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Macro & Micro Economics - Essay Example

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Macro & Micro economics Table of Contents Summary of chapter 10 3 Summary of chapter 11 7 Summary of chapter 12 11 Reference 15 Summary of chapter 10 The chapter reveals some of the expansionary fiscal and monetary policies which impacts on the aggregate demand of the economy…
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Macro & Micro Economics
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Macro & Micro Economics

Download file to see previous pages... This causes the rate of interest to fall or rise respectively. On the other hand the fiscal policies alter the aggregate demand in the economy through the increase or decrease of government purchase components and the after tax share of the GDY which is held by the private sector. The following diagrams would portray a graphical analysis of some of the policy measures that are undertaken and their impacts in the economy (Ashby, 2011, “Expansionary policies”). In the above diagram the general equilibrium exists at the point if intersection of GDP, ASF and APE. Monetary policies would shift the ASF line to the right. However, it is seen from the diagram that this point cannot be reached as it is impossible for the economy to reach that point. This would consequently require a negative rate of interest but the interest rate cannot fall below zero. This shows that monetary policies independently cannot allow the economy to attain the former GDP. This requires the need for fiscal policies in the economy (Ashby, 2011, “Inconsistency Problem”). Fiscal policies in the form of government purchases and tax cuts would be able to move the APE line to the right far enough so that the IS curve would be able to intersect the GDP line at a point of low interest level which would be attainable. Thus the monetary policy would shift the ASF line towards the right and this would pass through the point which is now attainable. To summarize it, monetary policy can be effective only with the assistance of fiscal policies in order to help the economy recover from the effects of recession. The picture also reflects the potential problems related with monetary policies. The faint response of APE after changes in the rates of interest coupled with the low level of interest makes it unable to fall enough to provide enough impetus to the APE to revert back to the original level (Ashby, 2011, “Some Fiscal Policy is needed”). A major problem associated with monetary policies can be explained in terms of the liquidity traps. This is a situation in which the economy enters into a severe depression which dramatic fall in prices, reduction in profits, businesses making losses which causes them to draw back from making investments in new projects. However, the problem is likely to arise only at extreme situations. Another concern associated with the economy is the crowding out effect which arises out of expansionary fiscal policies which increases aggregate demand, APE significantly without a corresponding rise in aggregate demand or APE. The main concern about the phenomenon is that the resulting loss of funds causes a rise in interest levels and this consequently crowds out the rise in APE. According to the views of Ricardo (1772 - 1823), fiscal policies also result in budget deficit in the government that is financed by treasury borrowing. Ricardo has put forth the fact that the tax payers would be able to recognize the fact the government will be required to redeem the bonds at the time of maturity and would then levy taxes to compensate for the principle amount of the outstanding debt and also any amount of accrued interest. A number of restrictive policies can be undertaken in order to curb inflation arising out of expansionary fiscal policies. Short term measures would include the intervention of government and implementing direct control over wages, prices, rather than the implementation of restrictive fiscal and monetary policies. ...Download file to see next pagesRead More
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