16/05/2013 § Leave a comment
#3. 25 marks.
a) Analyze the methods by which the central bank might decrease the money supply.
Money supply is the combined value of the currency and demand deposits of a country. The government has three methods in which it can change the money supply. They are to increase the discount rate, sell government bonds, and raise the reserve requirement ratio. Firstly, the discount rate is the rate charged by central banks when making loans to big commercial banks. If the discount rate is higher, big commercial banks will be given a signal that will discourage them from borrowing money from the central bank. This ends up raising the interest rates for borrowers and decreasing the money supply in the money market. Secondly, a government bond is a certificate issued by the government that can guarantee repayment of an initial amount charged with an agreed upon interest rate. When central banks sell government bonds into the open market, the reserves of of commercial banks will be taken out of private banks. The private banks will then charge more for what they have left, and because the bonds are sold with liquid money, the over supply in the money market will decrease. Selling bonds puts a downward pressure on price levels, output and employment, and it also increases interest rates, contracting consumption and investment as a result of reducing the money supply. Finally, raising the reserve requirement forces banks to reduce the amount they can loan out. The reserve ratio is the percentage of deposits that banks are required to hold at all times. Obviously if the required amount of money increases, there is less supply of money left in the money market.
b) Discuss the likely impact on an economy of a substantial decrease in the level of interest rates.
At first, a substantial decrease in the level of interest rates will give the economy beneficial consequences in the short term, but could possibly pose some difficulties in the long run. Interest rates are the opportunity cost of spending money, shown as an amount charged out of the initial amount of money provided. A substantial decrease with interest rates can only be accomplished through an expansionary monetary policy. This would involve decreasing the discount rates, buying government bonds, as well as lowering the reserve ratio. If at first the interest rates are what will fall, in the short run, investments will increase as a result. Firms and households see that the interest rates aren’t as high as they used to be and they don’t know when they’ll be low again so more often than not, investments will rise because firms and households are willing to spend more. This also means that growth and consumption may increase, and as a result, employment and inflation could increase in the long run. Since growth and consumption are part of the factors that make up the aggregate demand, or national output (GDP) of a nation [C + G + I + (X – M)], their increase could result in the rightward shift of the AD, which suggests economic growth for the nation. The shift could be great because the decrease in interest rates was substantial. That’s in the short run, but the long run could show a possible shift in the AS curve, which involves factors of production such as human capital (wages), and physical capital (technology). A shift in the supply is caused by the shift of the AD, as typically the supply tries to meet the demand. This means the people and the government can invest more on education, but a higher educated population could introduce lower wages to households and firms. There would be more competition because of a higher educated society – people would know how to use technology and fewer workers would be needed to do the job that previously forty workers were needed to accomplish. This would then put people into structural unemployment and they would need to learn new skills, perhaps go back to a school that would teach them more modern skills that could be of more use. Typically, a substantial decrease in the interest rate could increase investments but only assuming that the individuals in households and firms are confident enough to make those investments. If this is the case, like with countries like Japan, then investment won’t actually rise after the government decreases interest rates by a lot. In the end, it also really depends on the nation, its current conditions (if it’s experiencing steady growth or a recession) and the nation’s values.
07/05/2013 § Leave a comment
#4. 25 marks.
a) What are the main macroeconomic objectives of government?
