University:
London School of Economics and Political Science
Course:
L400 | International Social and Public Policy
Academic year:

2024
Views:

301

Pages:

4
Author:

Prerna T

Title: Aman Heading: Discuss the effectiveness of reducing Government spending in order to lower demand pull inflation. Definition: Government spending can be defined as spending by the local and central authority on goods and services. Explanation of Demand-Pull Inflation: Demand-pull inflation is a rise in the price level caused by an increase in aggregate demand. Government spending is a component of AD, so it can be used to reduce demand-pull inflation. Impact of Reducing Government Spending: A reduction in government spending is an example of deflationary fiscal policy and is likely to reduce demand-pull inflation. Government spending is a component of AD, so a reduction in government spending, ceteris paribus, is likely to result in a fall in AD at all price levels. This will shift the AD curve to the left. Diagram Analysis: The fall in AD will shift the macroeconomic equilibrium position from A to B, which means the price level falls from P1 to P2. Overall Description: The image provides a visual representation of the relationship between government spending, aggregate demand, and inflation. It demonstrates how a reduction in government spending can help lower demand-pull inflation by shifting the aggregate demand curve to the left. The accompanying text explains the underlying economic concepts and provides a detailed analysis of the diagram. Impact of Reducing Government Spending: If the cut in government spending is through reducing benefits, it will cause a lowering of demand-pull inflation. This is because people have less real disposable income. This means they are less likely to reduce the purchasing of consumer products. Consumption is a component of AD. This means that AD is likely to shift left, and the price level will also fall. Impact on Labor Force: A lowering of benefits will increase the incentive for people to work. More people are likely to enter the labor force. This will increase the quantity of labor. Impact on Aggregate Supply: In the long run, AS is likely to increase since the quantity of resources has increased. Overall Impact: The increase in AS will shift the macroeconomic equilibrium from A to B, and the price level will fall. Effectiveness of Reducing Government Spending: The effectiveness of reducing government spending on demand-pull inflation depends on what the reduction is spending on. A reduction in training and education or subsidies is unlikely to affect AD significantly. Reducing spending on training and education can impact aggregate supply by causing an increase in firms' costs of production. This will not reduce demand-pull inflation but is likely to cause cost-push inflation. The price level will increase from P1 to P2, showing cost-push inflation. Other Components of AD: There are other components of AD that may counteract the change in government spending. For example, if interest rates are low, consumption may increase. Consumer confidence may also play a role. If consumer confidence is high, consumption may increase, which will cause a rise in AD. Government spending may play a smaller role in determining AD compared to other factors. Therefore, a change in government spending may be insignificant in reducing AD.