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Chapter 24: Q. 28 (page 656)

Many developing countries suffer from endemic corruption. How does this help explain why these countries鈥� economies typically have high inflation and economic stagnation? Use a graph of aggregate demand and supply to demonstrate.

Short Answer

Expert verified

The diagram displaying effect of corruption within the economic system is as follows:

Excessive inflation and declined output degree reasons stagnation within the financial system.

Step by step solution

01

Concept Introduction

Inflation occurs when the purchasing power of a currency declines as a result of a steady rise in the general price level. Stagnation occurs when the economy ceases to grow and develop.

02

Explanation

The diagram displaying the effect of corruption within the economic system is as follows:

Where,

- LRAS is the long-run aggregate supply curve.

- SRAS is the short-run aggregate supply curve.

- AD is the aggregate demand.

Inefficient marketplaces and distribution of goods and services are the results of corruption in the economy. These inefficiencies lower the economy's long-run productivity, acting as a permanent negative supply shock. This long-term negative supply shock results in excessive inflation and a drop in potential output. The economy is in a state of stagnation due to this excessive inflation and declining output.

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Most popular questions from this chapter

鈥淚f autonomous spending falls, the central bank should lower its inflation target in order to stabilize inflation.鈥� Is this statement true, false, or uncertain? Explain your answer

What will happen if policymakers erroneously believe that the natural rate of unemployment is 7% when it is actually 5% and therefore pursue stabilization policy?

For aggregate demand shocks and permanent supply shocks, the price stability and economic activity stability objectives are consistent: Stabilizing inflation stabilizes economic activity, even in the short run. For temporary supply shocks, however, there is a trade-off between stabilizing inflation and stabilizing economic activity in the short run. In the long run, however, there is no conflict between stabilizing inflation and stabilizing economic activity.

Suppose three economies are hit with the same temporary negative supply shock. In country A, inflation initially rises and output falls; then inflation rises more and output increases. In country B, inflation initially rises and output falls; then both inflation and output fall. In country C, inflation initially rises and output falls; then inflation falls and output eventually increases. What type of stabilization approach did each country take?

For each of the following shocks, describe how monetary policymakers would respond (if at all) to stabilize economic activity. Assume the economy starts at a longrun equilibrium.

a. Consumers reduce autonomous consumption.

b. Financial frictions decrease.

c. Government spending increases.

d. Taxes increase.

e. The domestic currency appreciates.
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