Macroeconomic Equilibrium and Public Sector Policies

Posted on Dec 4, 2024 in Economy

Aggregate Demand and Macroeconomic Equilibrium

Defining Aggregate Demand

A country’s economic activity is defined by variables that determine price level, employment, and production. These variables fall into two categories:

  • Aggregate Supply (OA): The total amount of goods and services businesses are willing to produce and sell at each price level. This depends on:
    • Productive capacity (facilities and their utilization)
    • Cost and availability of production factors
    • Available technology
  • Aggregate Demand (DA): The total amount families, businesses, and the public sector are willing to spend at each price level. It consists of four elements: consumption (C), investment (I), government spending (D), and net exports (X-M). DA = C + I + D + (X – M)

Macroeconomic Equilibrium

Macroeconomic equilibrium occurs when aggregate supply equals aggregate demand. This equilibrium determines the price level (influencing inflation) and the equilibrium output level (Ye), which affects employment. This balance can present social problems like high inflation or unemployment. To address these, the government can influence aggregate supply and demand curves through macroeconomic policies.

Macroeconomic Policies

These are measures taken by the government to adjust aggregate supply (OA) or aggregate demand (DA) to modify price or production levels.

Demand-Side Policies (Influencing DA)

  • Fiscal Policy: Modifies DA through taxes and public spending.
  • Monetary Policy: Modifies DA through interest rates and money supply.
  • Trade Policy: Modifies DA through exchange rates and competitiveness.

Supply-Side Policies (Influencing OA)

  • Reindustrialization Policy: Adjusts labor supply to real work demand.
  • Incomes Policy: Distributes national income more equitably among production factors.

The Business Cycle

Economies experience cyclical changes in production. These changes form a sequence called economic cycles, each with four phases:

  1. Trough: The lowest point with minimal demand, accumulating stocks, halting production, and high unemployment.
  2. Expansion/Recovery: Positive expectations lead to investment, increasing demand, production, and reducing unemployment.
  3. Peak: Maximum production level, making further growth difficult, with the lowest unemployment.
  4. Recession: Decreasing demand reduces production and gradually increases unemployment.

The Public Sector and Fiscal Policy

Functions of the Public Sector

The public sector aims to achieve three economic goals:

  1. Promote economic efficiency
  2. Ensure citizen equality by improving income distribution
  3. Encourage economic stability and growth

To achieve these, the public sector:

  1. Establishes and collects taxes.
  2. Regulates economic activity through laws (e.g., competition, advertising).
  3. Provides public goods and services (e.g., healthcare, roads) when the private sector doesn’t or provides insufficiently.
  4. Redistributes income for greater equality.
  5. Stabilizes economic variables to prevent fluctuations and crises.

Fiscal Policy

Fiscal policy encompasses government measures to influence production and prices by altering public expenditure, transfers, and taxes. Expansionary fiscal policy increases aggregate demand, while contractionary fiscal policy reduces it.

Discretionary Fiscal Policies and Automatic Stabilizers

The government uses discretionary policies and automatic stabilizers to implement fiscal policy.

  • Discretionary Policies: Explicit measures to influence public spending or consumption (e.g., public works programs to create jobs and infrastructure).