Gross domestic product (GDP)
This is the total monetary value of all goods and services that are produced by a country excluding the goods and services produced abroad usually in a period of one year. It consists of public and private consumption, investments, government expenditures and the net exports.
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This the total monetary value of goods and services produced within a country’s borders in a certain period of time and whose value has been adjusted to accommodate the inflation rate in that period. It can also be referred to as inflation corrected GDP. Real GDP puts into account price level changes hence are mostly used because they are more accurate than nominal GDP.
Nominal GDP is the total monetary value of all goods and services produced within a country for a given period but this value has not been adjusted to accommodate inflation. It is also called Current currency value GDP. Usually, the nominal GDP is higher than its actual value and is not an accurate measure of GDP compared to real GDP.
The unemployment rate refers to the percentage or section of the country’s total labor force that is not employed due to either low wages or excess labor supply. Unemployment rate is a show of a country’s lagging economy.
Inflation rate is the measure at which percentage price indices such as the consumer price index increases over a given period of time or the loss of the currency’s purchasing power, mostly per annum. Inflation rates can be used in adjusting wages and determination of real interest rates.
This is usually the rate at which one is charged or pays for borrowing money. It is in a percentage form per year of the principal amount that was lend or borrowed. It is found through the division of interest amount by the total principal amount. Interest rates are determined by the central bank and the commercial banks.
Economic resources flow in different directions in any economy. This is usually between the government, the households and the businesses. The flow of resources is caused by different kinds of economic activities.
Purchasing of groceries
Purchasing of groceries is one economic activity whose impact is not limited to the buyer and the seller. Purchasing of groceries in a macroeconomic environment can be referred to as consumption because the buyer does not take the groceries to another place or resell them, he consumes them directly. Consumption has effects on all the components of the economy, which is the government, the households (consumers) and the businesses (firms).
The households are affected by consumption in different ways. The households use their income to purchase the groceries. Therefore, the demand for groceries by households causes a reduction in their level of income. The amount of the groceries demanded by households is dependent on their level of income. If the level of income of a particular household is high, its purchasing power will be high hence that household can purchase additional groceries. Households usually have to find a balance between their disposable income and savings. These implies that any household sets aside part of its income for consumption purposes while another part of the income will set aside for savings. Consumption of the groceries reduces the income level of the household and reduces the amount of income that can be saved. The households level of investments will also be affected because the more the consumption, the lesser the savings hence investments reduce.
The other component of the economy that is affected is the firms or the businesses. These are the producers and sellers of the groceries and other consumption goods for the households. Producers benefit from the consumption of groceries by households. The households transfer their income to the businesses each time they make grocery purchases. The income of the firms will increase when households purchase groceries. The firms will use the income from the household purchases to produce more goods and at the same time save the extra income. Extra income for the businesses can be saved or invested through expansion of the businesses. Businesses also have to pay taxes to the government, therefore, the higher the amount of sales they make, the higher the amount of tax they pay. This is on the assumption that taxes are paid per every unit of groceries sold. Therefore, as the groceries (products) move from the business to the consumer, the incomes flow in the opposite direction to the businesses and then to the government.
The government is the third component of the economy that is affected by the purchases of groceries. The government collects taxes from both the households and the businesses. Once the households receive their incomes, they have to pay a predetermined percentage of that income to the government in form of taxes. Businesses also pay taxes to the government. Therefore resources move from both the businesses and households to the government. However, the government also moves these resources back to the firms and businesses by giving transfer payments and tax reliefs to households while the businesses receive tax incentives from the government. Therefore, for the purchase of groceries, income flows from households to the businesses then to the government. The resources then flow from the government to both households and businesses.
Massive layoff of employees
Massive employee layoffs imply that there is an increase in the level of unemployment in the economy. This is an economic activity that is detrimental to all the components of the economy. This usually occurs when the economy is experiencing a downturn or a recession.
Employee layoffs mean that the households are negatively affected. This is because the employees are the members of these households who make up the labor force in the economy. The households will therefore lack income or their income will be reduced. They will therefore depend on their savings since their income has reduced or is not there at all. Their consumption will reduce because of the loss of purchasing power.
The businesses will have to reduce on the level of production because the consumption levels will have significantly dropped. Similarly, the businesses that will have lain off employees will break even because their wage bill will have been cut down. The businesses will produce few goods and services because of the lower level of labor force than the level before other employees were laid off. This low production also affects the amount of taxes that the businesses pay to the government. Therefore, the amount of productivity reduces, wages reduce, unemployment increases, the amount of taxes paid reduce and the economy shrinks because of the massive layoff of employees.
