Name: Priyesh Kasan
Student Number: 448851
Course: Economics 1 (ECON 1000)
Topic: Essay – Semester 2 (2010) (Final Copy)
Essay Topic 2:
“During the 2006-2008 period COSATU called for changes to government fiscal policy citing “prospects for a more expansionary fiscal policy” (COSATU Secretariat Report to the Ninth National Congress, Sept 2006) and arguing that “[fiscal policy] is unduly focused on chasing macro-economic targets, such as low budget deficits” (COSATU General Secretary, Zwelinzima Vavi’s address to the AGM of NEHAWU Securities, Nov 2008).”
Answer the following:
By making reference to the compulsory readings, discuss whether you think it was advisable for the South African ...view middle of the document...
The aggregate expenditures model is used to predict future GDP direction. The multiplier in macro economics is the amount by which autonomous expenditure is enlarged in order to find out the change in real GDP. According to economic theory aggregate expenditure and aggregate demand are linked to one another if changes in consumption expenditure, government expenses, investment or net exports occur. Thus aggregate demand is defined as the relationship between the price level and the quantity of real GDP demanded (Parkin, Powell, & Matthews, 2008.).
For example, if equilibrium expenditure in figure 1 (a) and figure 1 (b) is (1300; 1300) and (1300; 105) below and is initially at point A in both (a) and (b). Now if consumption expenditure, government expenses, investment or net exports increase; it will shift the aggregate expenditure curve upwards thus resulting in higher equilibrium expenditure and shift the aggregate demand curve rightwards to point B in both (a) and (b) resulting in an increase in real GDP and no change to price level therefore an overall higher equilibrium expenditure of 1500. However if the opposite effect were to have taken place, the aggregate demand would have shifted downwards and aggregate demand shifting to the left, resulting in a decrease in real GDP and no change to price level therefore an overall lower equilibrium expenditure (Parkin et al. 2008, pp. 517, 578, 579.).
Figure 1: Graph showing the effect of an increase of aggregate expenditure on real GDP and aggregate demand.
Source: Parkin et el. (2008, pp 579)
The aggregate expenditure model is directly related to the GDP gap. Potential GDP is the GDP that an economy would produce at full employment. Full employment is the level of production whereby potential GDP is equal to real GDP. The difference between real GDP minus potential GDP is called the GDP gap. If the output gap is positive i.e. real GDP exceeds potential GDP it is called an inflationary gap and price levels of goods would increase. But if the output gap is negative i.e. potential GDP exceeds real GDP it is called a recessionary gap and the economy might experience a recession which is due to slow growth of real GDP (Parkin et al. 2008, pp. 520, 521.). So according to economic theory an increase in consumption expenditure, government expenses, investment or net exports would result in a position shown by point B in figure 1 and the gap under point C in figure 2 and would increase the inflationary gap taking into account the level of potential GDP and the actual increase in GDP. The opposite effect would occur if consumption expenditure, government expenses, investment or net exports were to decrease therefore increasing the recessionary gap as shown by the gap above point A in figure 2.
Figure 2: Graph showing fluctuations in real GPD vs. potential GDP.
Source: Parkin et el. (2008, pp 521.)
The Cost Price Index (CPI) which is used to calculate inflation rates and when interpreted can help one...