BUS702 Economics for Managers

(a) “The simple idea that by pumping up total spending, government can supplement depressed private spending and temporarily boost economic activity has appealed to economists and governments since the Great Depression of the 1930s.” (Page 22)

Explain this “simple idea” due to J.M. Keynes.

(b) “Separating out the automatic changes in the fiscal position from the discretionary ones is difficult, and it is impossible to assess the counterfactual of how the economy would have performed had there been no fiscal response.” 

During a recession, automatic changes take place in the fiscal position (budget deficit/surplus). Why Also give some examples of discretionary changes in the face of a recession and their effect on the budget.

(c) “What has been ignored in current debate is that fiscal contraction that targets wasteful government programs improves macroeconomic performance.” 

Explain by what process a fiscal contraction could possibly improve macroeconomic performance.

(d) “The key question is whether Australia really needs fiscal ‘stimulus’ in the form of budgetary outlays when monetary policy is best placed to influence short-run macroeconomic activity.” 

In what way can monetary policy be used to create economic ‘stimulus’ and why, does Makin argue, is it more effective than fiscal policy.

Own price elasticity refers to the changes in demand due to change in its own price can be defined by,

E_d =

Value of E implies whether demand is elastic (E>1), inelastic (E<1) or unitary elastic (E=1) that further helps in measuring the responsiveness of the consumers. From the given cross price elasticity data it is evident that milk, fruits and vegetables of high calories has elastic demand whereas sugary snacks have inelastic demand. This clearly signals the government about what could be the results of changing price of the unhealthy foods as well as healthy foods if tax or subsidy is imposed. Consumption of unhealthy food increases the risk of more health issues that calls for more of government expenditure in that sector. To curb that and ensure overall good health, government can impose tax on sugar based junks or subsidy on healthy foods. The per unit subsidy given on fruits and vegetables make their prices apparently lower which increases the purchasing power and consumption as well due to elastic demand that explains that demand would rise by more than one unit for one unit fall in price.

Imposition of subsidy acts like setting of price ceiling by government beyond which sellers cant charge price. Now for per unit of consumption consumers pay OA and AB is paid by government to the sellers as subsidy (Mytton, Clarke and Rayner 2012). Apparently reduced price increases demand that requires supply to increase and this shifts supply curve to the right.

1. The great Depression and resultant chronic economic slowdown led to reduced economic activities in terms of production, income and consumption. Keynesian policy of boosting aggregate demand turned  out to be one of the important breakthrough for the drooping global economies. The idea was to boost demand through autonomous government spending. Another mechanism was to boost the money supply in the economy through fall in the interest rate. This allowed the business to expand as cost of borrowing and investment fell. The shift in aggregate demand through expansion in consumption, investment and government expenditure led to increased level of output as well as price level pushing the economy out of the recessionary phase (Afonso Economic recession leads to downfall in production reducing employment that further reduces income and income induced consumption. Now to stabilize the economy government takes up various allowance schemes to provide them source of income and reduce tax rate. Again in times of inflation, the tax revenue is pretty high and does not require government to take up schemes that enhances its expenditure depending upon the economic and market condition the action of government stabilizes the economy automatically. The discretionary policy refers to the idea that government imposes fiscal policies to stabilize the issues over the existing policies. In time of recession it can lower tax rate and increase G. These lead to rise in economic output and price vanishing the recessionary impact over long run..

This improves the economic health over time. Fiscal contraction makes the economy be into budget surplus being self-reliant.

1. An expansionary monetary policy focuses on increasing the level of money supply in the economy operative through open market operation. This leads to fall in rate of interest, which further induces bondholders to liquidate it and hold the money in hand (Taylor 2012). The attractiveness of savings fall and investment becomes cheap. All this happens very quickly as the falling interest rate sends out signal to  money market and allows participants to act quickly and enhances equilibrium income.

Compared to this fiscal policy are much time consuming to be implemented as it has time lags due to complex political procedures of implementation as well as strong political impact. Fiscal policy when expansionary leads to deficit budget putting strain on the national savings. Hence monetary policy is always effective and efficient than fiscal policy.

References

Afonso, A. and Sousa, R.M., 2012. The macroeconomic effects of fiscal policy. Applied Economics, 44(34), pp.4439-4454.

Dellepiane?Avellaneda, S., 2015. The political power of economic ideas: The case of ‘expansionary fiscal contractions’. The British Journal of Politics & International Relations, 17(3), pp.391-418.

DeLong, J.B. and Summers, L.H., 2012. Fiscal policy in a depressed economy. Brookings Papers on Economic Activity, 2012(1), pp.233-297.

Mytton, O.T., Clarke, D. and Rayner, M., 2012. Taxing unhealthy food and drinks to improve health. BMJ: British Medical Journal (Online), 344.

Stiglitz, J.E. and Rosengard, J.K., 2015. Economics of the Public Sector: Fourth International Student Edition. WW Norton & Company.

Taylor, J.B., 2012. Monetary policy rules work and discretion doesn’t: A tale of two eras. Journal of Money, Credit and Banking, 44(6), pp.1017-1032.