Analyzing Macroeconomics: Policies, Equilibrium, and UK Trade-offs

This macroeconomics assignment explores various key concepts, starting with how governments can use fiscal and monetary policies to influence equilibrium output in a closed economy. It differentiates between real and nominal exchange rates and explains fixed versus floating exchange rate regimes, including depreciation and appreciation. The assignment also examines the positive impact of EU economic integration on economic growth, supported by diagrams. Furthermore, it discusses policies the UK government can implement to manage inflation and unemployment, based on the Phillips curve. The analysis extends to the equilibrium conditions in goods and services, money, and labor markets. The impact of expansionary and contractionary fiscal and monetary policies on income and investment is also detailed. Finally, the assignment identifies the primary factors affecting investment and capital formation, such as interest rates, economic growth, technology, and market confidence, providing examples to illustrate these points. This document is available on Desklib, a platform offering a range of study tools and resources for students.

Running head: MACROECONOMICS ASSIGNMENT
Macroeconomics Assignment
Name of the Student
Name of the University
Author Note

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Table of Contents
Answer 1....................................................................................................................................2
Answer 2....................................................................................................................................3
Answer 3....................................................................................................................................5
Answer 4....................................................................................................................................7
Answer 5....................................................................................................................................8
Answer 6..................................................................................................................................10
Answer 7..................................................................................................................................13
References................................................................................................................................14

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Answer 1
In a closed economy, the output (Y) can be determined by the following equation:
Y = C(Y-T) + I + G, where, C denoted the consumption expenditure, T denotes the
tax imposed by the government or the earnings of the government, I denotes the investment
expenditure and G shows the amount of government expenditure in the economy (Mankiw
2014).
Thus, to increase the equilibrium output of the closed economy the government of the
concerned economy can take expansionary fiscal policies, which include increase in the
government expenditure, reduction in tax imposed, thereby inducing increase in the
consumption expenditure by increasing the disposable income (Y-T). These expansionary
fiscal policies can lead to an increase in the aggregate demand in the economy, thereby
shifting the IS curve in the following way:
Figure 1: Expansionary fiscal policy leading to increase in equilibrium output
(Source: As created by the author)

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On the other hand, the equilibrium output can also be increased though expansionary
monetary policies, which may include lowering of the rate of interest prevailing in the
economy, which in turn leads to an increase in money supply in the economy and greater
amount of money in the hands of people, thereby leading to increased in aggregate demand in
the economy (Burda and Wyplosz 2013). This increases the output in the economy shown as
follows:
Figure 2: Increase in equilibrium output due to expansionary monetary policies
(Source: As created by the author)
Answer 2
The nominal exchange rate of the domestic currency of a country can be defined as
the amount of foreign currency which can be exchanged for one unit of the domestic currency
of the country. However, the real exchange rate of the domestic currency of a country shows
the actual purchasing power of the currency of the country, that is how much goods and

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services of the country itself can be exchanged for the goods and services produced in the
foreign countries (Heijdra 2017).
Thus, Real exchange rate = Nominal exchange rate*(Foreign price/Domestic price)
On the other hand, the fixed exchange rate is that exchange rate which remain pegged
at a predetermined rate and does not change regularly, which can be shown as follows:
Figure 3: Fixed exchange rate
(Source: As created by the author)
In cases of fixed exchange rate systems, any increase or decrease in export or import
dynamics of the country does not lead to depreciation or appreciation of the value of its
domestic currency with respect of foreign currency but is adjusted in terms of demand and
supply of the foreign currency in order to keep the exchange rate in the country same.
On the other hand, floating exchange rates are those which vary according to the
fluctuations in the international foreign exchange markets, which can be shown as follows:

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Figure 4: Flexible Exchange Rate
(Source: As created by the author)
In these instances, when the demand for foreign currencies increases, it leads to an
appreciation of the value of the foreign currency in terms of the domestic currency, thereby
increasing the exchange rate of the domestic currency of the country.
Answer 3
The European Union, being an agreement among the European countries, was
primarily formed with the objective of economic integration, which targets the reduction and
removal of trade barriers (both tariff as well as non-tariff ones) in order to ensure free trade
among the member countries, which not only involves free flow of goods and services but
also eased movement of productive resources across the member countries (Dassonneville
and Lewis-Beck 2014).

