Fiscal Policy Simulation Essay Example | Topics and Well Written Essays - 500 words

Fiscal Policy Simulation - Essay Example In 2008, however, as the economy continues to expand, inflation has surged up to 10.05%. A very high figure from the previous years, to address the inflation is the major aim of the government. In order to address the inflation, the government has adopted a contractionary fiscal policy, which entails decrease in expenditure for infrastructure of 600 million, decrease in spending in the educational programs, and decrease in the income tax rate. The effects of these changes include a taming of the inflation rate, down to 5.30%. However, as what economics is about, there is always a tradeoff—because of the decrease spending, unemployment rate increases from 3.53% to 4.35%. Lastly, real GDP decreases from 42.00 billion to 41.32 billion in 2008. In 2009, as the economy continues to approach its potential output, inflation continues to be beyond the acceptable level. In order to curb down inflation and bring it down, the government has to adopt contractionary policy by decreasing spending in educational programs by 400 million. This change lowers real GDP from 42.00 billion to 41.35 billion. This aims to curb down inflation rate from 42.00 billion to 41.35 billion. However, due to decrease in spending, unemployment is expected to increase from 3.53% to 4.32%. b. Erehwon’s marginal propensity to consume is 0.8, which means that for every dollar the consumers receive, 0.8 cents are spent. Given this, the multiplier of the economy is computed by using the formula 1/1-mpc. With a computed mutliplier of five, for every change in the components of aggregate demand, the overall economy expands five times. Let us examine the first situation. In the first situation, the government spending for infrastrucue is 300 million, and 100 million for educational program. This increases the aggregate demand not by 400 million, but by the increase multiplied by the