Fiscal Policy and Aggregate Demand
Traditionally fiscal policy has been seen as an instrument of demand management. This means that changes in spending and taxation can be used “counter-cyclically” to help smooth out some of the volatility of real national output particularly when the economy has experienced an external shock.
Discretionary changes in fiscal policy and automatic stabilizers
Discretionary fiscal changes are deliberate changes in direct and indirect taxation and govt spending – for example a decision by the government to increase total capital spending on the road building budget or increase the allocation of resources going direct into the NHS.
Automatic fiscal changes are changes in tax revenues and government spending arising automatically as the economy moves through different stages of the business cycle. These changes are also known as the automatic stabilizers of fiscal policy
Tax revenues: When the economy is expanding rapidly the amount of tax revenue increases which takes money out of the circular flow of income and spending
Welfare spending: A growing economy means that the government does not have to spend as much on means-tested welfare benefits such as income support and unemployment benefits
Budget balance and the circular flow: A fast-growing economy tends to lead to a net outflow of money from the circular flow. Conversely during a slowdown or a recession, the government normally ends up running a larger budget deficit.
ANS4. The marginal propensity to consume (MPC) indicates what the household sector does with extra income. The MPC indicates the portion of additional income that is used for consumption expenditures. If, for example, the MPC is 0.75, then 75 percent of extra income goes for consumption.
MPC=change in consumption
change in income
The average propensity to consume (APC for short), on the other hand, is the ratio
C/Y =a + bY
Suppose a is positive. That means that the APC is greater than the MPC. As Y increases, a/Y falls, so the APC also falls. Now consider a negative a. That would mean that the APC is less than the MPC, but it increases as income rises.
ANS5. Yes, if quantity theory is true inflation can be costly because we know that there is inverse relationship between value of money and price of commodity and value of money and price can explain the quantity theory of money.
If price of good increases it will lead to decrease in the value of money.
Similarly, if in the economy there is inflation, it means the price of product will get rise and it will further lead to decrease in the value of money.
According to quantity theory of money there is a direct and proportionate relationship between quantity of money and general price level and inverse relationship between quantity of money and value of money.
Equations of quantity theory of money
Cash balance equation
Constant ratio between bank money and Currency money
Money is a medium of exchange
Price level is a passive factor
ACCORDING TO FISCHER
The quantity theory of money is correct in the sense that the level of prices varies directly with quantity of money and value of trade are not changed.To fisher demand for money is made for transaction motive. Value of money, like any other good is determined at the point where demand for money is equal to supply of money.
Consumers need money to purchase goods and services. The quantity of money is related to the number of pounds exchanged in transactions. The link between transactions and money is expressed in the quantity equation.
On the left hand side, “M” is the quantity of money, “V” is the velocity of money, and “Vâ€¢M” is essentially a measure of how the money is used to make transactions.
The theory above is based on the following hypotheses:
The source of inflation is fundamentally derived from the growth rate of the money supply.
The supply of money is exogenous.
The demand for money, as reflected in its velocity, is a stable function of nominal income, interest rates, and so forth.
The mechanism for injecting money into the economy is not that important in the long run.
The real interest rate is determined by non-monetary factors.
Yes, the inflation will high in short time period, one more thing is it is good for long term only and according to this theory if price will high then income will increase but it will create inflation in short term.
ANS6. (A)As we all know that in the economy there is negative or inverse relationship between investment and rate of interest. So, Investment mainly depend upon the rate of interest. If rate of interest is high, than a businessman will not invest his money in building a factory.
According to this case, Intel is not having much funds in its hand so it is borrowing money on giving some amount of interest. If the rate of interest is higher , than intel should not do any type of investment in building a new-chip making factory.
(B) If Intel has enough of its own funds to finance the new factory without borrowings, so according to my opinion if there is any increase in the rate of interest, it would not affect Intel’s decision to build the factory. Intel will do investment in making a new chip-making factory.
ANS7. Savings are money or other assets kept over a long period of time, usually in a bank without any risk of loss or making profit.
Investments are money or other assets purchased with the hope that it will generate income, reduce costs, or appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price. And usually it has also a risk of some loss
Make My Assignment Consumption Investment And Monetary Policy Economics Essay