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The reduction of the trade barriers and economic integration, which have been done
by the EU, are expected to have several benefits on the overall economy, which can be shown
with the help of the following figure:
Figure 5: Benefits of Free Trade
(Source: As created by the author)
As is evident from the above figure, with economic integration and imposition of free
trade, the overall price of products falls due to increase in competition, which results in
higher consumer surplus (1). The increase in import and export activities also lead to increase
in production of the industries which lead to economies of scale. The welfare of the society
also increases (2+4) (Blanchard and Giavazzi 2003). However, the tariff revenue of the
government falls, but due to the increased productivity, economies cost efficiency, economies
of scale and consumer surplus, both aggregate demand and supply in the economies across
the EU are expected to increase, thereby contributing positively to economic growth.

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Answer 4
In the economy of the United Kingdom, there exists a trade-off between inflation and
unemployment. When the economic productivity in the country is increased, it leads to
creation of more scopes of employment. This increased employment leads to increase in the
economic welfare of the population which in turn leads to aggregate demand in the economy.
This increases the overall price levels in the economy (Palley 2012). Thus, there exists an
inverse relationship between inflation and unemployment in UK, which can be shown with
the help the following figure of Phillip’s Curve:
Figure 6: Phillips Curve
(Source: As created by the author)
Keeping the trade-off into account, the government of the country needs to design the
policies in such a way so as to maintain a balance between the inflation and unemployment of
the country. An efficient policy to reduce inflation is of that of contractionary fiscal policy,
which however reduces aggregate demand thereby leading to increase in unemployment and
vice versa. This in turn leads to the need for balanced strategic framework for the country.

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Answer 5
The equilibrium in the goods and service markets occur at the point where the demand
for the same is equal to the supply of the same, which can be shown as follows:
Figure 7: Equilibrium in the goods and services market
(Source: As created by the author)
Here, Q* is the equilibrium quantity and P* is the equilibrium price levels (Johnson
2017).
The equilibrium in the labour market, occurs at the point where labour demand is
equal to the labour supply:

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Figure 8: Equilibrium in the labour market
(Source: As created by the author)
Here, the market reached equilibrium at the labour demand and supply level L*, with
the equilibrium wage being W*.
The equilibrium in the money market occurs, where money demand is equal to money
supply:

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Figure 9: Equilibrium in the money market
(Source: As created by the author)
In the short run, the money supply remains constant. Thus, the equilibrium occurs at
the point where the supply curve intersects demand curve, with M* being the equilibrium
quantity of money and R* being the equilibrium rate of interest.
Answer 6
Expansionary fiscal policy increases investment (public or private), thereby increasing
the output of the economy while the contractionary ones lead to decrease in investment and
output:

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Figure 10 (a): Expansionary Fiscal Policy
(Source: As created by the author)
Figure 10 (b): Contractionary fiscal policy
(Source: As created by the author)

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On the other hand, expansionary monetary policy reduces the rate of interest, thereby
increasing investment and vice versa as they are inversely related:
Figure 11: Inverse relationship between investment and rate of interest
(Source: As created by the author)
Thus, an expansionary policy shifts the LM curve rightwards, increasing output and vice
versa:
Figure 12: Expansionary monetary policy

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(Source: As created by the author)
Answer 7
The primary factors affecting investment and capital formation in an economy are as
follows:
a) Rate of interest- A higher rate of interest lowers investment and vice versa
b) Economic Growth- When an economy prospers, the investment in the economy rises,
as can be seen from the inflow of investment in the UK in between 2005 and 2015,
due to the increase in the economic growth of the country at that time (Persson and
Tabellini 2012).
c) Technology- Technological innovation and progress also induces higher investment
d) Confidence- The confidence in the market also leads to greater investment in the
same, which was seen to be occurring in the economies of UK, USA before 2007.

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References
Blanchard, O. and Giavazzi, F., 2003. Macroeconomic effects of regulation and deregulation
in goods and labor markets. The Quarterly Journal of Economics, 118(3), pp.879-907.
Burda, M. and Wyplosz, C., 2013. Macroeconomics: a European text. Oxford university
press.
Dassonneville, R. and Lewis-Beck, M.S., 2014. Macroeconomics, economic crisis and
electoral outcomes: A national European pool. Acta Politica, 49(4), pp.372-394.
Heijdra, B.J., 2017. Foundations of modern macroeconomics. Oxford university press.
Johnson, H.G., 2017. Macroeconomics and monetary theory. Routledge.
Mankiw, N.G., 2014. Principles of macroeconomics. Cengage Learning.
Palley, T., 2012. The economics of the Phillips curve: Formation of inflation expectations
versus incorporation of inflation expectations. Structural Change and Economic
Dynamics, 23(3), pp.221-230.
Persson, T. and Tabellini, G., 2012. Macroeconomic policy, credibility and politics.
Routledge.