Exam Assignment Example | Topics and Well Written Essays - 1000 words

Exam - Assignment Example With time, this aggregate demand affects the allocation of resources and the productive capacity of an economy through its influence on the returns to factors of production, the development of human capital, the allocation of capital spending, and investment in technological innovations. Tax rates, through their effects on the net returns to labor, saving, and investment, also influences both the magnitude and the allocation of productive capacity. Macroeconomics has long featured two general views of the economy and the ability of fiscal policy to stabilize or even affect economic activity. The equilibrium view sees the economy quickly returning to full capacity whenever disturbances displace it from full employment. Accordingly, changes in fiscal policy, or even in monetary policy for that matter, have little potential for stabilizing the economy. Instead, inevitable delays in recognizing economic disturbances, in enacting a fiscal response, and in the economy’s reacting to the change in policy can aggravate, rather than diminish, business-cycle fluctuations. An alternative view sees critical market failures causing the economy to adjust with more difficulty to these disturbances (Ellis p 163). If, for example, consumers were to reduce their current spending in order to consume more in the future, producers, who would not know the consumers’ future plans for want of the appropriate futures markets for goods and services, would see only an indefinite drop in demand, and this might encourage them, in turn, to reduce their hiring and capital spending. In this world, changes in fiscal and monetary policy have greater potential for stabilizing aggregate demand and economic activity. How the economy reacts to fiscal policy depends on whether it is at full employment or operating below its full capacity. Wages and prices will start going up at great rates if monetary policy creates demand enough to enhance capital and labor markets beyond its long-run goals. A monetary policy that constantly attempts to its halve its short-term rates at an all time low will at the end achieve higher inflation will have no fixed increases in the growth of output or reduction in unemployment. In the long run, monetary policy cannot set employment and output. As there is a trade-off seen between lower unemployment and higher inflation in the short run, this trade-off will not be in the long run. This policy will also affect inflation directly through the people’s expected future inflation. If for example the fed eases the monetary policy and consumers and businesspeople figure it out, that will lead to higher inflation in the future and they will ask for an increment in their wages and prices. That will heighten inflation without great changes in output and employment. National saving provides the resources for a nation to invest domestically and abroad. Domestic investment in new factories and equipment can boost productivity of the nationâ €™s workforce. Increased worker productivity, in turn, leads to higher real wages and greater economic growth over the long term. U.S. investment abroad does not add to the domestic capital stock used by U.S. workers to produce goods and services. U.S. investment abroad does increase the nation’s wealth and will generate income adding to U.S. GNP. When national saving is lower than domestic investment, a nation can borrow from foreign savers to make up