Introduction to Macroeconomics - Essay Example

Running Head: Introduction to Macroeconomics Your name Course name Professors’ name Date Question 1 Equilibrium real GDP = $800 billion dollars Spending is increased by $20 billion dollars a. MPC is 0.6, the value of the multiplier is obtained as follows: Equilibrium real GDP is given by Y = kA where A = a + I + G + mpcTx; DY = kDA Since mpc = 0.6, then k = 1/ (1-0.6) = 2.5. Value of multiplier = 2.5 This is in agreement with Keynesian argument that changes in Autonomous spending could have a greater impact on national income, Y (Parry, 2009). The assumption behind the simple output multiplier is that there are no proportional taxes, all expenditures are directed for domestic production of goods and services and that the price level is constant. b. New equilibrium: Since the multiplier = 2.5, change in GDP is $20 * 2.5 = $50 billion dollars. The new value of Y is $800 billion + $50 billion = $850 billion dollars. c. If MPC is 0.8, value of multiplier is 1/ (1 - MPC) = 1/ 0.2 = 5 d. New equilibrium value: If multiplier = 5, then the change in GDP = $20 billion dollars * 5 = $100 billion dollars. The new value of Y is therefore $800 billion dollars = $100 billion dollars = $900 billion dollars. The diagram below is an aggregate expenditure model which seeks to illustrate calculation made above. Source: Amitava (1996) Aggregate expenditure is often used together with Y to predict direction of GDP. From the Graph above, Y represents the Gross Domestic Product. An economy is in equilibrium when Y is equal to AE. This is shown in the graph by the point of intersection between AE and Y. Initially, the equilibrium income is $800 and the $20 billion dollar increase in government expenditure will have the effect of raising the GDP by the value of multiplier i.e. 2.5. This effect is shown in the graph by change in real GDP by 50. The second scenario is an increase in GDP by $100 b following a multiplier effect of 50 on government expenditure. Question 2 According to Amitava (1996), AD and AS explains the price level and output by drawing on the relationship between aggregate demand and aggregate supply. To understand how the model works, initial equilibrium positions are identified. This is followed by changing an external variable to see its effect on equilibrium level. Source: Anindya (2002) The horizontal axis is the real gross domestic product which measures true value of annual national production. Price is represented on the vertical axis. The point of intersection of AD and SAS i.e. F.e is full-employment. If global demand for oil is increasing faster than the supply, the effect is that price level will shoot up since there is excess money in circulation. The new price level is therefore P1 up from equilibrium price of Pe. The new equilibrium also has a higher level of real GDP of Y1. Movement along the SAS means that workers will be taking home a lower wage rate since there is an increase in output prices. At this point, workers will seek wage increases to compensate for the reduced real wage. Firms will respond by granting wage increment so as to avoid losing their workers. The AS and AD model gives a clear explanation of persistence of inflation brought about by a growing aggregate demand which is more rapid as compared to growth in aggregate supply. This situation takes place in the long-run basis with an aggregate supply curve shown by the vertical orientation. Changes in demand in developing countries have the effect of influencing prices of oil. According to international monetary funds, developing countries often experience rising production in addition to improving standards of living. It therefore implies that demand would increase. Stability of economies further affects the price of oil and is demonstrated by the $US15 increase in price of oil following unprecedented situation in Libya and Syria. There is no doubt that as demand for oil expand faster that increase in supply, prices will be driven even higher. Question 3 I. AS and AD model on Australian economy ] Source: Anindya (2002) The AS and AD model above seeks to determine the general equilibrium i.e. the price and output that clears the goods in the market. In the short run, equilibrium occurs when AD and SRAS are equal. Equilibrium also takes place where AD equals the LRAS. Full employment occurs when an economy is in the long run with a vertical supply curve. This full employment situation requires that real GDP is equal to potential GDP. From the Graph above, X is the full employment scenario. A reduction in unemployment rate from 5% to 4.5% means that output has increased as more factors of production are employed. These situation only proceeds until it reaches full employment i.e. all factors of production have been utilised. II. Standard labour supply and demand Source: Vienneau (2005) A labour market is a good example of factor market with supply of labour classified under the category of employees and demand for labour are the employers. The demand curve for labour is downward sloping because of the law of diminishing returns. According to the law, any additional worker hired contributes less additional output (Vienneau, 2005). An increasing demand for Australian resources is more likely to expand demand for labour. This will shift the demand curve upwards along the same supply curve. At the same time, wage rate also increases since there is an excess demand for skilled labour. The high wage will be maintained in the market as long as other able workers do not enter the market to drive down the wage rate. Owing to the fact that training skilled manpower takes time, the high wages in the market would be sustained for a long time. How the initiatives will impact on Australian economy In the first instance of the graph, output is increasing without any additional cost. In the long run, the graph starts to rise as the level of output approaches potential capacity otherwise termed as full-employment. At this stage costs starts to increase following scarcity. It means that any further increase in output creates a higher price level. Point X shows that all factors of production has been utilised. This is the case in Australia where unemployment is reducing from 5% to 4.5. An initiative to increase the number of workforce through education and training, intake of immigrants, and welfare reform would have the impact of further reducing unemployment rate. In the long run, the economy will be back to full capacity. Any further employment of skilled labour beyond the full capacity amounts to costs (Hacker, 2000). Impact of the initiative on the labour market If demand for Australian resources from China and India is increasing, it means that more labour is demand to keep up with a growing economy. Increasing workforce by training, educating or intake of skilled immigrants would have the effect of reducing the excess demand as shown by the graph above. The economy will now settle at a new equilibrium, Q2 but with a higher wage P2. Reference Amitava, K. D., & Skott, P. (1996). "Keynesian Theory and the Aggregate- Supply/Aggregate-Demand Framework: A Defense." Eastern Economic Journal, Eastern Economic Association, 22(3): 313-331. Anindya, B., & Morendy, O., (2002). Schooling, Experience, and Earnings. New York, Singapore National University: Columbia University Press. Hacker, R. S. (2000). "The Impact of International Capital Mobility on the Volatility of Labour Income". Annals of Regional Science 34 (2): 157–172. Parry, G., & Kemp, S. (2009). Discovering Economics. South Perth: Tactic Publications. Vienneau, R.L. (2005). "On Labour Demand and Equilibria of the Firm", Manchester School, 73(5): 612-619. Read More