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Using aggregate demand and supply analysis, evaluate the effect on the
economy of a cut in spending on schools and education (30)
Aggregate demand is the total demand for goods and services produced in an
economy over a period of time. Similarly, aggregate supply is measure of the
total volume of goods and services produced in an economy over a period of
time. Changes in aggregate demand and supply help us examine economic
growth and inflation in an economy. Government spending is an injection into
an economy even though it has decreased. Typically, it helps increase the
circular flow of income but in this as it has decreased it will reduce the circular
flow of income.
The diagram used shows changes in real GDP and price level. From the
changes in price level we can study inflation and deflation. GDP stands for
gross domestic product and it is value of the output produced by an economy.
The word ʻrealʼ specifies that we are looking at changes in GDP excluding
inflation.
The equilibrium A show that the economy started at a price level of P1 and a
real GDP level of Y1. Then as we studied before that aggregate demand will
drop along with government spending. This shifts the aggregate demand
curve to the left. We are now at equilibrium B with a reduced GDP of Y2 and a
reduced price level of P2. From this we can interpret that perhaps deflation
has taken place.
The government has four macroeconomic objectives and those are (i) keep
unemployment low (ii) low and steady inflation (iii) steady economic growth
and (iv) a sustainable balance of payments. As we can see that by cutting
government spending and the decreased aggregate demand has lead to a
smaller GDP. This shows that the government is not fulfilling its third
objective. This is not good for the economy because if GDP is low this can
spur on other adverse impacts such as increased unemployment.
Another thing, if less people are going to higher education because it is too
competitive, then it is fact that they will earn less money than somebody who
goes to university. So by cutting money spent in education we are indirectly
increasing the percentage of the population who earns lower incomes than
they should have (if they went to university). This can again lead to the
multiplier effect because if incomes are small then people will spend less. This
will lead to cut in consumption and ultimately a lower aggregate demand level.
And the cycle will continue.