Economic Stability: Production, Consumption, and Fiscal Policy
Production and Consumption Imbalance
Lack of Equilibrium: When production doesn’t match consumption.
Causes:
- Overproduction: Excess goods lead to unsold inventory, price drops, and layoffs.
- Underproduction: Shortages cause higher prices (inflation).
Impact: Overproduction can cause recessions; underproduction leads to inflation. Balance is crucial for stability.
Investment Determinants
Interest Rates: Lower rates encourage investment; higher rates discourage it.
Business Confidence: Optimism boosts investment; uncertainty reduces it.
Technological Advances: Innovations drive investment for productivity and competitiveness.
Fiscal Policy and Economic Stabilization
Non-Discretionary Fiscal Policy
Automatic adjustments stabilize the economy without new legislation. Example: Unemployment benefits rise during recessions.
Contractionary Fiscal Policy
When to Use: To combat high inflation, rapid growth, or reduce government debt.
How to Implement:
- Cut government spending to lower demand.
- Raise taxes to reduce spending.
Fiscal Policy Effects
Budget Deficit: Expansionary policy increases the deficit.
Economic Growth: Stimulates growth by boosting demand and investment.
Time Lags:
- Recognition Lag: Delay in identifying economic problems.
- Decision Lag: Time to decide on fiscal measures.
- Implementation Lag: Delay in applying policy changes.
- Impact Lag: Time for the policy to affect the economy.
Factors Affecting Multiplier Effect
High Saving Rate: Reduces money circulation, weakening the multiplier.
Tax Increases: Lower disposable income reduces spending, weakening the multiplier.
Multiplier Effect Explained
An initial spending increase leads to a larger rise in income and output due to repeated spending.
Characteristics:
- Amplifies spending.
- Depends on spending habits (MPC).
- Weakens over time.
Discretionary Fiscal Policy
Deliberate government action to manage the economy. Example: Stimulus packages during recessions.
Savings and Investment Imbalance
Excess Savings: Lowers demand and slows growth.
Excess Investment: Causes higher borrowing, interest rates, and inflation.
Consumption Determinants
Income: Higher income increases spending; lower income reduces it.
Wealth: Perceived wealth increases spending.
Interest Rates: Low rates encourage spending; high rates discourage it.
Government Influence on Economy
Expansionary: Increases spending or cuts taxes to boost growth.
Contractionary: Reduces spending or raises taxes to control inflation.
Direct Tax Characteristics
Paid directly by individuals or businesses.
Insurance and Deficits
Premium Risk
Risk that premiums may not cover future claims and expenses.
Deficit
Expenses exceed income, leading to a shortfall.