Explain why the price elasticity of demand for primary

commodities tends to be relatively low while the price

elasticity of demand for manufactured products tends to be
high.

The price elasticity of demand measures the responsiveness of quantity

demanded to a change in the price of a related good. If a change in price
leads to a change in the quantity demanded, then the particular good is
considered to be price elastic or price sensitive. On the contrary, if a change
in price causes a smaller change in the quantity demanded, then the good
has an inelastic price. This kind of characteristics in price is determined by
the type of good sold in the market, whether its a primary or manufactured
good.
In the first case, primary good tend to have a relatively low PED. A primary
good is a synonym for raw materials, like oil, fruits, and crops, as they are
products without a manufacturing process. Some of the factors that have
influenced this tendency in price are the fact that these type of products are
a necessity, not just to all the manufacturing firms whose product depend
on, but also to people, especially those with a low proportion of income.
Sometimes, people cannot afford manufactured products such as juice, so
they prefer to buy the fruit and end up with a similar product. Furthermore,
there are no or few substitutes for primary goods so, when there is an
increase in price, consumers will still be buying unless they find a substitute
(e.g. for corn oil the substitute could be soy oil) or they stop purchasing (this
mostly does not happen or happens in a
very small proportion). All these aspects
cause the PED to be inelastic, as it is
shown in the next graph:

A change in price, from P 0 to P1, comes

along with a change in the quantity
demanded, from Q0 to Q1.

Now its time to mention the manufactured products where the opposite of
primary goods takes place. A manufactured good is a tangible product
created from the conversion of raw materials into consumable or useful
products. In this category, an example can be a bag of potato chips or pizza.
Differently from the primary goods, if there is a change in a certain product
the quantity demanded that product decreases. This happens because these
type of goods have a large number of substitutes, meaning that, for
example, if a certain brand of potato chip had increased its price we can
replace it by buying another brand or maybe a product similar to it like
tortilla chips. In addition to this, the products, not a necessity and can be
considered as a low-range luxury as a great percentage of consumption

comes from people with normal to higher income. These characteristics

made the PED be elastic and the behavior is shown in the following graph:

change in price, P to P1, comes with a

greater change in demand, from Q to Q 1.

In sum, both of these goods have different characteristics in price because

they are exposed to different factors that influence them. In this part, the
determinants of number of substitutes and luxury or necessity were
used to understand how the price is controlled by external factors.

The income elasticity of demand for primary commodities tends

to be lower than that for manufactured products and services.
Examine the implications of this for producers and for the
economy as a whole.

The income elasticity of demand measures the responsiveness of quantity

demanded of a good to a change in consumers income. If a change in
income causes a large change in the quantity demand, then the product is
considered to be price elastic, shown in the following graph: where a
decrease in income comes with a great change in demand.

On the contrary, if a change in income causes a smaller change in quantity

demand, the good has an inelastic price. This is shown in the following
graph: If income decreases from I to I 0, demand increases a little from Q to
Q1.

Furthermore, and base on this concept, goods are classified into normal and
inferior goods, where a normal good increases its demand while income
rises and demand for inferior goods increases as income decreases.
A primary good is a good without a manufacturing process. This kind of good
not only has a low YED (income elasticity of demand) but also, is in the
category of inferior goods. While a manufactured product has an elastic
price and enters in the normal goods category. These characteristics may
bring some implications for producers and the whole economy in terms of
expansion of industries and hence future profitability and the relative growth
rate of the primary, secondary and tertiary sector of the economy.
Firms that sell primary goods normally are part of a large industry. This
happens because firms feel attractive to invest in this market because of the
following benefits: thanks to the inelastic price, when there is any change in
the consumers income the demand for those products would not see
significantly affected and, as it is an inferior good, even during times of
recession (when income decreases), these firms are still going to be selling
their products at a, probably, normal rate. In addition, in the long run, these
firms are going to have a constant profitability. Something different happens
with manufactured products as they are part of a smaller industry. This is
because there are few firms that take the risk to invest in the industry, and
some of them cant adapt and, therefore, end leaving the market. All of
these because of the tendency of the price of being elastic.
In regard to the growth rate of the sector of an economy, we can notice the
relation between the countrys national income and the presence of the
primary or secondary and tertiary sector. In the least developed countries,
that have a relatively lower national income, a great percentage of firms
belong to the primary good. This has to be with the inelasticity of price for
primary goods because with this, firms do not experience an abrupt change
in their production, therefore, not a significant change in their profits. On the
other hand, in the most developed countries, with a relatively higher
national income, a great part of firms belongs to either secondary or tertiary
sector. This occurs because as there is a great production for primary goods,
these firms use them as raw materials (from domestic or foreign production)
for their manufactured goods, and they risk to invest in this sector thanks to
the elasticity of these group of goods.

