic situation? Why? Explain by using an AD curve, an AS curve, and macroeconomic
equilibrium, and also explain the graph in paragraphs.

Reduced government expenditure has the ability to help relieve inflationary pressures in the present
economic environment. Let's look at the link between government expenditure, the aggregate
demand (AD) curve, the aggregate supply (AS) curve, and macroeconomic equilibrium to see how this
works.

The AD curve depicts total spending in an economy at various price levels. It slopes downhill because
when prices rise, consumers tend to buy less since their purchasing power decreases. The AS curve,
on the other hand, depicts total output in an economy at various price levels. It first rises because to
variables such as increased labor and resource usage. The AS curve, however, gets steeper or vertical
with increasing levels of output, suggesting that the economy has achieved its production capacity.

In the case of inflation, a continuous rise in the general price level indicates that aggregate demand is
surpassing aggregate supply. This can happen when there is an increase in demand for goods and
services, which puts pressure on prices. By reducing government spending, the AD curve shifts to the
left, representing a fall in overall spending.

When government spending falls, there is less demand in the economy, resulting in a drop in overall
output and prices. This change can assist in bringing the AD curve closer to the AS curve, potentially
lowering inflationary pressures. The new equilibrium point occurs at a lower price level and output
level. This shows a decrease in inflationary pressures, but also a decrease in economic activity.

It's crucial to remember that the success of cutting government expenditure in lowering inflation
depends on a variety of circumstances, including the extent of the cut and the overall state of the
economy. If inflationary pressures are predominantly driven by sources other than government
expenditure, such as supply-side shocks or foreign factors, lowering government spending alone may
not be sufficient to fix the problem.

Furthermore, policymakers must examine the impact of lower government expenditure on other
parts of the economy, such as employment and social welfare programs. A sudden and severe fall in
government expenditure can lead to lower demand for products and services, possibly harming
companies and employees.
Here is a graphical representation:

P AD1
AS1

E1
P1

Y1 Y

In this graph, the vertical axis represents the price level (P) and the horizontal axis represents the level
of real GDP (Y). The AD curve is downward sloping, indicating the negative relationship between the
price level and total spending. The AS curve initially slopes upward and becomes steeper or vertical at
higher levels of output, indicating the relationship between the price level and total production.

Now, let's consider the situation of inflationary pressures due to excessive government spending.
Initially, the economy is in equilibrium at point E, where the AD curve (AD1) intersects the AS curve.
At this point, the economy is operating at full capacity, and the price level (P1) and output (Y1) are in
balance.

To address inflation, the government decides to decrease spending. This reduction causes the AD
curve to shift to the left, let's say to AD2, as shown below:

P AD1
AS1
AD2

E1
P1
E2
P2

Y2 Y1 Y

As a result of the decrease in government spending, the AD curve shifts leftward from AD1 to AD2.
The new equilibrium point is E2, where the AD2 curve intersects the AS curve. At this new
equilibrium, the price level (P2) has decreased, and the level of output (Y2) has also decreased. This
adjustment indicates a reduction in inflationary pressures since the decrease in government spending
has helped align aggregate demand with aggregate supply.

Overall, this graph demonstrates the potential impact of decreasing government spending on the AD
and AS curves, as well as the resulting macroeconomic equilibrium. It illustrates how reducing
government spending can help address inflationary pressures by reducing aggregate demand and
bringing it closer to aggregate supply. However, policymakers must consider the broader economic
context and potential consequences before implementing such measures.