Aggregate Demand, Supply and Fiscal Policy

ECO 202 WK 2 case Aggregate demand, supply and fiscal policy
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Okun's law
Okun’s law implies that a 1% rise in unemployment rate results in a 2% slow down in the GDP given as 2(unemployment rate- natural employment). The employment rate affects income that is related to the GDP, and a 4% GDP growth would result in unemployment of 2%. Okun’s law represents the changes in the output gap, where the economy produces more than the full employment during periods of boom and vice versa (Kennedy, 2000).
The decline of income, employment, and trade in a business cycle
A decline in the total output, employment, income as well as trade for six months or more months indicates that the economy is in a recession (Investopedia.com, 2015). The real variables indicate the health of the economy and since there is a contraction from slowdown in the economy. Typically, negative economic growth for two or more consecutive quarters indicates the onset of a recession. The small businesses are less resilient during recessions because they do not have the financial strength to withstand the slowdown in the economy, and are more likely to lay off their workers during such difficult economic times.
Impact of increased government expenditure vs. decrease in taxes on aggregate demand
Both an increase in government expenditure and a decrease in taxes are expansionary fiscal policies that cause a rightward shift of the aggregate demand (Pettinger, 2008). The tax multiplier influences the changes in aggregate demand for tax reductions and the level of spending for government expenditure. Through increasing government expenditure this has a higher spending multiplier since the whole amount goes into aggregate demand. On the contrary, the tax multiplier has a smaller effect on the aggregate demand since it merely affects a portion of the disposable income that then has a direct impact on consumer expenditure. As such, the multiplier effect causes illustrates the difference of increasing government expenditure as an expansionary fiscal approach compared to simply reducing the taxes. Increased government spending and reduced taxes increase the budget deficits and policymakers weigh the pros and cons of each option before deciding on the better of the two depending on the prevailing economic conditions.
Eliminating a recessionary gap, using fiscal policy
Keynesian economics holds that markets are not always self-regulating and an expansionary fiscal policy is prescribed to eliminate the recessionary gap (Arnold, 2014). Fiscal policies involve expenditure decisions and taxation, unlike the monetary policies that is concerned with interest rates and the money supply. Hence, policy makers can either deliberately increase government spending or implement tax cuts to spur economic growth. The recessionary gap is associated with a recession when the real GDP falls below the potential GDP (full employment GDP) (Arnold, 2014). Additionally, the unemployment rate is higher than the natural rate of unemployment since that are more jobs seekers that the jobs available. The government can choose to increase government expenditure on goods and services, but political priorities and affect this choi...