Question

The United States is suffering from a high rate of unemployment.

a) Identify two fiscal policy actions that Congress might initiate to solve the problem.

b) Using a correctly labeled AD/AS graph, show and explain how the policies you identified in (a) will affect each of the following in the short-run

aggregate demand

output and employment

price level

c) Explain how the policies you identified in part (a) will impact real interest rates in the short-run.

d) If the interest rate effect you identified in part(b) continues in the long run, explain how economic growth will be impacted.

Answer 1

Answer (a): The rate of fast rising Unemployment in the United States is the fastest growing social concern for the Government and for the economy as a whole. This rapid growth of unemployment has to be stopped at any cost to stop the negative impacts of it in the economy. The Government can introduce various measure to curb unemployment, one of the types of measures being the Fiscal Policy. Fiscal policy can lead to an increase the economic growth and the aggregate demand in the economy, thereby resulting in decrease of the rate of unemployment. Two of the most critical fiscal policies that the Government can take include the reduction of tax rate in the economy and the increase of the Government funding o the State investment in to the economy. Tax reduction will directly result in an increase in the net savings of the poorer section of the society, and the government investment will pour in fresh money in the economy which will infuse more economic power in the hands of the poorer people and will directly help in the reduction of unemployment from the economy.

Answer (b):

H 2

As shown in the above diagram, The curve K represents the Aggregate demand (AD) curve before the tax rate reduction and before the Government investment in the economy , and the GH curve represents the rate of the Average supply before the tax rate reduction and before the Government investment in the economy. Now, once the Government reduces the rate of taxation in the economy and also infuses more investment in the economy, the money in the hands of the poorer section of the society increases and they now have more purchasing power, therefore the aggregate supply in the economy has to rise to meet the rise in demand. This pushes up the purchasing power of the poorer section of the society and the Demand as well as the supply curve both increase, as shown in the diagram by the L curve denoting the increase in the demand curve and the HB curve denoting the increase in the supply curve.

Answer (c) : In the shorter run , the influx of huge investment from the government in to the economy and a subsequent reduction in the tax rate will directly lead to more purchasing power in the hands of the poor people of the country , and it will increase the power of the financial institutions to lend more money, the circulating of the money being more flexible now. Since the availability of money has now risen considerably, the interest rate in the economy will drastically reduce to a level where, the common people can easily afford to borrow money from the Government or private lending institutions at cheaper interest rates.

Answer (d) : If the rate of interest remains very low in the longer run, it may affect economy in two contrasting ways. First, being the rise of many new firms, which will push up the development level of the economy. When interest rate in the economy is low, more and more investment would be done in the economy, which will bring up many new firms and thereby reduce the existing prices of the products in the market. This will lead to the economy getting richer as the days go by, However, a negative affect of this would be the loss of the lending firms and the government institutions in the longer run. The Government cannot earn profits from the reduces rate of taxation in the economy, which will reduce the ash reserve in the Government accounts, also , if the Government needs to influx more and more in the economy, this will huge loss to the State accounts, thereby negatively affecting the economic and political stability of the government institutions. In te longer run, therefore, these steps may not be too conducive for the economy.