Introductory Macroeconomics - Assignment Example

Introductory Macroeconomics Client Inserts His/her Name Client Inserts Grade Course Client Inserts Tutor’s Name 23/09/2011 Question One The multiplier refers to the ratio of a change in national income to the initial change in autonomous expenditure that brought it about. It is therefore a measure of the effect on total national income of a unit change in a component of aggregate demand such as investment, government expenditure or export (Rittenberg & Tregarthen 2008). It can be expressed as follows: Multiplier = Total change in national income Initial change in national income The term national income multiplier is a general term that covers the multiplier effects arising from any changes in the components of aggregate demand. For example, it is possible to have the following multiplier: Government expenditure multiplier = Eventual change in national income Initial change in government spending The size of the multiplier is found by:- 1 1-marginal propensity to consume Or 1 Marginal propensity to save Marginal propensity to consume (MPC) + marginal propensity to save (MPS) =1, therefore, MPS=1-MPC (a)In our case when the MPC is 0.6 the value of the multiplier can be obtained by:- 1/ (1-0.6) =2.5 This implies that out of any addition to government income 60% is spent and 40% is saved. If the government increases spending by $20 billion dollars, $ 12 billion would be spent on consumption while $8 billion would be saved. (b) The new equilibrium value of real GDP corresponding to the $20 billion dollar increase in government spending will be $850 billion. This is obtained by the consumption amount of $20, will increase GDP by 2.5 times, this will give us an increase of 20*2.5=50. Therefore, the new equilibrium GDP will be $800+$50=$850. (c) If the MPC is 0.8 then the value of the multiplier can be obtained by:- 1/ (1-0.8) =5 This implies that out of any addition to government income, 80% is consumed and 20% is saved. If the government spending is increased by $20 billion dollars, $16 billion dollars would be spent on consumption and $4 billion dollars would be saved. (d) The new equilibrium value of real GDP corresponding to the $20 billion dollar increase in government spending will be $900 billion dollars. The investment amount of 20, will increase GDP by 5 times, this will give us an increase of 20 X 5 = 100. Therefore, the new equilibrium GDP will be $800 + $100 = $900. Fig 1: A diagram showing an Aggregate Expenditure Model Source: http://www.flatworldknowledge.com/node/30043#web-30043 Question Two Fig2: Diagram aggregate demand/aggregate supply model. Source: http://www.whitenova.com/thinkEconomics/adas.html The above diagram of aggregate demand and aggregate supply model of the economy and starting from full employment equilibrium, illustrates the impact on the price level and real gross domestic product of global demand for oil growing faster than supply. Global demand for oil is growing faster in the entire continent; Each and every country in the world is really demanding for oil for various purposes, therefore causing demand to be more than supply. A country like the United States of America is still the biggest buyer of oil despite the economic difficulties it is experiencing. And it always needs extra oil in the northern hemisphere summer when Americans hit the road. Most likely the most pervasive myth in energy-economics is that “high oil prices hurt economic growth”. When the demand for oil all over the world is more than the supply it definitely leads to higher prices (Potts 2011). Oil demand in Asia especially in India and China cannot be quenched; these two countries industry is growing at a very faster rate. More and more energy is needed to run all the machines. Oil being the major source of energy used by the machine is needed at a very high rate. Therefore when the demand for oil is more than the supply it definitely affects the prices. This leads to an increase in oil prices all over the word (Petroleum Pub. Co. 2007). Potts (2011) further reveals that the situation in Africa is different, oil prices are affected three times more by changes in demand than for the US and Europe. According to the International Monetary Fund, rising production, growing car ownership as living standards improve and as farms are mechanized all lead to an increase on oil prices. Changes in the following non-price level factors cause changes in aggregate demand and shifts of the entire aggregate demand (AD) curve; Autonomous consumption, for example increase in money supply, consumer nominal wealth increase, consumer expectations and confidence concerning job security and future income decrease. All this can be observed only in Africa where the living standards of the people are improving (Institute of Petroleum 2010). Changes in the following factors will change short-run and long-run aggregate supply and shift the SRAS and LRAS curves: resource endowments, permanent changes in international trade barriers in resource markets, technology and education and permanent changes in business regulations and taxes. Therefore short run changes in input prices and resource costs will shift the SRAS curve without changing the full employment level of real GDP and shifting the LRAS curve (Rittenberg & Tregarthen 2008). Oil is a very scarce resource and a few countries have discovered the deposit. There some countries oil but do not export it. The Organization of the Petroleum Exporting Countries (OPEC) was founded in Baghdad, Iraq, with