Macroeconomic Principles And Policy Example

Macroeconomic Principles and Policy

In 2003, the Internal Revenue Service began to mail out refund checks because of a change in the tax law. Economic forecasters predicted that consumption and GDP would increase because of higher refunds on income taxes.

Pretend as if you are an economist and explain your thoughts on whether the tax cuts from the past few years have been successful in promoting economic growth or in preventing a deeper decline?

When income taxes are reduced then consumer real income will rise, the real income is that income which has been deducted taxes, when this income increases there are a number of outcomes that will result, the first is the increased demand for goods as real income increase for those goods that are normal goods.

When income taxes are reduced the consumers’ real income will or the disposable income will increase resulting to an increase in the demand for goods and services in the economy, when there is increased demand then this signals to suppliers to supply more through increased production, this increased production will result to higher GDP levels in the economy and therefore the tax cut will promote growth in the economy.

The other result of a tax cut is the increased in the investment levels, as the disposable income

Macroeconomic Principles and Policy

of the individuals in the economy increases, all the extra disposable income will not be consumed through purchase of goods and services, rather the disposable income will find its way into investment, when there is increased investment then there are prospects of high economic growth due to this tax cut, the multiplier and accelerator theory depict the result of this tax cut below:

From the above diagram and increase in income that results into an increase in investment is called the accelerator effect, on the other hand an increase in investment that results into an increase in income levels is called the multiplier effect.

When there is increased income levels then there will be the accelerator effect that leads to increased investment, increased investment also means increased economic growth and employment. When investment increases then there will be increased income due to increased employment and earnings by employees as shown, therefore an increased disposable income due to a tax cut will eventually lead to increased GDP.

Tax cut result: economic growth or in preventing a deeper decline

Therefore a tax cut will result to a growth in the economy, this is because the increase in consumer real income will result into greater demand for goods in the economy and this will result into greater investment and employment opportunities, this is the accelerator effect.

The tax cut will also promote investment in that the increase consumer disposable income will not all be consumed, individuals will invest a portion of the increased disposable income in the economy, this is because the factors that result into economic growth include capital accumulation, investment, increased resources and investment in human capital. Therefore this tax cut will not result into a deeper decline but a growth in the economy.

Macroeconomic Principles and Policy

Are there other changes to fiscal policy that you feel would have been more successful?

When there is increased demand then this may turn inflationary, this inflation as Keynes stated will be caused by excessive demand, this type of inflation is known as demand pull inflation, therefore the best fiscal policy that will follow will be that which reduces inflation, government spending is inflationary and followed by this inflation caused by the tax cut then there is need to reduce government spending in order to reduce the inflationary pressure which would lead the economy into a recession.

The tax cut will also reduce government revenue, therefore there is need for the government to reduce spending in order not to run deficit budgets, the tax cut reduces government revenue and the government should reduce spending in order to avoid still this inflationary pressure and also deficit budgets.

References:

Brian Snow (1997) Macroeconomics: introduction to macroeconomics, Rout ledge publishers, U K

Stratton (1999) Economics: A New Introduction, McGraw Hill Publishers, UK

Philip Hardwick (2004) Introduction to Modern Economics, Pearson Press, New  York