Question

Right now many economies in the world are experiencing a downturn due to the Corona Virus.

a) What kind of fiscal policy can governments use to address the decline?

b) What actions will be taken by the government in implementing the fiscal policy that you described in part a?

c) What will be the effect on Aggregate Demand (if any) as a result of the actions taken in part b?

d) What will be the effect on Aggregate Supply (if any) as a result of the actions taken in part b?

Answer 1

a) Many of the economies are experiencing downturn due to the outbreak of corona virus. The aggregate demand is low in many of the economies of the world. The lower demand reduces the price level and reduces aggregate supply. As aggregate supply decrease there is less output and more unemployment. The way to removes this situation is to increase aggregate demand through an expansionary fiscal policy.

b) As a part of expansionary fiscal policy the government must reduce the tax rate and increase the public expenditure. The reduction in tax rate and increased public expenditure creates more income of the people. The higher income will lead to more demand and more output. Higher output creates more employment and more income and further rise the aggregate demand.

c) The generation of high income through expansionary fiscal policy will create more aggregate demand. The higher demand for goods and services creates more production and employment. The economy will move from recession to prosperity.

d) The higher price level due to higher demand will increase the profit of the business community. With higher profit, the business community will undertake more investment. Thus aggregate supply will increase.