ECONOMICS

Economics

Economics

a)

Discretionary fiscal policy is the deliberate manipulation of government purchases, taxation, and transfer payments to promote macroeconomic goals, such as full employment, price stability and economic growth. As for Automatic stabilizers they are Structural features of government spending and taxation that reduce fluctuations in disposable income and thus consumption over the business cycle. For example, if economy is in a boom, then there is more income and more income leads to higher taxes, and these higher taxes would reduce the economy's tendency to overheat and result in high inflation rate.

Similarly, if economy is in a recession, there are many unemployed, so government would be entitled to provide more unemployment benefits (i.e. cash), and economy will have more money and reduce impact of the recession "automatically"

b)

AS simple multiplier:

   (A13)

where c is the marginal propensity to spend out of GDP. This number is often called the simple multiplier. But if the money supply is constant, a rise in GDP will raise the demand for money, which will bid up interest rates, which will reduce or 'crowd out' interest-sensitive expenditure. Thus, the multiplier that allows for induced changes in the interest rate, sometimes called the interest-variable multiplier, will be smaller than the simple multiplier.

Algebraically, the interest effect can be seen by first differencing equation (A12), which is the equilibrium solution for Y. Doing this, and assuming that ?M = ?P = 0, i.e. holding the real money supply and hence the LM curve constant, yields

  (A14)

This is the IS/LM, the interest-variable multiplier. To understand it, assume first that spending is totally insensitive to interest rates, which means b = 0. The multiplier then becomes 1/(1 - c), which is the interest-constant multiplier. If however expenditure does respond to interest rates, then b takes on a negative value. Now, since d and e, ...