The four main macroeconomic objectives of a government are 1) low unemployment (or full employment), 2) low inflation rates, 3) economic growth, and 4) equity in income distribution. Firstly, unemployment is the condition of someone of working age (typically 16 – 64 years of age but this varies across counties) who is willing and able to work and actively seeking employment but unable to find a job. A nation with high levels of unemployment could suggest a low AD, which means that their economy as well as the contents of their GDP are not very strong. This means that the people who already have low income (due to a lack of a job that would otherwise provide them with a steady stream of money) would be further disincentivized to purchase goods, only pushing the AD further back. This puts a strain on the government in terms of spending on unemployment support instead of capital as well as supporting those who are in the lower percentile of total income. Secondly, low inflation rates are pretty self-explanatory. Inflation is the sustained increase in the average price level of goods and services in a nation and can be measured with the CPI (consumer price index). Governments try to keep the inflation rates low because high inflation rates mean more expensive goods. For all citizens in the nation, this is a disadvantage to them because it takes away more of their income and reduces their purchasing power. Although rising inflation rates could spur sudden spending from consumers, that’s only in the short run. In the long run, high inflation rates keep consumers from spending, which would them reduce consumption therefore lowering the nation’s AD. Thirdly, governments want economic growth to increase their GDP and strengthen their economy. Economic growth is an increase in the total output of goods and services (essentially the GDP) in a nation over time. This can be illustrated as an outward expansion in the PPC curve or the rightward shift of the AD in an AD/AS curve. Economic growth is followed by multiple consequences, one of them obviously being an economic increase in the level of income and consumption in a nation. The non-economic consequences however include negative externalities (because, naturally, as an economy grows, industries start to use more advanced technology that emit pollution and waste because that keeps costs low), inflation (due to the movement of the AD rightwards), structural unemployment (upgrades in capital and technology make for unemployed individuals lacking skills required today), a change in the composition of output, and an unequal income distribution (as the people who would benefit from economic growth are typically the minority; such as politicians, the higher educated classes, and large corporations). Finally, the fourth economic goal is equity in income distribution which can be illustrated with the Lorenz curve and explained through the Gini coefficient. Equity means economic fairness while equality means minimizing the disparities in income and wealth among a nation’s households. Equity ultimately promotes greater equality in income distribution. Generally a more equal distribution of a nation’s income among the nation’s people can avoid relative and absolute poverty as well as promote greater consumption. Governments can achieve higher levels of income distribution by using the three different taxes (proportional, regressive and progressive).
b) Assume the government chooses to pursue one of these objectives. Evaluate the possible consequences for the other objectives.
The first example that comes to mind is our very own country, Japan. Japan values the first macroeconomic goal far more than the other goals, or so they’re making it seem. When the government is presented with the opportunity to lay off some of their workers due to inefficiency and lack of productivity, they choose to keep the workers there instead of use their money on something more beneficial, like technology, education and better capital (human or physical). For example, there are many zombie companies/firms in Japan that consist of men who don’t really do anything every day for a living and still get a check at the end of each month. While they are bound to their jobs by a contract, the government still chooses to keep them there, putting their money into people who are technically unemployed (they aren’t using their skills nor are they contributing at all to the nation’s GDP). Because all this money is going into something unproductive, Japan’s GDP is the one that pays. This means that the macroeconomic goals of inflation and growth, perhaps even equity in income distribution have to pay the consequences, but mostly Japan’s economic growth. Since the government isn’t spending on human or physical capital, it’s almost impossible for the SRAS to shift rightwards and increase the output of supply in the economy. Similarly, though Japan is trying to keep almost all of its people employed, they’re failing as the people working in the zombie corporations are technically unemployed, therefore growth is also hindered since Japan can’t be pushed to it’s level of full-employment and can’t push the LRAS rightwards either. And that’s all I have for today.
06/05/2013 § Leave a comment
#1. 25 marks.
a) Using a Lorenz curve diagram and examples, distinguish between a country with a high level of income equality and one with a low level of income equality.
A Lorenz curve is a diagram used to graphically represent a country’s income distribution among its population. With it comes the Gini coefficient, which is an economic indicator of the level of income distribution in a nation. This number is normally between 0 and 100; the closer it is to 100, the greater the disparity amongst the nation’s population, and the closer the number is to 0, the more equally the income of the nation is distributed throughout the households. In a simpler sense, we can distinguish between countries with higher levels of income equality and countries with lower levels of income equality by how close they are to the line of equality in a Lorenz curve. Country A (the purple line), for example, would then be the country with a higher level of income equality simply because it’s closer to the line of equality (which is 45° from the axes). Therefore, Country B (the orange line) would be the country with the lower level of income equality because it’s farther from the line of equality. This suggests that Country B has a higher disparity amongst its people, meaning that the difference between the rich and the poor is vaster than that of Country A. In order to improve its income equality, the government could implement certain taxes, ranging from proportional, regressive and progressive taxes.
b) Justify the claim that poverty’s consequences makes its elimination the most important objective of economic policy.
