ECN 200: Introduction to Economics Nusrat Jahan Lecture-10 ECN 200: Introduction to Economics Nusrat Jahan Lecture-10 Fiscal Policy and Monetary Policy

Sources of Economic Fluctuations  Aggregate Demand Aggregate demand curve relates price level to product output purchase quantity level. It is a downward-sloping curve.  Determinants of Aggregate demand - Consumer spending - Investment - Government purchases - Net export  Aggregate Supply The aggregate supply curve, which relates price level to businesses' real product output production levels.  Determinants of aggregate supply - Change in input prices - Change in productivity - Change in legal-institutional environment Price Level GDP Price Level GDP AD AS

Price Level GDP Price Level GDP AD’AD AD’ AS YY’Y P P’ P RecessionDemand-pull Inflation

Ways to control economic fluctuation 1. Fiscal Policy Fiscal Policy consists of deliberate changes in government spending and tax collections designed to achieve full-employment, control inflation and encourage economic growth.

 Expansionary fiscal policy: When recession occurs expansionary fiscal policy can be implemented to prevent economic downfall.  During recession investment↓ as a result AD curve shifts to the left.  Expansionary fiscal policy can be taken 3 ways-  Increased Government Spending  Tax reduction  Combined Government spending increases and tax reductions

 Contractionary fiscal policy: When demand-pull inflation occurs, a restrictive or contractionary fiscal policy can be implemented to control it.  When demand-pull inflation occurs, the demand for goods & services ↑ as a result investment↑ which shifts the AD curve rightwards.  Contractionary fiscal policy can be taken in 3 ways-  Decreased government spending  Increased taxes  Combined government spending decreases and tax increases

2. Monetary Policy It consists of deliberate changes in the money supply to influence interest rates and thus the total level of spending in the economy to achieve and maintain price-level stability, full employment and economics growth.  Expansionary Monetary Policy: - It is exercised during recession. - Interest rate is lowered to bolster borrowing and spending. - Greater spending will create greater aggregate demand and increase real output.  Contractionary Monetary Policy: - Interest rate in increased in order to reduce borrowing and spending. - Lower spending curtails aggregate demand and hold down price-level increases.