Question

PART B

The government responds to the events above by implementing the following economic policies:

• increasing transfer payments to the unemployed and pensioners;
• decreasing income taxes on individuals and
• increasing subsidies and taxation allowances to Australian firms.

Required:

1. Explain the OVERALL intended effects of the above government following economic conditions on the equilibrium price level and Real GDP of the Australian economy (Note: a diagram is not required for this question).

2. Identify and briefly explain two AD and or AS factors that will limit the success of the government’s policies.

Answer 1

1 - Due to the increase in unemployment benefits and decrease in income tax rates , the income of the public will increase . This will increase the AD in economy. Due to the subsidies offered to the firms , their cost of production will decrease. This will lead to rise in AS. Hence the equilibrium level of GDP will increase due to increase in both AD and AS as part of this fiscal expansionary policy.

2 -

a - The unemployment benefits and the decreased income tax effect may be inefficient if the MPC in the economy will be less as this would result in lesser increase in AD.

b - The crowding out effect may occur due to which the investment in economy will decrease and make the policy inefficient.