ECN 107 Macroeconomics Assignment Spring 2009

1.

i)         When the economy is experiencing unemployment it is viewed that a possible policy to combat this is an increase in government expenditure on goods and services. This increase in government expenditure is known as fiscal expansion and is a policy aimed at increasing aggregate demand in the economy. The unemployment may arise from the economy not producing to its full potential, thus resulting in firms not needing the workers as they are producing less, this is usually due to a recession. The governments increase in spending would result in an rise in aggregate demand, this boost in demand would mean that the firms and industries would be producing more to match the demand thus creating the need for more workers and reducing unemployment as seen in the diagram below.

However, it could be argued that this policy will put a great strain on the government’s funds. This may be said because as stated earlier the rise in unemployment is likely to be the result of a recession meaning the government will already be in debt, and increases in spending will only further level of borrowing. This increase in borrowing means that the market interest rate also rises, the government can afford to pay this but individuals and firms who also want to borrow may not be able to afford to. This is known as a crowding out effect. With an increase in government spending some speculate a rise in taxes to compensate but seeing as the policy is to boost aggregate demand it is unlikely that there would be a vast increase in taxes.

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ii)        Legislation to reduce the length of a working week is a policy based on the principle of sharing the current level of work throughout the working population. In order for this policy to work the current wage rate must increase to compensate for the fall in hours. If the wage rate does not increase then the weekly wage for workers will fall, this may result in a rise of voluntary unemployed people, these are the workers who are looking for a job but will turn down work at the going wage rate. The legislation aims for firms to employ ...

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