Reaganomics Was a Set of Economic Policies - Essay Example

?Answer Reaganomics was a set of economic policies pursued by the United s in the 1980’s by the president of that time (Ronald Reagon). The policy had 4 main objectives: Reduced government spending Reduced income tax and capital gain tax Reduced government regulations Control over money supply to control inflation The main aim was to play with the tax and government spending tools; defense budgets to be high and tax brackets to be lowered to revive the economy that was at present at a level of -0.3%1. There are lots of critics for this model, especially politicians of that time who claim of the inefficiency of this economic model as it alleviated the upper class tax bracket2; however, it is important to note that during the time it would be a fair conclusion to draw that these measure were vital for the growth of U.S economy which was at stake at that time. As statistics show, the GDP rose, unemployment fell and incomes rose bringing the economy back to life. GDP grew from -0.3% in 1980 to 4.1% in 19881 which in return decreased the unemployment rate from 7.1% to 1.6%3 which created a net job increase of approximately 16 million. One of the most ironic statistics is that of inflation; this model has a very optimistic approach towards the economy as economic growth is associated with large scale inflation, however, statistics show that inflation, from 13.5% in 1980 declined to only 4.1% till 1988. It’s a startling fact that outlines the success of this economic model. Focusing on the statistics, one may draw out the conclusion of the success of Reagonomics, there are critics who argue in every field but past trends supported by authentic statistics answer the question of the efficiency of any model, which in this case turned out to be optimistic. A report published in 1996 also draws out the conclusion by stating that the economy of the U.S performed better during the Reagon years4. Answer 2: The whole economy revolves around a few commodities that are essential for day to day operations of a Country; one of the most vital of these commodities is Oil. OPEC is one of the biggest oil companies and each economy is affected by prices set by OPEC (It’s like an oligopoly). Increase or decreases in fuel prices by such monopolies tend to hamper or support economic growth; such monopolies are directly related to a Country’s economic system. In general, oil is known to be a compliment or a raw material for many other goods in an economy therefore a price change of oil may lead to cost push inflation or deflation. In case where OPEC decides to increase the price of oil, this would lead to cost push inflation in the economy; the aggregate (total) supply of the economy would shift upwards bringing about price hikes as shown in the diagram: In the short run, what’s happening is the increase in price of oil is pushing the supply down and creating price hikes as the short run aggregate supply curve moves from AS1 to AS2. This effect will impact people but not as much in the short run; people are more flexible and have fixed schedules and will not alter their fuel consumption just because of an increase in fuel prices in a day; even if the increase is steep, in the short run it is expected that people would absorb the impact The demand for oil in the short run would be relatively inelastic and the economy would not suffer to a large extent. However, in the long run, situation may be different as people’s demand for oil may become elastic as they want to adapt to changes in an optimistic light. In the long run, the demand for OPEC oil would be relatively elastic and fuel price increases may cause the economy to suffer at large. The direct impact on the economy depends on where the economy is operating at the point and what is the shape of their long run aggregate supply curve as there is a difference in opinion for the monetarist and Keynesian model for long run aggregate supply curve. If we follow the Keynesians model; the impact to the economy of an increase in oil prices depends largely on where the economy is in the current scenario; how away it is from the full employment level. This is the Keynesian model: If the economy is operating at the full employment level of output (I.e. RDOFE) then the impact of increase in OPEC price may hamper overall performance of the economy and may cause a deflationary gap to occur as shown: As shown in the above diagram, in the long run, when the economy is operating at full employment at “Qfull” and price level P2, but increase In OPEC oil prices distort the full employment level and move the output to Q1, also since the impact would be on an elastic demand curve, the prices would also sharply go up in the economy as a result of Cost push inflation. This may hamper further confidence in investors and economy may be trapped in a spiral of down turning conditions. If the effect has to be countered, the government has to step in to sit with the OPEC representatives or otherwise use monetary and fiscal to bring back the equilibrium output to the full employment level, however that too would cause massive inflation as there is already inflation from OPEC price hikes. Answer 3: A Phillips curve, in simple terms, highlights the relationship between inflation and unemployment. Under simple conditions, it shows the rising inflation tends to reduce unemployment and if there is higher unemployment, inflationary pressure tends to be lowered; it makes sense as more inflation would be as a result of more output and would increase employment, however, the real world situations are more complex and require more understanding therefore we today have newer models of the Phillips curve. Under simple conditions, a Phillips curve would look like this: Under more complex situations, one may talk about rational expectations of the Phillips curve. What happens is, the economy is at equilibrium at point A with certain level of inflation followed by unemployment as illustrated below. The government uses its fiscal or monetary policy to expand the economy and hence that causes inflationary pressure within the economy pushing the inflation percentage upwards to point “B”. This would further raise inflation expectation and hence the Phillips curve would shift upwards to “New short run Phillips curve”. At the end of the day, the economy is back to its original position with the difference that the price levels (inflation percentage) is higher but the employment level remains to full employment. This rational expectation explains that any measure to reduce unemployment through government’s tools may result in the same level of employment in the long run with only inflationary pressure to follow; the short term period is so small that it is not even considered as a result of rational expectations of inflation. The long run adaptive expectation theory explains that as the aggregate demand in the economy rises, the inflation rate tends to be constant at high rates, and the workers’ nominal wage rate rises the overall profits fall; later the unemployment rate is restored to full employment level of the economy. The two terms are rather similar. The primary difference in the two is that in adaptive expectations people believe that current, up-to-date and recent information would be the best tool to indicate and expect about the future, and in rational expectation people would use all the data they have available with them to predict the future and the economic policies of tomorrow. References for answer 1: 1. Gross domestic product, bureau of economic analysis, May 31, 2007 2. Elebari, Mehrun (July 17, 2003) – Trickle-Down economics 3. United States Bureau of Labor Statistic – 1940 to date 4. Willam A. Niskanen and Stephen Moore – Supply side tax cuts and the truth about Reagan economic record Reference for other concepts: Wikipedia Read More