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Closed Economy - Essay Example

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A closed economy is an economy whose national income and output does not include the foreign sector, that is to say exports and imports are not included in the calculation of national output. In a closed economy where flexible wages and prices then an increase in the nominal quantity mean that the money in circulation in that economy will increase.
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Closed Economy
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Download file to see previous pages An increase in money supply will cause an increase in the level of prices. (Stretton (1999))
The law of demand states that when the level of demand rises beyond the level of supply then the price rises, if the level of demand falls below the level of supply then the level of prices will go down, but the level of the price fall depends on the elasticity of supply and demand.
Theoretically the increase in prices is caused by the increase in customer expenditure and this causes an increase in aggregate demand and as according to the law of demand and supply, when demand increases the prices will rise. therefore in this case the level of prices will rise in the short run but will eventually move back to the original position in the long run when the high prices eventually causes an incentive to suppliers who eventually meet the demand and therefore prices will fall.
Aggr dd is the aggregate demand while Agg ss are the aggregate supply, when you increase the money supply in an economy, people will tend to spend the money and therefore the aggregate demand increases therefore shifting the aggregate demand to the left, when aggregate demand increases beyond the level of aggregate supply the price of goods...
to the left, when aggregate demand increases beyond the level of aggregate supply the price of goods rises as depicted by the movement from p2 to p1, national output increases from y1 to y2.
For a government to increase the money supply it simply needs to decrease the interest rates which can be defined as the opportunity cost of borrowing money, when the interest rates are decreased the opportunity cost of borrowing money decreases and more people will acquire loans and borrow funds from banks, this will increase the amount of money in the economy.
Another way in which the government can increase the money supply is through decreasing the reserve ratio maintained by the central bank such that banks will now be required to maintain a lower amount with that bank and therefore they will be in a position to undertake credit creation and therefore increase money supply.

2.) An increase in the willingness to work

An increase in the willingness to work means that the marginal productivity of labour increases, this increase in labour productivity therefore output will rise. The cost of production will go down and supply will rise, when supply rises we expect prices to go down due to the law of demand.
An increase in the willingness to work is therefore an advantage to the economy, this is because an increase in the willingness to work will increase the marginal productivity of labour and therefore increase the productivity of labour and at the same time reduce of the cost of production of the various goods and services in an economy. Therefore the increase in the willingness to work will cause a shift in the aggregate supply because the producers will now have the opportunity to produce more at lower costs, prices will also go down due to the fact that supply exceeds ...Download file to see next pagesRead More
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