Macroeconomic Policy and Aggregate Supply Analysis

Factors Causing an Outward Shift in SRAS

Explain two factors that could cause an outwards shift on the Short-Run Aggregate Supply (SRAS):

1. Costs of factors of production: Favorable changes in non-price factors that affect aggregate supply will shift the SRAS curve to the right.
2. Indirect taxes/lower production costs: This would lead to lower average prices in the economy and subsequently cause an expansion in Aggregate Demand.

Monetary Policy Fundamentals

Define monetary policy: The government’s control and use of interest rates and the money supply to control levels of inflation.

Expansionary Monetary Policy

Explain expansionary monetary policy: This policy aims to increase Aggregate Demand in the economy. Lower interest rates lead to a shift to the right, the equilibrium changes, and prices increase.

Contractionary Monetary Policy

Explain contractionary monetary policy: This involves increasing interest rates so people do not consume as much, causing the Aggregate Demand curve to shift to the left with the aim of decreasing inflation.

Fiscal Policy and Macroeconomic Aims

Define fiscal policy: The use of taxation and government expenditure strategies to influence the level of economic activity to achieve macroeconomic aims, such as low unemployment, sustainable economic growth, and low inflation.

Promoting Growth and Low Unemployment

Three ways in which fiscal policy is used to promote long-term economic growth and low unemployment:

• 1) Government spending on physical capital goods: Investing in tangible assets used to produce other goods.
• 2) Government spending on human capital formation: Investing in education and training (knowledge and skills) to create a more skilled labor force.
• 3) Provision of incentives for firms to invest: The provision of tax breaks and tax incentives to stimulate investment in the long run.

Taxation and Government Revenue

Taxation and its two types: Money taken from taxpayers for the government to spend. This is the main source of government revenue.

• 1) Direct taxation: Imposed on the income, wealth, or profit of individuals and firms.
• 2) Indirect taxation: Expenditure taxes imposed on the spending of goods and services in the economy.

Categories of Government Spending

Explain the three types of government spending:

• 1. Current expenditures: Government spending on goods and services consumed within a year. This includes items of spending on a recurring basis for immediate operations and benefits to satisfy the needs of individuals or groups in society.
• 2. Capital expenditures: Long-term items of government spending that boost the economy’s productive capacity. This involves a large amount of money to increase the nation’s capital stock, which is planned and funded carefully to create future benefits for society.
• 3. Transfer payments: Welfare expenses from the government to redistribute income to others in society by funding essential public services such as education, housing, and healthcare.

Fiscal Policy Stances

Expansionary and contractionary fiscal policy:

• Expansionary fiscal policy: Shifts the Aggregate Demand curve to the right by providing benefits and government spending that increase the GDP. This can also be achieved by lowering taxes, which means consumers have more money to spend.
• Contractionary fiscal policy: Reduces the level of economic activity by decreasing government spending and/or raising taxes to limit consumption and investment.