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Closed Economy - Essay Example
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.
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 ...