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AD-AS Analysis

Demand Management Polices

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Unit 2-The Exam
· 90 minutes long
· 50% AS
· Total 80 marks- 1 data response from a
choice of 2.
· Each data response exercise contains 1 30
mark essay, which will require definitions,
diagram(s), analysis and evaluation.

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Fiscal Policy
· Fiscal policy is defined as the use of
government expenditure and taxation to
influence the level of AD in an economy, in
an effort to achieve the macro objectives.

· In the UK, fiscal policy is mainly targeted at
economic growth and employment.

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Fiscal Policy
· Keynesian economists argue that fiscal policy is a
very useful tool for changing AD in an economy,
especially when the economy is operating below
full capacity (existence of a negative output gap).

Price Level
LRASK




P*

AD1


Q1 QF Real Output
Output gap

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Fiscal Policy
· There are a number of transmission
mechanisms we can look at.

· Firstly, any increase in government
spending will increase the G component in
AD, and so as G, AD.

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Fiscal Policy
Price Level G, AD
LRASK




P*




AD1 AD2


Q1 Q2 QF Real Output

Output gap shrinks

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Fiscal Policy
UK Government Spending




Source: HM Treasury 2010-2011

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Fiscal Policy
Government spending made up of:

1. Transfer payments- e.g. social protection
2. Current govt spending- e.g. defence, wages
3. Capital spending- e.g. education,
transport

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The Multiplier Effect
· Whenever we deal with a change in government
expenditure, it is useful to consider the multiplier
process.

· An increase in any component of AD will lead to
an even greater increase in national income
overall, via the multiplier process.

· So for an increase in…

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Multiplier



G directly adds to AD This multiplier effect The overall impact
and triggers multiple dampens out over time on GDP is greater
rounds of repeat due to withdrawals (S, T, than the initial
spending (C) M) injection

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