National Economic Policy - Essay Example

? National Economic Policy: Macroeconomic Question One Policymakers in all economies should ensure that they makethe best decisions regarding their economies so that positive results may be attained. The policymakers always make these decisions depending on whether the economy is closed or open.  They should always ensure that the best policy mixes are put in place so as to get the optimum results possible.  Assuming that policy makers in a closed economy want to increase output without changing interest rates, there is a policy mix that I can recommend so that they may achieve their objective with ease, rather than gambling with the many options which are available to them. In the policy mix, there would be expansionary monetary policy. Basically, this policy means that money supply will be increased. The policy makers will have to apply this policy to ensure that the money in supply   in the economy increases. This increase in money supply will lead to an increase in output, income and employment. This will be        caused by    the fall in interest rate which occurs after the LM curve shifts to the right (Young & Zilberfarb, 2000), as reflected in the IS-LM curve below. It is worth noting that if money supply is increased, while interest rate is held constant, a higher level of income is needed to ensure    that there is a corresponding demand level for money to the supply. This as mentioned earlier moves the LM curve to the right. The increased income and constant interest rate where the money demand and supply equal each other is seen at the far right of the curve. In case the inflation rate at one point of constant interest rate makes holding money costly, thus few decide to hold it. This calls for rising of income at a certain real interest rate in the universe so as to put the needed money to be held thus maintaining the economic equilibrium, which can be traced to the right of the IS-LM curve (Carlberg, 2000). The components of GDP will be affected as a result of applying this policy. First of all, the aggregate demand will increase. This increase in demand refers to the increase in the number of goods required by consumers in the economy. This is usually a very good thing for triggering an increase in output in the economy. Especially in the short run, this usually raises the production of the economy which is very desirable. This policy will also have a negative effect on employment. One of the reasons for the increased unemployment is the fact that producers react to the high demand by government thus taking production to a higher level. The increase in production demands that labor increases. The people who are hired earn money thus are able to spend in larger amounts than when unemployed. Question Two  Expansionary fiscal policy A variety of fiscal policies which leads to a rise in government spending, a shrink in taxes, or a swell in transfer payments is applied to counter the mishaps of economy contraction. The objective of expansionary fiscal policy is to bridge a recessionary gap, ignite the economy, and reduce the unemployment level. Expansionary fiscal policy is sometimes backed by expansionary monetary policy. Taxation Taxation is the major fiscal policy tool that works quickly to correct an ailing economy. Basically individual income taxes levied by the state; however other taxes are also applicable. Taxes are the spontaneous levies that the government charges on the entire the economy to create the proceeds required to provide basic goods and services and to facilitate other state functions. Personal income levies are precisely the taxes gotten from the earnings received by individuals in each house hold. Expansionary fiscal policy works by either a decline of the income tax levies or an instant rebate of levies previously collected. The decrease in taxes empowers the each household with extra per capita earnings that can be utilized for spending costs, which then ignites cumulative production and employment and translates to further upsurge in income. Taxation is either progressive or retrogressive. Progressive taxation is a form of taxation where the amount taxed increases as the amount of income increases. The implication of progressive taxation is that a higher level of income is highly taxed as compared to a lower level of income (Handa, 2008). Progressive taxation is the preferred form of taxation since it cushions the lower level earners in the economy. Retrogressive taxation occurs when a constant level of taxation is levied across all levels of income at constant periods say monthly or annually. Retrogressive taxation is not welfare maximizing in the economy since it does not offer a chance sharing resources equitably. This occurs from the fact that lower level earners are burdened with an equal tax load as their highly paid counter parts hence reducing their purchasing power. A highly paid individual has a higher disposable income compared to a low paid individual. Therefore, taxing the same amount to the two classes of earners has a significant effect on the low paid person since their margin is thin comparatively. Intuitively, tax alterations tend to be administratively light to execute, they are often considered over government spending when expanding a contradicted economy. Furthermore, political heads and the electorates usually favor a reduction in the tax load to a swell in state spending. Closing the Gap In the short run, the price elasticity of demand determines the level to which a decrease in taxation will affect the quantity of output purchased. Price elasticity of demand is the percentage change in the quantity demanded that results from a unit increase in the level of income. A higher price elasticity of demand implies that a unit change in the level of income will lead to a corresponding increase in the quantity of purchases. A lower price elasticity of demand on the other hand implies that a unit decrease in the level of income resulting from reduced taxes will have a minimal effect on the quantity of goods purchased in aggregate. To show how this happens, consider the graph below. The top portion exhibits a recessionary gap. The void can be closed with an expansionary fiscal policy in form of: a boost in government spending, a decline in taxes, or an amplification of transfer payments. This policy moves the collective demand curve to the right and fills the gap. If executed correctly, the aggregate demand arch meets the short-run collective supply curve at the complete employment point of aggregate output exhibited by the long-run collective supply curve. Recession Gap Expansionary fiscal policy is deemed to bridge a recessionary gap by altering aggregate expenditures and moving the collective demand curve. A recessionary void is closed with a right hand shift of the collective demand curve. A right ward shift in the aggregate demand curve resulting from a decrease in taxes indicates that at the same price level, more will be produced in the economy and this is a welfare maximizing phenomena in the short run(Mishkin, 2007). On the other hand, the level of production in the long run is not affected by a shift in the aggregate demand curve since the long run optimum level of production is constant and cannot be altered. This draws the conclusion that, taxation policy as an expansionary tool is more applicable in the short run as long as price elasticity of demand exists in the economy. Question Three It is worth noting that money supply increase will always have various effects on price level, GDP nominal wage rate and real wage rate depending on whether it is in the short run or long run. When the money supply increases in the short run, the interest rate is pushed down since people's need for near cash things is changed by changes in the demand for money. For example in a situation of open economy, with difference in interest rates between countries to be respected, the rate of exchange will rise (Mishkin, 2007) This makes local goods attract more people, thus increasing domestic as well as foreign demand. This makes output in the economy grow. Under this position, the prices are usually higher than anticipated. In the short run equilibrium, production in the economy will be higher than that experienced during the previous period of long run. Interestingly, the real wages will be lower than those in the long run due to prices which are above what was expected. The long run effect of increase in the money in supply depends on whether the increase stays for long or it does not last. In case it lasts for long or is permanent, the prices will have to go higher (Carlberg 2000). This is a result of increased output. To increase output, it means that human capital as well as machines work for longer hours. This means that the companies will have to pay higher costs in terms of wages, salaries and repair among others. The interest rate in the short run increases due to the increase in money supply, as demand tries to match the supply (Mankiw, 2011). In the long run, the rates decrease due to the increased prices. In conclusion, it is very important for policy makers to ensure that only the best policy mixes are utilized so that the economy may benefit. The effects brought about by the policies applied to the GDP components should be studied to ensure that they do not affect the economy. The effect of interest rates on the output should be handled with care since it is very material in fostering growth in the economy (Handa, 2008). It is important to study the nature of increase in money supply. This is because there is difference in the effect on price level, real GDP, nominal wage rate and real wage rate when it is permanent or temporary in the short run and long run. References Carlberg, M 2000, Economic policy in a monetary union, Springer. Handa, J 2008, Monetary Economics, New York: Routledge. Mankiw, G 2011, Principles of Macroeconomics, New York: Cengage learning. Mishkin, F 2007, Monetary policy strategy, The Mit press. Young, W & Zilberfarb, B 2000, Is-Lm and Modern Macroeconomics. 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