Inflation entails the persistent rise in the general prices of goods and services in a country. This phenomenon has various consequences that touch on individuals and the economy as a whole. Inflation results in reduced real incomes. Rising inflation levels in an economy tend to reduce individuals’ incomes as well as the real GDP of the economy as people spend more on few commodities due increased prices. The cost of obtaining loans and mortgages increases during high inflation regime as people strive to finance increased living costs (Mankiw 53). The demand for loans increases during inflation, resulting in high borrowing costs. Additionally, inflation has negative impacts on interest rates. When the rate of inflation is above interest rates, investors tend to lose since interests on their savings are poor. High inflation produces business uncertainties that may scare investors away due to lack of business confidence (Mankiw 53). Overall, inflation has severe consequences on an economy and limited benefits. It affects various aspects of an economy, resulting in poor economic performance.
Methods that can be used to reduce inflation
Inflation results mainly from increased demand that pulls the prices up, leading to the demand pull type of inflation. The excess demand usually results from people having more money to spend on commodities (Mankiw 79). Therefore, contractionary monetary policies like the sale of bonds to reduce the amount of money in the circulation can be very effective in reducing inflation. For example, in the United States and the United Kingdom, the monetary policy has been very instrumental in the maintaining of low inflation (Economics n.p). Fiscal policy entails another useful demand management tool that helps to regulate the level of inflation by regulating the level of aggregate demand. This policy involves altering the level of tax as well as government spending to lower inflationary pressures. The level of inflation can also be regulated through exchange rate control. For example, UK increased the value of pound as a way of lowering inflation (Economics n.p). Fluctuations in wages tend to produce varying levels of aggregate demand. High wages results in inflation. Therefore, wage control can also be a useful mechanism for reducing inflation rate.
The difference between Keynesian LRAC and the new classical LRAC
According to Keynesian model, all the inputs used in production can be changed in the long run. Firms can reduce production costs through changes in technology. Keynesian theory argues that LRAC (Long-run average cost curve) is downward sloping (Economics para 3). The downward sloping nature of the Keynesian LRAC used to describe the efficiency of a firm. It shows how a firm can increase output while reducing the cost to achieve the economies of scale (Tily, 68).
According to the classical model, the LRAC is used in profit maximization through the adjustment of inputs. The Classical theory argues that a firm can adjust the size of its factory to minimize the average cost in the long-run. The efficient output level is achieved when the price equates long-run average cost. The LRAC under the classical model rises on both sides of the marginal revenue curve (Economics para 5).
How government can use fiscal policy to alter the level of aggregate demand in the economy
Fiscal policies such as changing the tax level and the level of government spending may produce changes in the level of aggregate demand. If the government increases the tax level, the disposable income reduces, resulting in reduced level of aggregate demand due to reduced consumption. Additionally, reduced government expenditure tends to have similar effects as increased taxation.
A contractionary fiscal policy reduces the level of aggregate demand from AD1 to AD2, resulting in the establishment of new equilibrium price p2. An example of a fiscal policy that can lead to reduced aggregate demand is decreased government spending.
How interest rate is likely to affect the level of investment in an economy
Interest rates have fundamental impacts on the tendency of people to demand money. When interest rates are high, people tend to have limited investment capital since their borrowing capacities are low. Consequently, the level of investment in the economy reduces. Thus, there is an inverse relationship between investment demand and the interest rate. However, according to Tily (119), some factors like business tax, technological advancement, and the amount of capital goods that influence the interest rates tend to cause shifts in investment demand, resulting in changes in the level of investment in an economy.
Source: Basic Macroeconomic Relationships.
Three use of national income statistics
These statistics have various uses, and therefore, governments should ensure their regular preparations. The analysis of these statistics helps in making essential economic forecasts such as economic growth anticipations. Additionally, income statistics are used to compare different countries in terms of growth and standards of living. Furthermore, income statistics are useful in improving government policies as well as determining the success of the government in the realization of macroeconomic goals (Mankiw 238).
Evaluation of GDP figures as a means of comparing countries
The value of GDP indicates the size of an economy. Additionally, GDP values are used to compare the living standards of different countries (Picker 39). However, the use of GDP figures to compare economic welfare of different countries is challenged by the fact that income distribution is not the same in various countries. Some countries have fair income distribution while others have great income inequality (Picker 41). Another challenge of using GDP values to compare countries is that all countries do not use the same currency. Thus, to make international comparisons on the basis of GDP figures, one need to convert all GDP values into the same currency (Picker 41). Moreover, different countries have different population levels. Therefore, the GDP per head cannot be compared reasonably unless countries have equal populations.
Works Cited
Basic Macroeconomic Relationships. BYU-Idaho. ECON 151: Macroeconomics. 2011. Web. 3 July 2016. < https://courses.byui.edu/econ_151/presentations/Lesson_06.htm>
Economics, Keynesian vs Classical models and policies. Web. 2 July. 2016< http://www.economicshelp.org/keynesian-vs-classical-models-and-policies/>
Mankiw, Gregory. Principles of Macroeconomics. 6th ed. United States: South-Western Cengage Learning, 2011. Print.
Picker, Anne. International Economic Indicators and Central Banks. United States: Wiley, John & Sons, 2007. Print.
Tily, Geoff. Keynes Betrayed: The General Theory, the Rate of Interest and “Keynesian” Economics. United Kingdom: Palgrave Macmillan, 2010. Print.
