Question

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

Short answer

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

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.

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.