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Stimulating an economy in recession

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Ranamae Zamora Economics Assignment: Stimulating an economy in recession March 27, 2007 1. How might a government attempt to stimulate an economy which is in recession? Recession occurs when the economy experiences two consecutive quarters of falling Gross Domestic Product (GDP). GDP is the accounted money value of the goods and services produced in an economy. Recession shows how economic activity slows down and falls over a period in time. The decrease in GDP is shown in figure I where the real GDP trend goes below the potential real GDP. During this period there is rising unemployment, decreased output, decreased consumption and interest rates, and deflation (decrease in price level). A decrease in the components of aggregate demand (AD) such as consumption, investment and government spending as well as an increase in the components of aggregate supply (AS) such as the price of labor and price of inputs would be some of the causes of recession. So to stimulate an economy during this period the government can cause a change in the components of aggregate demand and aggregate supply. The government may use expansionary fiscal policies that influence the AD curve by decreased taxation and increased government spending. A decrease in tax would increase consumption because of an increase in disposable income and would therefore increase AD. This is shown in figure II as a shift from AD0 to AD1 and would be in line with the long run potential output shown by point A. ...read more.


The same was done in the Bush administration during 2002 and 2003. Tax credit cheques were sent to high income households with children and tax allowances were given to firms allowing them increase investment at a lower cost. The credit cheques were strategically given out during the back to school month to encourage families to spend more and thus increase consumption. Real GDP by 2003 increased at an annual rate of 8.2%. However, in 1970, after the implemented fiscal policies, government debts increased and there was high inflation and high unemployment. In 2003, deficit spending increased the budget deficit in the US; government expenses exceeded receipts. Price levels also increased and the policies did not have a noticeable impact on unemployment in the US. Expansionary monetary policies decrease the rate of decrease in aggregate demand as shown in figure III with the decrease in the shift of AD (AD0 to AD2 instead of AD0 to AD1). This is because monetary policies anticipate inflation and try to solve it earlier. So, interest rates are used to stop excessive changes in AD before they occur. Only an assumption of how inflation would look like and how interest rates would hopefully stop it is made because it takes between two to six quarters until interest rates affect inflation and up to two years until AD is affected. ...read more.


With supply side LRAS increases allowing AD to increase without inflation as shown in Figure V(b) because increased research and labor increase the factors creating a rise in the full employment level of output (Y0 to Y2). Therefore, in the long run, supply side policies are more effective for the growth of the economy because of the increase in output thus increase in real GDP without inflation. However this is only good for growth and when development is mentioned the decrease in social welfare that occurs with the implementation of these policies is unacceptable. Demand management policies help even out the economic cycle and create a stable economy. With the help of automatic stabilizers and discretionary fiscal policies governments steer the economy to achieve economic goals and improve social and economic welfare. Tax rates, unemployment benefits and government spending increase social welfare systems and an increase in living standards is caused by full employment. Unlike the supply side policies demand management involves a lot of social welfare development. It is safe to say that it is better for the development of a country or economy. However as mentioned in the previous paragraph, these policies cause inflation and would be disadvantageous to the economy in the long run. The case of supply side policies is the opposite. It increases output without the risk of inflation but with decreasing social welfare. ?? ?? ?? ?? Zamora 1 ...read more.

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This essay strongly captures how the government might stimulate the economy in an economic recession, and evaluates the use of these government policies to a certain extent. The writer begins with very strongly by accurately defining “recession” and this accuracy ...

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Response to the question

This essay strongly captures how the government might stimulate the economy in an economic recession, and evaluates the use of these government policies to a certain extent. The writer begins with very strongly by accurately defining “recession” and this accuracy is indeed splendid as many students’ idea of a recession is vague in terms of definition. The writer remembers to look past the negative GDP aspect to focus on low unemployment, interest rates, etc as well. The definition of GDP could be more refined. The writer’s approach in explaining that both AD and AS play a role and then elaborating how the components of AD can be affected by expansionary policies is commendable for its clarity. Such links lined up with real-life examples puts the issue in a realistic aspect and makes the essay flow logically. Throughout the essay, the writer also makes clear reference to the graphs and diagrams, but the bad aspect is that these diagrams do not appear properly. The evaluation section is very well done in that the writer discusses the strengths and weaknesses of the demand-side and supply-side policies employed to curb recessions. The writer gives a balanced account of these policies and manages to draw a justified conclusion on these policies.

Level of analysis

The essay is deep in its content to a large extent. While the initial part on explaining recession may not be crafted very well, the subsequent section on evaluating the policies is of the great depth. The writer discusses the idea that each of these policies is suitable in handling a certain aspect of recession – demand side policies to boost aggregate demand or supply side policies to reduce unemployment. The writer accounts for long-term and short-term effects of these policies. The writer then zooms in on the stakeholders of these policies, namely the government, the producers and consumers. The writer also elaborates on the advantages and disadvantages of these policies after explaining how these policies are designed to work. A remarkable aspect of this essay is the complex blend of both macroeconomic and microeconomic concepts where relevant. For example, the writer comments on the opportunity cost of economic decisions. A small area for improvement would be to refer to diagrams in the evaluation section as well as to define the economic terms such as opportunity cost, which markers especially look out for. Finally, the wrier could manage to squeeze in a conclusion at the end on which is the best policy in which situations based on the analysis so far.

Quality of writing

The use of technical terms is only moderate. For example, more specificity and accuracy could be shown in the terms used such as the particular type of unemployment prevalent in a recession as well as the technical terms of these “supply side policies”. Definitions for key economic terms like taxation, opportunity cost are lacking as well. Nevertheless, the essay shows immense effort in maintaining a high standard of grammar, punctuation and vocabulary. Overall, this is an excellent piece of economics commentary.

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