Published by Patrick Mutisya · 14 days ago
Understand the range of policies available to promote economic growth and evaluate their effectiveness.
These policies aim to shift the long‑run aggregate supply (LRAS) curve to the right, increasing the economy’s productive capacity.
| Policy | How it Works | Potential Effectiveness | Possible Drawbacks |
|---|---|---|---|
| Improving education and training | Raises human capital, increasing labour productivity. | High – long‑term gains in productivity and innovation. | Benefits realised only after several years; requires substantial public spending. |
| Investment in research and development (R&D) | Stimulates technological progress and new products. | High – can lead to breakthrough innovations that boost growth. | Uncertain outcomes; may benefit private sector more than public. |
| Infrastructure development (roads, ports, broadband) | Reduces transaction costs and improves efficiency. | Medium‑High – improves productivity across many sectors. | High upfront costs; risk of “white elephant” projects. |
| Tax incentives for investment (e.g., lower corporate tax, accelerated depreciation) | Encourages firms to expand capital stock. | Medium – can stimulate private investment if confidence is high. | May reduce government revenue; effectiveness depends on business expectations. |
| Labour market reforms (flexible wages, reduced employment protection) | Increases labour market efficiency and reduces unemployment. | Medium – can lower structural unemployment. | Potential social costs; may increase income inequality. |
These policies aim to increase aggregate demand (AD) in the short‑run, moving the economy towards its potential output.
| Policy | Mechanism | Short‑Run Effectiveness | Long‑Run Implications |
|---|---|---|---|
| Expansionary fiscal policy (increased government spending or tax cuts) | Boosts disposable income and consumption, raises AD. | High – can quickly raise output and employment. | Risk of higher public debt; may cause inflation if economy is near full capacity. |
| Monetary policy easing (lower interest rates, quantitative easing) | Reduces cost of borrowing, stimulates investment and consumption. | High – effective when interest rates are not already near zero. | Limited impact if confidence is low; may fuel asset‑price bubbles. |
| Exchange‑rate depreciation | Makes exports cheaper and imports more expensive, improving net exports. | Medium – helps export‑oriented sectors. | Can increase import‑price inflation; depends on price elasticity of demand. |
When assessing a policy, consider the following criteria:
Assume a marginal propensity to consume (MPC) of 0.75. A government reduces income tax by \$10 billion. The immediate increase in disposable income is \$10 billion, and the induced increase in consumption is:
\$\Delta C = MPC \times \Delta Y_D = 0.75 \times 10\text{ bn} = 7.5\text{ bn}\$
The total change in aggregate demand, using the simple multiplier \$k = \frac{1}{1-MPC}\$, is:
\$k = \frac{1}{1-0.75}=4\$
\$\Delta AD = k \times \Delta C = 4 \times 7.5\text{ bn}=30\text{ bn}\$
This illustrates how a fiscal stimulus can have a multiplied effect on output.