Question

The Council of Economic Advisers requests that you carefully describe and explain at least two long-run macro policy options that the President can consider to boost productivity growth and potential GDP. These policies should be aimed at raising potential GDP and shifting the Long Run Aggregate Supply curve (LRAS) out over time. The administration is considering several policies that could boost productivity over the long run. These policies include massive infrastructure spending, various tax breaks, as well as policies that could bring manufacturing activity back to the United States. Describe how the policies that you propose will affect real GDP. Recall that GDP = Consumption Spending + Investment Spending + Government Spending + Trade Balance (Exports – Imports)

(PLEASE DO NOT ANSWER IN HANDWRITING)

Answer 1

* Massive infrastructure spending

Infrastructure development reduces the cost of production. It also leads to a decrease in transportation cost of goods and services. However the main component of GDP that will be influenced by the massive spending in infrastructure is investment. Better infrastructural facilities will lead to a rise in both foreign as well as domestic investment.

* Tax breaks

Tax breaks will increase the income available with the consumer for spending ( disposable income) , as a result consumption will increase. Tax breaks will also increase the incentive to work and invest. If tax concessions ot tax breaks are provided to Export Industries and import substitution industries, it will to aalso lead to an Increase in net Exports ( Exports- imports). Thus tax breaks can lead to a rise in consumption, investment and net exports.

* Policies that could bring manufacturing activities back to US.

When manufacturing activities come back to US, production and Employment will increase. As a result, consumption will increase. If government implements an industrial policy that provides adequate support for industries, investment in the economy will rise. The Increase in production along with export promotion activity can lead to an increase in net Exports. When manufacturing units come back, imports will decline as the production will be able to meet domestic demand to a great extent. As result of rise in Exports and fall in imports , net Exports will increase.

Thus it's clear that proposed Policies , if implemented successfully will create an expansion of GDP via increasing its components-consumption, investment, government Expenditure and net exports.