Reasons for Differences in Economic Growth between Countries - Example

Economics Name Institution Section A Positive Externalities In every economy, there are benefits and costs accrued in the production of goods or services. The benefits are enjoyed by an individual or the society. Hence, the production of goods and the use of resources in an economy do have a positive or a negative impact on the allocation of natural resources in a particular economy. By definition, an externality refers to a costs and benefits which affect individuals or a group indirectly, whereby the third-party does not have a choice in enjoying the benefits or a choice in incurring the costs (Cairncross and Sinclair, 2014).There are two forms of externalities: positive and negative. A negative externality is also known as an external cost which poses a negative effect on the third party. Conversely, the positive externalities are also known as external benefits as they have a positive effect on the third party (Cairncross and Sinclair, 2014). For instance, in the health sector, the positive externality exhibited in most of the health systems is the medical care which is provided to others. When others are healthy, it reduces the risk of acquiring a contagious disease. Hence, an individual enjoys the benefit of others receiving the healthcare. Further, when the workers are healthy, the absenteeism rate lowers hence increasing the employee productivity. The health care sector results to economic gains. Additionally, when a majority of people are vaccinated and get immunity against a disease it reduces the likelihood of a large population contracting the disease. With the positive externality, the social benefit is greater than the personal benefit (Swann, 2014). Additionally, the benefits occur in both consumption and production. For an economy to achieve a socially optimal equilibrium, then the MSB=MSC. Therefore, the production of a particular commodity should continue if the MSB>MSC. However, despite the social benefits of the positive externalities, there is need for government intervention to prevent market failure. When the positive externalities operate in a free market mechanism there would be a market failure. The failure is a result of under consumption and under provision of the goods or service. Taking into consideration an example of the positive externality is education, the education received by an individual may result in positive effects on the society as a whole. However, the cost of education may be too high which results in a few people affording it; hence the education consumption is less. For a maximum social benefit, the government intervenes through subsidy which lowers the cost of education hence making it affordable to a majority. Therefore, the social marginal benefit exceeds the private marginal benefit (Swann, 2014). In an illustration to show the impact of the positive externalities while operating in a free market, assuming that the market is healthcare, the free markets would supply the services at point Q, at price P. This indicates that the MPB>MSB. This is because, at A, the health services are sold at a higher price whereby few people are able to purchase the commodity, hence leading to an increase in the marginal private benefit. However, with the inclusion of a socially efficient output, the output rises up to point Q1.Therefore, by consuming at quantity Q, the MCB>MSC. This indicates that consumers should increase their consumption of the good. Additionally, at Q, MSC can be represented as A (Q-A) whereas the benefits enjoyed by an individual are represented as a(q-a). Moreover, the Marginal social benefit can be calculated as C (Q-C). However, if quantity which represents the consumption remains at Q, it indicates that the society experiences an opportunity cost represented by ACB as well fare loss. The social welfare loss shows that there is an under consumption of the commodity. This represents market inefficiency hence a market failure as a result of the unregulated positive externalities. In order to solve the under consumption problem of the commodity and to achieve an efficient allocation of resources socially, the positive externalities should be encouraged through government intervention by implementing the economic policies. The government should give subsidies to the producers of goods that generate external benefits by reducing the cost of production hence enhancing an increase in supply (Tarasova and Tarasov, 2016). This is a remedy to goods such as education and healthcare. The government can also increase the demand for the commodities by reducing the consumer prices. For example, a reduction or subsidized higher education school fees. Reasons for Differences in Economic Growth between Countries Savings and Investments Higher savings finances higher investments hence boosting productivity in the long run. The effect of savings and investment on the economy is illustrated by the Domar model, which argues that savings and the capital-output ratio are the major factors that influence economic growth (Le Van, 2013). The model indicates that there is warranted growth rate in an economy if the level of savings is high and that all the savings are absorbed in the investment. Further, the developing countries have low level of savings, if operating in a free market. Therefore, the government needs to increase the savings or the rate of savings so as to invest and hence increase productivity. This explains the differences in the level of economic growth rates in countries. Greater Investment in Education Countries that are economically successful often have a competitive advantage over other economies. To achieve the competitive advantage, the workforce should be educated and trained. With the aim of achieving more trained workers, the government puts incentives