Business Principle Economics

• Tutor Name: Mr. John Opoku.• Topic: Demand Side, Supply side, Fiscal Policy• Institute: London School Of Accountancy & Management

• Group Members:• Mr Walter Adigwe : ST 9667• Miss Haleema Sadia : ST 9297• Mr Ankitkumar Shukla : ST 8344

Demand Side Policy

• Demand side policies aim to deal with just the demand. For example if we decrease interest rates, we will increase the demand in the economy as people have more money as their mortgage costs are decreased.

• It is the same idea with lowering taxes - this will boost demand, as people have more money to spend as less is taken away from them by the government.

Demand Side Policy

• In general demand side policies aim to change the aggregate demand in the economy. A.D. is made up of consumer spending + government spending + investment + exports - (minus) imports.

• So anything that effects these factors will affect demand. We tend to use these for short term changes - if inflation is getting too high, we increase interest rates for example to cool the economy down.

Strengths of Demand-Side Policies• Demand side policies(or Keynesian polices) are good for boosting a

country out of a recession by moderating the business cycle. When the economy is experiencing an inflationary gap, the government would raise taxes and/or decrease government spending in order to bring the economy down to a more stable level. Even though the demand of purchasing goods have decrease, the tax revenue would still apparently be the same as shown in the Laffer curve.

• A constant tax rate would only mean a decrease in the tax revenue. Inversely, the government would lower taxes and/or increase government spending during a recession in order to bring the economy out of it, such as cutting employment benefits. The ultimate goal of demand side policies is to limit the erratic nature of the business cycle, decreasing the magnitude of both recessionary and inflationary gaps.

Weaknesses of Demand-Side Policies

• Time Lags - Demand side policies are useful for getting out of a recession, but by the time the government is able to determine where the country's economy is located, it is too late to fix things.

• Data lags - The amount of time it takes to gather data on the economy, it can also be too late to fix the problems.

• Political lags - By the time politicians get through lengthy negotiations, the economy could have changed, and their policies could be ineffective.

• Implementation lag -The time it takes for money to be printed and spread into the economy, can also be too late.

• It can cause inflation.• Can cause a budget deficit - The government spends money that it does

not have and has to borrow money that probably has interest on it.

Supply Side Policy• Supply-side economic policies are mainly micro-economic policies

designed to improve the supply-side potential of an economy, make markets and industries operate more efficiently and thereby contribute to a faster rate of growth of real national output

• Most governments now accept that an improved supply-side performance is the key to achieving sustained economic growth without a rise in inflation. But supply-side reform on its own is not enough to achieve this growth. There must also be a high enough level of aggregate demand so that the productive capacity of an economy is actually brought into play.

• There are two broad approaches to the supply-side. Firstly policies focused on product markets where goods and services are produced and sold to consumers and secondly the labour market – a factor market where labour is bought and sold.

Supply Side Policies for Product Markets

• Product markets refer to markets in which all kinds of commodities are traded, for example the market for airline travel; for mobile phones, for new cars; for pharmaceutical products and the markets for financial services such as banking and occupational pensions.

• Supply-side policies in product markets are designed to increase competition and efficiency. If the productivity of an industry improves, then it will be able to produce more with a given amount of resources, shifting the LRAS curve to the right.

Supply side policies for the Labour Market

• These policies are designed to improve the quality and quantity of the supply of labour available to the economy. They seek to make the British labour market more flexible so that it is better able to match the labour force to the demands placed upon it by employers in expanding sectors thereby reducing the risk of structural unemployment.

• An expansion in the UK’s total labour supply increases the productive potential of an economy. That expansion in the supply of people willing and able to work can come from several sources for example: encouraging older people to stay in the workforce; a relaxed approach to labour migration and measures to get non-working parents to actively look for work.

Fiscal Policy

• Fiscal policy is the use of government spending and taxation to influence the economy.

• When the government decides on the goods and services it purchases, the transfer payments it distributes, or the taxes it collects, it is engaging in fiscal policy.

• The primary economic impact of any change in the government budget is felt by particular groups—a tax cut for families with children, for example, raises their disposable income.

Fiscal Policy

• Fiscal policy is said to be tight or contractionary when revenue is higher than spending (i.e., the government budget is in surplus) and loose or expansionary when spending is higher than revenue (i.e., the budget is in deficit).

• Often, the focus is not on the level of the deficit, but on the change in the deficit. Thus, a reduction of the deficit from $200 billion to $100 billion is said to be contractionary fiscal policy, even though the budget is still in deficit.

Effect of Fiscal Policy

• The most immediate effect of fiscal policy is to change the aggregate demand for goods and services.

• A fiscal expansion, for example, raises aggregate demand through one of two channels. First, if the government increases its purchases but keeps taxes constant, it increases demand directly. Second, if the government cuts taxes or increases transfer payments, households’ disposable income rises, and they will spend more on consumption. This rise in consumption will in turn raise aggregate demand.

Fiscal Policy with Government Aggregate Demand

• When the government runs a deficit, it meets some of its expenses by issuing bonds. In doing so, it competes with private borrowers for money loaned by savers. Holding other things constant, a fiscal expansion will raise interest rates and “crowd out” some private investment, thus reducing the fraction of output composed of private investment.

• In an open economy, fiscal policy also affects the exchange rate and the trade balance. In the case of a fiscal expansion, the rise in interest rates due to government borrowing attracts foreign capital. In their attempt to get more dollars to invest, foreigners bid up the price of the dollar, causing an exchange-rate appreciation in the short run.

Fiscal Policy

• This appreciation makes imported goods cheaper in the United States and exports more expensive abroad, leading to a decline of the merchandise trade balance. Foreigners sell more to the United States than they buy from it and, in return, acquire ownership of U.S. assets (including government debt). In the long run, however, the accumulation of external debt that results from persistent government deficits can lead foreigners to distrust U.S. assets and can cause a deprecation of the exchange rate.

Thank You