On the graft below, draw the consumption function C=$150+0.8YD. Essay Example

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  1. On the graft below, draw the consumption function C=$150+0.8YD.

Consumption is $billions per year.

Disposable income is $100 billion per year.

Answer the following questions:

  • At what level of income do households begin to save? Indicate the point on the graph with the letter A.

  • By how much does consumption increase when income rises $200 beyond point A? Indicate this new level of consumption with point B.


YD (dollars)


Saving (S)


Student ID:

  1. (10 marks)Fiscal and monetary tools are used to fix the macro economy. Briefly explain how might a tax cut affect both AD and AS?

. The principle aim of monetary policy and fiscal policy is to reduce cyclincal fluctuations in the economic cycle. More often it is inflation targeting which much emphasis is put in monetary policy. Leeper, 2006)The aims of monetary and fiscal policy are similar. They are used to: (1) maintain positive economic growth; keep inflation low; and aim for full employment (

  • Monetary policy involves influencing the supply and demand of money, primarily though the use of interest rates.

  • Fiscal Policy involves chaning government taxation and spending. This policy involves a shift in the governments budget position.

What are the effects of tax cut affect both AD and AS?

. In this case, we will see a rise in consumer spending because employees are in a position to do so. (AD=C+I+G+X-M). Because employees spending is a component of AD (rougly 60 per cent) then a rise in employees spending will cause a rise in aggregated demand. Leeper, 2006). When the tax rate is lower, employees are in a position to keep more of their gross income, this in turn the will have more money to make purchase (Leeper, 2006)Let use an example of a tax cut in the basic rate of income tax from 21% to 17%. In this situation employees will see an increase in their income (

. By contrast, the imperfect-information model assumes that the labor market is always in equilibrium, so the greater supply of labor leads to higher employment immediately: the SRAS shifts outLeeper, 2006)(. In the sticky-wage or sticky-price models the quantity of labor is demand-determined, so the SRAS curve does not move Leeper, 2006)(while the labor demand curve is unchanged The effect of tax cut of aggregate supply (AS) will mainly depend on which model an individual uses. The labor supply curve will shifts outward because employees are willing to supply more labor at any given real wage

Student ID: 1

.(15 marks) One of the goals of a Federated Government is to stimulate the economy. This may be achieved in three distinct steps. You are required to use 3 different grafts to indicate these three steps. Question Three.

Fiscal Policy

Student ID: 2

. An expansionary fiscal policy will cause aggregate demand to shift to the right, from AD 1 to AD 2, increasing Real GDP and Price Level so that the economy is in equilibrium at point B on the LRAS curve.Leeper, 2006)(Y= C+I+G+NX.  If “G” (government) increases, then “Y” (GDP) will also increase. In the above graph, the economic is in a recession at point A, with Price Level and Real GDP below the potential along the LRAS curve

. If the Federated Government fees the country’s economy is growing too fast or overheating, the government may be forced to decrease spending. Leeper, 2006). This will inturn increase the demand for those goods and services. If the demand goes up, production of these goods and services will go up. And if manufacturing of these goods goes up; manufacturing companies will be required to hire more workers. Workers that once did not have jobs and money to spend on these goods and services (Leeper, 2006)Fiscal policy is a Federated government’s decision regarding taxing and spending. If the Federated government want to stimulate the economy, it will try to increase spending for goods and services (

. If taxes are reduced, people will have more money on their pockets, and enough money to spend and this will increase demand and businesses will have to produce more. As a result of this all sector in the economy will experience some growth. Leeper, 2006)Another side of fiscal policy is taxes. Cut in taxation will stimulate the economic growth (

Monetary Policy

Student ID: 3

. A monetary polict aht attempts to keep short rerm rates low will create a higher norminal interest rates and higher inflation. Leeper, 2006)Prices of goods and services and wages will rise at faster rates if monetary policy stimulates aggregate demand enough to push capital and labor markets beyond their long-run capacities (

. In contractionary policy is used to slow the rate of growth in the money supply and can slow economic growth, increase unemployment and depress borrowing and spending by consumers and businesses.Leeper, 2006). In expansionary policy will increase the monetary supply in order to boost private sector borrowing, lower unemployment, stimulate economic growth and consumer spending (Leeper, 2006)There are two types of monetary policy, contractionary and expansionary (


Leeper, Eric M. 2006. «Equilibria under ‘active’ and ‘passive’ monetary and fiscal policies».

, 27, 129–47Journal of Monetary Economics