Question

Suggest how a particular policy tool (monetary/fiscal policy) might be used to improve economic activity including output and employment or the price level.

Answer 1

Monetary policy can improve the economic outcome. The economy may be suffering from a recession where the output level and the price level are lower than their full employment level. Monetary policy expansion in terms of increased money supply can stimulate aggregate spending. This is likely to shift the aggregate demand curve to the right, which then increases the output level and the price to their full employment level. This can also be done by a fiscal policy expansion where government increases it's spending or reduces the tax rate. With greater demand for goods and services employment also increases.

Take for example the tax rate under fiscal expansion. When tax rates are reduced, personal disposable income is increased. This increases consumption. In initial stage, aggregate demand increases directly by increase in consumption. with multiplier effect, there are subsequent increases in personal disposable income and consumption. This increases aggregate demand again and again so that output and price level increase and finally reach their long run equilibrium levels. Due to a rise in economic activity, employment increases as well.