Some time ago (the year is unknown) three friends got together and decided to ta
ID: 1196757 • Letter: S
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Some time ago (the year is unknown) three friends got together and decided to talk about the economy. First friend said "I think our economy is doing pretty good, unemployment rate is 2% and inflation rate is 0%". Second friend said that "I also heard that economy is doing pretty good, but I think our GDP growth rate is 5% and unemployment rate is 8%" Third friend says, "You are both wrong, our unemployment rate is 8% and our inflation rate is almost 0%!". According to the economic theory, which of three friends' assessment of the economy is most likely correct? Please explain. Make sure to explain why you think other two friends' statements are not consistent with economic theory. Based on your answer in part a) do you think this economy is expanding or contracting? Explain. Ideally, economists would like to see unemployment rate equal to inflation rate equal to and GDP growth equal to d) List two fiscal policies which could help to improve economy described by a third friend. Describe the current state of U.S. economy? Discuss unemployment rate, inflation rate, and GDP growth rate. Do you think our economy is expanding or contracting? Explain.Explanation / Answer
a. According to the economic theory the assessment of the Second friend is more likely correct. Economic growth is the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP.
In economics, "economic growth" or "economic growth theory" typically refers to growth of potential output, i.e., production at "full employment". As an area of study, economic growth is generally distinguished from development economics.Growth is usually calculated in real terms – i.e., inflation-adjusted terms – to eliminate the distorting effect of inflation on the price of goods produced.Measurement of economic growth uses national income accounting. So the assesment of the second friend is more likely correct rather than other two friends who did not mentioned the GDP.
b. Incidentally, a growing economy characterizes an expansion, which is also known as a recovery. A contracting economy characterizes a recession. A growing economy generates increasing amounts of jobs, incomes, and goods and services for its citizens. All of these are good things, of course. In a contracting economy, jobs and incomes are lost and the amount of goods and services produced shrinks. This puts people out of work, and means that there are fewer goods and services to go around. In this case unemployment rate and inflation rate both are going down where GDP is increasing. So it acn be said that this is an expanding economy.
c. Ideally, economists would like to see unemployment rate equal to the natural rate , inflation rate equals to zero,
d. A recession is a decline in total output, when unemployment rises and inflation falls. This is the economic condition of the country as per the second friend, so Expansionary Fiscal policies will be needed for this economy.Expansionary fiscal policy is designed to stimulate the economy during or anticipation of a business-cycle contraction. This is accomplished by increasing aggregate expenditures and aggregate demand through an increase in government spending (both government purchases andtransfer payments) or a decrease in taxes. Expansionary fiscal policy leads to a larger government budget deficit or a smaller budget surplus.
In general, expansionary fiscal policy works through the two sides of the government's fiscal budget -- spending and taxes. However, it's often useful to separate these two sides into three specific tools -- government purchases, taxes, and transfer payments.
Government Purchases
One of the three fiscal policy tools available to the government sector is government purchases. Government purchases are expenditures by the government sector, especially those by the federal government, on final goods or services. It is that portion of gross domestic product purchased by governments.
Expansionary fiscal policy involves an increase in the funds appropriated to these assorted agencies. The agencies then make the additional purchases which stimulate aggregate production, boost income, and increase the level of employment.
While an increase in government purchases have been used frequently over the years to implement expansionary fiscal policy, it can be a relatively involved process. Moreover, additional government purchases leads to a relatively larger government sector. For these reason, policy makers often opt for the second fiscal policy tool -- taxes.
Taxes
The second of three fiscal policy tools is taxes, primarily personal income taxes levied by the federal government, but other taxes are also used. Taxes are the involuntary payments that the government sector imposes on the rest of the economy to generate the revenue needed to providepublic goods and to undertake other government functions. Personal income taxes are more specifically the taxes collected on the income received by members of the household sector.
Expansionary fiscal policy involves either a decrease of the income tax rates or a one-time rebate of taxes previously paid. The reduction in taxes provides the household sector with additional disposable incomethat can be used for consumption expenditures, which then stimulates aggregate production and employment and leads to further increases in income.
Because tax changes tend to be administratively easier to implement, they are often preferred over government purchases when conducting expansionary fiscal policy. Moreover, political leaders and voters usually prefer a reduction in the tax burden to an increase in government spending.
Transfer Payments
The third fiscal policy tool is transfer payments. Transfer payments are payments made by the government sector to the household sector with no expectations of productive activity in return. The three common transfer payments are Social Security benefits to the elderly and disable,unemployment compensation to the unemployed, and welfare to the poor.
Like the income tax system, transfer payments rely on a payment schedule based on qualifying characteristics of the recipients -- age, employment status, income, etc. Those who meet the criteria then receive payments.
Expansionary fiscal policy involves either an increase in payment schedule for one or more of the transfer systems or perhaps some sort of across-the-board lump-sum payment to all who qualify. That is, the unemployment compensation might be increased by 5 percent or all Social Security recipients might receive an extra $500 payment. The increase in transfer payments provides the household sector with additional disposable income that can be used for consumption expenditures, which then stimulates aggregate production and employment and leads to further increases in income.
Recessionary Gap
Expansionary fiscal policy is used to address business-cycle instability that gives rise to the problem of unemployment, that is, to close a recessionary gap. A recessionary gap exists if the existing level of aggregate production is less than what would be produced with the full employment of resources. This gap arises during a business-cycle contraction and typically gives rise to higher rates of unemployment.
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