There are two kinds of poverty in an economic sense. There is relative poverty, which is the poverty that people experience even in the world’s richest countries, but absolute poverty refers to the people in the lowest percentile in terms of income, wherein they cannot even afford the most basic necessities for survival and safety. Of course the presence of any kind of poverty in a nation presents multiple different problems for the country, including political and social unrest. Obviously if there is poverty, there is a gap between the poor and the rich that sets off a big disparity that differentiates one group from the other based on their income. This reduces the equality the citizens feel, as well as the difficulty politicians have to face when making decisions, either to keep their positions or to improve their people’s situation.
Governments can use different taxes to improve or worsen their citizens’ quality of life. Certain taxes can put different burdens on the rich and the poor. A proportional tax puts more of a burden on the rich because both sides pay the same percentage of their income, but since the poor have an overall smaller amount of income, they typically pay less than the rich, who would naturally have to pay more. A regressive tax puts more of a burden on the lower income households because it is a tax that decreases as an individual’s income increases. This tax is more of an incentive for people to work harder to increase their incomes at work. Finally, a progressive tax is what normally works the best if the macroeconomic goal of the nation is the establish equity in the distribution of income. Technically, as the income increases, the tax an individual needs to pay also increases. The principle of this tax is that those who can pay more should pay more and most Northern European countries who use this tax have the most equal distributions of income.
However, even if the government has options to eliminate poverty through taxes, there are of course consequences in altering taxes. If the taxes increase, people would be disincentivized (?) to work hard, especially the rich people. Following this, productivity and efficiency in households and firms would decrease because of the lack of motivation. Additionally, if the government chooses to eliminate poverty, it would mean subsidizing the poor, and where would they get the money to do that? Taxes, the burden of which is undertaken by the rich, because they can afford the tax. This would cause unrest among the rich but if the government didn’t support the poor through subsidies, there would be an even larger percentage of inefficient and uneducated citizens in their nation which would add to the production costs of firms, reducing AS, lowering the price, therefore causing deflation. In this sense, if the government solely focuses on eliminating poverty, they’d only cause more problems for themselves.
03/04/2013 § Leave a comment
#1. 25 marks.
a) Outline three strategies which governments may use to increase their economic growth rates.
Economic growth is defined as an increase in the total output of goods and services (or GDP) in a nation over time. Rate would then be the amount of growth over time. Economic growth is one of the four macroeconomic objectives of nations. Governments can aim to increase their rate of economic growth by focusing on improving their productivity growth. This means that the government can improve their education, seek capital at the highest quantity and quality, and promote policies towards training their population. If the government can improve their population’s education, then they can raise smarter and more capable workers, therefore human capital would be improved upon through education. This means hiring better teachers, investing more in schools, and really spending more money on education as it is a vital factor in improving human capital. The government can improve their physical capital by increasing the quantity of capital per worker to increase their level of output, resulting in higher economic growth (because then all the workers would have more capital to work with, therefore they would all have the ability to produce more). The government should also invest in seeking the highest quality of capital, like replacing a farmer’s buffalo for an old tractor, and then later replacing that old tractor with a faster, more high tech version. This increases the productivity of that farmer, resulting in an increase of output of his goods. Finally, also to improve their human capital, a good government will promote policies that help to train and make better and more efficient workers out of the population. Not only will this improve a nation’s workers, it also provides jobs – for trainers, and would open up the R&D and HR departments for firms.
b) Discuss whether increasing the rate of economic growth should be the major policy objective of government.
In macroeconomics, a nation’s government doesn’t have only economic growth to worry about. They have three other objectives that they can focus on, and it always depends on their culture and history on what they value more. For example, Japan, between the four macroeconomic goals (low inflation, low unemployment, economic growth, and equal income distribution), would probably value low unemployment over economic growth because of their culture. Japan would break if too many people were unemployed, therefore increasing the rate of economic growth would not be a major policy objective of their government. The same can’t be said for the U.S. though, who seems to value economic growth as well as moving forward more than, say, low unemployment and equal income distribution. Improving and increase the rate of economic growth comes after many things, such as reducing unemployment, improving the quantity and quality of the nation’s resources, training and education the people to improve efficiency, and seeking better technology among other things. Economic growth should then be a long-term goal kept in the back of the government’s minds at all times, but should not be a hugely major policy objective.
28/02/2013 § Leave a comment
#2. 25 marks.
a) What are the costs of a high rate of inflation?
