Demand Management/Demand-side policies

Question 1

Fiscal policy

Answer 1

Pertains to government expenditure and taxation rate

eg:
Capital expenditure - adds to capital stock of economy - improving roads
Current expenditure - ongoing payments - wages or school textbooks
Transfer payments - benefits like social security

Question 2

Aims of fiscal policy

Answer 2

Maintain low and stable rate of inflation
Lower unemployment rate
Stable economic environment
Reduce business cycle fluctuations

Question 3

Expansionary fiscal policy

Answer 3

Keynesian demand management to influence levels of AD
- lower taxes to increase disposable income
-encourage greater investment by reducing corporate tax
-increase spending on public goods

Shifts AD to right creating inflationary presiire as PL rise but there will be increase in output in SR, should increase employment rates as more demand for FoP

Question 4

Crowding out effect

Answer 4

if goverment increases borrowing, it reserves large portions of money in circulation for its own purposes -> harder for other firms to acquire loans - decrease in investment - will influence interest rates as it is increased to discourage borrowing

Question 5

Multiplier Effect

Answer 5

The fiscal multiplier effect occurs when an initial injection into the economy causes a bigger final increase in national income.

Multiplier effect can also work in reverse. If the government cut spending, some public sector workers may lose their jobs. This will cause an initial fall in national income. However, with higher unemployment, the unemployed workers will also spend less leading to lower demand elsewhere in the economy

Question 6

Size of the multiplier

Answer 6

The value of the multiplier depends upon the percentage of extra money that is spent on the domestic economy.

If people spend a high % of any extra income (a high mpc), then there will be a big multiplier effect.

However, if any extra money is withdrawn from the circular flow the multiplier effect will be very small.

Question 7

Monetary policy (Central Bank)

Answer 7

Monetary policy involves influencing the demand and supply of money, primarily through the use of interest rates.

Monetary policy can also involve unorthodox policies such as open market operations.

Question 8

Expansionary monetary policy

Answer 8

To increase AD the interest rate may be lowered to increase spending and investment

Increase supply of money which would lower its price/interest rate

Question 9

How Central Banks Can Increase or Decrease Money Supply

Answer 9

1) Modifying Reserve Requirements
By lowering reserve requirements, banks are able to loan more money, which increases the overall supply of money in the economy - fractional reserve banking

2) Changing short term interest rate on loans
By lowering (or raising) the discount rate that banks pay on short-term loans from the Federal Reserve Bank, the Fed effectively increases (or decreases) the liquidity of the banking system.

3) Open Market Operations
If the CB wants to increase the money supply, it buys government bonds. This supplies the securities to dealers who sell the bonds with cash, increasing the overall money supply.

Question 10

Equilibrium Nominal Interest Rate

Answer 10

I.R = opportunity cost of holding/spending money

NIR= Rate of interest available in the market without inflation

If interest rates are low, then the cost of spending money is lower, incentivizing spending and increasing demand for money. This is why the supply of money is a downwards sloping curve.