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Sample essay topic, essay writing: Actions Of The Government And The Increase In Prices - 772 words

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Actions of the Government and The Increase in Prices The United States economy is currently producing at a level of fullemployment in long-run equilibrium. The government then decides to increasetaxes and to reduce government spending in an effort to balance the budget. Theresults of the actions taken by the government is the decrease of real GDP.When taxes are increased that the amount of disposable income that is availableto consumers is lowered. This lowered level of disposable income leads to adecrease in consumption spending as well as a decrease in savings. Thisdecrease in consumer and government spending causes the total spending todecrease by a multiplied amount, As a result of the decrease in total spendingthe aggregate demand decreases and the aggregate demand curve shifts to the left.This decrease in consumer and government spending also causes businesses to havea surplus of inventories.

At this point the output is greater than spending andas a result prices begin to fall. Because of the surplus of goods and fallingprices consumption becomes more desirable to consumers and the level of consumerspending rises. The fall in prices causes business to become less profitableand producers decrease the level of production. This results in the decrease ofthe aggregate quantity supplied to decrease. This continues until aggregatequantity demanded equal the aggregate quantity supplied and a period of short-run equilibrium is established

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The real GDP and the price level have bothdecreased from the original long-run equilibrium level and the economy isoperating under the full employment level. At this point the U.S. economy is ata recessionary gap and a monetary policy must be used to pull the economy fromthe current recession. There are three options that the Federal Reserve has to try and end thecurrent recession. The federal funds rate could be lowered, the discount tobanks could be lowered, or open market operations could be used. The mosteffective of these three options is the use of expansionary monetary policythrough open market operations.

The first step in this option is for theFederal Reserve to start to purchase bonds from consumers. As the FederalReserve begins to buy these bonds back the bond prices are increased to make theselling of these bonds more attractive to consumers. When the Federal Reservepurchases a bond from a consumer a check is issued to the seller for the agreedprice. This higher bond prices also lowers interest rates. The seller thendeposits this check into his/her bank. This action increases deposits in thebank, which in turn raises the banks reserves to increase.

The requiredreserves are increased by the amount of the check times the required reserveratio, and excess reserves increase by the difference between the check and theamount of the required reserves. Because the excess reserves of the bank haveincreased, the bank is now able to loan out more money. The bank will continueto make new loans until it is loaned out. The lower interest rates that arecaused by the higher bond prices encourages more consumers to borrow money.This increase in the amount of loans causes a raise in the money supply by amultiplied effect. Because of the increased desire to loan money by banks and the increaseddesire to borrow money by consumers companies receive more loans which is usedfor investment. This rise in loans that are used for investment increasesinvestment spending.

This increase in investment spending causes the totalspending to increase by a multiplied effect. This increase in total spendingthen causes an increase in aggregate demand which causes the aggregate demandcure to shift to the right. Spending is now greater than output. As a resultof spending being greater than output many suppliers and manufacturers expandproduction of their goods. Prices will also increase because production costsrise as well. The increase in production causes a increase in the level ofaggregate quantity demand supplied to consumers is increased. The increase ofprices makes the value of money and wealth decrease. Because of this decreaseconsumption becomes less desirable by consumers and the aggregate quantitydemand decreases.

Another result of this increase in prices is the decrease ofexports because the higher prices make U.S. products less desirable.Consumption and net exports are now decreasing. The level of aggregate quantitysupplied continues to rise and the level of aggregate quantity demandedcontinues to fall until aggregate quantity demanded and aggregate quantitysupplied are equal. This causes the U.S. economy to enter a state of long-runequilibrium at full employment. This new level of equilibrium should be verysimilar to the original long-run equilibrium.

The total real GDP has not beenaffected. Government spending and consumption have both decreased. Investmentspending has risen because of the new lower interest rates. Because of thisreal GDP is not effected in the long run.

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