MARKETS AND THE ECONOMY

Markets and the Economy

Markets and the Economy

Question 1

Budget deficits and surpluses can help stabilize economy. If economy enters the recession will fall as income taxes and employment. At same time, public spending will increase as people receiving unemployment benefits and other transfers such as welfare payments. These automatic changes in income and labor costs to increase deficit. At same time, they also work to mitigate decline in disposable income that households are experiencing.

If economy is expanding and experiencing inflation, the budget surplus to stabilize economy works. In this example, taxes increase in response to increased employment and income. At same time, public spending fall as fewer people are receiving unemployment compensation and other transfer payments. These changes in working to reduce level of consumption and therefore level of aggregate demand. Thus, surplus in works to stabilize economy during periods of inflation.

For foregoing reasons, it is possible to argue that the balanced annual budget can actually work to destabilize economy. In particular, this requirement can work to worsen recessions and inflations. In case of recession, which we have already seen that income drops as costs rise creating the deficit. In order to balance budget, government must raise more revenue (higher taxes) and reduce costs. Both actions will lower disposable income. As the result, consumption and aggregate demand will fall. As aggregate demand falls, recession deepens.

Question 2

Intersection of aggregate demand curve economics and short-run aggregate supply determines equilibrium real GDP and price level in short term. intersection of aggregate demand and aggregate supply determines its long-term long-run equilibrium. In this section we will examine process by which an economy moves from equilibrium in short term to long-term equilibrium.

Long-term perspective, the country's macroeconomic house in order: only frictional and structural unemployment remains, and price level stabilizes. In short term rigidity in nominal wages and prices of others may prevent economy from reaching its potential. Actual production may exceed or fall below potential output. In such the situation, economy operates with the deficit. When output is above potential, unemployment is above natural level of employment. When output is below potential, unemployment is below natural level.

Some economists argue that stabilization policy can and should be used when gaps of recession or inflation exists. Others urge confidence in one's ability to correct economy. Sometimes they argue that tools available to public sector to influence aggregate demand is not likely to shift curve, or argue that tools would shift curve in the way that could do more harm than good.

Economists who advocate stabilization policies argue that prices are sticky enough proper adjustment of economy to its full potential will be the slow and painful process. For an economy with the gap of recession, unacceptably high levels of unemployment will be maintained for too long. For an economy with an inflationary gap, rising prices are presented as aggregate supply curve in short term moves up imposing an excessive rate of inflation in short term. These economists believe it is preferable to use stabilization policy ...