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Suppose that new data indicates that the global economy is slowing down, and we are heading for another global recession. As a result, there is pessimism among domestic consumers and investors affecting consumer and investment spending.
a) Show this development using Aggregate demand/Aggregate Supply (AD-AS) model of the domestic economy. (Hint: Begin with the AD-AS diagram for the economy that shows the economy is in long-run equilibrium). Make sure to label the variables represented on the X-axis and Y-axis of the graph clearly. Also mark the curves in the graphs clearly indicating what they represent. Marks will depend on the neatness and completeness of the graph.
b) What are the fiscal and monetary policy measures that the policy makers (government and the central bank) can undertake to correct the impact of the fall in spending? (Explain the policy measures in writing. Diagrammatic representation of the effects of these policies not required).
c) What are the possible long run impacts of the recommended policy measures in part (b)? (Explain the impact in writing, a diagrammatic representation not required).
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