Question

1. Suppose Malaysia is operating below full employment, explain using Keynesian’s model how you would change government spending to restore full employment.                              

2. How would you answer change if you choose to change the level of taxes?             

3. Given the macroeconomic condition in part (a), how may Bank Negara Malaysia response if the central bank’s priority is to restore full employment? Explain your answer using a loanable fund market model.                                                                                                                                      

4. Explain your answer in part (c) using IS-LM model.                                                            

Answer 1

AD= C + I + G

In the given condition where Malaysia is operating below full employment, according to Keynes, government spending (G) must be increased. An increased government spending will in turn boost aggregate demand (AD) in the economy. As G increases, AD will increase. To compensate for the increase in aggregate demand in the economy, the supply must also be increased. To increase supply, labour will be required and hence demand of labour will also increase. This, according to the Keynesian model, will reduce unemployment in the economy by way of changes in government spending.

In case the level of taxes need to be changed, the taxes must be reduced. A reduction in the tax rates will lead to a higher disposable income and this will induce the consumers to spend more. With a higher domestic spending , Consumption (C) will increase and this again, will induce an increase in AD. In the same way as mentioned above, an increase in AD will lead to an increase in employment levels.