Take-Home Quiz 3 - Essay Example

There are two types of fiscal policy: discretionary fiscal policy and non-discretionary fiscal policy. Discretionarily policy is the deliberate changes in government spending and taxes in order to ensure stabilization of the economy through increased demand by achieving control inflation, full employment and economic growth. (Fisher 2011) Expansionary policy- a) When the government increases its spending then the aggregate demand will shift to the right b) The reduction in taxes will make the aggregate demand curve to shift to the right c) The application of increasing government spending and decreasing taxes.

contractionary policy a) By reducing the government spending , there will be a shift of the aggregate demand to the left with prices falling down with an assumption that there is downward price flexibility b) When taxes are raised , the aggregate demand will shift to the left c) Combination of tax increase and reduction in government spending. Non-discretionary policy- These are automatic stabilizers which do not require any government regulations. They often take place as a result of changes in taxes as GDP changes.

Recession can happen if there is the fall on consumption, investment, government spending and exports. The short term effect is the raising of unemployment. The fiscal policy is therefore to deal with unemployment. The tool that the Bahrain government can use includes raising government expenditure, lowering taxes and the combination of two. (Fisher 2011) If AD shifts to the left, it is countered by adopting discretionary expansionary fiscal policy. In the chart, assume that the RGDP1 is the full employment level of output in Bahrain.

If Ad falls AD2, RGDP will fall to RGDP2 as a result of full multiplier of the changes in G, I, X, or C. Reducing taxes and increasing its expenditure will enhance the spending capability of the populace. When the government pays for the services, it will create more jobs and enhanced wages people earn that will in turn be pumped into the economy. Through pump priming the government will be able to create more jobs and improve the consumer’s capacity to buy goods. This will at the end rekindle business and improve the growth of an economy.

The private sector will benefit from the ability of customers to buy their products besides enjoying cheap services funded by the government. The private sector will be able to create more jobs to the people and in turn pay more taxes to the government. Question 2 An economy can be impacted either positively or negatively by the changes in interest rates. Interest rate influences the spending patterns of consumers and the growth of an economy. If the federal government cuts the interest rate there will be a reduced cost of borrowing and therefore there will be an increased disposable income to the consumers.

This will lead to higher spending and improved growth of the economy. If the fed increases interest rates, there will be reduced inflation. Consumers will be shy of spending and injecting their money into the economy in form of investments. This will then result into an economic downturn or recession. The growth of an economy will be slow, which will in turn result to increased capacity spare and increased cases of unemployment. A growing economy is characterized by