In conclusion, producers determine in which sector they want to invest

mostly based on their countrys national income to prevent any possible
money loss. Besides, a countrys economic development can be measured
by the predominance of a productive sector. All of this came upon the price
characteristics of products.

Analyze the consumption externalities which might arise from

the provision of education and health care for the citizen of a
country.

An externality is a transaction where a third party (someone different from

the buyer and seller) experiences a loss or benefit by the production of
consumption of a certain good or service. In this case, it is referring to
education and health that are merit goods, goods considered to be good for
society but are under consumed and underprovided by a free market. It I
because of this that these services present mostly positive externalities, and
in the following text, I am going to expose them focused on the benefit third
parties experience from the provision of education and health care for the
citizen of a country.
A positive externality has a side-effect associated with a market, whereby
production benefits parties other than the producer and yet the producer is
not compensated. In other words, when the consumption of a good or
service creates benefits that spill over to third parties, the marginal social
benefits is greater than the marginal private benefit (MSB > MPB), as it can
be showed in the next graph:

The market produces Qe worth of education at a given price of P e. However,

the optimal production is at Q* at price of P*, where the social costs and
benefits are equal. This means that the free market does not produces all
the quantity itself and must be provided by other entities to reach the
demand. If all the societys benefits were included, then the potential
welfare gain is represented by the shaded triangle in the diagram.
When it comes to education, the benefit goes to society itself. More years of
educating implies that a person is more skilled and productive member of
the workforce. Their income will generate tax revenue and they are less
likely to perform any criminal activity. With this, we can add that the social

benefits exceed the private benefits so society will gain considerably by

consuming more education.
In the same way, we have health care with positive externalities on society.
One of them is vaccinations, that by consuming them, we become
immune to a certain infectious disease and this reduces the probability of
catching it again. Others include the fact that healthy workers are absent
from work less and are more productive workers, this ends in economic
profit; and that the study of health care has increased the technology
efficacy and expansion of different industries and market, besides the
increasing knowledge and technological capacity of society.
After all, we can guarantee that these services enter in the category of merit
good as they provide from far more social benefits than private. The
government should consider to invest more and encourage their citizens to
make use of these services not only because of the benefits all the society
gets but also for the benefits the consumers itself get.

Evaluate the use of government

consumption of health care.

policies

to

increase

the

Health care is a merit good because it considered to be good for society but
it is under consumed and underprovided by a free market. This implies that
this is a situation of market failure, where the allocation of resources is not
efficient. As it is a merit good, it has positive externalities, reason why
governments policies are focus on increasing the production of health care,
and therefore its consumption. In this aspect, some of the government
policies used are subsidies and advertising.
First, subsidies are government payments to the producers in order to
reduce their cos of production. This encourages more firms to start
supplying the merit good, increasing the availability of the resource in the
market. In the same way, it has a positive impact on consumer, as the price
of the good decreases while the availability increases, this means that the
consumption itself increases as well. This is shown in the following graph:
The production of health care
is, at first, represented by S,
and with the subsidy it the
curve supplies to the right
increasing the availability of
this good service for society.
Consumers, before the subsidy,
buy at the equilibrium point of
Q2 and this changes when
government
decides
to
increase
the
health
care
consumption. As now prices
decreased from P0 to P2 with
the subsidy, they see this as an
opportunity to increase their consumption and the demand curve shift to the
right as well.

Something similar happens with advertising, as it increases the consumption

of this merit good. Government starts to advertise and promote a good if
they consider it has a good impact on consumers and they want the whole
society to enjoy it. This is showed in the next diagram:

With advertising, government is

highlighting the positive effects
that the consumption of health
care has, and consumers start to
demand more of the good or
service,
representing
as
the
constant shifting of the demand
curve from Q0 to Q1 to Qm. Even
though the increase of the
demand increases, the size of the
positive externality is reduced
meaning that the private marginal benefits have increased but not as much
as the social marginal benefit.
The advantages of using subsidies as a government to increase
consumption of health care goes to producers and consumers, as consumers
have access now to a great variety of places they could assist with lower
prices. Producers with see the cost of production lowered as an opportunity
to invest in the market as they are going to get the same profit. The
disadvantage is that governments might increase taxes to cover up the
subsidy.
On the other side, advertising just increases consumption and the benefit
goes entirely for producers as their profit experiments an increase, while
consumers still pay for the same price. Besides, the availability of this
resource is limited and because of the high prices not all the consumers can
afford it. On the other hand, government only spends a littler amount of
money on advertising rather than subsiding the whole service.

