MACROECONOMICS SIMULATION: ECONLAND
ECN-202-004 | FALL 2022
Table of Contents
Table of Contents 1
The Analysis of Year 1: 3
The Analysis of Year 2: 4
The Analysis of Year 3: 5
The Analysis of Year 4: 6
The Analysis of Year 5: 7
The Analysis of Year 6: 8
The Analysis of Year 7: 8
Appendix 1: Base case (First trial) 12
Appendix 2: Base case (Second trial) 13
Appendix 3: Rollercoaster (First trial) 14
Appendix 4: Rollercoaster (Second trial) 15
Appendix 5: Stagnation (First trial) 16
Appendix 6: Stagnation (Second trial) 17
The report will examine and analyze the microeconomic policy decisions that we made as a group as the government of Econland. The report’s objective is to demonstrate our understanding of the relationship between macroeconomic policies and their effects on our citizens. The projects have two main parts: First, every team needs to play a game for 7 years and try to get the highest average approval rate. Second, each one of us needs to reflect on her experience. The report contains a full assessment of the main fiscal and monetary policy decisions taken during the seven-year administration, as well as an explanation of the underlying causes for those decisions and the policies’ associated consequences.
The game consists of 3 scenarios, and each of them contains seven years, and we have played each scenario twice. Our goal in each scenario is to get the highest approval rating. And to maintain a high rate, we need to keep in mind that real GDP growth must be higher than 2.5%, unemployment rate less than 5%, inflation rate less than 3%, and budget deficit less than 3%. In this report, I will discuss the highest approval rate that we achieved, which was 81 points. My chosen scenario is stagnation, which indicates that output is decreasing and economic growth and volatility are low.
The Analysis of Year 1:
As a first-year, we have decided as a team to keep everything constant to see the change in the economy. As shown in figure 1, the interest rate is 3%, the income tax rate is 24%, the corporate tax rate is 30%, and the government expenditure is $30 billion. In year 1, we got a high average approval rating of 70 points (Figure 2). However, the real GDP for the first year is 2.5%, which is considered on average and shows that economic growth is slow. As a result, the unemployment rate rose, and consumer confidence fell. On the other side, we achieved a low inflation rate of 2% and a 3% budget deficit (Appendix 6). We have received feedback from a policy advisor who suggests that we should investigate a component that can enhance real GDP growth. As we studied, some changes are required to boost real GDP and lower the unemployment rate. We came up with one solution: lower interest rates, which will enhance real GDP for the second year.
The Analysis of Year 2:
In the second year, we have decided to take monetary policy decision, lowering the interest rate to 2.5% and keeping all other factors constant. We made this decision based on our understanding of Keynes’ theory of liquidity preference, which states that the interest rate adjusts to bring money supply and demand into balance, assuming the money supply is fixed by the central bank. As a result, falling prices diminish money demand (MD), shifting the MD to the left and lowering the interest rate (r). A fall in interest rate increases investments and the number of goods and services demanded.
According to Pettinger (2019), economic growth is defined as an increase in real GDP, and aggregate demand (AD) is a factor that causes short-term economic growth. The aggregate demand consists of consumer spending (C), investments (I), government spending (G), and net exports (NX). According to figure 1, which shows an increase in aggregate demand shift the curve in to the right, where low-interest rates can lower borrowing costs, encouraging consumers to spend and businesses to invest, so increasing in consumer spending and investments lead to increase the real GDP (Y).
As a result, the average approval rating jumped to 78 points, which is considered a high score (Figure 3). According to year 2, the results show that the real GDP increased by a small amount and reached 101 (Appendix 6). According to appendix 6, consumption increased from 55 in year 0 to 59.1 in year 1, and there was a 0.2 increase in investments. This resulted in an increase in real GDP. Furthermore, the inflation rate remained unchanged at 2%, and the budget deficit decreased to 2.1%, which is also favorable for the economy (Appendix 6). However, the unemployment rate has increased to 5.6%, and we must find a solution to this problem. So, we decided to increase the government expenditure in year 3 to increase the real GDP and decrease the unemployment rate.
