In a macro economy, the government uses

certain policies in order to influence or

control the aggregate demand and supply of

the economy

These policies include Demand Side Policies

& Supply Side Policies

These policies try to influence the level of

aggregate demand in an economy

This is done by using a couple of policy

instruments

1. total public expenditure

2. levels of taxation

3. the interest rates

Fiscal Policy

Expansionary fiscal policy

Contractionaryfiscal policy

Monetary Policy

Expansionary monetary

policy

Contractionarymonetary

policy

Fiscal policyIt involves varying the

overall level of public

expenditure and taxation

rates in order to manage

or control the aggregate

demand in an economy

Monetary policyIt involves changes in

the money supply and

interest rates in an

economy to influence the

aggregate demand in an

economy

This policy is usually used during an

economic recession

It is used in order to boost the aggregate

demand in an economy

Cutting taxes on profits enables

producers to spend more

Cutting taxes on incomes may encourage

workforce to increase productivity

Cutting taxes on incomes may also increase the

disposable income of consumers

However some consumers may just save the

surplus money

Or some consumers may spend more on

imported goods and services

An expansionary fiscal policy may also

create a budget deficit

In may eventually creates expectations of

inflation

This policy aims to reduce aggregate

demand in an economy

This is done by reducing public expenditure

or increasing taxation

This way the budget deficit may go in a

surplus

However it may reduce employment and

output

Advantages of

Fiscal Policy1. Fiscal policy instruments

can bring about equality

in the distribution of

income

Disadvantages

of Fiscal Policy1. Fiscal policy is

cumbersome to use

2. Increases in public

expenditure decreases

private spending

3. Increasing taxes can

reduce incentives to

work and enterprise

This involves a cut in the interest rates and expansion in money supply to increase demand

It is used when unemployment is rising and economic growth is falling

Monetary policy is decided by the central bank

A cut in interest rates will encourage more people to borrow

Lower interest rates can increase consumer expenditure and investment expenditure

This will boost output and increase employment

More money supply can result in consumers

having a higher amount of money to spend

on goods and services

However excessive growth in money supply

can result in inflation

This involves raising interest rates and

cutting money supply to reduce aggregate

demand

This is considered in a situation of inflation

Increasing interest rates will encourage more

consumers to save rather than spend

However this may result in rising

unemployment and falling economic growth

Increasing interest rates encourages saving

thence increasing exchange rate

This may solve the problem of inflation

Decreasing interest rates decreases

exchange rates

This may solve the problem of

unemployment and may improve the foreign

exchange of an economy

These are designed to boost productive

potential of an economy to increase the

aggregate supply of goods and services

These will help reduce inflation,

unemployment and boost production of

goods for exports

Selective tax incentives

Selective subsidies

Improvement in education and training

Labour market reforms

Competition policy

Removing trade barriers

Privatization

Regulation and deregulation

Tax incentives and relief fund provided by

the government may encourage people to

invest more

Investing in modern technology may make

production processes efficient

A subsidy is a form of financial assistance

provided to a business by a government

This decreases the cost of production for

private producers

Businesses can expand there operations

using subsidies

The government aims to improve the

educational infrastructure and training sector

This will increase labour productivity

Changes have to be made in laws related to

market of labour

A restriction in the supply of labour will

increase the wage price

A government may introduce such laws o

reduce the power of trade unions

However employment funds provided to

labour may make individuals lazy

The government will make certain rules and

regulations to control monopolies

Government can also influence the supply of

an economy by putting restrictions on

imported goods

However when trade barriers are removed

globally this will increase the total supply in

the world

Privatization is a process in an economy

when the public sector firms are sold to the

private producers

The supply of goods and services will

increase due to the high level of efficiency

Regulations are the laws a business has to

abide by

These are set to protect some industries

from unfair competition

It also protects the rights of labours

These are set to protect consumers from

misleading advertising and to protect the

environment

Deregulations is a process in which certain

laws nd rules are eliminated

This provides freedom of decision making of

producers

These may help to remove production costs

as well

Deregulations help to reduce production

costs