Explain how three of the following factors (lack of infrastructure,

ineffective taxation structure, income inequality) may act as
barriers to development in a less developed country

Economic development can be defined as the sustainable increase in living

standards for a country, characterized by an increase in life span, education
levels, and income. Because of this, countries can be classified as a least
developed country or most developed country. For this section, we are going
to focus on the LDC, which are countries that do not experience an increase
in their standards of living because of different barriers, that can be
domestic or foreign, that do not allow them to achieve an economic
development. In order to explain some of the barriers, we will use the
domestic barriers of lack of infrastructure, ineffective taxation structure and
income inequality.

Infrastructure, part of the factor of production capital, are essential facilities,

usually provided by the government, which allow economic activities to take
place. Infrastructure improves a countrys efficiency that leads to lower
costs and higher income, therefore, when there is a lack or low-educated
capital (human as the capitals workforce), the country becomes less
attractive for foreign investors and therefore the supply of productivityenhancing foreign capital is limited.
In the same way, taxation structures act as a barrier to development. Taxes
are compulsory payments to the government in order to finance their
spending. When there is an ineffective taxation structure, the country
become less attractive for potential foreign investors who might otherwise
invest in the country. This deters investment and reduces the amount of
foreign capital in the country. How does this deter investment? Because
most of the income goes for this government payments, households and
firms are going to hide their income from the government or save them
abroad. This action deprives the country of the needed resources to achieve
economic development.
The final point taken in consideration is the inequality of income. This term
refers that the great part of a national income is distributed to a privileged
group of the population, while the rest of the population receives the
smallest part of the total income. This can be measured by Gini index, an
economic indicator between 0 and 100 where the values closest to 100
shows a greater disparity between the richest and poorest households in a
nation, and by the Lorenz curve, the far the exponential curve is the linear
curve, the more unequal the income is distributed. This is a problem when it
comes to achieving economic development because the poorest people
cannot escape from poverty as the income is not equally distributed, and
therefore the country will count with a limited human capital.
As we saw, these three domestic factors are barriers to achieving economic
development, and these are most present in the least developed countries.
There are many ways to contribute the development by improving the
education, the health system, the bank credit and the infrastructure, with
this the human and infrastructure capital of a country would be appropriated
and foreign investors would consider attractive to invest in these countries.

Evaluate the view that foreign direct investment is the key

factor in determining whether a developing country will be able
to achieve economic growth and development.

Economic growth is an increase in real GDP on the previous year, is the

countrys economy success, it usually means more money, activities, and
employment. On the other hand, economic development is the sustainable
increase in living standards for a country characterized by an increase in
span, education levels, and income. It is believed that the foreign direct
investment is the key whether a developing country will be able to achieve
both economic development and growth, and I agree with this statement.
The least developed countries or developing countries income is based on
their national output as foreign investors are not attracted to invest in those

countries because of different domestic barriers like lack factors of

production. These countries can overcome these barriers by improving the
education level, the health system, the infrastructure and bank credits. With
the first three mentioned factors, countries would improve capital by
providing the vital places where the economic activities take place and by
providing an educated and healthy workforce. By improving bank credits,
entrepreneurs from poor communities, provided with domestic or foreign
financial assistance, will start to create their small business with a socially
beneficial purpose. This kind of characteristics encourages foreign firms to
invest in them.
Foreign direct investment is an investment by firms based in one country in
productive activities of another country. When foreign firms start investing in
the developing countries in not only starts to diversify the sources of
national income but also has determined that the country has growth and
developed. Why? Well, it is because when a country starts improving itself,
it is starting to develop economically because the education levels, the
living standards are slightly increasing. It has also growth economically
because of the new businesses, provided for bank credit strategies,
generate new sources of employment, new activities and therefore, an
increase in income. At this moment, foreign firms began to invest drawn by
better countrys condition; with this, I intend to say that foreign investment
works as an indicator that a country has achieved economic growth and
economic development, whether it have been in a small percentage.
However, it is necessary to show some of the arguments against foreign
direct investment. Foreign firms, mostly multinational corporations that
invest, they carry some of their workers to the developing countries in which
they are investing in. With this, it is generating little local employment by
preferring to used its experienced workforce instead of hiring new
employers or unskilled employees to manage the machinery
implementation. In addition, tax concessions may have to be made and this
reduces firms revenues.
After all, we can say that foreign direct investment (FDI) are measures that
mostly bring benefits to the least developed countries in the short and longrun. When it comes to make an economic decision, developing countries try
to focused them to achieve economic growth and development, and one
way to achieve both is by improving foreign direct investment and regulate
them so there are not many negative impacts.

