Answer to Question #317595 in Macroeconomics for Nobuhle

Question

1. Explain how fiscal policy can use both policy instruments at their disposal to stimulate an economy?
2. Based on your answer (1), illustrate and explain by aid of the AD-AS model what the identified policy employment by Fiscal Authorities will have on the general price level and the level or real production and income in the economy.

Answer 1

1) The government can use fiscal stimulus to spur economic activity by increasing government spending, decreasing tax revenue, or a combination of the two

2) Expansionary fiscal policy that is intended to increase aggregate demand includes cutting taxes and increasing government spending. Both provide more money to consumers and businesses, allowing them to purchase and invest.

e AD/AS framework implies two ways that inflationary pressures may arise. One possible trigger is if aggregate demand continues to shift to the right when the economy is already at or near potential GDP and full employment, thus pushing the macroeconomic equilibrium into the steep portion of the AS curve. In Figure below, there is a shift of aggregate demand to the right; the new equilibrium E₁ is clearly at a higher price level than the original equilibrium E₀. In this situation, the aggregate demand in the economy has soared so high that firms in the economy are not capable of producing additional goods, because labor and physical capital are fully employed, and so additional increases in aggregate demand can only result in a rise in the price level.