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Answer to Question #49384 in Macroeconomics for UDAY BHASKAR

Question #49384
Q.) Even though the MPC is so high and MPS is so low in US, why the economic bailout packages of the government have little expansionary effect on US economy. Discuss the above statement with reference to the multiplier operations.
Q.) What according to you were the reasons for the price rise in India? In spite of the fall in inflation rate below 4%, why some of the essential items price is still very high? Illustrate.
Expert's answer
Q1) In a recession, consumers may reduce spending leading to an increase in private sector saving. Therefore a rise in taxes may not reduce spending as much as usual.
The increased government spending may create a multiplier effect. If government spending causes the unemployed to gain jobs then they will have more income to spend leading to a further increase in aggregate demand. (e.g. construction workers employed by government increase spending in pubs and transport, causing other sectors of the economy to benefit from the government spending). In these situations of spare capacity in the economy, the government spending may cause a bigger final increase in GDP than the initial injection.
Q2) The value of a rupee does not stay constant when there is inflation. The value of a rupee is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflation goes up, there is a decline in the purchasing power of money.
Causes for rise in prices in India
(A)Demand Pull factors:
Monitoring government expenditures, deficit Financing and increase in money supply, role of Black Money, uncontrolled growth of population
(B) Cost-Push Factor:
Taxation in rising cost, fluctuations in output and supply, control of Inflation.
Inflation is the continuous increase in the price of goods and services over a period of time. If money supply increases the investment increases, if investment increases employment increases, if employment increases household income increases, if household income increases consumption increases, if consumption increases demand exceeds supply therefore it is the situation of INFLATION. In the year 1990-91 there was a high inflation of 13.81% which was not good for the economy. The government has to take decision to control the inflation. In 1995-96 the inflation started reducing. But again there was a high inflation in 1997-98 for which the government has to think again. As the population was increasing the consumption was also high. The supply was not be met by the government and the demand was increasing. In year 2008 to 2010 the inflation was again in the two digit and it effected a large part of the nation. Too much inflation is not good for the economy and it should also be not too less. If the inflation is very low the consumption has to be reduced and if the consumption reduces the house hold income reduces, and finally a situation will occur where there be decreasing money supply.

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