Inflation is an increase in the average price levels of goods and services in a nation over time. If the rate of inflation is less than 2%, the economy could be expecting disinflation and eventually, deflation. The healthy rate of inflation is considered to be 2 – 3%. Inflation rates over 3% are then high and can have negative consequences such as the loss of purchasing power. An increase in inflation can take away from the income of a household. Even if a worker’s income increases, if the inflation right in the economy is higher than that of the worker’s income increase, then they’ve lost much of their purchasing power and have essentially become poorer than they were before the inflation rate increased.
High rates of inflation also lower real interest rates for savers, who are interested in fixed-interest assets, such as government bonds or savings accounts. As inflation rises, the interest rate earned on savings would fall. A high inflation rate also creates higher nominal interest rates for borrowers, meaning that during times of high inflation, banks would raise their nominal interest rates that they charge borrowers – obviously they want to earn more profit and in this case, we could say that inflation rates and interest rates are linked. This means that borrowers pay more, making it more expensive for firms or households to borrow money from banks.
Finally, higher interest rates reduces a nation’s competition with the rest of the global market. High inflation within the country makes the domestic output look far less attractive to foreigners therefore they’d stop importing goods from that domestic country. That nation with the high inflation (hey, that rhymed) would experienced reduced profit from their Exports/Imports sector. Similarly, the high inflation rates would make imports look more attractive to the domestic citizens instead of their own domestic goods.
b) “What is wanted is not inflation or deflation but price stability.” Discuss.
We learned that with the Phillips curve comes the NAIRU, or the non-accelerating inflation rate of unemployment. This is the level of unemployment in the economy that works well when the nation is producing at full employment. The key to the NAIRU is that price levels are stable, they are not pressured upwards or downwards. Based on the LRPC and the neoclassicist point of view that, when left alone, an unstable economy will be able to correct itself as the unemployment rate will always be able to move back to its natural rate of unemployment. This is the part of the LRPC that is neither perfectly elastic or inelastic – it’s around in the middle. Straying away from this middle would cause either inflation (a rise in the average price levels) or deflation (a decrease in the average price levels).
We know there are more losing stakeholders than there are winning stakeholders when it comes both inflation and deflation. The winners during times of inflation are borrowers, flexible income earners, and importers, but the losers are the lenders, fixed-income earners, savers, and exporters. The lenders are the ones who received less money the borrowers paid them back because inflation had lowered their interest rates. The fixed-income earners have an overall reduced income and purchasing power. The savers also experience lower interest rates and can’t save as much as they used to. And exporters lose business because other nations won’t buy from them.
The costs to deflation are multiple, including rising unemployment, falling investment, falling consumption and increased savings, and increased debt burden on households. Deflation clearly diminishes the confidence and animal spirit among firms, which plunges the economy into a deflationary spiral that only pushes the AD further back as well as bumping prices lower and lower (as AD moves left – backwards – price moves downwards). Consumption, net exports, investments are all key factors that push the AD back and continue the deflationary spiral.
That being said, since both inflation and deflation can be extremely harmful and costly to an economy, it’s safer to maintain stable prices. For countries that really want to focus on economic growth, they should definitely try and maintain the healthy inflation rate of 2 – 3% but nothing more or less unless they’re willing to experience the negative consequences of deflation or inflation.
25/02/2013 § Leave a comment
#1. 25 marks.
a) Distinguish between structural unemployment, frictional unemployment and seasonal unemployment.
Structural, frictional and seasonal unemployment are all part of a nation’s NRU: natural rate of unemployment. Even when a nation is producing at a level of full employment, there is a small amount of unemployment that is natural and that the nation desires.
Structural unemployment occurs when a worker loses his job due to the changing structure of a nation’s economy. His unemployment is normally the cause of globalization or the improving development of his nation’s economy. Naturally, as a nation further develops its economy and becomes more globalized and attuned to the financial ways of other, more modernized nations, some lines of work will have to be cut off since the type of labour or service they provide is no longer desired. The range of development usually starts from the labor farmers offer to the type of manufacturing work that factory workers offer, and finally to the type of work from large service sector that more educated and skilled workers can offer. We can see the clear increase of the level of skills and intelligence needed in the workers as the nation’s GDP develops. A factory worker then who used to work at a plant that contributed to the economy of a developed nation that is well on its way to further improve its economy might then get laid off naturally as the nation starts to diminish its need for factory workers and increase its need for service sector workers. The ways a nation can reduce its amount of structural unemployment would be to invest in public education and training for adult workers for the long run, to train the workers for the newer jobs, and to generally improve their education so that when it’s time for them to work, they will already be ready.