The government will lose in that the employees who get the sack will not be paying taxes anymore hence government revenue reduces as well as government expenditure. The government may decide to increase its expenditure so as to trigger economic to create employment and increase productivity. In this case, money flows from the households to the businesses then to the government while resources flow from government to firms to households. The government can use the fiscal policies or monetary policy tools to solve this problem of unemployment increase. Resources will flow from the government to the households and businesses if at all this problem will be solved because during this time, resources move from households to businesses and to the government.
Decrease in taxes
A decrease in the amount of taxes is also an indication that the economy is shrinking. It may have very negative effects on each component of the economy or have a positive effect depending on the cause of the decrease in taxes.
A decrease in taxes affects the government in different ways. First, a decrease in the amount of tax implies that the government’s expenditure is automatically reduced due to reduced revenues. The decrease in taxes also results in the government laying off some workers or abandoning some of its activities that it may not be able to fund. The government will have a very low expenditure power in that it will not cater for all its needs. The government may decide to place a heavier tax burden on households and the businesses or to promote economic growth by reducing the tax burden on both households and the firms. Tax cuts result in incentives for businesses who invest more resources to take advantage of the incentives to make more profits. The households will benefit by having a higher level of disposable income hence will have ability to purchase more gods than before. This will result in high levels of economic activity that induce economic growth.
Businesses will benefit from tax decrease more than any of the other economic components. This is because the lower the level of tax levied, the higher the amounts of profits the businesses make. The decrease in taxes will therefore make the businesses they will to invest more of their available resources so as to maximize their profits. Therefore produce more output than before the taxes were decreased.
The households will also benefit from a tax decrease because they will have a higher purchasing power due to the income effect resulting from a tax reduction. The consumers will consume more goods and services than before the tax decrease. The consumer’s savings will also increase due to the tax decrease hence they will invest more than they used to invest before the tax cut. Therefore a decrease in tax causes a flow of resources from the government to the households and businesses while other resources will flow from the households to businesses as they will be receiving them when they sell their products.
There are several resources that can be used to obtain historical economic information and in economic forecasting information. These resources include: consumption patterns, investment patterns, exports and imports, government expenditure, interest rates, gross domestic output (GDP), Inflation rates and unemployment rates.
Information on consumption can be used to determine the ability the public and the private components of the economy. Through consumption patterns, the income levels of the people, the price levels in the economy and the inflation rates can be determined. Consumption patterns are important when determining the size of the economy through Gross Domestic Product calculation. The consumption amounts over a period of time can be used to forecast future consumption patterns using the prevailing economic conditions.
The investment patterns in an economy will be resourceful to an economist because they are used to determine the amount of savings, taxation, inflation and interest rates in an economy. Investments contain factors like inflation rates, interest rates and tax rates which are useful in the calculation of future economic lending rates and amounts of investments.
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Government expenditures are very important when calculating a country’s gross domestic product and the calculating the amount of taxes that the public pays as well as the transfer payments by the government. Components such as taxes and transfer payments are very useful in determining the future levels of government expenditure.
These are the exports less imports that are very important is determining a country’s economic productivity and economic state. A surplus value for the net exports indicates a stable economy and can be used to predict future economic success.
The changes and economic responses of fiscal policies have different levels of effectiveness in the Keynesian and Classical economic models.
The Keynesian model
It is based in the use of taxation and government spending to stabilize the demand side of the economy through wealth and income redistribution. It is assumed that an increase in the government spending raises demand through the multiplier. An increase in the spending multiplier increases the efficiency of the fiscal policy. This is possible by raising the marginal propensity to consume. The fiscal policy will therefore be efficient only when the consumer’s propensity to consume is high, meaning they will have demand more goods and services in the economy. Therefore in the Keynesian model is used by increasing government expenditure to increase the purchasing power of the public.
The classical model
In this model, the fiscal is used to improve the economy’s supply side. This is through provision of incentives that will enhance profit maximization. Therefore, the fiscal is effective when the producers are given tax cuts through low tax rates to cut down on the production costs. This will raise investments and savings hence producers will produce and supply more goods and services than before. Therefore, the taxation part of the fiscal policy is the most effective in improving supply. The evaluation of the fiscal policy is done by analyzing the quantity produced and supplied.
Abel, A. B., & Bernanke, B. (2008). Macroeconomics (6, illustrated ed.). New York: Pearson / Adison Wesley.
Boyes, W., & Melvin, M. (2011). Fundamentals of Economics (5 ed.). London: Cengage Learning.
International Monetary Fund. Fiscal Affairs Dept. (2002). The Effectiveness of Fiscal Policy in Stimulating Economic Activity. New York: International Monetary Fund.
Taylor, J. B., & Weerapana, A. (2008). Principles of Macroeconomics (6, illustrated ed.). London: Cengage Learning.