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MACROECONOMICS - Case Study Example

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Q.a) Each point on the Aggregate Demand curve represents short run equilibrium in the economy. During recession, the output declines. This is either because any one of the components of aggregate demand (AD) including consumption (C), investment (I), government spending (G) and net exports (NX) decreases or the price level increases…
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Download file to see previous pages This results in the shift of the AD curve to the left. Aggregate supply (AS) is the total desired output of all the nations’ producer (Chrystal, p. 666). Since there is imported inflation in UK because of the rising oil prices, the AS is shifted leftwards as shown in the diagram below. Keynesians argue that demand (AD) finds its own supply. They stress about increasing AD or implementing policies that will stimulate aggregate demand. Monetary and Fiscal policies are demand-side policies; they serve to boost Aggregate demand. Aggregate demand can be increased by implementing expansionary fiscal policy like more government spending and lower tax rates and expansionary monetary policy which is reducing interest rates and increasing money supply. Classical economists are proponents of supply-side policies. They argue that supply finds its own demand. They are in favor of boosting aggregate supply through supply side policies like training and educating workers. Classical economists argue that if AS increases due to supply-side policies, there will be less inflation. Inflation associated with production costs will be lowered. There is also lower structural and frictional unemployment as a result of increased AS. It works this way: increasing AS will require more workers so employers will start hiring. Since productivity increases as a result of increasing AS supply, a country like UK will be able to export more as a result of this. Q.b) This economic shock where the whole economy has slowed will result in workers being laid off and people who are already unemployed will find it very difficult to find a job. Cyclical unemployment or demand-deficient unemployment occurs whenever total demand is insufficient to purchase all of the economy’s potential output, causing a recessionary gap in which actual output is less than potential output (Chrystal, 2004, p. 595). It can be measured as the number of people who would be employed if the economy were at potential GDP minus the number of persons currently employed (Chrystal, 2004). Frictional unemployment results from the normal turnover of labor. Young people who enter the labor force and searching for jobs are an important source of frictional unemployment (Chrystal, 2004, p. 600). Also people who are planning to switch their present job are a source of frictional unemployment. Some people leave a job because of job-dissatisfaction and others are terminated. Structural unemployment occurs because structural adjustments can cause unemployment (Chrystal, 2004). Since the demand for labor is a derived demand, when the demand for product changes, the demand for labor also changes. If labor does not adjust as per the changing product demand, there is structural unemployment. Cyclical unemployment best describes the rising unemployment in the UK. Since UK is in the recessionary period of the business cycle, it means there is low economic activity and also there is less demand for the country’s output. Hysteresis is a Greek word which means ‘coming late’ and in economics, it means that the current equilibrium is not independent of what has gone before- it is path dependent (Chrystal, 2004, p. 601). The impact of hysteresis on NAIRU (natural rate of unemployment) is that the NAIRU will be higher after periods of high unemployment than after periods of low unemployment. Through hysteresis, the shock ...Download file to see next pagesRead More
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