Appreciation in the Foreign Exchange Rate Value of the Economy's Currency - Assignment Example

Name: Instructor: Course: Date: Question 1 Lifting Interest Rate Lifting interest rate will reduce cost of companies and households borrowing, increasing consumption and investment spending. There the AD will shift to the right from AD1 to AD2 as illustrated by the graph below From the above diagram, in the short run the AD curve will shift to right which is as result of lifting interest rate and this will cause the equilibrium shift from point A to B. however, in the long Run the aggregate demand curve will go back to its original point and therefore equilibrium point will go back to point A An increase in private domestic investment spending An increase in the private domestic investment spending would cause the AD curve to shift to the right in the short run but in the long run the aggregate demand back to where it was originally as showed by the diagram below An increase in the good and services tax (GST) An increase in the good and services tax will cause the aggregate demand curve to shift to the left in the short run since there will be a reduction in consumption going on in the economy. However, in the long run, since these taxes are going to the government then loaned out to companies thus increasing investment and this will slowly shift the aggregate demand back to where it was originally as showed by the diagram below An appreciation in the foreign exchange rate value of the economy’s currency This would AD curve to shift to the right in the short run but in the long run the aggregate demand back to where it was originally as showed by the diagram below Fall in price of real estate This will cause a price movement in the aggregate demand curve holding other factors constant Exports and imports If a country’s main export fall in price while imports rise in price people will buy more exports as compared to import hence increasing net exports and the aggregate demand will shift to the right Question 2 GDP is the monetary value of all goods ands services produced within a country in a specific time plus taxes on the goods and services minus any subsidies. GDP is a primary indicator used to measure the outlook of a country. More recently, GDP measure is used to calculate the growth of a country’s economy from quarter to quarter. Quarterly movements in a country’s GDP provide a pattern of GDP growth that can indicate failure or success of an economy and economic policies. Most importantly, quarterly movements provide an accurate indication on whether a country’s economy is going through recession. Quarterly movements provide more timely economic data than annual economic outlook. The data is also more comprehensive than short-term indicators. Quarterly data mainly focuses on temporary issues in the economy such as acceleration and deceleration of an economy. Quarterly movements are crucial GDP indicators on growth trends in an economy. Quarterly movements in GDP can be used to improve economic policies that will impact on the annual economic outlook. When a country has two successive negative quarters of economic growth, its economy is said to be in recession. Recession in itself is a general slump in economic activities within a country (Abel & Bernanke, 2008). Question 3 In market-based economies, economic decision regarding investment production and pricing of goods and services is determined by the forces of demand and supply within a market. The economy is based solely on voluntary exchange in a free market. Market-based economies have minimal government intervention or central planning. It is assumed that market-based economies should be controlled by supply and demand forces in a free market. Demand and supply forces and availability of capital are relied on in market-based economies to determine what is good for the society. However, market forces might not be effective in meeting social objectives such as fair pricing of basic needs goods and wealth distribution. Market-based economies should be monitored to prevent failures such as uncompetitive markets and growth of monopolies. Market forces in market-based economies only set the prices for goods and services while the government in such economies monitors the behavior of firms in such economies to ensure they do not go against the interest of the public. Market-based economies cannot be self-sustaining since players may not necessarily meet the social objectives of a society as defined by the government (Abel & Bernanke, 2008). Question 4 This model was developed by John Keynes in an attempt to understand the great depression. Keynes suggested that to achieve optimal economic performance, the aggregate demand had to be influenced through economic intervention inform of government policies. He belived that wages are sticky downwards and that increase or decrease in prices wwill not affect Aggregate Supply. Aggregate demand ia a function of Consumer expenditure / savings, Government expenditure , Investment. Exports and Imports as Indicated below. A change in any of this factor will shift AD. Rise in Private Investment (I) will increase Aggregate demand will cause a shift in the AD curve to the right from AD1 to AD2 which will in turn increase the RNI. Increase in savings by consumers will reduce consuer expenditure © which will shift AD from AD2 to AD1 Question 5 State the difference between Uncertainty and risk Risk involves exposure to impact with potential consequences to a subject. Risk defines the level of possibility that an action will lead to a loss or undesired outcome to a subject. In a risky situation, the outcome is not known but the distribution of the outcomes and the accompanying consequences is known. Uncertainty, on the other hand, is unpredictable with many undefined variables. In uncertainty situations, the outcomes are not known and the distribution of outcomes is also unknown (Knight, 2006). Interest rates and exchange rates Interest rate represents a percentage of a