Definition of a liquidity trap: When monetary policy becomes ineffective because, despite zero/very low-interest rates, people want to hold cash rather than spend or buy illiquid assets. A liquidity trap is characterised by Very low-interest rates Low inflation Slow/negative economic growth Preference for saving rather than spending and investment Monetary policy becomes ineffective in boosting …
The marginal propensity to consume (MPC) measures the proportion of extra income that is spent on consumption. For example, if an individual gains an extra £10, and spends £7.50, then the marginal propensity to consume will be £7.5/10 = 0.75. The MPC will invariably be between 0 and 1. The marginal propensity to consume measures …
Definition of fiscal policy Fiscal policy involves the government changing the levels of taxation and government spending in order to influence aggregate demand (AD) and the level of economic activity. AD is the total level of planned expenditure in an economy (AD = C+ I + G + X – M) The purpose of Fiscal …
Definition of expansionary fiscal policy. This involves the government seeking to increase aggregate demand – through higher government spending and/or lower tax. Expansionary fiscal policy is usually financed by increased government borrowing – and selling bonds to the private sector. Keynes said expansionary fiscal policy should be used during a recession – when there is …
Marginal propensity to save (MPS) refers to the proportion of any extra income that is saved by consumers. For an individual, the marginal propensity to save will reflect how much they want to put extra income into different forms of saving. For example, if a worker receives a pay rise of £1,000 and they add …
Automatic stabilisers refer to how fiscal instruments will influence the rate of growth and help counter swings in the economic cycle. Automatic stabilisers will influence the size of government borrowing. Example of automatic stabilisers High Growth – In a period of high economic growth, automatic stabilisers will help to reduce the growth rate. With higher …
A recession is a fall in real GDP/ negative economic growth. To avoid a recession, the government and monetary authorities need to try and increase aggregate demand (consumer spending, investment, exports). There is no guarantee that they will work. It will depend on the policies and also the causes of the recession. The primary policies …
Say’s law states that the production of goods creates its own demand. In 1803, John Baptiste Say explained his theory. “It is worthwhile to remark that a product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value.” (J. B. Say, 1803: …