Key Economic Indicators - Assignment Example

Running head: BUE 1508 MACROECONOMICS QUESTIONS Answering 10 Questions Name Course Information Professor Information Date Due 1. A discussion on the short-run and long-run effects of the following events: a) When Central Bank lifts interest rate, the immediate impact is on investment. It is a form of contractionary policy. High interest rate increases cost of borrowing. This is a disincentive to borrow for purposes of investment or consumption. Without investment, aggregate demand would shift to the left in the short-run leading to low output and prices. This is evident in diagram 1. Since prices are low, the long-run impact is that output will increase in response to low cost of factors of production. This is confirmed by a rightward shift in AS from AD to AD1 Diagram 1: Leftward shift in aggregate demand b) When private domestic investment spending is increased, aggregate demand will shift outwards in the short-run given that investment increases aggregate expenditure and eventually the aggregate income. This is accompanied by higher prices, which has a negative effect on cost of supplies. In the end, AS curve shifts to the left to settle finally at a new equilibrium, Z. Diagram 2: Rightwards shift in aggregate demand c) Goods and services tax are levied on value addition along the production process. It is passed on from producer to and finally paid by the consumer. Since the consumer is the one who pays for the increased goods and service tax, it affects disposable income such that demand reduces as illustrated by movement along demand curve. Diagram 3: Impact of goods and services tax d) Currency appreciation is the strengthening of a country’s currency against another currency, which makes exports to be expensive in international market. This means that people will import more goods and export less. High level of importation represents outflow of currency from a country hence negatively affects national income. As a result, aggregate demand would decline evidenced by leftward shift in AD curve similar to diagram 1 above. In the long run, value of national currency would go down to stimulate exports. e) The wealth of an individual person would decline with a fall in real estate prices. Such an individual will face low disposable income. Reduction of disposable income culminates into reduced aggregate demand explained by leftward shift in AD curve as shown in diagram 1. Over a long period, low costs stimulate supply of more goods and service. f) A fall in price of exports leads to high export demand. On the other hand, high price of imports discourage importation of goods and services. Combined together, high exports and low imports increases national income. This enhances domestic demand resulting in rightward shift in AD curve clearly shown in diagram 2. Eventually, AS curve will shift leftwards to counter rising cost of production. The new equilibrium is at a higher price. 2. A business cycle reflects periodic fluctuation in a country’s economic activities. These quarterly movements inform policy makers of the required policy action i.e. to employ expansionary or contractionary policy. Recession is a stage in a business cycle that captures two successive negative economic growth quarters. 3. A market-based economic system relies on information flow as well as demand and supply to settle the economy at equilibrium point. The market does not have any form of regulation. However, the system is unstable i.e. prone to inflation, unemployment, and growth hence requires the aspect of monitoring. 4. In order for people to save more, they have to reduce their consumption expenditure since . Cognizant of the fact that , a declining consumption leads to lower aggregate expenditure. Diagram 4 seeks to show a downward shift in AE that follows a declining consumption level. From the diagram, the declining AE leads to lower equilibrium income i.e. from W to Z. Diagram 4: Increase in savings An increase in private investment spending leads to high aggregate expenditure since the in the AE model has increased. This gives an outward shift in AE curve resulting in high equilibrium income V. 5. Risk is an unknown outcome that can be measured. On the other hand, uncertainty is an event whose outcome cannot be described. While risk is objective, uncertainty is subjective. Interest rate is the cost of borrowing but exchange rate is the value of national currency in terms of another currency. Supply side shocks are economic events leading to shifts in supply curve. Conversely, demand side shocks are unforeseen economic events that cause demand curve to shift. Trade deficit is the excess of imports over exports. The difference between gross foreign debt and non-equity assets held by residents to non-residents of a country is the net foreign debt. 6. The increase in money supply is a form of expansionary monetary policy. The money market is such that demand for money is inversely related to interest rate. When interest rate moves down due to an increment in money supply, a lower equilibrium is attained at point in diagram 5. Low interest rate is a message to investors to borrow for investment. When investment rises, output level as well as employment will increase. When employment in an economy is high, income levels rise. People would therefore have more disposable income to use in demanding for goods and services. Rising demand, however, makes the price to shoot up or rather inflation. 7. Economic indicators are macroeconomic data such as prices, incomes, housing finance, production, consumption and investment, and demographics (Australia Bureau of Statistics, 2014). Business indicators comprise of profits, sales, inventories, and wages. All these variables are necessary in analysing current economic performance and the future scenarios. Professionals would demand for economic and business indicators in order to advice their clients on investment possibilities. Additionally, a country would utilize business indicators in compiling national accounts. 8. Depreciation is not necessarily a bad thing because it makes domestic goods and services attractive in international market. Eventually, balance of trade will be improved. When a country’s currency becomes stronger than other leading currencies in the world, exports become less attractive. At the same time, the country would experience increased quantity of imports. The positive aspect about currency appreciation is that industries are motivated to improve their outputs in terms of quality so that they become attractive in international market. Additionally, domestic consumption is encouraged. 9. Diagram 5 is the money market, which shows an inverse relationship between money supply and interest rate. Increasing money supply through expansionary policy would push down the nominal and real interest rate. The difference between nominal and real interest rate is that real interest rate is adjusted for inflation but nominal is not (Arnold, 2013). Cost of credit is low when interest rate moves down. This policy action is applied during recession to aid in stimulating demand. 10. A country does not have to worry too much about balance of payment when it is operating a flexible exchange rate. The rationale is that the system adjusts itself depending on the balance between imports and exports. When there is a deficit caused by declining exports, there will be shortage of foreign currency in the domestic market. Because of the shortfall in foreign currencies, their prices would go up leading to local currency depreciation. Because of the depreciated currency, price of exports will decline. This prompts demand for exports to increase and demand for imports to decrease consequently bridging the deficits in balance of trade. Gillespie (2014) is convinced that external value of currency adjusts to equate the exchange rate. In favour of flexible exchange administration, the system helps to contain inflation. Monetary policy will be effective under flexible exchange system because of the aspect of interest rate i.e. monetary policy relies on the adjustment of interest rate. On the other hand, fiscal policy is appropriate in fixed exchange system. References Arnold, R. (2013). Economics. Mason, OH: Cengage Learning. Australia Bureau of Statistics. (2014). Key Economic Indicators, 2014 (Cat no. 1345.0). Canberra: Australia Bureau of Statistics. Gillespie, A. (2014). Foundations of Economics. Oxford: Oxford University Press. Read More