AD can be increased if the economy is below full employment level and there is spare capacity within the economy. In order to increase AD, the government can increase consumption expenditure (C), investment (I), government expenditure (G) and exports (X).
One of the ways is to cut the tax and increase the level of government spending (G). Cutting taxes can raise consumers’ disposable income, so as their purchasing power. And consumer confidence increases as they are optimistic towards the market. This increases the AD. As AD rises, both price level and real GDP of an economy grow, leading to an increase in sales revenue as well as profits of firms. In order to meet the emerging market and rise in AD, the firms demand for more workers in order to increase long-run aggregate demand (LRAS). As a result, unemployment decreases while capacity of the economy increases. This increases the rate of economic growth.
In addition, using demand-side policies to increase AD i.e. increasing government spending (G) will lead to multiplier effect, that is the process by which change in injection leads to greater final change in real GDP. For example, increasing subsidy on transport can encourage more people to go to work as well as increasing workers’ disposable income. With the knock-on effect, they will spend more thus AD will increase. This accelerates economic growth.
Increasing AD has an immediate impact on the economy, and with multiplier effect, AD is likely to keep rising. However, there are some limitations in increasing AD as well. If the government uses fiscal policy, it will only be effective if other components of AD do not drop at a level greater than the increase in specific component of AD i.e. government expenditure (G). Also, if consumer confidence is low, reduce in taxes may not lead to an increase in consumer spending (C).
In conclusion, demand-side policies i.e. fiscal policies are likely to be effective in boosting economic growth in short run as there is an immediate impact on the economy. Also, multiplier effect can help to accelerate economic growth. Compared to supply-side policies, there are less risks and possible negative impacts.
However, both demand-side policies and supply-side policies can help to increase economic growth. The most ideal way to achieve a sustainable economy is to use both demand-side and supply-side policies while minimising misleading market information through market research.
by
niic0le1223 (student)
