Sub: Economics Topic: Micro Economics
Question:
What are two possible fiscal policy solutions for the problem?
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What are two possible fiscal policy solutions for the problem? Using a Keynesian approach, you
should be able to get numerical solutions. More points are given for numerical solutions
Solution:
In the above mentioned economy, the Equilibrium real GDP is ($5,880) less than the Full
employment Real GDP ($6,000) the economy is operating below potential level. The fiscal policy
consists of two main tools- the changing of tax rates and changing government spending. The
main point of fiscal policy is to keep the surplus/deficit swings in the economy to a minimum by
reducing inflation and recession.
As the economy is below full employment level, an expansionary fiscal policy must be
implemented. An increase in government expenditure or a reduction in tax will lead to an
increase in the equilibrium income to a larger extent due to multiplier effect. With the help of
multiplier concept, we can calculate numerically exactly what change in autonomous
expenditure will be required to reach the full employment level.
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