Macroeconomics Essay Example | Topics and Well Written Essays - 1000 words - 7

Macroeconomics - Essay Example expenditure, thus Another way to reach eqn. (3) is to start from the equilibrium at the market for loanable funds. National saving (S) can be considered to be the supply of loans in the economy and national (gross) investments (I) as demand for the loans. Now, The govt. expenditure multiplier is 1/ (1-c1), as calculated from eqn. (3), where, c1 = MPC. In this example MPC is 0.8. Hence, a  £1 rise in govt. expenditure will raise the GDP by  £1/ (1-0.8) =  £5. Again from the equation (3) we can calculate the tax-cut multiplier to be c1/ (1-c1). In this example, c1 = 0.8 and hence the value of the multiplier will be 0.8/ (1-0.8) = 4. Therefore a  £1 cut in the income tax would raise the GDP by the amount of  £4 and so a  £100 million of tax cut shall raise the GDP by 4 x  £100 million =  £400 million. If now G goes up by  £100 million GDP would rise by  £500 million. Again if this increased G is financed by raising T by  £100 million, i.e. if T goes up by  £100 million, GDP would fall by  £400 million. Hence the net effect of this balanced budget fiscal stimulus on GDP would be  £ (500 – 400) million =  £100 million, i.e. GDP would rise exactly by the amount spent on the public activities. In an economy in the short run, the prices as well as wages tend to be sticky. Hence, people often prefer to stay unemployed since they cannot get the right wage for their labour. This is the case that determines the natural rate of unemployment. Again, prices in the short run are sticky as well and thus are used to determine the real wages of workers that they consider to maintain a similar standard of living throughout. The wage setting equation is, W/P = w * (P/Pe) and the price setting equation is, p = P + a(Y – Y*) ADAS Model is a part of the classical model in economics that considers money to be neutral. According to the quantity theory of money, MV = PY where M = Money Supply, V = Velocity of money