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Economical Strategy of the Government - Assignment Example

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The author of the current paper casts light upon the fact that in an economy without an external sector, both the money market and the commodity market behave according to the principles of the classical model. A few assumptions for the classical model: prices & wages are perfectly flexible…
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Economical Strategy of the Government
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Download file to see previous pages From the diagram, the demand of the loanable sum is inversely related to the interest rate (r). Firms generally will compare the expected profitability of investments with the interest rate. At lower interest rates, projects are profitable, and there will be a higher demand for loanable funds. When the government finances the fund from the private pool, the demand increase by the government expenditure minus the tax income (G - T ).
The increase in government financing reduces the availability of loanable sum in the market. Equilibrium of the supply and demand curve is disturbed and shifted to a higher interest rate. Both national saving and investment would be lower. The government loan forces the investor to compete for real interest rate make investment less attractive, assuring that investment will decrease (I shift to I' in the diagram) along with the national saving. This is called crowding out. It causes lower economic growth. Economist generally advises reducing the deficit.
When the government switched from public to bank for credit, the supply of loanable fund to the market reduced. This thus causes a shift of the supply line to the left as in the diagram. The result of the reduction of the loanable fund is the increase in the interest rates of the loan. Private sector or firm will try to reduce their loan due to the high interest. There will not be a lot of projects going on and as a consequence, the investment in the country will drop. Both situation 1 and 2 would result in inflation as interest rate increased.
When money falls from a helicopter, the supply of money or the saving hold by the public in the market increases. In the diagram, this is illustrated by the shift of the supply curve (S) to the right (S'). The household expenditure might increase due to the increase in saving. Thus, the interest rate reduces (from r to r') and the demand for loanable funds increases (from I to I'). From the reduction of interest rate, more loan will be taken out to construct development projects. This is a situation where the money in the market increase without causing inflation.
Scenario II In the same economy the money market adheres to the principles of the classical model but the commodity market displays a substantial amount of Keynesian unemployment with stable prices.
A few assumptions for Keynesian model: prices & wages are fixed at a given level at these price & wage levels, there is involuntary unemployment (there are workers without a job who would like to work at the going market real wage). ...Download file to see next pagesRead More
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