Housing Market in the USA, Marginal Propensity to Consume - Assignment Example

Institution : xxxxxxxxxxx Title : xxxxxxxxxxx Tutor : xxxxxxxxxxx Course : xxxxxxxxxxx @2016 Question 1a The rise in consumer confidence in Australia comes as a result of high prospects in the labor, housing, and stock market. This is in terms of reports that unemployment had reduced making households optimistic about the number of available opportunities. Furthermore, the capital market has also been on an upward trend with the share prices increasing significantly. This was also the case in the housing market which has experienced clearance in previous auctions. Other factors include a strengthening Australian dollar, low interest rates, decreasing inflation, and low petrol prices. These factors contribute toward the prevailing trend in consumer confidence since consumers are assured of a vibrant economy. They projected increase in future cash flows and will not have to hold on to their disposable income. When an economy displays such signs, consumers tend to increase expenditure to take advantage of the attractive opportunities in the market. For instance, households could choose to purchase houses when the interest rates are low. The low petrol prices also result in decreased production costs in industry and consequently the marginal prices of products. The previous recession and financial crisis which became exaggerated by ripples from the housing market in the USA. Just like in this case, the high prospects in the mentioned sectors will cause consumers to have confidence in other sectors and consequently the economy. Households and consumers strive to be rational and this is what will cause the confidence levels to increase. They make arrangements to make use of the attractive opportunities prevailing in the market. Question 1b The aggregate expenditure model states that consumption is the function of household consumption, consumer investments, exports, and government expenditure. Also it categorizes the household consumption into autonomous consumption the secondary consumption which varies with disposable income. Secondary household consumption is a function of the marginal propensity to consume (MPC) and marginal propensity to save (MPS). These two concepts signal as to whether or not households are more incline to consume or save. Low and middle income households generally tend to have higher MPC whereas their high income counterparts have higher MPS(Chen and Groenewold, 2013 page 731). Also related to these concepts are average propensity to consume (APC) and average propensity to save (APS). APC shows the value of disposable income channeled towards expenditure whereas APS the portion directed towards savings. The aggregate expenditure model summarizes its theoretical applications by stating that aggregate expenditure should be equal to aggregate production to attain equilibrium. As mentioned, the consumer confidence in Australia has been on the rise. This signals high prospects for the economy of Australia given the fact that it can possible impact the level of employment and output at equilibrium. From the above, it is clear that the low and middle income households have higher MPC. This translates into a preference to consumer as opposed to saving. Due to the increase in consumer confidence about the Australia’s economy, it is possible that these two households will increase their expenditure towards consumption. Since they constitute the majority of the total consumers, it will result in an increase in demand in the economy. It is obvious that an increase in demand will trigger increased supply from the producers. This will increase the level of equilibrium output. It also translates into an increased level of employment because the producers will have to upgrade labor capacity in order to deal with an increase in production output. It goes to show that an increase in the level of consumer confidence in the context of Australian economy will have a similar effect of the equilibrium employment and output. This also translates into an increase in the aggregate expenditure in the entire economy. But this is not the only factor that will increase the aggregate expenditure. The high income households will also impact on the overall value because of their high MPS. Such consumers prefer to purchase financial market assets to increase their investment portfolios. The case also states that the Australian dollar has been on the rise. Whereas this signals a brighter outlook for the economy, it presents challenges in terms of making exports unattractive. The consumers in foreign domestic market will find Australian exports very expensive as a result of the higher domestic units required to access Australian currency during payment. In the end, this will decrease the Question 2 The Aggregate Demand - Aggregate Supply (AD-AS) model Another concept that is related to aggregate expenditure is the aggregate demand (AD) aggregate supply (AS) model. Basically, AD represents the total goods that households demand in an economy whereas AS is the total goods producers supply to the market. Therefore, it argues that AS and AD levels in the economy are the same at equilibrium. Since the Australian economy has been experience an upsurge in consumer confidence, it is highly possible that the demand will also take the same trend. It is expected that there will be an increase in demand for goods. At this point, the households are not worried