IS-LM and Modern Macroeconomics - Assignment Example

Economics and of the Question Part A IS-LM model means the Investment Saving- Liquidity Preference Money Supply. The IS-LM is a macroeconomic tool that shows the relationship between the real output and the interest rates in the money market and the goods and service market (Blanchard, 2006). The IS-LM curve intersects at the point where the market is at equilibrium. This point is called the equilibrium point of the IS-LM curve. The figure below shows the IS-LM curve. Income The decision made by the United Kingdom Government in 2008 to decrease the VAT from 17.5% to 15% during the Christmas period will see the level of aggregate demand in the economy increase steadily (Young and Zilberfarb, 2000). This situation can be explained through the IS-LM curve (Young and Zilberfarb, 2000). The LM curve shows the relationship between the interest rates and the level of income. When the VAT is reduced, this means that the tax rates are reduced greatly. This also means that most of the people have increased incomes in the end as this model shows. In this case, when the rate of taxation reduces, the level of income consequently increases progressively more. In this situation, the decrease in the taxes therefore causes an increase in the incomes causing a shift in the LM curve downwards. The equilibrium level of income also increases hence causing an overall increase in the levels of incomes in every individual. When the United Kingdom decided to reduce the VAT taxes, this condition was similar what was happening to the economy. There was an aggregate increase for the income per person since the taxation decreased steadily. In the long run, people had much money to spend in the economy hence preferred to purchase more goods during this Christmas holiday. The IS-LM model is hence perfect at analyses the various conditions in the market and their effects (Young and Zilberfarb, 2000). They are used by economic experts in making sound decisions as made by the United Kingdom Government in the year2008. Part B Most of the taxes have a positive effect to the economy if they are used properly. In any case, if the tax collected is fully siphoned back into the economy, it can grow steadily. Many types of taxes can be corrected from the economy including the direct and the indirect taxes. Economists argue that people have different views on the effect of tax on the economy (Blanchard, 2006). Some people say that the effect is positive while others say that the effect is negative. The indirect tax is the tax that is paid on goods such that the buyer of these products pays more. An example of this tax is the VAT. The other type of taxes collected from the people includes the direct taxes. An example of this tax is the income tax. Taxes have a great positive effect in the economy since they assist in reducing the amount of money in circulation in the economy. Assuming a situation whereby there are no taxes, people receive 100% of their total earnings. Consequently, there is much money in circulation hence increasing the inflation rate in the economy. Inflation is a general rise in prices of all products in the economy, which is characterized by much money chasing only a few goods in the market. The condition of the economy continues becoming worse with time. The application of taxes additionally has a positive advantage to the economy since the government uses this amount to finance its projects. This money is used for development processes to improve the economy of the state in the end. Through research, it is proven that when all the tax collected from the economy is positively utilized by the government officials, it leads to better living conditions. However, there are also many negative effects of tax collection, especially to the citizens. All the types of taxes in the long run lead to a reduction in their disposable income. Consequently, they are left with very little to spend on a daily basis compared to when taxes are not collected. In most situations, the most unfavorable types of taxes are the direct taxes whereby an individual is deducted a certain percentage of their earnings as tax. Conclusively, it is important to note that all the taxes, both the direct and the indirect taxes have positive effects on the economy, if the officials plough back 100% the total amount back into the economy. Question 2 Part A The reduction of the government’s deficit can be made achievable by reducing on its taxes and reducing on its expenditure. However, reducing the deficit causes great negative effects to the economy. This situation is proven true since the government reduces on the public spending since it has fewer taxes to finance its projects leading to reduced investments (Mankiw, 2007). Additionally, it can also be argued that the deficit leads to a fast economic growth since it encourages private investments in the economy. The government can cause more trouble to the citizens since it reduces the peoples taxes and gets most of its funds from borrowings. The borrowings accumulate steadily with time consequently leading to increased fear among the citizens. The national debts continue rising steadily such that the