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More On The Austerity Debate Essay

1504 words - 7 pages

The Warwick MBA
Assignment Cover Sheet
Submitted by: 1167899
Date Sent: 21st of May 2012
Module Title: Economics of the Business Environment
Module Code: IB827Z
Date/Year of Module: May 2012
Submission Deadline: 21st of May
Word Count: 1 113
Number of Pages: 9
More on the austerity debate
Question 1: Use the AS/AD framework
Question 2: Austerity measures and stimulus

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Government directly affects AD through its spending. By cutting public spending, you then
decrease Aggregate Demand (AD curve shift to the left to AD1).

Page 2 on 7

EBE – Lesson 4 assignment

Economics of the Business Environment
Lesson 4 assignment


21st of May 2012

Having the AD curve shifted to the left implies a decrease in Qty of outputs, ie GDP, and a
decrease in Prices from Pe to P1, ie deflation.
If the Qty of output decreases, then people in employment decreases as well, and as a
consequence, the unemployment raises.
If we know look at the effect of having an increase in the rate of VAT, the same effect is
observed for the GDP, but the prices reacts with an inflation.
The other entire thing remaining equal, if VAT rate raises, then costs of products are higher. This
will affect the aggregate supply curve as buying raw materials (or energy) will cost more (AS
curve shift to the left to AS1)

Page 3 on 7

EBE – Lesson 4 assignment

Economics of the Business Environment
Lesson 4 assignment


21st of May 2012

Having the AS curve shifted to the left implies a decrease in Qty of outputs, Qe to Q1, ie a
recession in the GDP, and an increase in Prices from Pe to P1, ie inflation.
A slowdown in the GDP growth of less developed economies will cause a decrease in world
income and hence in demand for the export of any individual economy. This decrease and its
associated extend depends on the world GDP elasticity of demand for a country’s export. If this
factor is high then the country will suffer large falls in its exports, especially in a context of
global recession. Then the aggregate demand is shifted to the left (from AD to AD1) as net
balance is decreasing.
As a consequence, prices are going to decrease and GDP as well, leading to a raise in
Public sector borrowing, which is in fact the amount of money that government has to borrow to
balance its expenditures, will react as follow in the 3 previous steps:
- A cut in public spending, will generate a slowdown in public sector borrowing as there
is less expenses to cover. This should help in the equilibrium of debt ratio
- An increase of the rate of VAT, will generate more revenue for the government, so
additional “national” income to cover expenses. Then Government should borrow less.
- A slowdown in the GDP growth of less developed economies will affect the aggregate
demand by shifting it to the left leading to a slowdown in public sector borrowing as
in first bullet.
France and its current situation within the EU, is a good example to illustrate all the above
statements. The country still suffers from public spending financed by borrowing money. Before
spending much, the balance in government accounts must be close to zero. When Nicolas
Sarkozy was on the president chair, expenses were not funded and taxes decreased because of
Page 4 on 7

EBE – Lesson 4 assignment


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