about spending freely since they expect consistent cash flows in the future. As mentioned, the two largest sources of expenditure in the economy are the middle and low income households. With the increase in confidence about the future, these two will increase expenditure naturally because of their high MPC. The increased expenditure of the disposable income will impact positively on the demand(EDDIE, ZHENG, and WEN-JUAN, 2012 pag 448). The end result would be to shift the AD curve to the right. Since equilibrium occurs where the AD intersects the AS curve, the equilibrium output and prices will increase. Producers will therefore make efforts increase production in order to satisfy this demand which signals an increase in total output. Therefore, the employment opportunities in the economy will increase since producers will require upgraded labor capacity to counter this increased output level. The AS-curve in the short run takes the shape of a curve. This implies that the equilibrium prices and output increase at an increasing rate with surge in demand. However, the long run situation is different because it is a vertical line. This long run curve intersects both the AD and AS curve. The implication of this is to match the actual and possible output levels. In the long run, the output levels and consequently employment will increase significantly whereas the prices will reduce. One of the facts from the case is that the Australian economy is about to reach full employment. This implies that there will be shortage of unattached labor in the market. Therefore, producers will have to compete for the scarce labor as they try to secure capacity to ensure efficient production. As a result, the cost of production will increase due to the fact that producers have to increase compensation packages in efforts to entice the unattached labor to their organizations. The increase in labor costs will eventually decrease the profits for all the producers in the economy. The producers will react to this new development by decreasing production to avoid incurring high labor costs. The end result would be a shift in the AS curve to the right to represent the decreased output level. This low output level will impact the price level causing it to increase. Furthermore, it could lead to decreased employment when producers have to trim their workforces of redundant employees. The past trend has seen the Chinese economy expand at a fast pace. It is possible that this expansion could trickle down to the households such that they have increased economic capabilities. Therefore, the Chinese households could have better spending power than in the past. Therefore, the Australian producers could look to the Chinese households to purchase the excess output in the market. In the above, the producers have had to decrease production due to the increased production costs and decreasing profits. But with the possibility of a wide untapped market, the producers could choose to sustain the previous output level and offload the excess supply in the Chinese market. The increase in foreign income and purchasing power could have the effect of shifting the AS curve to the right. Movement to the right along the AS curve always results in increased levels of equilibrium output, price, and employment. Question 3 Increase in confidence in an economy tends to impact positively on the aggregate demand. As seen above, the consumers predict better economic outlook in the future and would be willing to spend their disposable income while anticipating increase returns in the future. But this is only in theory. Other factors can interfere with the projected increase in demand. For instance, the Australian economy like others across the globe suffered under the last global financial crisis. The ensuing recession resulted in many households becoming indebted as they tried to maintain consumption amidst tough economic times. Currently, most of the middle and low income Australian households have high debts. With the expected increase in their disposable income, they will award priority towards satisfying their debt requirement. The only households that are immune from this are high and upper middle income both of which constitute the minority. Therefore, their expenditure could not possibly impact the aggregate demand. In any case, these two have high MPS and would save the expected increased disposable income. Therefore, the aggregate demand in this case will not change even as the consumer confidence increases. With the unchanged demand, the producers will have to maintain the current level of production. This also implies no changes in the equilibrium output. The trend will also be the same with the prices since the level will remain constant. The Chinese economy has also shown the signs of slow expansion. The households in the Chinese economy will not experience increased purchasing power. Such characteristics will not motivate the Australian producers to boost production since they will have nowhere to offload the surplus. Therefore, the prices and employment levels just like output will remain unchanged. Bibliography Chen, A. and Groenewold, N., 2013, The national and regional effects of fiscal decentralisation in China, The Annals of Regional Science, 51(3), pp. 731-760. Eddie C.M. Hui, Zheng, X. and Wen-Juan Zuo, 2012, Housing wealth, stock wealth and consumption expenditure: a dynamic analysis for Hong Kong, Property Management, 30(5), pp. 435-448. Read More