government has no finances left. Additionally, the government too collects little taxes from the public, finally leading to more strains in the economy. However, with time, the economy can grow again since the government reduces on its spending leading to a stronger economy. Similarly, in the 2014/2015 budget, the move to reduce the taxes collected by the government, and reduce on its expenditure in the long run would lead to a better economic growth in Britain (Mankiw, 2007). At first, the government will experience much struggle since its finances will greatly be reduced compared to the previous time when it used to collect many taxes from the public. However, the citizens will be encouraged since they will have more to spend since their taxes are decreased. Additionally, most of the individuals with private businesses are the great beneficiaries in the British economy since they are charged fewer taxes, consequently leading to better profits. However, the economy in the end grows at a very slow rate since the government does not spend much money on financing development projects. This situation is negative since government investments lead to structural and a fast growth rate in the economy. Part B AD-AS is a macroeconomic concept means the Aggregate Demand-Aggregate Supply model. The economic model is very effective in showing the relationship that exists between the aggregate supply and the aggregate supply in the economy. In the question, the decision by the government to increase its spending on the output will cause many effects as depicted by the AD-AS macroeconomic model. In this case, if the government spends more on the outputs in the economy, it aims at producing more outputs in the economy. This situation is made possible through the subsidization of products (Dornbusch and Fischer, 2013). Consequently, increased output of products leads to reduced prices of products in the economy since some of the costs are catered for by the government. Additionally, this leads to increased demand of these products in the market since their prices are set to be lower. Governments’ expenditure on employment means that it struggles to ensure that most of the people in the economy, especially the youth are employed in the economy. Consequently, if the number of employed people increases, there is much money in the economy chasing little goods in the market. The price levels of products increase steadily since most of the people in the economy are financially stable. Consequently, one the prices of these products increases, the demand also increase steadily (Snowdon, 2002). The demand of the products also increases since most people have the urge to increase their aggregate demand as they have more money to spend. The increase in the government expenditure on prices of the products will see them reduced. Consequently, the reduction in prices of the products leads to a decrease in the supply of products in the economy (Snowdon, 2002). The output also steadily decreases in the economy since the demand of the products has reduced. Question 3 The move by the Bank of England to increase the interest rates in the economy is very positive. This is because the interest rates are very useful in an economy since it boosts it greatly. The interest rates in the economy increases greatly consequently encouraging many people to invest in the long run. Referring to the IS-LM model and the AS-AD model, increasing the interest rates has various effects on the economy of the United States (Blanchard, 2006). At first, the government can reduce the level of inflation in the economy. Consequently, the demand of the products also reduces steadily as the rate of economic growth reduces too. The output in the economy decreases since most o the people are encouraged at saving their money to raise more interest rates with time. The prices of the products can stabilize in the medium run since most of the money that was in circulation reduces greatly due to the massive savings. However at the short run, the prices of the products decrease greatly since they is little money in circulation as most people preferred to deposit much of their money to gain interests (Blanchard, 2006). The rate of growth of the company too decreases since most people are slow at spending their money and have no advice to borrow. Most of the businesses are affected negatively since, most of their customers do not spend as they used to earlier. Consequently, the growth of businesses in the economy greatly reduces, consequently leading to the reduction of employment in the economy. Supply of products also decreases steadily since most of the customers buy the products in very small quantities, hence meaning that the demand of products has reduced too. References Blanchard, O. (2006). Macroeconomics. Upper Saddle River, N.J., Pearson Prentice Hall. Dornbusch, R., & Fischer, S. (2013). Macroeconomics AC-AD model. New York, McGraw-Hill. Mankiw, N. G. (2007). Macroeconomics. New York, Worth Publishers. Snowdon, B., & Vane, H. R. (2002). An encyclopedia of macroeconomics. Cheltenham, UK, E. Elgar. Young, W., & Zilberfarb, B. (2000). IS-LM and modern macroeconomics. Boston, Kluwer Academic Publishers. Read More