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Monday, 15 August 2011

Word of the Day

Automatic Stabilisers

A factor that changes in such a way as to automatically stabilise AD and the economic cycle.

They reduce the contractionary multiplier effects from changes in AD. This happens because when the economy is in a recession, there is lack of AD and unemployment tends to rise. Unemployment benefits are automatic stabilisers used when the economy is in a recession. Spending on unemployment benefits increase because more people are unemployed and this causes government borrowing to rise, injecting demand into the economy/circular flow of income.

In a boom, automatic stabilisers reduce the expansionary multiplier effects on the economy. Progressive taxation is used as the automatic stabiliser. As employment and incomes rise, tax revenues increase as a faster rate than income is rising, taking out demand from the economy and preventing it from overheating.

Automatic stabilisers help reduce volatility of the economic cycle.