Insight into Economics-4

Insight into Economics-4

Now that we saw Macro Economics divided into Fiscal economics and Monetary economics, the difference between them is, in Fiscal Economics budget deficits and interest rates are the policy tools for controlling the economy, where as in Monetary economics it is the money supply as I showed last.

Now let us talk about the Tax Multiplier. Before that one must know what is the MPC and MPS. MPC is the marginal propensity of a citizen to consume from his income, that is what  percentage of his income he uses to consume. MPS is the marginal propensity to save that is what percentage of income he saves which is always (1-MPS).

Now we have to know something about the GNP and GDP. GNP or gross  national product or the measure of the amount of output in an Economy is the sum total of its (consumption+investments+government spending+(exports-imports).  When we remove the last term depicting the foreign trade from gnp equation we get the GDP or gross domestic product.  These are the measured used to see how the economy is doing. If the gdp grows we say the economy is expanding or if it decrease we say the economy is contracting.

An economy is divided into 4 quarters of 3 months each. If the economy contracts for 2 such continuous quarters we say the economy is in Recession. Then policy makers has to use the the Fiscal and Monetary tools to revive the economy back to normal.

In an economy tht (the leakages)=(the injections)

Ie; savings+taxes+net trade=consumption+investments+net trade.

This shows that what we are taxed turn out to tamper with growth of an economy in the way of leakages. Or vice versa if we reduce taxes we aid in expansion of the gdp.

The measure of how much the economy grows when taxes are cut is termed the  Tax multiplier. Suppose if we cut the tax by say t%, then tax multiplier is ((MPCx(-t))/( 1+MPC))+1.

So in policy making excess leakages can lead to heavy contraction and creation of poverty in a nation. So the tax policies need address these issues.

If the economy is in high unemployment state with high wages  then we say the economy is in Stagflation. Then the government uses Reflationary policies like cutting taxes. Reducing interest rates etc; to rejuvenate the economy.