Question

5. Assuming the price level does not change, explain what happens if the leakages are less than injections and why?

13. Explain why the Classical Macro theory is a full-employment model and how it can incorporate deviations of the economic activity from the potential as well as explaining economic growth.

15. Evaluate critically: A change in any autonomous spending such as government and likely investment spending will not change the total spending, since thee expenditure changes will be counterbalanced in other components of the spending.

17. Explain the ineffectiveness of discretionary policy (monetary and fiscal policies including changes in taxes) in view of the classical theory.

Answer 1

5. A leakage is any income not passed on in the circular flow. Leakages from the spending stream include savings, taxes and imports. Injections include investment spending, government spending and exports. leakages are the non-consumption uses of income, including saving, taxes, and imports.

When leakages equal injections, total spending will equal total output and the macroeconomy will be in equilibrium. If leakages exceed injections, then total output exceeds total spending and the level of national output (GDP) will fall.

13. The classical theory is that the economy is self‐regulating. Classical economists maintain that the economy is always capable of achieving the natural level of real GDP or output, which is the level of real GDP that is obtained when the economy's resources are fully employed.

17.  Monetary policy changes the country's money supply to influence macroeconomics performance, including unemployment, inflation and economic growth.  Monetary policy is conducted by the nation's central bank, the Federal Reserve System in the United States.  Changes in the money supply relative to its demand affect financial markets, including interest and exchange rates.  These changes alter investment, consumption and net exports, which in turn influence macroeconomics performance.

Fiscal policy is the process of moulding government taxation and government spending so as to achieve certain objectives.  According to Prof. Samuelson, by a positive fiscal policy we mean the process of forming public taxation and public expenditure in order to:

• To ensure the working of business cycle,
• To contribute towards the maintenance of a growing high employment economy free from excessive inflation or deflation.

Monetary policy, like fiscal policy, is a demand side macroeconomics policy.  In particular, monetary policy indirectly affects aggregate demand and macroeconomics performance through the financial markets.  Fiscal policy, which involves changes in government expenditures and taxes, directly affects aggregate demand. Government expenditures influence government demand; tax policy influences both consumption and investment demand.

In the Classical economics, in the prevailing economic theory market economies are inherently stable.  In particular, actual GDP automatically adjusts to the economy's productive capacity, called as GDP.  Economic capacity is determined by the quantity and quality of resources available (e.g., labour, capital and natural resources).  If resource prices are flexible, they will adjust until resources are fully employed and the economy is operating at economic capacity.