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Government Policy and Outcome

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Submitted By waarrrreen
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Virtual Economy – Government Policy and Outcomes

INTRO
Within our model we have changed five variables (as shown in figure 1): lowered the basic rate of income tax to 20%, lowered VAT to 12% and increased government spending on health, education and employment, and defence each by 5%. This report will explain the impact upon mainly 3 economic indicators: unemployment, inflation and government debt, before analysing different implications on the economy. It should be appreciated that the government targets for these three factors are low unemployment, low inflation and low government debt, although recently this target has become to reduce government debt. It should also be noted that sustainable positive economic growth is also a government target. We will analyse the effects that these policies have and speculate its impact upon other economic indicators. Upon doing so we will determine a base rate (interest rate) that will improve the economic circumstances of our model and give recommendations on policy usage.
Inflation
The initial RPI deflation as seen in figure 2 can be explained by the government reflationary policy of lowering the rate of VAT. The affect of lower VAT payments results in business’ passing on their savings onto the consumer via a lowered price, which leads to deflation in the short term. However, within a two year time period RPI will augment to 7.5%. Keynesian fiscal theory suggests that reflationary fiscal policy is the best way to stimulate aggregate demand (AD); lower tax leads to increased disposable income of consumers causing higher demand, whilst increased government spending also contributes to increase AD. Such increases in AD commonly leads to demand-pull inflation as producers cannot cater for this vast increase in demand. This can be seen on an AD-AS diagram, as shown in figure 7.
According to monetarist theory, an increase

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