Policies to Increase Equilibrium National Output

Explain briefly the effects of a decrease in foreign income on UK exports. Then, using diagrams based on the Keynesian model, explain carefully how this affects: (i) the equililbirum level of income, and
(ii) the balance of trade.

I have answered this question previously Keynesian approach

Discuss what policy measures could be used to return the equilibrium level of output to its original level, and the possible limitations of these policies.

If National Output is below full capacity. Basically the government has 2 main policies available.

Fiscal Policy.

To increase AD, the government can pursue expansionary fiscal policy. Cutting taxes and increasing government spending. This injection into the circular flow will increase AD (AE) and cause Real GDP to increase. However, expansionary fiscal policy has many limitations including:

• Time lags
• Crowding out effect.
• Other components of AD
• Impact on Government borrowing
• For more details see: Evaluation of fiscal Policy

Monetary Policy

To increase AD, the government or monetary authorities can reduce interest rates to boost AD.

• What determines effectiveness of Monetary Policy?

The government could also try to depreciate the exchange rate, making exports more competitive.

Exchange Rate

A Lower value of the exchange rate could also be used, a lower exchange rate will make exports more competitive and boost AD.