Government policies can have a big effect on how much money people spend (aggregate demand or AD) and how much companies can produce (aggregate supply or AS). Let's break it down into simpler parts.
How Government Policy Affects Aggregate Demand (AD)
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Fiscal Policy:
- Government Spending: When the government spends more money, like £400 billion in 2020, it helps increase AD. This is because when they spend on things like roads or schools, it creates jobs. More jobs mean more people have money to spend, which boosts AD.
- Taxation: If the government lowers taxes, more money stays in people’s pockets. This leads to more spending. For example, if income tax decreases by 1%, it could increase AD by about £1.5 billion.
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Monetary Policy:
- Interest Rates: Central banks, such as the Bank of England, may choose to lower interest rates, for example, from 0.75% to 0.25%. This makes borrowing cheaper, which encourages people and businesses to borrow and spend more, increasing AD.
- Quantitative Easing: This means the government adds money into the economy. With more money available, borrowing costs go down, and people feel more confident to spend.
How Government Policy Affects Aggregate Supply (AS)
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Supply-Side Policies:
- Investment in Education and Training: When the government invests in education, it helps workers get better skills. For instance, spending £2 billion on training programs can make workers more productive, which increases AS.
- Regulation and Taxation: Lowering taxes for companies, like reducing corporate tax from 19% to 17%, can encourage businesses to invest more. This helps increase AS.
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Infrastructure Development:
- Improving things like transportation and energy systems can lower production costs for companies. This helps shift the AS curve to the right, meaning businesses can produce more.
In summary, government policies are very important. They can change how much people spend and how much businesses produce, shaping the economy overall.