on training by write-offs and tax breaks as well as provision of the required facilities (Tarasova and Tarasov, 2016). The trained workers are more productive than untrained workers and hence earn more. However, the training levels also differ from one country to another. Although the availability of resources is a determining factor on the level of training, skills workers often create spill over and externalities hence increasing productivity results to a continuous economic growth rate (Tarasova and Tarasov, 2016). Stable Economy The level of stability varies from one country to another. Globally, each country is affected by the business cycle. During a recession, a country's economy is at a low point and there is little or no expansion of the economy. After a recession, the ability of a country to recover fast and expand economically depends on the fiscal and monetary policies of a particular country (Lazaroiu, 2015).The quick recovery is enhanced by the stability in the economic indicators such as the employment rate. On average, if a high percentage of the population is employed it indicates an efficiency in the labor market. Labor cost index is a determinant factor in that if the labor index is rising steadily, there is strong consumer demand which controls the level of inflation. Further, when the worker productivity gains are stable as a result of trained workers, the production cost is low which dampens the inflator pressures (Lazaroiu, 2015). Better Infrastructure Improved infrastructure in terms of the transport system and communication enhances economic growth. In a country where means of transport is efficient, it lowers the production costs which reciprocate to low costs of the final product. The low cost of commodities increases the purchasing power of the consumers hence an increase in consumption. According to Cairncross, and Sinclair (2014), national competitiveness is basically influenced by the institutional development and the general infrastructure. Improved infrastructure leads to industrial growth which promotes productivity. Additionally, infrastructure smoothes income inequality in that as the economy grows steadily, the quality of life improves reducing income inequality. Conducive Environment for Investment An efficient capital market encourages foreign and domestic investment. The theory of efficient market theory indicates that the prices of assets are a reflection of the available information regarding the intrinsic value of the particular asset. Theoretically, profit opportunities which are represented by an undervaluation and overvaluation of stocks encourage the investors to trade. According to Nasreen et al. (2015), since market efficiency is a continuum, if the transactions costs are low, which includes the overall cost of obtaining information in trade, the market is more efficient. Hence, when the capital market is efficient investors invest more. Further, tax reform enhances economic growth by deducting some amount of tax on income tax, or consumption. The base broadening raises the average marginal tax rate on savings, investments and the labor supply (Nasreen et al., 2015). The broader-based system enhances distribution of resources to the area of the economy which has a higher tax returns. The reallocation increases the size of the economy. Countries without tax reforms expand slowly economically than countries with tax reforms. Additionally, a minimum amount of government bureaucracy encourages investments as the trade policies and laws favors investors. Adventurous Entrepreneurship Center Entrepreneurship plays a vital role in the economy. Entrepreneurship enhances innovativeness, reduces unemployment. However, entrepreneurship requires a conducive environment for productivity. A conducive environment includes a flexible legal procedure in starting the business. Political stability encourages the foreign investors as there is an assurance of security for their business. In a country with political instability, the investors scare away for fear of insecurity and loss of business. Natural resources The existence of natural resources in a country enhances economic growth. For instance countries with oil as resources are incomparable to countries without any raw materials. The raw material is exported earning revenue for the country which enhances economic growth. The importer countries of raw material spend more on importing and processing the raw materials to finished goods, hence a slow economic growth. Industrial relations In a country where there is harmonization of the industrial relations, the economic growth is steady. Industrial relations involve the study of the laws and regulations that exist in a workplace. The industrial relation is associated with human resources and the interaction with the labor unions. The employment should be fair and just. Companies should adhere to the collective bargaining agreements to prevent oppression of the workers. A conducive workplace motivates the employees to perform better hence increasing the country’s output levels (Lazaroiu, 2015). (www.economicsonline.co.uk) For a country to persistently experience growth rate than another country, the level of productivity should be high. A combination of the discussed factors increases productivity whereby, in the long run, the aggregate supply curves shifts outwards. As a result of increased supply then high aggregate demand level is met, which causes an increase in the GDP. Section B The Multiplier and the Accelerator In economics, the multiplier and accelerator are two parallel concepts. The multiplier indicates the effect of changes in investment on a change in income as well as employment. Conversely, the accelerator shows the effect of changes in consumption on the private investment. The multiplier effect can be described as the changes in the