TMJC 2023 A Level H2 EQ6_AP Answers

6. The use of expansionary demand -side policies designed to achieve economic growth or to lower unemployment may lead to undesirable consequences. (a) Explain why expansionary fiscal policy designed to achieve economic growth or lower unemployment may lead to undesirable consequences. [10] (b) Discuss whether expansionary supply -side policies would be effective in achieving the macroeconomic policy aims of an economy. [15] ………………………………………………………………………………………………………. Suggested Answers to part (a): Introduction: Discretionary fiscal policy involves the change in government spending (∆G) and/or taxation (∆T) to influence the level of economic activities and living standards. An expansionary fiscal policy will involve raising government expenditure (G) and/or reducing taxes (T) to increase aggregate demand (AD). Requirement 1: Explain briefly how EFP works and expla in one undesirable consequence a. Briefly explain how EFP works to achieve economic growth and lower unemployment: [Reduction in taxation] A government can reduce personal income tax and/or corporate income tax to increase consumption expenditure (C) by households or investment expenditure (I) by firms. For example, a reduction in corporate income tax rates will increase firms’ post-tax profits which raises the expected yields from investments. Firms are more willing to invest which in turn increases investment expenditure. [Increase in government spending] A government can also increase spending on public projects like building of roads, healthcare, or education. With an increase in C, I and/or G, this will lead to an increase in AD, ceteris paribus. Assuming the economy operates with spare capacity as shown in Figure 1 below, the increase in AD will result in a rise in real output by a multiplied amount due to the working of the multiplier where one’s spending becomes another’s income. As real output increases from Y1 to Yf, actual growth is attained. The increase in production would mean that firms would increase their demand for factors of production, including labour. ADL increases and thus, demand-deficient unemployment is reduced.

Figure 1 b. Explain one undesirable consequence of EFP → conflict with other macroeconomic goals (e.g. price stability and favourable BOT position) Expansionary fiscal policy may have the unintended effect of conflicts with other goals. Impact on Inflation: If the economy is at or near full employment, excessive increases in AD which are persistently greater than AS cause demand-pull inflation where the excess total demand cannot be met because existing resources are fully or almost fully employed. Assuming that the economy is operating near full employment where the initial equilibrium is at E1 and expansionary fiscal policy is implemented to increase AD. The increase in AD causes total spending to exceed total output resulting in a shortage at OP1. This leads to a fall in i