Question

1. Outline how counter cyclical fiscal policy and balanced budget fiscal policy would close a recessionary gap. Be specific on goals, how each theory would achieve those goals, how they would close the gap, and potential negative effects.

2. According to monetary policy, explain how the Bank of Canada would react to a recession. Be specific on goals, how they would achieve those goals, how they would close the gap, and potential negative effects. 2.According to monetary policy, explain how the Bank of Canada would react to a recession. Be specific on goals, how they would achieve those goals, how they would close the gap, and potential negative effects.

3.Please describe how the PPC curve represents scarcity, choice and opportunity cost.

4.When would a PPC curve be a straight line rather than a curved line?

5.Discuss the differences calculating GDP using the expenditure approach and income approach.

Answer 1

1. Fiscal policy can be used as a tool to fight recession and revive the economy. During Recession the government will adopt an expansionary fiscal policy which consists of reduced tax rates, increased government spending and this expansionary fiscal policy stimulates the economic activities. The government spending has a multiplier effect and this multiplier effect can be leveraged to augment the aggregate demand. When government spends in one avenue it boosts the income of that avenue and they in turn will spend there income in another avenue and this virtuous cycle of spending, production and consumption will continue resulting in increase in employment, aggregate demand and overall economic activities thus enabling the revival and growth of the economy. Even tax cuts can act as a impetus in boosting the aggregate demand and reviving the economy as when the government cuts tax rates the disposable income of the people increases and this results in increasing their purchasing power and this might result in increase in consumption and production.

There are few flaws in expansionary fiscal policy. When the government reduces tax it does not necessarily mean that the individuals will increase their consumption due to reduces tax rates, this is because the individuals are well aware that when the government adopts expansionary fiscal policy and incurs deficit this deficit will be financed in the future by increasing the tax rates and reducing government expenditure and to meet the future surge in tax payment the individuals will adopt measures of austerity and nor increase their present consumption. Hence the government should be cognizant of this and not incur unnecessary deficit and should spend in revenue generating assets so that it need not rely solely on the tax payers to finance its debts. It is imperative that the expansionary fiscal policy is adopted at the right time and in the right spirit other wise if will fail to achieve its purpose and might even have adverse effects on the economy if implemented in an unscrupulous and untimely fashion.

Hence a well planned, decisive and  judicious fiscal policy can be a potent tool in fighting recession and reviving and stimulating the economy.

2. When there is a recession, the Central Bank of a country can close the recessionary gap through its monetary policy by lowering interest rates i.e. adopting an expansionary monetary policy which aims at quantitative easing i.e. lowering the  interest rates and infusing liquidity in the economy by providing credit at low cost and it can also conduct open market operations of purchasing the securities such as bonds etc and all these activities of the central bank results in stimulating borrowing and spending and thus boosting aggregate demand and economic activities. When there is a recession in Canada, Bank of Canada will aim at reviving the economy by adopting quantitative easing where it will lower the interest rates and make credit available at low cost. When credit is available at low cost producers will begin to borrow to make investments for augmenting their production, household will borrow to make purchases for consumption and these activities of borrowing and spending stimulates the economic activities and boosts the aggregate demand. Through monetary policy the Central Bank  infuses liquidity in the economy and when there is high liquidity it can also result in boosting the exports as the currency will get devalued and foreign entities will find it cheaper to purchase goods from Canada which will cause the exports to surge. Thus expansionary monetary policy which Bank of Canada adopts to fight recession will stimulate economic activities by infusing liquidity and making credit available at low cost thus boosting aggregate demand and reviving the economy as it acts as an impetus for boosting production and consumption which are the bloodlines of an economy.

Despite it being a catalyst for reviving and boosting economic activities there are some negative effects of an expansionary monetary policy though these effects might not always materialize. Some of the negative are when you increase liquidity and when the domestic currency gets devalued the importers have to bear the burn of the devalued domestic currency as import would become more expensive because of the devaluation. When there is high liquidity and when credit is available at low cost it might cause individuals to go on a borrowing spree resulting in creation of asset bubbles, causing hyperinflation. It is important to ensure that the production capacity is increased to accommodate for the surge in demand due to easy availability of credit , it is vital to have an alignment between demand and supply when they are not in congruence with each other the desired purpose of expansionary monetary policy cannot be achieved. It is also important to adopt the expansionary monetary policy at the right time to revive the economy if it adopted in an untimely fashion is will adversely affect the economy.

Hence a prudent, decisive, judicious monetary policy can do wonders in reviving the economy during recession if implemented in the right spirit and manner.

3. Production Possibility curve shows various combinations of two goods that could be produced with the given level of inputs. The factors of production are limited and these limited resources have to be used to produce goods to satisfy the needs. Increase in the production of one good would mean that the production of another good has to reduced to facilitate this increase since the factors of production are limited and must be adjusted between various production process to accommodate for the changes. The reason the PPC is a curved line, is because you have to some units of one good to produce an additional unit of another product and the  sacrifice you are willing to make in the production of one good for the production of an additional unit of another good will keep  decreasing  as you produce each additional unit of another good. This is known as diminishing Marginal Rate of Technical Substitution and is due to the fact the opportunity cost increases as you produce more additional units of another good hence you propensity to substitute one good for another will also decrease.

4. Production Possibility Curve (PPC) shows various combinations of output of 2 goods that could be produced with the given inputs. When the PPC curve is a straight line it means that a constant unit one Good is given up to produce one additional unit of another Good. The opportunity cost of producing an additional unit of one good will remain the same with each additional unit of production.

5. GDP (Gross Domestic Product) refers to  the total output of a country during a given period. There are multiple ways of measuring it.

GDP as per income approach is calculated by the income earned by all factors of production and all the entities in the economy such as the companies, household, government. It is based on the accounting reality that the income should be equivalent to the expenditure.

GDP as per income approach :

GDP = Total national income (wages + rent + interest + profits) + Sales tax + Depreciation + Net foreign factor income.

Wages , rent , interest , profit are the income earned by factors of production. Sales tax is the income earned by the government. Net foreign income refers to the difference between the total cash inflows and cash outflows from foreign countries.

GDP as per expenditure approach. Here all the expenditure during a given period is added to obtain the GDP as the total expenditure would reflect the total output of the nation during the period. Usually nations adopt this method while calculating the GDP.

GDP as per expenditure approach ;

GDP = Consumption + Investment + Government expenditure + Net exports ( export - imports )

Consumption refers to the money spent by households. Investment refers to the money spent by the producers. Government expenditure, needless refers to the money spent by the government. Net exports refers to the difference between the total exports and import of the nation during the given period.