So, according to this if the normal rate of growth of GAP is 3% and the rent unemployment rate is 6%, an increase in GAP growth to 4% would cause unemployment to change by 0. 33% percentage 2. When total output, income, employment, and trade decline for 6 to 12 months, the economy is in what part of the business cycle? When these real variables decline, the economy is in the recession phase of the business cycle. Recession is the period when output, income, employment, and trade decline. The downturn is last for 6 months or more which causes in the contraction in the business activity in the different sectors of the economy.
. Which has a larger effect on aggregate demand: an increase in government expenditure or an equal sized decrease in taxes? Explain your answer. Decrease in taxes has a small effect on aggregate demand than increased government expenditure. Spending and taxation are the two levers available to the government for setting fiscal policy. In expansionary fiscal policy, the government increases its spending, cuts taxes, or a combination of both.
The increase in spending and tax cuts will increase aggregate demand, but the extent of the increase depends on the spending and tax multipliers.
The government spending multiplier is a number that indicates how much change in aggregate demand would result from a given change in spending. The government spending multiplier effect is evident when an incremental increase in spending leads to an rise in income and consumption. The tax multiplier is the magnification effect of a change in taxes on aggregate demand. The decrease in taxes has a similar effect on income and consumption as an increase in government spending. However, the tax multiplier is smaller than the spending multiplier.
This is cause when the government spends money, it directly purchases something, causing the full amount of the change in expenditure to be applied to the aggregate demand. When the government cuts taxes instead, there is an increase in disposable income. Part of the disposable income will be spent, but part of it will be saved. The money that is saved does not contribute to the multiplier effect. 4. To eliminate a recessionary gap, what fiscal policy should the government pursue? Be specific. A recessionary gap exists when potential GAP exceeds real GAP.
A recessionary AP can arise from a decrease in aggregate demand because the decrease in aggregate demand decreases real GAP. A recessionary gap could be eliminated by increasing government spending and/or decreasing personal taxes. Both of these policies have the effect of raising aggregate demand and shifting the aggregate expenditures schedule upward toward full-employment GAP. 5. Indicate which of the following is expansionary OR contraction fiscal policy: Increasing income tax Increasing income tax is contraction fiscal policy.
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