The paper "World Economic Outlook" is a wonderful example of an assignment on macro and microeconomics. According to Mankiw (2011), real GDP is the valuation of goods that have been produced at a constant price. This means that the measure of goods and services are not affected by fluctuation in prices. In order to measure real GDP, a base year is first established. This base year is then used to find the value of goods and services in subsequent years. In the base year, real GDP is always the same as the nominal GDP.
In summary, nominal GDP makes use of current prices to value goods and services while real GDP utilizes base-year prices to value the goods and services. Since prices in real GDP valuation is held constant, the change in real GDP reflects a change in quantities produced. Chart 1: Line graph of RGDP for China, Australia, and Indonesia Data retrieved from World Economic Outlook Database, International Monetary Fund (2013). Real GDP of the countries were converted to GDP deflator in order to facilitate plotting of each country on the same graph as shown in chart 1 above. Assuming that 2008 is the base year for all countries, RGDP growth rates can be obtained as follows; Australia Year Real GDP for Australia change % change 2008 11,723.46 0.00 2009 12,803.68 1,080.22 9.21 2010 14,141.28 1,337.60 10.45 2011 15,456.40 1,315.12 9.30 2012 16,646.55 1,190.14 7.70 Chart 2: Business cycle for Australia Illustrated by the diagram above, Australia is in recession (Tucker, 2010). Indonesia year Real GDP for Indonesia change % change 2008 2,082,456.12 0.00 2009 2,178,850.33 96,394.21 4.63 2010 2,314,458.85 135,608.52 6.22 2011 2,464,676.55 150,217.70 6.49 2012 2,618,139.21 153,462.66 6.23 Chart 3: The business cycle of Indonesia Indonesia is currently experiencing a recession. China Year Real GDP for China Change % change 2008 1,335.13 0.00 2009 1,354.04 18.90 1.42 2010 1,389.60 35.56 2.63 2011 1,423.16 33.56 2.42 2012 1,475.40 52.24 3.67 Chart 4: The business cycle of China China is experiencing expansion and will soon attain prosperity. In the case of Indonesia and Australia, which are experiencing a recession, the expansionary policy is required.
This expansionary policy will improve aggregate demand by lowering credit and rates of bonds (Sexton, 2012). When the available credit is increased, businesses will have a larger working capital consequently leading to a larger output. Fiscal policy can also be utilized to increase demand in an economy. This policy calls for tax cuts, rebates, and increasing government expenditure. Considering the case of China that is going through an expansion, a contractionary policy is necessary. The rationale for deploying a contractionary policy is that expansion is accompanied by rising prices. The contractionary policy reduces the pace of economic expansion by reducing the money supply and aggregate demand.
To achieve this policy objective, the Federal Reserve can increase interest rates and reserve requirements. The regulatory body can further reduce the money supply directly or indirectly by offering bonds. This is a form of borrowing from the public. It has the impact of reducing the money supply and inflation. RGDP, inflation, and unemployment of China Chart 5: RGDP, Inflation, unemployment It is apparent from the diagram that when real GDP is low, unemployment is rising faster.
At the same time, low real GDP is accompanied by low inflation. The graph further shows that inflation is low at a low real GDP. On the other hand, a rising real GDP is accompanied by a low unemployment rate and rising inflation. Many factors explain changes in inflation and unemployment rates. On the demand side, the two factors that affect inflation and unemployment rate are increases in the quantity of money and government expending. When the quantity of money in supply and government spending is increased, aggregate demand starts to rise.
Starting with full-employment, an increase in aggregate demand has the effect of shifting the aggregate demand curve to the right to above full-employment equilibrium as shown in the diagram below. In the diagram above, supply cannot meet the demand hence the rise in price from P1 to P2. There is a shift in the AD curve along the AS curve simply because demand is rising faster than supply. The outcome is an inflationary gap. The intersection of the new aggregate demand curve and the aggregate supply curve is at a point that is above full employment.
At this point, there is a shortage of labor, which pushes up wage rates. This makes the short-run aggregate supply curve decline and shifts to the left consequently pushing further up the price and achieving full employment. On the supply side, an increase in the money wage rate and an increase in money price of raw materials contributes to changes in inflation and unemployment. When the price of raw materials increases, the short-run aggregate supply decreases and shifts the SAS curve to the left.
This decreases real GDP while the price level increases leading to stagflation. In response to stagflation, the regulatory body can stimulate demand with a view of reducing high unemployment and low level of real GDP. This stimulus package has the impact of increasing aggregate demand hence shifting the AD curve rightwards to AD2. Chart 7: Supply factors affecting inflation and unemployment In the context of rising inflation and unemployment rate, a contractionary policy is necessary. The contractionary policy reduces money supply and aggregate demand. To achieve this policy objective, the reserve bank can increase interest rates and reserve requirements.
The regulatory body can as well use bonds to borrow money from the public. When the interest rate is increased, the planned investment will decline. This decline in planned investment lowers income, which eventually reduces aggregate demand and shifts the AD curve downwards. The outcome is that the economy will return to full-employment equilibrium.
International Monetary Fund 2013, World Economic Outlook Database, 2013, viewed 14 January 2014, http://www.imf.org/external/pubs/ft/weo/2013/02/weodata/index.aspx.
Mankiw, N 2011, Principles of Economics, Mason, OH, Cengage Learning.
Sexton, R 2012, Exploring Macroeconomics, South-Western, Cengage.
Tucker, I 2010, Macroeconomics for Today, Mason, Ohio, South-Western College Pub.