The Analysis of Year 3:
In year 3, we decided to make an expansionary fiscal policy by increasing the government expenditure (G) by 1 billion. In order to stimulate the economy, we increased government spending to $31 billion while keeping all other factors constant (Figure 5). We took this decision because we knew that making a fiscal policy has two effects on aggregate demand, the multiplier effect and the crowding-out effect. So, increasing government expenditure will increase income and thereby increase consumer spending. This will boost the real GDP and then decrease the unemployment rate.
Pettinger identified the multiplier effect as an initial injection into the economy that results in a higher gain in national income. For example, if the government spends more money on one company, wages will rise, causing the company to hire more workers and increase its output. In addition, these workers will increase their spending leading to an extra increase in the real GDP. According to the graph, the first increase in aggregate demand increases output to Y2. The secondary effect, on the other hand, results in an increase in AD (AD3) and a rise in real GDP (Y3). The injections can include investments, government expenditure, and exports (2019).
As a result, we received the highest average approval rating of 85 points in all seven years. As shown in the graph, we have a high real GDP of 106.8 and a low unemployment rate of 4.7%, but the inflation rate climbed slightly to 1.9%, which is still considered low. And the budget deficit becomes lower with -0.5% of GDP. Right now, the economy is performing well on all fronts, and customers are satisfied with the outcomes of our work. Because of the multiplier effect, as we raised expenditure to grow real GDP by investing in the economy, investments climbed to 16.6, and consumption increased to 68, boosting real GDP higher than the second year.
The Analysis of Year 4:
In year 4, we were confused about two decisions: we needed to increase investments, and therefore we considered lowering corporate taxes or lowering interest rates. However, we ultimately chose to reduce the corporate tax rate to 28% while keeping all other variables constant (Figure 7). We reached our decision based on our understanding of fiscal policy and aggregate demand, as we learned that there are two methods to implement the expansionary fiscal policy: one is to boost government spending directly, and the other is to reduce taxes indirectly. Tax reductions may encourage investors to increase their investments, causing the AD to move to the right, thus increasing real GDP.
According to Greenlaw et al. (2017), Both consumption and investment spending are affected by tax policy. Income tax cuts tend to enhance consumption spending, while the rise in the tax tends to decrease consumption. Tax policy also can boost investment demand by reducing the corporate tax rate or providing tax incentives for specific types of investments. In order to do that, the shift in consumption spending (C) and investment spending (I) will affect the entire AD curve. Based on figure 3, both graphs show a shift in the aggregate demand curve (AD). In figure (a), the curve shifts to the right, and the new equilibrium has greater production and price than the initial equilibrium. This shift could be caused by an increase in government expenditure or a reduction in taxes, resulting in greater consumption and, in turn, an increase in real GDP. While figure (b) indicates an AD shift to the left, the new equilibrium will have lower productivity and price levels than the initial equilibrium. This shift could be caused by a reduction in government spending or an increase in taxes, resulting in lower consumer spending and, as a result, lower real GDP.
The average approval rating fell to 81 points which are considered a good score. However, it emphasizes that the decision was incorrect because we found a problem with real GDP, which fell from 2.6% to 1.1%. Furthermore, due to the worldwide economic slowdown, the unemployment rate has risen to 5.5%, which adversely affected Econland this year. On the other hand, the inflation rate has increased to 2.9%, and the government is operating in a surplus. The results are considered favorable because we need to keep the inflation rate and the budget surplus below 3%, which we have achieved (Appendix 6).
According to feedback from the policy advisor, the economic growth is slow, and we have a surplus, which means we can raise government spending or lower taxes to encourage economic growth.
The Analysis of Year 5:
In year 5, We chose to lower the interest rate to 2% to encourage investors to invest and thus boost real GDP growth (Figure 9). As we studied the interest rate effect, a lower interest rate leads to more investment spending, which is one of the components of aggregate demand, hence real GDP will rise (Y). Because real GDP is expected to increase, we expected unemployment to fall and inflation to rise.
