5-1 The policies of the federal government influence the outcomes of the various

Question

5-1

The policies of the federal government influence the outcomes of the various activities in that economy. When government policies change or unplanned events occur, the resulting economic events or activity will usually change. Listed below are several policies or events that affect the performance of the economy:

1. The federal government employs a budget plan over several fiscal years that results in significant increases in the national debt, with no relief or plans to deal with the problem.

2. The federal government enacts new tariffs and quotas on all imports.

3. The general public loses confidence in their leadership, in terms of their ability to manage the economy, especially in the area of job creation.

4. The federal government, in an effort to stimulate the economy, decreases taxes on all individuals except those earning over $250,000 per year.

5. The level of investment decreases because of a lack of confidence in the economy.

6. Interest rates are kept artificially low by the Federal Reserve for several years.

Explanation / Answer

1. Increase in national debt occurs when government increases its expenditure. It increases the supply of money which resulted into fall in the value of domestic currency and increases the price of commodities i.e. inflation. Exports will increase compared to imports.

2. When government imposes new tariff or quota on imports than imports from other countries decreases and help the infant industries to grow in the market. Import quota or tariff are imposed to protect the domestic industries from foreign competition. It saves the value of domestic currency and saves the currency from depreciation.

4. Decrease in tax increases the money supply in the economy because disposable income of consumer increases. This increases the Consumption component of aggregate demand.

5. Decrease in investment decreases the I component of AD and shift it leftwards. It leads to decrease in the equilibrium price and equilibrium quantity.

6. Low interest rate by the Federal Reserve decreases the market interest rate which is charged by the commercial banks on loans. Decrease in interest rate leads to more investment because cost of borrowing decreases. Decrease in interest increases the money supply as people now wants to hold more money in the form of cash due to lower interest rate.

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