Essay by the title: Evaluate, using appropriate diagrams, how policies to correct a budget deficit may affect other UK macroeconomic polices
achieved 17/25 (A)
Evaluate, using appropriate diagrams, how policies to correct a budget deficit may affect
other UK macroeconomic polices
A budget deficit is when the tax revenue received by the government is lower that the
amount that the government spends, this can be corrected by using fiscal policy.
By using a contractionary fiscal policy, the macroeconomic objectives like
unemployment will see a rise. By increasing income tax, consumers will be getting a smaller
proportion of disposable income and increase the amount that the government is receiving
in revenue. this means that people are more likely to save thus there is a decrease
consumption in the economy, and as consumption is a component of AD. AD will shift to the
left to AD1 from AD2. This shift in AD causes a decrease in RGDP which will cause an
increase in cyclical unemployment because it is derived demand, if it persists there can be a
hysteresis crisis. This will cause a negative multiplier effect.
1. (AD shifting left)
By using a supply side policy to correct the budget deficit will have more of an effect.
Using a supply side policy like increased spending on education and training, there will be an
increase in the productive potential in the economy, and an increase in labour mobility. This
increase in productive potential will cause the rightward shift of the LRAS curve form LRAS
to LRAS1, which will cause the ability for sustainable growth in the long run. this will cause a
decrease in structural unemployment. And therefore, with more people in work and earning
more due to their improved skills the government will be gaining more in tax revenue and
therefore reduce the budget deficit.
2. (LRAS shifting right)
The UK current account may be affected by the attempt to correct the budget deficit.
If a contractionary fiscal policy is used, the decrease in government spending will cause a
leftward shift of AD, and as consumption is a component of AD. AD will shift to the left to
AD1 from AD2. This means that there is less demand in the economy causing the prices to
fall. This will increase the level of international competitiveness the UK faces relative to
other countries, which will increase their increase their exports causing an improvement in
their current account.
In judgement, For the supply side policy will see the effects later, this would help reduce the
budget deficit in the long run because there is a time lag, a shorter time lag is the money is
spent on university education rather than primary school education. It would also depend
on where the UK is on the LRAS if they are pass full employment then the contractionary
fiscal policy will cause a reduction in the inflationary pressures. For the effect to be seen on
the current account, it would need to depend on the countries exchange rates and as well
as this the quality of the products that the UK is importing. A lower exchange rate will see an
increase in exports and higher quality products will also see the same.
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