• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Using an appropriate diagram explain how a government may attempt to close a deflationary gap.

Extracts from this document...

Introduction

Using an appropriate diagram explain how a government may attempt to close a deflationary gap. Inflation is a sustained general increase in the level of prices. The level of inflation may be 3% per annum, which means that $100 will buy 3% less goods next year than it does now. The opposite of inflation is deflation. This technically means that the price level, or the average prices of goods and services in an economy, is decreasing. In effect, this means that money is worth more over time. However, the word deflation has gained another meaning, and is more often used to describe a situation where an economy's output growth is slowing. A situation representing deflation can be drawn using the Keynesian 45? Line, which shows combinations of points where the two axes are equal. AD represents aggregate demand, which is the sum total of all demands in the economy at any given price. ...read more.

Middle

Fiscal policy may consist of government injections into an economy in money, or decreases in taxes that raise real income. An example of use of fiscal policy to recover from deflation of an economy is the massive public works projects that Japan funded in the mid 1990's which stimulated the economy, and helped to move it out of a depression. One would think that this government spending would be reflected by an increase in taxes to fund such works, however, as in the case of Japan, the government may go into budget deficit to fund works, or may use money leftover from budgeting, called budget surplus. The fact that a massive increase in government spending stimulates the economy is due to the multiplier effect. In essence, the multiplier shows how increases in planned injections into the economy lead to larger increases in output and income, and therefore GNP and AD rise. ...read more.

Conclusion

That is, how large will the increase in National Income be in proportion to initial spending? The size of the multiplier is determined by the equation Size of multiplier = 1 (1-mpc) MPC is the marginal propensity to consume. This refers to the amount of an increase in autonomous (outside the economy) income is spent on domestic goods and services and how much is saved. When autonomous spending increases aggregate expenditure, the increase will increase household income. This income may leak out in the form of savings, taxes or spending on imports, but the rest will be spent on domestic goods and services. The opposite of marginal propensity to consume is marginal propensity to save, which refers to what proportion of an autonomous income increase will be saved as opposed to spent. For example, if the MPC is 0.5 the multiplier will be 2, which means that an increase in government spending of $100 million will increase NY by $200 million. The multiplier effect and its use by governments to stimulate AD can be shown in the diagram below. ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our AS and A Level Macroeconomics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Here's what a star student thought of this essay

4 star(s)

Response to the question

This essay responds to the question well, but only after the first paragraph. The introduction gives an unnecessary definition and summary of inflation, which is irrelevant here. It is a common mistake to think of a question regarding the deflationary ...

Read full review

Response to the question

This essay responds to the question well, but only after the first paragraph. The introduction gives an unnecessary definition and summary of inflation, which is irrelevant here. It is a common mistake to think of a question regarding the deflationary gap as a question about inflation and deflation, whereas it is looking for a discussion of how to move output to full employment levels. Past the introduction, this essay does engage well with this task, looking at how the multiplier and government spending can influence. Diagrams have not transferred over, but by looking at the comments, they seem to be relevant. In a question such as this, it is vital to include diagrams as this is the easiest way to define a deflationary gap and look at policies to reduce it.

Level of analysis

The analysis here is sound. There is a strong awareness of how aggregate demand and supply are at equilibrium to give the level of output, and why this is below the level of full employment. Building a good foundation of knowledge early on allows you to move swiftly into analysis. I particularly liked the historic example of Japan investing in infrastructure, as this shows the ability to apply theory to real life situations. It was great to see a perceptive comment that an increase in government spending isn't always matched by increases in taxation, as a government may choose to run a budget deficit. The multiplier is always a tricky concept, and this essay explores it well. There is a clear definition, and some numerical analysis. I would've liked to have seen some discussion of the significance of the multiplier, showing how a small increase in government spending can help reduce the deflationary gap. It seems as if the argument moves away from the question near the end - it is vital to stay on focus.

Quality of writing

The structure here is fine, having a clear introduction. I would've liked to have seen some attempt at a conclusion, weaving the argument together and posing a justified judgement. Although the question doesn't prompt for an evaluative response, a conclusion is often a good place to make a passing comment. Technical terms are used fluently throughout, and the style allows for a convincing argument. It was a shame that some of the points don't upon the analysis to answer question! Spelling, punctuation and grammar are fine.


Did you find this review helpful? Join our team of reviewers and help other students learn

Reviewed by groat 02/04/2012

Read less
Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related AS and A Level Macroeconomics essays

  1. Marked by a teacher

    The aim of this essay is to discuss the relevance of John Keynes to ...

    5 star(s)

    The effects of the credit crunch can also be observed on figure 2 as GDP experience a sharp decline within the same time scale after a long period of relative stability. Figure 4 above shows the Business cycle. The business cycle is "the periodic fluctuations of national output round its long-term trend" ( Sloman J,2001:256).

  2. Peer reviewed

    GDP, or Gross Domestic Product.

    5 star(s)

    These figures can also go unrecorded in the GDP figures. Most people would accept that pollution, road and housing congestion all detract from the standard of living, but the official figures take no account of this. GDP per capita takes no account of the hours worked.

  1. Bangladesh. Most government aim for full employment and stable prices. Which of those two ...

    This change is extremely unpopular among the people. However, stable but low prices suppress unemployment. Low prices cause pessimism among investors and hence they are unwilling to make investment into the country's industries. With no prospective investment, output levels do not rise. Since output does not have to be increased labor which has a derived demand, is not

  2. What are the government objectives? Explain why each is important and how the government ...

    computer skills. Where people are occupationally immobile, this can enable them to take the jobs, which are available therefore reducing unemployment. This improved education and training will too increase the flexibility of the labour markets therefore making it easier for people (workers)

  1. "Consumption is determined by Income"

    This means that, effectively, the price of the goods has increased. Households react to this by reducing their demand for durables and so cutting their consumption. Many households also have borrowed money to purchase houses. Increased interest rates lead to increased mortgage repayments.

  2. What are the Government's main economic objectives?

    will be adopted. The CPI is recognised to be more precise ad reliable, taking better account of factors neglected under the RPIX. It is also internationally recognised and makes the UK rates comparable with the rest of the Euro Zone and America. This change means the new target level for inflation will be two per cent.

  1. Governments set economic objectives - Discuss the relative importance of each of these objectives ...

    An increase in aggregate demand from AD2 to AD3 again increases output and causes the price level to rise. At AD3, the economy is in full employment. If there is a further rise in real expenditure, the aggregate demand curve is increased again to AD4, where the quantity of real

  2. Unemployment, inflation, economic growth and balance of payments have close relationships with aggregate demand

    A trade deficit would suggest that the exports are less than imports and a surplus would indicate that the country is exporting more than it imports. Balance of payments deficit is a situation in which debits exceed credits which leads to a shortfall of foreign currencies and causes problems.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work