Explain the
inflation.

difficulties involved

in measuring

the

rate

of

Inflation can be defined as the sustained rise in the general price level over
a period of time, it can cause the value of money to decrease. Inflation is
assessed using a tool called Consumer Price Index (CPI), which is a weighted
price index which measures the monthly change in prices of products and
services. Goods taken into calculation for weightings may vary between
different countries, due to religion, culture or preference in goods. Some
household may be overlooked when calculating average weightings.

Weightings may change over years, so it must be measured consistently to

avoid inaccurate data.
CPI is determined by using the following formula:

CPI j =

PbJ
x 100
PbJ

Where:

PbJ = the price of a particular basket of goods in July

Since

PbJ

divided by

PbJ

is 1, the total index for the base period is 100.

To calculate the price of the same basket of goods in August, using the last
information must be used.

CPI A =

PbA
x 100
PbJ

When it comes to measuring CPI, series of difficulties may appear. A real CPI
includes hundreds and thousands of goods and services of various types,
goods and services that often change in preference (eg. A new version of
the iPhone coming out) and peoples spending habits change frequently,
making this a difficulty when it comes to being measured. The family
expenditure survey is limited to only 6,000 households, which may be
unrepresentative for the inflation rate. If a product becomes better with time
and the price also rises, how much of the change in price is due to the
improved quality? People may be willing to spend a higher proportion of
their incomes on the product, but it is hard to know the extent to which
expensive goods should count as inflation or improved quality, so this is
difficult to incorporate into CPI. The automobiles of the 1990s were very
different from the 1970s, which in turn were very different from the ones
from the 1950s. Changes in quality are evident and present in short periods
of time, sometimes not, like the tremendous improvement of electronic
products (televisions, audio, equipment, and computers). Official statistics
attempt to take into account the changes in quality of products, but this
process is quite subjective. Peoples inflation rate may differ, as not
everyone shares the same income; eg. Old people spend a higher percent of
income on fuel and public transport, so if these goods increase in price old
people may be relatively worse off. People of lower incomes tend to also
spend a higher percent of their income on food and fuel, so they have a
higher inflation rate. If the price of one good goes up, this changes the
pattern of peoples spending as they will probably stop buying this good, but
the price they pay will stay the same. This mentioned is called Chain
Weighted index and it takes changes in quantity into account. Spike in
inflation because of a rise in goods such as energy prices and food (volatile
goods) could occur, therefore the headline CPI rate may give a misleading
impression to underlying inflation, meaning core inflation.

Discuss the view that deflation is a more serious problem than

inflation for the economy of a country.

Deflation occurs when the overall price level decreases so that inflation rate
becomes negative, it is the opposite of inflation. The reason for deflation in
most cases is a reduction in money supply or credit availability, also
reduced investment spending by government or individuals. Deflation leads
to a problem of increased unemployment due to slack in demand. Central
banks focus to keep the overall price level balanced by avoiding situations
of severe deflation or inflation, they may infuse a higher money supply into
the economy to counter-balance the deflationary impact. A depression
occurs when the supply of goods is more that of money.
On the other hand, inflation can be defined as the sustained rise in the
general price level over a period of time; inflation can cause the value of
money to decrease. This effectively measures the change in prices of a
basket of goods and services in a year. Inflation occurs due an imbalance
between demand and supply of money, changes in production and
distribution cost or increase in taxes of products. When the economy
experiences this, (eg. When the price level of good, services of both rises)
the value of currency reduces. This means that now each unit of currency
buys fewer goods and services. Consumer are the most affected, as daily
high prices make it difficult for them to afford basic commodities in life.
Basically inflation rises the price of goods and services while deflation
decreases prices of goods and services. But why is deflation more of a
serious problem than inflation for the economy? The thought of prices
falling, things getting cheaper and consumers catching a break may sound
appealing. But severe deflation is a problem that can damage the economy
of a country pretty badly. Inflation is considered positive because it gives an
illusion of gain, however it helps borrowers, who get to spend their
borrowings now and pay it back with cheaper dollars later. Governments are
always borrowers, and so they will always back up inflation. Deflation helps
saver, but it can also slow the velocity of money as it is and put a downward
pressure on wages. When people expect falling prices, they become less
willing to spend, and in particular less willing to borrow. So you would
basically be sitting down seeing how money becoming an investment as
prices fall. For example, Japanese bank deposits are a really good deal
compared with Americas, and anyone considering borrowing has to
consider the fact that the loan will have to repaid in dollars that are worth
more than the dollars that were borrowed. If the economy is doing well, all
this can be offset by keeping interest rates low; but if the economy isnt
doing well, full employment wont be achieved. So when this happens, the
economy may stay depressed because people expect deflation, and
deflation may continue because the economy remains depressed =
deflationary trap. To sum this up, cash becomes more valuable over time,
purchases are delayed = economy stops. While making money more
valuable, a debt appears, a debt that will be harder to pay money, so to get
money = work more to earn more valuable money, but how will this be
reached when full employment cant even be achieved? With inflation, the
incentive is reversed. Keep the money moving, spend it or invest it in

