# Disequilibrium: Monetary Policy and Y=e Expenditure

Topics: Monetary policy, Inflation, Economics Pages: 7 (1437 words) Published: May 6, 2011
Why might an economy experience disequilibrium? Use appropriate theoretical model(s) to distinguish between disequilibrium positions and explain the importance of this information for policymakers when seeking to attain full employment national income. What are the weaknesses of this analysis? When studying economies in equilibrium the main thing we focus on is national income and aggregate expenditure. National income is the value of goods and services produced by a country over a particular time period (Heal, 2006). In a closed economy which consists of consumption investment and government expenditure the equilibrium point would be where the aggregate expenditure meets the Keynesian 45o line which where income equals expenditure (Sefton, 2006). The situation of full employment level of national income occurs when national output is at its maximum level hence real income can obtained at all levels as stated in Sloman(2009). Situations of disequilibrium occur either when an economy is facing a deflationary gap where by the equilibrium level of national income is below the full-employment level or when experiencing inflationary gap which can cause high inflation due to the fact that equilibrium level of national output is above the full-employment level (Bulletin of Economic Research, 1990). Y

Y
In the case of a deflationary gap this disequilibrium will cause excess capacity in the economy thus resulting to demand deficient unemployment. The equilibrium level of national income is represented by Ye and the full-employment level is represented as Yf. W, E, J

W, E, J
a
a
The national equilibrium is where W=J and Y=E
The red line represents the full-employment level of income. On the diagram ‘a’ represents the amount Expenditure has fallen short on income. ‘b’ represents the amount injections have fallen short on withdrawals

The national equilibrium is where W=J and Y=E
The red line represents the full-employment level of income. On the diagram ‘a’ represents the amount Expenditure has fallen short on income. ‘b’ represents the amount injections have fallen short on withdrawals

Y
Y
b
b
Yf
Yf
Ye
Ye
W
W
J
J
E
E

AE represents consumption, investment and government expenditure. The injections clearly exceed withdrawals as shown in the region marked ‘A’

AE represents consumption, investment and government expenditure. The injections clearly exceed withdrawals as shown in the region marked ‘A’

Y=E
Y=E
Inflationary gaps on the other hand represent a limit on national output so any further expenditure will only result in demand pull inflation. A
A
National income
National income
expenditure
expenditure
Ye
Ye
Yf
Yf
AE
AE

The expansionary fiscal policy and expansionary monetary policy are used to close a deflationary gap. The contractionary fiscal policy and contractionary monetary policy are used to reduce the money in the economy. When focusing on monetary policy and a government wants to control the level of spending in an economy the aggregate expenditure, it must be able to control the banks’ ability to lend which involves interest rates .Influencing firms and households willingness to borrow by controlling the money supply. The fiscal policy involves controlling government expenditure and also the taxes . This shows the relationship between interest rate and investment. When interest is at R1 the investment is 10 and when the investment is at R2 the investment is at 20. This shows that if governments regulates interest rates it can control the aggregate expenditure by either increased or decreased investment to either to close a deflationary gap or lower injections in an inflationary gap This shows the relationship between interest rate and investment. When interest is at R1 the investment is 10 and when the investment is at R2 the investment is at 20. This shows that if governments regulates interest rates it can control the aggregate expenditure by either increased or...

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