As a result, the average approval rating increased to 82 points in year 5 (Figure 10). And our goal has been achieved, since the real GDP growth increased to 2.8%. However, the unemployment rate is still high at 5.4%, and it decreased by a small amount. Furthermore, the unexpected event is the decrease in the inflation rate to 2.2%, which is good for the economy. And the government is performing in surplus with 1.5% of GDP (Appendix 6). Based on the feedback from policy advisors, the economy is growing at a good pace, but the government is running a budget surplus. So, we can adjust the decision by either increasing government expenditure or reducing taxes in order to boost economic growth and reduce the unemployment rate.
The Analysis of Year 6:
In year 6, we were confused between two decisions: further lowering the interest rate or expanding government spending. However, the final decision was to decrease the interest rate to 1.5%, and the other factors remained the same (Figure 11). Our goal is to boost real GDP growth in order to lower the unemployment rate. We knew that decreasing interest rates would grow the economy by stimulating investment, which in order would help people find work.
As a result, the average approval rating decreased to 80 points (Figure 12). Our goal was to lower the unemployment rate, which we did, but only by a small percentage, which reached 5%. Furthermore, the economy increased its budget surplus to 2.7% and the inflation rate to 2.8%, which is still low (Appendix 6). However, we faced an unexpected issue where economic growth slowed due to the budget surplus. Here we make a mistake that leads to having more budget surplus, so if I was in that situation again, I will increase the government expenditure to boost the real GDP and reduce the unemployment rate. Additionally, the economy is running a budget surplus, and I knew that most governments are running the government with a low deficit.
The Analysis of Year 7:
In year 7, to adjust the wrong decision that we have taken in year six, we decided to increase the government expenditure to 32 billion, which we expect to have a good impact on the economy (Figure 13). As discussed previously, increasing government spending will raise real GDP, reduce the budget surplus, and lower the unemployment rate. Furthermore, we expected this adjustment to increase inflation since whenever the economy develops, so does inflation.
According to the year 7 results, the average approval rating improved to 81 points (Figure 14). Based on appendix 6, real GDP growth grew to 3%, the unemployment rate remained unchanged, and inflation increased to 3.5%, the highest level in the last seven years. Furthermore, the budget surplus climbed to 3.3%. If I were in that situation again, I would increase the government expenditure by more than 32 billion since the graph shows a budget surplus, which is unusual. I could also raise the interest rate somewhat to reduce inflation.
To sum up, playing the game was an enjoyable time that allowed me to implement my learnings in real and see the consequence of my decisions. Our highest approval rating within the 6 trials is 81 points, which was in the stagnation scenario. However, we faced some difficulties in determining how much we should adjust. What I have learned from this experience is that it’s hard to keep everything in the economy running smoothly because something unexpected happens every year. Besides, there are always tradeoffs, and the government can never enhance all indicators at once, so they try to compromise. Furthermore, this game shows how difficult to have the ability to make decisions since it is a big responsibility to make your citizens happy and reach a 100% approval rating. The most lesson learned was that the government uses fiscal and monetary policies to mitigate the unfavorable consequences and turn the economy to its natural rate.
Greenlaw, S. A., Shapiro, D., Richardson, C., Sonenshine, R., Keenan, D., MacDonald, D., … & Moledina, A. (2017). Principles of Micro-economics 2e. for AP® Courses. Rice University.
Pettinger, T. (2021, October 19). The multiplier effect. Economics Help.
Pettinger, T. (2019, November 28). Causes of economic growth. Economics Help.
Appendix 1: Base case (First trial)
Appendix 2: Base case (Second trial)
Appendix 3: Rollercoaster (First trial)
Appendix 4: Rollercoaster (Second trial)
Appendix 5: Stagnation (First trial)
Appendix 6: Stagnation (Second trial)