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ECO403 Macroeconomics GDB Solution Fall 2012

Indonesia is a country in Southeast Asia. It has 34 provinces with over 238 million people, and is the world’s fourth most populous country. The country has abundant natural resources in the shape of natural gas, copper, tin gold and crude oil. Major exports are oil, gas rubber and textile while imports are chemicals, machinery and equipment. Economy of Indonesia is working under mixed economic system in which both private and public sectors play a significant role. The industrial sector is the economy’s largest sector and accounts for 47% of Gross Domestic Product (GDP). Suppose economic condition of Indonesia deteriorated as a result of political instability and inexperienced government. Private sector could not invest more because of decrease in consumption, although economy has an extra ordinary population. Income of the people of Indonesia was not so sufficient that could give them basic necessities. Resultantly not only unemployment increased but also crime and other serious economic issues were emerged .In other words, we can say the economy was jeopardized. Government has nominated a team of economists to analyze the whole situation.

Requirement:
Read the above scenario carefully and discuss with logical reasoning, which type of fiscal policy, either expansionary or contractionary, the team of economists should suggest in order to stream line the whole situation.

Solution:



 
EXPANSIONARY FISCAL POLICY:

A form of fiscal policy in which an increase in government purchases, a decrease in taxes, and/or an increase in transfer payments are used to correct the problems of a business-cycle contraction. The goal of expansionary fiscal policy is to close a recessionary gap, stimulate the economy, and decrease the unemployment rate. Expansionary fiscal policy is often supported by expansionary monetary policy. An alternative is contractionary fiscal policy.
Expansionary fiscal policy is designed to stimulate the economy during or anticipation of a business-cycle contraction. This is accomplished by increasing aggregate expenditures and aggregate demand through an increase in government spending (both government purchases and transfer payments) or a decrease in taxes. Expansionary fiscal policy leads to a larger government budget deficit or a smaller budget surplus.
In general, expansionary fiscal policy works through the two sides of the government’s fiscal budget — spending and taxes. However, it’s often useful to separate these two sides into three specific tools — government purchases, taxes, and transfer payments.


CONTRACTIONARY FISCAL POLICY:

A form of fiscal policy in which a decrease in government purchases, an increase in taxes, and/or a decrease in transfer payments are used to correct the inflationary problems of a business-cycle expansion. The goal of contractionary fiscal policy is to close an inflationary gap, restrain the economy, and decrease the inflation rate. Contractionary fiscal policy is often supported by contractionary monetary policy. An alternative is expansionary fiscal policy.
Contractionary fiscal policy is designed to restrain the economy during or anticipation of an inflation-inducing business-cycle expansion. This is accomplished by decreasing aggregate expenditures and aggregate demand through a decrease in government spending (both government purchases and transfer payments) or an increase in taxes. Contractionary fiscal policy leads to a smaller government budget deficit or a larger budget surplus.
In general, contractionary fiscal policy works through the two sides of the government’s fiscal budget — spending and taxes. However, it’s often useful to separate these two sides into three specific tools — government purchases, taxes, and transfer payments.

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