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In international economics, the term disposable income is used to refer the total amount of income households receive after tax deductions. The level of disposable income determines two important aspects of the consumer behaviors: their consumption and propensity to save (Gali, Jordi, &Tommaso p.23). In expenditure and consumption model, consumption function shows demarcates the tradeoff between savings and consumption levels. This model implicates that as income increases, consumer expenditure will upsurge. However, spending will rise at a lower rate than income.
C=150 + 0.8YD
Hence, C= 150 + 0.8(100)
However, when Disposable is Zero, Consumption becomes 150 units
Plotting these points gives us the consumption frontier as below.
At point A, consumption is at 700 billion dollars and the total disposable income is 800 billion dollars. Therefore, savings is ($800-700) $100 billion. As disposable income increases, the rate of consumption also increases although at a higher value than the aggregate expenditure. When the disposable income increases by $200 billion per year beyond point A, the households would be earning $1000. At this point, consumption rate is $950 billion per year.
2. Effect of tax cuts
Economic balance is an important question in the maintenance of economic health of a country. It brings spending and incomes of individuals to equilibrium by controlling the effect of inflation. Achieving this state, therefore, has been the greatest concern of most international economists and world governments. Both fiscal and monetary tools are used to achieve this condition.
Fiscal policy is a government initiated intervention that influences the economic direction of a country through changes in taxes and spending.
Aggregate supply refers to the total amount of goods and services suppliers are able to float on the market at a given price.
Aggregate demand refers to the total quantity of goods and services buyers are able to consume or purchase from the market at a specific price. In an economy, AD IS divided into four major components: consumption, government spending, net exports, and investment. Changes in any of these constituents lead to a shift in the aggregate demand curve.
The tax cut is an expansionary fiscal policy. It is used to stimulate the economy in times of recession. This is because reducing taxes boosts the aggregate demand which in effect increases output (production) and employment levels in the economy (Galí, López‐Salido, & Vallés p.18). A reduction in taxes will, therefore, cause consumption and savings to upsurge by leaving more disposable income, the aggregate demand curve, in turn,shifts to the right from AD1 to AD2 because prices have reduced from P2 to P1. The shift in the Aggregate Demand curve in response to the tax, however, depends on the magnitude of the tax multiplier.
The Aggregate supply curve, on the other hands, shifts outwards from AS1 to AS2 because suppliers are willing to produce goods or offer more services because of the increase in the aggregate demand and spending. This in response creates more jobs offered at handsome wages due to higher aggregate disposable income in the economy, thus, furthering the increase in aggregate demand. This secondary effect is known as the multiplier effect
Economic growth is one of the major goals of international economics. 3.Acemoglu (2009) defines economic growth as the general improvement in the ability of an economy to produce goods and services in a given period compared to the other. Economic growth can either be measured in real or nominal terms. The real term is always adjustable for inflation. Anciently, economic growth used to be measured gross domestic products (GDP) or gross national products (GNP). Federal economic growth can stimulate in a number of ways either in the short-run or long-run.
The number one option available for undertaking this step is focusing on improving the aggregate demand across all market in the economy. Aggregate demand is important in ensuring a short-run economic growth. The U.S. Economy seems to be having a spare capacity, especially in relation todemand goods and services in the economy. A tap on this opportunity may result in the increase in the country’s real GDP
Aggregate Demand in the country has four major components: consumer spending, Exports, Government Spending, and gross fixed capital investments. An effort to increase all these variables would result in economic growth due increase in the real GDP demand.
An increase in the real GDP denotes an economic expansion as the amount of goods and services being produced rises from Q1 to Q2. This stimulates the creation of employment opportunities. Prices also referred to on this paper as the GDP Deflator, on the other hands, rise in response to the increase in aggregate. The rise prices in this situation would be considered as a demand inflation as it results from the increase in the aggregate demand.
To improve the aggregate demand. Therefore, the federal government ought to increase government spending on public development projects such as roads and other public investments while reducing taxes charged on corporate bodies and business startups.
Long-run economic growth
With a focus on long-term economic growth, the federal government should ensure that quantity of goods and services supplied in market continually increase as shown in the below.
Changes in the in the quantity of goods supplied in the active markets affects nation real GDP which is the determinant of economic growth. To influence these, the government ought to focus on capital ventures such as investment infrastructure or creation of new factories. Other avenues can be increasing labor productivity (through improved technology and better education (Lehn et al. p.2) and training), working for population (through higher birth rate and immigration) and employing tax cuts.
In the long run, tax cuts improve the gross national output by increasing the supply the labor supply from Y1 to Y2. This leads to a change in equilibrium from point to point B as shown in the graph below. At this point, the national production peaks since workers are satisfied with their wage rate P2
From the diagram aggregate economic growth can be assessed as the difference between LRAS2 and LRAS1. That is economic growth= LRAS2-LRAS1.
Acemoglu, D. (2009). Introduction to Modern Economic Growth: Parts 5! 9.Deparment of economics, Massachusetts institute of technology
Galí, J., López‐Salido, J. D., & Vallés, J. Understanding the effects of government taxes on Market forces. Journal of the European Economic Association, .2007. 5(1), 227-270.
Gali, Jordi, and Tommaso Monacelli. «Optimal monetary and fiscal policy in a currency union.» Journal of international economics 76.1 (2008): 116-132.
Lehn, Christian, Aspen Gorry, and Eric Fisher. «Male Labor Supply and Generational Fiscal Policy.» 2016 Meeting Papers. No. 536. Society for Economic Dynamics, 2016.
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