Question

An article in the Wall Street Journal stated that "Japan's cabinet approved a government stimulus package that includes \(¥ 7.5\) trillion (\$73 billion) in new spending, in the latest effort by Prime Minister Shinzo Abe to jump-start the nation's sluggish economy." a. Draw an aggregate demand and aggregate supply graph that shows where the Japanese government expects the economy to be without the stimulus package. Briefly explain what you graph shows. b. In the same graph, show the effect of the stimulus package on the economy. Briefly explain what your graphs shows.

Short answer

The initial AD and AS graph indicates Japan's economy before the stimulus, at equilibrium E0. Post-stimulus, the AD curve shifts to the right (AD1) indicating increased demand, with a new equilibrium E1. This shift represents expected economic growth due to the stimulus package.

Step-by-step solution

Draw the initial Aggregate Demand (AD) and Aggregate Supply (AS) graph

Draw a graph with 'Price level' on the y-axis, and 'Real GDP' on the x-axis. The initial Aggregate Demand curve (AD0) and the Aggregate Supply curve (AS) intersect at the equilibrium point E0. This illustrates the current economic condition before the government stimulus was introduced.

Map effect of stimulus package

Government expenditures are a component of Aggregate Demand. The stimulus package worth \(¥ 7.5\) trillion would increase the Aggregate Demand. Hence, draw a new Aggregate Demand curve (AD1) to the right of the initial one. The new equilibrium, E1, is where AD1 intersects the AS curve.

Interpretation of the graph

The shift in the Aggregate Demand curve from AD0 to AD1 depicts an increase in demand for goods and services, due to the government stimulus package, leading to a higher equilibrium of Price level and Real GDP. This represents an expected economic growth after the stimulus.

Key concepts

Government Stimulus

Government stimulus can be a crucial tool in reviving an economy. It refers to when the government spends money to boost economic activity. In Japan's case, a stimulus package worth ¥7.5 trillion was introduced with the aim of jump-starting the country's sluggish economy. Here's how it works:

• The government injects funds into the economy, which can increase consumer spending and business investment.
• This injection is expected to lead to higher aggregate demand, which pushes the overall demand curve to the right.
• As aggregate demand increases, businesses are likely to produce more to meet new demand, potentially leading to job creation and higher economic growth.

The ultimate goal of such stimulus is to change the course of the economy, by allowing it to reach higher growth and more employment.

Economic Growth

Economic growth is about the increase in a country's output of goods and services. This is often reflected in a rise in Real GDP, which signifies more production within an economy.

• Economic growth can stem from various factors, including increased consumer spending, greater investments by businesses, and sometimes external influences like government policy.
• In the context of Japan and their stimulus package, if successful, it could accelerate growth by increasing spending and production.
• This growth not only boosts the economy's overall performance but can improve citizens' standard of living by potentially lowering unemployment rates and increasing wages.

Government policies, like stimulus packages, are often targeted toward creating or enhancing such growth, pulling an economy out of stagnation.

Equilibrium Point

The equilibrium point in an economy is where the Aggregate Demand and Aggregate Supply curves intersect. This indicates a balance between what is produced and what is consumed without surplus or shortage.

• Initially, Japan's economy was at equilibrium E0, where the two curves met before any stimulus intervention.
• With the stimulus, the Aggregate Demand curve shifts rightward, resulting in a new intersection point, E1, indicating a revised equilibrium.
• This new equilibrium reflects a higher Price level and Real GDP, showcasing the effect of economic policies aimed at stimulating growth.

Understanding these intersections helps policymakers visualize where the economy stands and how close it is to achieving desired economic conditions like full employment and stable inflation.

Price Level

The price level in an economy refers to the average of current prices across the entire spectrum of goods and services produced. It is an essential factor when looking at inflation and purchasing power.

• An increase in the price level often indicates inflation, where goods and services become more expensive.
• In Japan's scenario, the government stimulus could result in a slightly higher price level, as higher demand from increased spending can lead to higher prices.
• However, controlled and moderate inflation is generally seen as a sign of a healthy economy.

Monitoring the price level helps economists and policymakers decide whether the economy is heating up too quickly or if it needs further support to facilitate growth.

Real GDP

Real GDP measures the value of all goods and services produced, adjusted for inflation or deflation. It gives a real picture of an economy's performance over time.

• An increase in Real GDP post-stimulus means more is being produced, signifying economic expansion.
• This growth in Real GDP is often driven by greater demand resulting from increased spending by consumers and businesses.
• Real GDP is critical as it often indicates the economy's size and health, guiding decisions on policies for sustainable growth.

In Japan's case, the stimulus is intended to boost Real GDP, thus pushing the economy towards healthier and more sustainable economic activity.