something that has returns on investment (finance) greater than the

inflation rate = encouraging economic activity and growth.

Explain how labour market reforms may be used to promote

economic growth.

Labour market reforms take part on supply-side policies, which are policies
designed to improve the quality and quantity of the supply of labour. The
seek to make the labour market more flexible so that it is able to match the
labour force to the changing demands placed by employers in expanding
sectors thereby reducing the risk of structural unemployment. As expansion
in the labour supply increases the productive potential of an economy
increases too. Expansion in the supply of people willing and being able to
work can come from various sources, for example: encouraging older people
to stay in work by promoting continuous employment and abolishing
mandatory retirement, encouraging greater labour force participation by
women, elderly and youth, which increase equity across different segments
of the labour force.
Not much like research, education and diffusion of technologies, the function
of labour market reforms are indirectly important to economic growth, as
supply reacts to shifting demand more quickly in less regulated markets and
since research incentives depend on institutions = competition and
openness. Taxes combined with labour costs and productivity define the
competitiveness of countries. Price competitiveness and changes in export
market shares are included in evolutionary growth models. Labour market
reforms could be used to promote economic growth, as they can be used to
increase equity on workforce. For example, taking women into the labour
force requires removing financial obstacles to work, creating more familyfriendly workplaces and increasing the availability of childcare = education
= economic growth. By enforcing training, geographical mobility and
activation policy, economic growth can be achieve, and investment could be
promoted in the future.

Market-oriented supply-side policies will always be more

effective in promoting economic growth than demand-side
policies. To what extent do you agree with this statement?

The demand-side policies are predominantly based off of Keynesian

thinking. The thought process is that if the government gives consumers
more money to spend (increasing their demand for goods and services),
then this would cause suppliers to produce more money to meet the higher
demand. The government could distribute this money either by printing
more or by lowering taxes. But this could lead to a larger than ideal
government and also takes away money from producers.
Supply-side policies predominantly features Reagan ideals, and the basic
theory is that if producers are encouraged to produce more, then the
demand would fall in suit. One way of doing this would be to lower taxes on
producers, so that they could lower prices and consumers would then be

better off. However, lowering these taxes often leads to the rich getting
richer (the supply-side).
In the end, supply-side policies often initially benefit the suppliers, but that
eventually trickles down to the demand-side as well. Demand-side policies
are meant to improve demand, but that does not always mean that the
supply-side will also benefit.
Market-based supply-side policies cut government spending and borrowing,
lower business taxes to stimulate investment and lower income taxes to
improve work incentives, measures to improve the flexibility of the labour
market, reform employment laws, boost competition such as deregulation
and tough anti-monopoly, sell off public sector businesses into the private
sector, open up an economy to overseas trade and investment.
I think that market-oriented supply-side policies are effective in promoting
economic growth rather indirectly, but theyre needed for economic growth
if balanced. Supply-side policies are an alternative strategy for improving
economic growth as they attempt to increase productivity and efficiency of
the economy by lowering income taxes, adding highly regulated labour
markets, better union relationships and so, but if someone invested in better
education and training, they could take several years to lead higher labour
productivity. They improve the long term growth rate, for example, in the
80s the United Kingdom pursued several relatively successful supply side
policies (market-oriented supply-side policies) but there was no economic
growth, until it went above the long run trend rate of 2.5%. Yes, marketoriented supply-side policies are better at promoting economic growth than
demand-side policies, as the latter cannot increase the rate of growth above
the long run trend rate, and could cause rising prices and inflation, growth
could be proved unsustainable using this.