Frictional unemployment occurs when workers are in between jobs (looking for a new job) or entering the labour force for the first time. When (or if) I graduate from college and need to start looking for a job, I would be frictionally unemployed because I would be entering the labour force for the first time, looking for my first job. My family’s friend also recently quit one job voluntarily to look for another one because the previous job would mean that he and his family would have to move to Singapore and they preferred to stay in Japan. He was frictionally unemployed until he was able to find another job – luckily. The key to frictional unemployment is that the individual who is unemployed has skills that the nation’s current GDP makeup demand and there are jobs out there for that individual so they won’t stay unemployed for too long.
Seasonal unemployment occurs between the seasons, like with life guards, ski-lift operators, golf-course workers, etc. These are workers who are voluntarily unemployed whenever it isn’t their work’s season and who need to seek other employment between the seasons. These workers choose these certain jobs to allow for flexibility of time and location and in doing so, they voluntarily choose to be unemployed when it isn’t their season. Ways a nation can avoid seasonal unemployment, though it’s natural, would be similar to frictional unemployment: reduce unemployment benefits (so workers would be forced to find work faster) and improve the information symmetry between the employers and the unemployed.
b) To what extent is the existence of structural unemployment in a nation a sign of economic weakness?
As a form of natural unemployment, structural unemployment is the result of a changing and, more importantly, developing economy. When a nation experiences a bout of structural unemployment, the workers that are getting laid off and losing their jobs are the ones who can no longer offer what the developing economy requires of them. These typically consist of agriculture workers: farmers. An economy that starts to move towards manufacturing goods will no longer need the services of a farmer and agricultural workers would soon find themselves out of employment. However, the farmers’ misfortune can be part of the economy’s good fortune because though he loses his job and income, it means that the nation’s GDP is moving towards a more globalized makeup. One of the four main macroeconomic goals of a nation is economic growth and a growing and developing GDP indicates a clear move towards a better and stronger economy.
21/02/2013 § Leave a comment
#4. 25 marks.
a) Identify the components of aggregate demand and briefly explain two factors which might determine each of these components.
The four components that make up aggregate demand are the same as those that make up GDP: consumption (depicted by variable C), investments (variable I), government spending (variable G), and net exports (exports = X, imports = M). A simple equation to calculate the aggregate demand would then be: AD = C + I + G + (X – M). Two factors that determine these components are wealth, and interest rates. Wealth is the total value of the accumulated assets owned by an individual or household. Interest rates are the opportunity cost of spending money, wherein the borrower always pays beyond the set price. We can use the inverse relationships of the wealth effect and the interest rate effect to explain these. Whenever price levels are high, obviously the public would feel poor and are discouraged to spend anything, therefore the quantity demanded will decrease (shift to the left). Likewise, if the price levels are low, the public feels richer and would then spend more, shifting the demand curve to the right. Similarly, when interest rates are high, borrowers find the values unattractive and too much, and wouldn’t invest, therefore the demand for the good decreases, shifting the curve to the left. When interest rates are low, borrowers find the values more attractive and the quantity demanded increases, shifting the demand curve to the right.
b) Evaluate the likely impact on an economy of a substantial rise in the level of savings among the nation’s households.
Households’ savings count as supply. If a nation’s households start to save more, it would have a negative impact on the economy. We know from the circular flow model that in the banking sector of a nation, savings count as leakages into the economy, which is a loss of money. Clearly then, when households save more than they invest, more money will lie stagnant and not in use, which is unhelpful for the economy, slowing or stopping the flow. Japan does this very well, but it shouldn’t. The government tries to plug money into the economy to get more of a flow going but the tradition in Japan has always been to save instead of to buy or try new things and because of this, the money that the government once subsidized for the entire nation of Japan (it was a really expensive plan) ended up in everyone’s bank accounts or in their pockets and not to firms’ goods and services. On the other hand, it the banks start to receive all the money that households are saving and putting into their banks, they would be able to lend more to the borrowers who need it. If they have a bigger supply, this might mean that banks would raise their interest rates in order to make more out of their borrowers. Savings would then have a positive impact on a nation’s banks.