With reference to "Weapons of Mass Distraction", discuss whether fiscal policy is an effective tool to control economic growth.

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Peter Tsarkov

With reference to “Weapons of Mass Distraction”, discuss whether fiscal policy is an effective tool to control economic growth.

Fiscal Policy is the method a government can use to control the trade cycle. Fiscal Policy uses government spending to increase or decrease various parts of aggregate demand. These are shown as AD=C+I+G+(X-M).

A major problem with fine-tuning the economy is the time lags that are involved with fiscal policy. These time lags mean that when a fiscal policy change has been put into effect, the results may come at a later period. If the economy is doing well at this period, this could well push the AD curve too close towards AS creating inflation. This means that even though it shows that fiscal policy is an effective tool, it maybe used improperly causing a problem not a solution. However, if fiscal policy is used at the right time, it will indeed be a very effective tool. And so we can infer that fiscal policy is indeed effective, yet a risk as timing also plays an important factor in its success.

One of the reasons it is so effective, is due to the multiplier effect. This multiplier effect measures the effect of the cycle of respending has on the economy. For example, if a government spends £100 million on building a road, the company would spend £70 million on wages for extra labour hired for the demand and £20million on materials. The extra workers would then spend £40 million of that in shops. And so, we can see that out of £100 million, we have used the same money over and over again, but the cycle of respending has boosted the economy even more. We can see this by the monetarist equation of MV=PQ. V is the velocity of money, which is determined when it’s changing hands, so if that’s increased, then so is the other side. The other side is prices (P) and total output (Q). The multiplier does show that fiscal policy is effective. However, how effective the multiplier is depends on the marginal propensity to consume.

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One way to work out multiplier is by taking the reciprocal of the mpc (1/1-mpc). The mpc is how of the income a person spends. So if they get £10 and spend £8, their mpc is 0.8.Therefore, the more income is spent, the more effective fiscal policy is as the great V is and so the greater total output is, meaning an increase in AD. The mpc is also included in the consumption function. The consumption function s C=a+b(Yd). A is the lowest amount received by a person, generally unemployment benefit. B is the mpc and Yd is disposable income. ...

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