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Q.53

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Principles of Economics
Found in: Page 743

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Short Answer

Specify whether the expansionary or contractionary fiscal policy would seem to be most appropriate in response to each of the situations below and sketch a diagram using aggregate demand and aggregate supply curves to illustrate your answer:

a. A recession.

b. A stock market collapse that hurts consumer and business confidence.

c. The extremely rapid growth of exports.

d. Rising inflation.

e. A rise in the natural rate of unemployment.

f. A rise in oil prices

a. Expansionary, in order to boost demand.

b. Expansionary, in order to boost demand.

c. Inflation-fighting, contractionary.

d. Inflation-fighting, contractionary

e. While an expansionary fiscal policy may be employed to boost AD and employment, it would have no influence on the natural rate of unemployment, in the long run, just a higher price level.

f. Expansionary, in order to boost demand.

See the step by step solution

Step by Step Solution

Part (a) Step 1: Definition

Fiscal Policy:

The use of state spending and tax policies to impact economic conditions, particularly macroeconomic variables like aggregate demand for goods and services, employment, inflation, and economic process, is mentioned as fiscal policy.

Part (a) Step 2: Explanation of solution.

It is reasonable to strengthen fiscal policy during a recession. Since fiscal policy growth leads to higher government spending or a decrease in revenue, this is the case. Expansion of fiscal policy, for example, will result in increased government spending. As a consequence, it is projected that aggregate demand and output will rise. An increase in output will boost the economy's employment rate. Because increased productivity involves the use of more workers, this is the case. As a result of fiscal policy expansion, the AD curve will shift to the right.

Part (b) Step 3: Introduction of concept.

The stock market meltdown has impacted consumer and business confidence. As an outcome, total demand will be lower. The government will prolong fiscal policy by increasing government spending to promote demand, leading the AD curve to shift rightward.

Part (b) Step 4: Graph

Part (c) Step 5: Concept introduction.

Contractionary, to fight inflation. Exports will rise in accordance with aggregate demand. As a result, prices will rise and the economy will grow. The government will tighten fiscal policy by raising taxes in this situation. Tax increases reduce people's purchasing power, which reduces aggregate demand. Inflation will be aided as a result of this. As a result, as fiscal policy tightens, the AD curve will shift to the left.

Part (c) Step 6: Graph

Part (d)  Step 7: Concept

Contractionary, to fight inflation during instances of rising inflation, the government will tighten fiscal policy by raising taxes. Increased taxes reduce people's purchasing power, which reduces aggregate demand. This item will aid in the fight against inflation. The AD curve will shift to the left as a result of the fiscal policy contraction.

Part (d) Step 8: Graph

Part (e) Step 9: Concept

While an expansionary fiscal policy may be employed to boost AD and employment, it would have no influence on the natural rate of unemployment, in the long run, just a higher price level and expansionary fiscal policy enhances aggregate demand and employment in the short run but has no long-term impact on the natural unemployment rate. This is because supply-side variables will always result in some level of unemployment, even if the economy is operating at full capacity and there is no demand mismatch.

Part (e) Step 10: Graph.

Part (f)Step 11: Concept Introduction.

Expansionary, to stimulate demand.Only if the AS curve swings to the left can oil prices rise. As a result, there is a reduction in quantity. To stimulate equilibrium quantity, expansionary fiscal policy is used, which causes the AD curve to shift rightward. As a result, the equilibrium quantity will return to its previous value, causing a price increase.

Part (f) Step 12: Graph.

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