Explain why countries measure national income.

National income can be defined as the total value a countrys final output of
goods and services produced in a year. National income is analyzed using a
tool called Gross Domestic Product (GDP). GDP is the monetary value of all
finished goods and services produced within a country in a specific time
period. Though GDP is calculated on an annual basis, it could be calculated
on a quarterly basis as well; this tool includes all private and public
consumption, government outlays, investment and exports imports that
occur in the country. GDP can be calculated using the following formula:
GDP= C + G + I + NX
Where
C: all private consumption or consumer spending
G: sum of government spending
I: sum of countrys investment (includes businesses capital
expenditures)
NX: nations total net exports (exports imports)
National outcome is an indicator of living standards as it takes toll as a
quality of life indicators. The standard of living measures our material
welfare by using the real GDP per capita (GDP / total population). GDP (and
unemployment) is also used by the business cycle, a pattern of expansion,
contraction and recovery in the economy, this assesses growth or recession

over time. This refers to the fluctuations in economic activity that an

economy experiences over a period of time. It consists of expansions
(economic growth) and contractions (economic decline). During expansions,
employment, production, sales and incomes increase. During contractions
(recessions) unemployment rises, production slows, and sales decrease and
incomes stagnate or decline. As it is common to use GDP as a measure of
economic welfare or standard of living in a nation, it can also be used to be
compared between nations. When compared for the purpose of seeing
differences in economic development, two issues immediately arise. First of
all, the GDP of both countries are measured in its own currency (eg. Japan
uses the yen, United States uses the U.S dollar) and second is measuring
the number of people habiting each countries. United States has a much
larger economy than Mexico or Canada, but it also has three times as many
people as Mexico and nine times as many people as Canada. So if we are
trying to compare standards of living across countries, we need to divide
GDP by population. Since GDP is measured in a countrys currency, in order
to compare different countries GDPs, we need to convert them to a common
currency. One way to do that is with the exchange rate, which is the price of
one countrys currency in terms of another. Once GDPs are expressed in a
common currency, we can compare each countrys GDP per capita by
dividing GDP by population. Countries with large populations often have
large GDPs, but GDP alone can be a misleading indicator of the wealth of a
nation. A better measure is GDP per capita. Countries measure national
income so therefore they can acknowledge their economic growth or
performance over time, seeing if they should employ policies to improve
their economy or stabilize it.

Evaluate the view that demand-side policies are the most

effective method of increasing the level of national income.

To increase the level of national income, further economic growth, essential

policies such as demand-side policies should be involved as they become
important during a recession. Supply side policies are also considered an
alternative, but they are important for determining long run growth in
productivity. Demand-side policies objective is to increase aggregate
demand, and is done during a recession or a period of below trend growth. If
there is a negative output gap, then demand-side policies can play a role in
increasing the rate of economic growth. Monetary policy is the most
common tool in economic activity. To boost AD, the central bank or
government can cut interest rates so the cost of borrowing is reduced =
encouraging investment and consumer spending = reduce the incentive to
save = spending is more attractive. Lower interest also reduce mortgage
interest = increase disposable income for consumers. Also fiscal policies are
used by the government to boost demand by cutting taxes and increasing
government spending. Lower income tax will increase disposable income =
encouraging consumer spending. Higher government spending creates jobs
and provide economic growth. Fiscal measures for growth include specific
spending priorities, putting money into areas which the government
believes will promote economic growth, influences the size of the circular

flow with the size of the government budget, and targets taxation and
subsidies.
Increase in AD with spare capacity:
The increase in AD causes a bigger percentage increase in real GDP and
smaller increase in price level.

This diagram shows that an increase in AD will cause an increase in Real

GDP in the short run. However, as prices increase, firms face an increase in
their wage bill so the SRAS shifts to the left. This causes Real GDP to return
to its original level of output.

Demand side policies also have their disadvantages or limitations. Demand

side policies cant increase the rate of growth above the long run trend rate
like supply side policies do. A delay between an economic action and a
consequence could occur, this is known as a time lag and could occur with
demand side policies. Evaluating both of these policies, it can be said that
both are needed in balance in order to adapt to a countries economy but
demand-side policies could be considered as an effective tool for increasing
the level of national income in the short run.