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Demand side and supply side policies

Demand side policies: Economic policies of fiscal & monetary to influence AD

Supply side policies: Microeconomic policies focusing on enhancing the long run output potential in the economy. The policies target specific markets such as labour, capital & competition. Policies are market orientated or interventionist.

Fiscal policies : Policy that manipulate/use government spending & tax rate to influence AD of an economy.

Monetary policies: Policy that manipulate/use government money supply & interest rate to influence AD of an economy.

List 2 policies under fiscal policy; expansionary fiscal policy

(2 marks) contractionary /deflationary fiscal policy

5 components of AD ; consumption, investment, government spending, export and import (5 marks)

Explain how fiscal policy might be used in an economy showing increasing inflation. Use diagram to illustrate your answer. (5 marks)

Contractionary fiscal policy can be implemented in reducing inflation level . Govt can increase tax rate or / and reducing G spending to deflate an economy showing signs of overheating. Increase Tax rate will reduce disposable income and reduce Consumption level. Since both consumption & G are major components of AD, contractionary fiscal policy will reduce AD to the left from AD1 to AD2. This lead to lower real output and lower avg price level . Thus contractionary will reduce inflation

Avg price level

AS

P1

P2

AD2 AD1

Y2 Y1 Real output

In an economy, the interest rate falls from 9% to 7% and at the same time the rate of inflation falls from 8 % to 5% . Explain why borrowers might not in fact be better off. (1 mark)

real interest rate has actually increased from 1% to 2 %

State 3 possible & macroeconomics trade- offs ; ( 3 marks)

Growth & price stability

Unemployment & price stability

Unemployment & balanced budget

Growth & trade balance

Domestic monetary policy (interest rate) freedom & stable (or fixed) exchange rate

Using diagrams, explain the difference between an increase in demand & an increase in AD. (6 marks)

Aggregate demand is total spending on goods n services in a period of time at a given price level. An increase in AD means an increase in total spending on goods n services in an economy. AD shifts to the right due to changes in AD’s components causing higher avg price level (inflation) and higher real output

Avg price level AS

P2

P1

AD1 AD2

Y1 Y2 Real output

Demand is the relationship between the quantity demanded of a good or service and its price. Changes in determinants of demand such as increase in income lead to an increase in demand, shifting dd curve shifts to the right – higher price quantity of the product.

Price S

P2

P1

D1 D2

Q1 Q2 Qty

Briefly explain 3 factors that can cause an increase in the level of consumption in an economy. (3 marks)

An increase in income - Briefly explain

Lower interest rate - Briefly explain

An increase in wealth - Briefly explain

Increase in consumer confidence - Briefly explain

Two categories of supply side policies; market oriented supply side policies

Interventionist supply side policies (2 marks)

State and briefly explain 3 market oriented supply side policies. (6 marks)

Lower income tax – incentive for workers to work harder

Lower corporate tax – encourage firms to invest

Reduce trade union power – reduce ability of union to negotiate high wages

Reduction or elimination of minimum wages – reduce c.o.p

Reduction in unemployment benefits – encourage unemployed people to take available jobs

Privatization (sale of public/govt-owned firms to private sector) – increase efficiency

State and briefly explain 2 interventionist supply side policies. (2 marks)

Education & training – increase quality of labor, providing necessary skills & knowledge for an economy

Research & development – develop new production techniques to stay up-to-date with modern

equirements, increase economy’s potential output

- Govt.can encourage R & D by private by firms (market oriented);

offering tax incentives (tax credit); firms don’t have to pay tax on

retained profits for R&D

Provision of infrastructure- improved infrastructure will enhance productive potential of an economy

a) What is “loose monetary policy”

reducing interest rate & increasing money supply to increase AD

b) macroeconomics problem that a “loose monetary policy” tries to solve is UN

Using diagram, explain the effects of implementing demand side policies to an economy to reduce unemployment. (5 marks)

Avg price AS To reduce unemployment

Level – expansionary fiscal policy G , T

_ loose monetary policy money supply, i/r

P2

P1 AD increase shift to AD2 ; lead to higher output; Y1 to Y2

( higher output/income means unemployment reduce)

& higher average price level ( inflationary pressure)

AD1 AD2

Y1 Y2 Real Output

Using diagram, explain the effects of implementing supply policies to an economy to solve unemployment.

(5 marks)

Avg price AS1 To reduce unemployment - ss side policies eg.

Level AS2 lower income tax rate – encourage people to work

lower corporate tax

reduce trade union power

P1 education or training program etc

P2

AS increase shift to AS2 ; lead to higher output; Y1 to Y2

AD ( higher output/income means unemployment reduce)

& lower average price level (no inflationary pressure)

Y1 Y2 Real Output

GOOD LUCK

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