the signing of an agreement in September 1960 by five countries namely Islamic Republic of Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. Other countries have later joined the organization namely; Algeria, Libya, United Arab Emirates, Angola, Ecuador, Nigeria and Qatar totaling to twelve in number (Adelman 1995). If the twelve countries are the only exporter of oil and petroleum products to the rest of the world it is most likely to have a low supply. Therefore, when the supply is less than the demand it usually leads to an increase in the price of oil. The situation has been made worse with the unrest in Libya lowering the supply of oil thus increasing the prices (Institute of Petroleum 2010). It can be concluded that when aggregate demand persistently exceeds aggregate supply at current prices it leads to demand pull inflation. Since the excess demand cannot be met in real terms, the natural market response is for prices to rise towards a new equilibrium. Question Three (a) A diagram showing the general price level and the level of unemployment In the next two years the Australian economy is forecasted to grow driven by a high demand for Australian resources from China and India. If we assume that an increase in aggregate demand for skilled labor takes place, the national output will rise and the unemployment rate will decrease but there will be no significant increase in the general price level. When there is an excess supply of resources at low cost this is in turn means that a large increase in output can be produced without an increase in the general price level (Economic Intelligence unit 2008). This outcome can be shown by range 1 in the price level in the above figure. Increase in demand from D1 D1 to D2 D2 leads to an increase in the general price level from P1 to P2. The economy achieves full capacity utilization at the level of output Yf. A diagram for Labour supply/labor demand model of the skilled labor market When the demand for skilled labor in Australia increases from D1 to D2, Employment increases from E1 to E2 and wages will increase from W1 to W2. Consequently the economy will grow significantly due to the high wages and the people of Australia will have a lot of income to invest in different economic sector. (b) In the May 2011-12 federal budgets Treasurer Wayne Swan announced a range of initiatives such as increased education and training in Australia designed to increase the workforce participation rate and alleviate the skilled labor shortage. This automatically leads to an increase in aggregate demand for skilled labor. Thus the national output will rise and the unemployment rate will decrease. Education and training is the most important thing in the labor market, as many employees improve their skills and capabilities thus improving their professionalism (Economic Intelligence unit 2008). Education and training as a mean to improve person skills if properly addressed in Australia, it enables the nation to produce dependable professionals. And when the demand for skilled labor in Australia increases from D1 to D2, Employment increases from E1 to E2 and wages will increase from W1 to W2. There is no way the country will run short of skilled labor if proper skills are nurtured. Welfare reform is a process of reforming the framework of social security and welfare provisions in Australia. When the government uses this method as a way of increasing the workforce participation rate and alleviates the skilled labor shortage, it usually achieves its target as an employee is motivated and ready to work. This leads to an increase in aggregate demand for labor thus increasing wage and employment. Welfare reform when used as a motivating factor for the employees it usually increases their availability (National Institute of Economic and Social Research 2010). When the demand for skilled labor increases from D1 to D2, employment increases from E1 to E2 and wages will increase from W1 to W2. The Australian government also allows increased skilled migrant intake and if they is an increase in aggregate demand for skilled labor it would be always available. The national output will rise and the unemployment rate will decrease but there will be no significant increase in the general price level. Skilled migrant intake by the Australian country usually provides the labor market with enough labor force (Economic Intelligence unit 2008). And when the demand for skilled labor in Australia increases from D1 to D2, Employment increases from E1 to E2 and wages will increase from W1 to W2. Consequently the economy will grow significantly due to the high wages and the people of Australia will have a lot of income to invest in different economic sector. List of References Adelman, M. A., 1995. The Genie Out of the Bottle: World oil since 1970. Cambridge: MIT Press. Economic Intelligence Unit (Great Britain), 2008. Country Report: Australia, 52 (54), p. 35. Institute of petroleum (Great Britain), 2010. Petroleum review, 54 (647), p. 25. National Institute of Economic and Social Research, 2010. National Institute economic review, 65 (37), p. 17. Petroleum Pub. Co., 2007. Oil and Gas Journal, 57 (18), p.16. Potts, D., 2011. Prepare for More Pain at the Pump, The Sydney morning Herald, [Online] Available at: http://www.smh.com.au/money/prepare-for-more-pain-at-the-pump-20110509-1eewa.html#ixzz1LpyU3cS3%3Cbr%20/%3E [Accessed 21 September 2011]. Rittenberg, L., Tregarthen, T., 2008. Principles of Macroeconomics. New York: Flat World knowledge, L.L.C. Read More