GDP as a result of changes in the components of aggregate demands such as investment. The size of the multiplier can be described as Multiplier=Change in GDP/Change in Injections while the value of the multiplier can be calculated as Multiplier=1/1-MPC=1/MPS (Keynes, 2016). Conversely, the accelerator depends on two factors; capital output ratio and the durability of the capital equipment (Keynes, 2016).The accelerator depends on the rate of consumption. Additionally, the greater the durability of the capital equipment, the greater the value of the accelerator in the economy. Different scholars have analyzed the interaction between a multiplier and the accelerator. The interaction of both components is possible only under certain circumstances which consist of continuous cyclical fluctuations. According to Samuelson et al. (2015), both the accelerator and the multiplier is taken independently can act alone. The two elements combine with endless possibilities. The possibilities depend on the value of the accelerator as well as the magnitude of the given multiplier. Hence, the existing interaction can be illustrated as: Ia (multiplier) Y (accelerator) Ib (K) Y An increase in autonomous investment results to a change in income whereby the income increases; this is facilitated by the multiplier. Further, the change in income results to a change in the induced investment (Ib), under the influence of the accelerator which further increase the income. The multiplier and accelerator enhances the cycle in the economy. This process involved in interrelationship can be termed as super-cumulative since a decrease, and an increase offsets an effect known as snowball whereby both Y and I, causes a change and increases the impact of the particular elements in an economy at the respective successful level. Therefore, in measuring the total effect of the initial expenditure on national income, there is need to consider the leverage effects of the multiplier and the accelerator. However, the two exhibit differences in that for the multiplier, consumption is dependent on investment while for the accelerator, investment is dependent on consumption. Additionally, the multiplier works rigorously in reducing the income as it does in the increase of income whereas, for the accelerator, it works in a backward direction up to the rate of capital replacement as a businessman can disinvest and fail to replace the worn out capital. (www.economicsonline.co.uk) According to Samuelson et al.(2015), in the interaction of the multiplier and the accelerator, if the values of k and a are high the income will increase at an increasing rate resulting to no cycle. In the above illustration, for trade cycles to be generated, the values of the accelerator and the multiplier should lie between both extremes of upper and lower. If the accelerator has high values, it leads to explosive fluctuations (curve D), increasing the strength of the cycles. If the accelerator has smaller values relative to the multiplier, causes the cycles to be weaker and weaker. Further, the cycle may be regular which is exemplified by curve E, which results to an equal periodicity and equal amplitude. Impact of a decrease in Money Supply on GDP, Aggregate Demand, and Inflation Money supply refers to the stock of currency and liquid instruments that circulate in an economy in a particular time period (Fisher, 2014). Economists conduct an analysis of money supply and develop policies so as to control the flow of money in an economy. An increase in money supply and decrease has effects on inflation, GDP, and the aggregate demand. People hold money for various reasons: As a store of value, to conduct transactions and for precautionary reasons. When people hold money, the money supply in the economy also reduces as the consumption is also low. Money supply is related to inflation in that according to the Fishers’ theory of money, quantity of money and its value are inversely related. A change in supplied money quantity results to a decrease or increase in the price levels. As P=MV/T, where P, is price level, T is transaction volume, M is the supply of currency and V is the velocity of money, When T and V remain constant, P changes proportionately with a change in money supply. Hence, when the money supply is low, then the prices are low. Conversely, when the supply of money increases the prices also increases which result in inflation. Aggregate demand is referred to as an economic measurement of the total demanded goods and services in a certain market; at a given time period and price level (Byun et al., 2016). AD is obtained by summing up the consumer spending, the government spending, all the investments and the net exports of a particular country. In an economy, the Aggregate demand curve assumes a fixed money supply. Changes in the money supply affect the aggregate demand, the GDP, and inflation. When the money supply falls, it results in an equal decrease in the nominal output which is referred to as the GDP. As a result of a decline in money supply, the consumer spending also declines which causes the AD curve to shift to the left. Consequently, the price levels also reduce since the capital available in the economy is less. (www..economicsonline.co.uk) The supply of money is regulated in an economy through an expansionary or contractionary monetary policy. The contractionary monetary policy has an effect of decreasing money supply in a particular economy. As the money supply decreases, GDP reduces and the consumer spends less. This decrease result to a change in the aggregate demand curve as it shifts to the left: from AD1 to AD2.Consequently, the level of price reduces from Pe1 to P e2.The GDP also reduces from QE1 to Qe2.Hence, the capacity GDP reduces and the inflationary gap closes. 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