Macroeconomic as/Ad Framework

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1) Use the AS/AD framework to show the separate effects on GDP, inflation and public sector borrowing on any single national economy of: a) cut in public spending b) an increase in the rate of VAT (sales tax) c) a slowdown in the GDP growth of less developed economies. (Make sure that you include clear and appropriate diagrams for this question) According to Begg and Ward (2009) fiscal policy is the government’s decisions regarding taxation and spending to influence level of demand for goods and services. Cut in public spending and increase in the rate of VAT are instruments of contractionary fiscal policy in order to slow down economy, reduce inflation and deficit. a) Cut in public spending…show more content…
43.390 5,1 14,8 –7,3 2008. 47.766 2,2 13,2 –8,9 2009. 45.667 –6,0 14,9 –5,0 2010. 45.920 –1,2 17,4 –1,0 2011. 45.923 0 18 –1,0 2012. forecast 45.799 –1,0 18,5 0,3 2013. forecast 47.708 1 18,3 0,9

Table 2 Croatian macroeconomic statistical indicators (Croatian National Bank) As a conclusion we can say that contractionary fiscal policy is showing effects on a long run (reduces deficit, and balanced ratio of government spending and revenue), however in short run it is causing recession and increased unemployment.

c) Slowdown in the GDP of less developed economies from perspective of exporting country to LDE will lead to the reduction of export (part of aggregate demand) to the LDE country because their output and consumption will be reduced. Consequently expenditure and production in exporting country will be reduced which results in increased unemployment and decreased output. Since government income from taxes has been reduced government will need to increase borrowing in order to cover deficit. Export to LDE is quite unique since such countries are mostly agriculture oriented. According to UNDP most of LDE import is based on basic food stuff (wheat and rice) and projections for 2015 are suggesting that this dependency will continue to increase. Also, according to UNDP export of LDE are heavily dependent on weather conditions which shift LDC country from deficit to surplus situation. Another
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