Essay

ESSAY 5

Question1: What are leakages, and how do they affect the economy?

Leakageis a situation where income or capital exits a system or economyinstead of the system or economy remaining with the capital orincome. In an economy, leakage can occur when there is an outflow ofincome through imports (Tucker,2014), savings and taxes. For example, through households savingresources to banks, there is an outflow of funds from the householdsto the banks that can help to depict a leakage. Besides, leakages inan economy can be depicted by government spending resources topurchase imports. This is a leakage because it represents an outflowof funds from the economy (Schiller et al, 2012). Leakages have aneffect on the economy because they tend to lower the level ofeconomic activity in an economy. When leakages are above theinjections in an economy, the economy does not grow since the economytends to have deflation. The deflation may lead to the retardation ofan economy because the economic activities decline.

Question2: If consumers increase savings during a recession, what will thisdo and why?

Theflow of resources or funds to the economy is critical in eliminatinga recession. Thus, the manner in which consumers spend their incomesinfluences the period that a recession can run. When consumersincrease their savings during a recession, it implies that theconsumers will spend less of their disposable income in purchasingcommodities and services in the economy (Tucker,2014). This reasoning holds from the argument that disposable incomeis determined by savings and spending that is, Disposable income =Consumption + Savings. So, in case savings are increased, thenconsumption decreases. A decrease in consumption is likely to implythat the government will have fewer resources to use in reducing therecession. This emanates from the reasoning that the governmentobtains its resources from consumer spending thus, in case consumersreduce their consumption spending, there will be fewer resourcesflowing to the government. Hence, in case consumers increase theirlevel of savings during a recession, there will be a prolonged periodover which the recession would be experienced since the governmentwill have fewer or lack resources to use in curbing the recession.

Question3: How does an inflationary gap occur?

Aninflationary gap describes an output gap, where the real GDP that isadjusted for inflation exceeds the full employment GDP of an economy(Tucker,2014). Thus, in understanding the inflationary gap, it is critical tocomprehend the full employment GDP and the real GDP. Full employmentGDP describes the monetary value of all services and commodities thatan economy has the ability to produce in a certain year providedeveryone is employed, while the real GDP describes all services andcommodities produced by the existing capacity for a given year andadjusted for inflation in regard to a certain base year. Aninflationary gap occurs as a result of effective demand going abovethe full employment level. Therefore, it occurs when the equilibriumincome is above the full employment income (Tucker,2014). In this case, there are too many resources in the economy, butchasing very few goods. The following graph depicts an illustrationof an inflationary gap

Aggregate equilibrium level

Expenditurefull employment level AE0

AE1

Inflationarygap

Yf Ye Output

References

Schiller,B., Hill, C. &amp Wall, S. (2012). TheMicro Economy Today:&nbsp13thEdition.New York: McGraw-Hill.

Tucker,I. B. (2014).&nbspMacroeconomicsfor today.Mason,OH : CengagePublishing.