Question

Milovia is a small open economy. The general price level in the economy has been increasing at a rate of about 7.5 percent each year. Jane​ Wilson, an industry​ analyst, is of the opinion that such high inflation is adversely affecting aggregate demand in the economy and therefore its ability to grow. Her​ colleague, Harry​ Gomes, however, disagrees. According to​ Harry, some amount of inflation is unavoidable in a growing economy. Higher prices for products help to increase the level of corporate profits and induce firms to increase aggregate output. Which of the​ following, if​ true, will indicate that higher prices will not induce firms to increase​ output? A. The Milovian government offers subsidies on inputs used in many manufacturing industries. B. The government purchased bonds in an open market operation last year. C. In spite of rising​ inflation, people in Milovia expect real incomes to increase substantially in the next few years. D. The​ country's trade balance has been positive for the last five years. E. The increase in the price of inputs outweighed the increase in the price of the final product.

Answer 1

Answer: Option E

Explanation: As per the law of supply, the producers increase the supply of product when there is an increase in the price of the product, but this law might not work when the increase in price of inputs needed is more than the increase in price of final product to be offered.

In case of above scenario there will be decline in profits for the suppliers hence they will decrease the production.

Hence, from the above explanation we can conclude that Option E is correct.