Answer to Question #147300 in Macroeconomics for Dillone Pillay

Question

Explain, using the AD‐AS model, how the South African Government can use fiscal policy as a tool to recover from the negative effects of this COVID‐19 pandemic. Your answer must include the following:  The description of the type of fiscal policy required; (4)  An explanation of how the implementation of this tool will work their way through the economy to achieve the desired effect; (6)  The AD‐AS graph showing the implications of your recommendations. (5)

Answer 1

$$Solution$$

a) The government will have to introduce an expansionary fiscal policy. This entails the government cutting on its taxes and also increase its spending.

b)The Expansionary fiscal policy will increase the level of aggregate demand, hence combating the negative effects of COVID. It achieves this through increasing consumption by raising the disposable income among the South Africans due to the tax cuts and government spending on the final goods and services.

c)This can be depicted in the AD-AS model curve shown below.

The original equilibrium $(E_o)$ represents a recession of the economy due to COVID, occurring at a quantity of output $(Y_o)$ below potential GDP. However, a shift of aggregate demand from $AD_0$ to $AD_1$ , enacted through an expansionary fiscal policy, can move the economy to a new equilibrium output of $E1$ at the level of potential GDP which the LRAS curve shows. Since the economy was originally producing below potential GDP and inflationary increase in the price level from $P0$ to $P1$ , though it's relatively small.