To answer, fill the gaps in the table should shift and in which direct? below. N

Question

To answer, fill the gaps in the table should shift and in which direct? below. No need to provide the reason (1.5 marks) 4. The figure below depicts the macroeconomic situation of stagflation inflicted by the negative supply shock Which policy? (0.5 mark) Which curve to shift? (0.5 mark) Which direction? (0.5 mark) LRAS SRAS c) Reviewing the policy responses in part a) and b), which one is most SRAS® effective dealing with stagflation? Briefly discuss (2 marks) Pl PO ADO YO As the economic advisor to PM Scott Morrison (!), you are contemplating the most appropriate policy response from the two choices (note that we do not consider the monctary policy here) in a given scenario below; .Expansionary fiscal policy .Contractionary fiscal policy For this question, there is no need to demonstrate the answer showing in the figure (but useful to have it in your mind)! a) The policy response focuses on achieving economic growth. What is the best policy response? Which curve should shift and in which direct? To answer, fill the gaps in the table below. No nced to provide the rcason (1.5 marks) Which (0.5 mark Which curve to shift? (0.5 mark) direction? (0.5 mark) b) How docs your answer changc if the policy responsc focuses on achieving price stability? What are the policy responses? Which curve A period of falling output and rising prices

Explanation / Answer

a) Expansionary Fiscal Policy Aggregate Demand Curve Rightward (north west direction)

b) Contractionary Fiscal Policy Aggregate Demand Curve Leftward (south west direction)

c) The US experience shows that if stagflation is controlled either by restrictive or expansionary measures, it will increase. Suppose restrictive demand managed monetary and fiscal measures are adopted, they tend to lower aggregate demand so that the new demand curve cuts the supply curve at the old price level.

This policy reduces the level of employment further and at the same time lowers the price level. Thus such a policy tends to increase unemployment and reduces inflation. Thus it fails to control stagflation. On the other hand, if expansionary demand managed monetary and fiscal policies are adopted, they will raise the aggregate demand so that the new demand curve cuts the supply curve at the old employment level.

This raises employment from but increases the price level. Thus such a policy also fails to control stagflation because it generates more inflation combined with higher employment. Economists, therefore, suggest other measures which slow inflation and maintain higher employment.

First, minimum wages should not be raised at all.

Second, tax-based income policies should be started. These policies are different for individual and business firms. In the case of individuals, target rates of wage and price inflation are based on some reasonable economic forecast of inflation.

Persons who accept wage increases below the target rates are rewarded with tax credits. Those who insist on wage increases above the target rates are levied a penalty tax. Similar is the case with business firms. Firms which keep wages down to the target rates are rewarded with a reduction in their business income tax. On the other hand, those who permit wage increases above the target rates are charged a penalty tax in addition to business income tax.

Third, there is need to introduce income policies. One of the important planks of the income policies is to link the increase of money wages to productivity increase. Thus the rate of increase of money wages should be limited to the overall rate of productivity increase.

Further, prices should be reduced in those industries having above-average productivity growth. On the other hand, prices should be raised in industries where productivity is increasing less than the national average rate.

Prices should be kept stable in industries where productivity is increasing at the national average rate. But such policies are difficult to implement in the case of an open country. If import prices of food and other consumer products rise, they tend to raise the domestic price level. This makes it difficult for unions to stick to wage agreements.

Fourth, the best policy measure is to reduce personal and business taxes because they tend to reduce labour costs and raise demand for labour. Similarly, sales tax and excise duties should be reduced in order to prevent the price level from rising. To encourage state and local government to reduce state and local sales and excise taxes, the central government should sanction additional grants-in-aid to them.

Thus to combat stagflation, a vast spectrum of policy measures is needed.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.