Business cycles are a type of fluctuation found in the aggregate economic activity of a nation—a cycle that consists of expansions occurring at about the same time in many economic activities, followed by similarly general contractions. This sequence of changes is recurrent but not periodic. Discuss in detail The new economic paradigm Explain the smoothing of cycles (Business Cycles)
Discuss in detail The new economic paradigm Explain the smoothing of cycles (Business Cycles)
INTRODUCTION
The new economic paradigm in terms of the smoothing of business cycles discourages monetary policy makers from using monetary and fiscal policies to fine tune the economy but rather encourages achieving stability through sound long term decisions relating to demand and supply in the economy/smoothing out the painful part of economic down-fall that is part of the market economy🗸🗸
(Accept other relevant definition/description of smoothing/new economic paradigm).
[Max 2]
BODY: MAIN PART
The new economic paradigm is embedded in the demand and supply side policies. 🗸🗸
Demand-side policies
- It focuses on aggregate demand in the economy🗸🗸
- When households, firms and the government spend more, demand in the economy increases. 🗸🗸
- This makes the economy grow but lead to inflation.🗸🗸
Inflation:
- Aggregate demand increases more quickly than aggregate supply and this causes price increases. 🗸🗸
- If the supply does not react to the increase in demand, prices will increase. 🗸🗸
- This will lead to inflation (a sustained and considerable in the general price level) 🗸🗸
Unemployment:
- Demand-side policies are effective in stimulating economic growth. 🗸🗸
- Economic growth can lead to an increase in demand for labour. 🗸🗸
- As a result more people will be employed and unemployment will increase. 🗸🗸
- As unemployment decreases inflation is likely to increase. 🗸🗸
- This relationship between unemployment and inflation is illustrated in the Phillips curve. 🗸🗸
- The PC curve shows the initial situation. A is the point of intersection of the PC curve with the x- axis. It shows the natural rate of unemployment, for instance 14%🗸🗸
- At point A inflation rate is zero. 🗸🗸
- If unemployment falls to C for instance, 8%, inflation caused by wage increases is at 6%.🗸🗸
- If unemployment increases from C to B to A, inflation falls from 6% to 2% to 0%.🗸🗸
Phillips curve (PC)
Heading – 1
Labelling of axes – 1
Drawing of correct 2 curves – 1
Point A – 1
Max 4 marks
Supply-side policies
Reduction of costs 🗸
- Infrastructural services: reasonable charge and efficient transport, communication, water
- services and energy supply. 🗸🗸
- Administrative costs: these costs include inspection, reports on applications
- of various laws, regulations and by-laws, tax returns and returns providing statistical
- information.
- It adds to costs and businesses carry a heavy burden 🗸🗸
- Cash incentives: it includes subsidies for businesses to locate in neglected areas where unemployment is high and compensation to exporters for certain costs they
- incurred in development of export markets. 🗸🗸
Improving the efficiency of inputs 🗸
- Tax rates: low tax rates can serve as an incentive to workers. It will improve the productivity and output. 🗸🗸
- Capital consumption: replacing capital goods regularly creates opportunities for businesses to keep up with technological development and better outputs🗸🗸
- Human resource development: to improve the quality of manpower by improving health care, education and training. 🗸🗸
- Free advisory service: these promote opportunities to export. 🗸🗸
Improving the efficiency of markets 🗸
- Deregulation: removal of laws, regulations and by-laws and other forms of government controls makes the market free. 🗸🗸
- Competition: encourages the establishment of new businesses 🗸🗸
- Levelling the play field: private businesses cannot compete with public enterprises 🗸🗸
Answers must be in full sentences and well described with examples to be able to obtain 2 marks per fact.
Learners should be awarded 1 mark per heading or sub-heading to a maximum of 8 marks.
(8 x 1) (8)
[Max 26]
BODY: ADDITIONAL PART
Explanation:
The above graph shows:
- Aggregate demand (AD) and aggregate supply (AS) are in equilibrium at point C. 🗸🗸
- If aggregate demand is stimulated so that it moves to AD1 and aggregate supply responds promptly and relocates at AS1; a larger real output becomes available without any price increases. 🗸🗸
- Supply is often sticky and fixed in the short term. 🗸🗸
- Therefore, if aggregate demand increases to AD1 and aggregate supply does not respond, intersection is at point F. Real production increases but so does the price, in other words, with more inflation. 🗸🗸
- The aggregate demand locates at any position to the left of AS1 inflation prevails. 🗸🗸
- The solution is to create conditions that ensure supply is more flexible. 🗸🗸
- If the cost of increasing production is completely flexible, a great real output can be supplied at any given price level. 🗸🗸
[Max 10]
CONCLUSION
It is clear from the discussion above that it is critically important to manage the aggregate supply and demand to ensure stability in the economy. 🗸🗸
[Accept any relevant higher order conclusion]
[Max 2]