principal a lender charges a borrower for using the former’s assets (money). Exchange rate, on the other hand, is the value of a country’s currency as compared to the currency of another country. Exchange rate determines the conversion value of a currency into another (Floyd, 2009). Supply-side shocks and demand-side shocks Supply side shocks are sudden unprecedented shifts in the aggregate supply of an economy caused by factors such as wage levels and indirect taxes. Demand side shocks are sudden unprecedented shifts in aggregate demand caused by factors such as exchange rate fluctuation (Abel & Bernanke, 2008). Trade deficit and net foreign debt Trade deficit is a negative balance of trade in which a county’s imports value exceeds that of its exports. A foreign debt, on the other hand, is the outstanding loan a country owes to another country and institutions in foreign countries. Money owed to international institutions such as World Bank is regarded as foreign debt (Abel & Bernanke, 2008). Question 6 Increased money supply in an economy means that the supply of money exceeds the demand of money in the money market. According to laws of demand and supply, when a commodity is in high supply and low demand, the price will fall to an equilibrium point where the quantity of the commodity demanded is equal to supply. Increase in money supply will cause a decrease in average interest rates in the market. The cost of borrowing money in the money market will reduce. Increased supply of money lowers interest rates thus increasing investment spending in the economy. Investment spending increases the quantity of goods and services produced. In the short-run, both aggregate price level and aggregate output level will increase and set a new equilibrium which raises nominal wages in an economy. The aggregate output is above the potential output. The aggregate price increases while the aggregate output reverts to potential output. Increase in money supply will raise prices in the long run but have no effect on output and employment (Floyd, 2009). Question 7 Businesses and economies are faced with challenging tasks of ensuring the resources under their disposal are utilized optimally to generate profitability. However, transforming resources into goods and services and selling them profitably involves a range of predictable and unpredictable factors that influence the outcome of exploiting production factors (Knight, 2006). Economists have to analyze a lot of business and economic indicators to help them gain valuable information that will enable them predict the short-run and the long-run outcomes of an economy and investment in such economies. In so doing, economists help governments and businesses come up with strategic policies to generate optimum productivity from an economic situation (Abel & Bernanke, 2008). Analysis of economic and business indicators also helps economists understand the implication of certain actions by policy makers on economies and recommend an appropriate cause of action to improve or maintain a favorable economic condition. According to Abel & Bernanke (2008), economists utilize economic theories and models that may not necessarily yield identical results in different economies. Question 8 Currency depreciation Currency depreciation is loss in value of a country’s currency as compared to the value of one or more foreign currencies. Normally, currency depreciation maybe caused by a number of factors such as high inflation rates, drop in exports, political instability and general economic slowdown. Currency depreciation may be a sign of poor economic outlook but on the positive it may be of benefit to a country’s international trade. When a country’s currency reduces in value as compared to other currencies, it becomes cheaper to buy goods from that country. The exports of the country in the international markets become competitive. As a result, the value of exports of a country with depreciated currency is bound to increase thus improving trade balance. With increased exports, the country will be able to increase output of goods and services in the economy resulting in creation of more jobs and economic growth. Currency depreciation may after all not be such a bad thing for a country (Floyd, 2009). Currency appreciation Currency appreciation is increase in value of a currency as compared the value of one or more foreign currencies. Normally, currency appreciation is caused by factors such as rise in value of exports and rise in interest values within an economy. When a country’s currency increases i value, it becomes expensive to import goods from that country. Goods from a country whose currency is more valuable in the international market become uncompetitive. Imports in the country also become cheaper. The country will therefore export less and import more and as a result affect the balance of payment negatively. Reduced production in a country due to low demand of exports hurts the economy resulting in low economic growth and job losses. Currency appreciation might not after all be a good thing for a country especially if it is not based on competitiveness of goods in the international market (Floyd, 2009). Question 9 Expansionary policy refers to a macroeconomic policy that aims to increase money supply so as to combat inflation as well as encourage economic growth. There are various forms of expansionary policies which include fiscal policy which comes inform of rebates, tax cuts and increase in government spending. Expansionary policy is appropriate during the recession period as it is used to stimulate the economy as well as decrease unemployment rate Impact of Expansionary policy on; Normal interest rate Expansionary policy will lead to a decrease in normal interest rates in the short run but an increase in normal interest rate in the long run Real interest rate An increase in money supply results to a decline in the real interest rates as money is available hence more loans are available and thus Competition for borrowers reduces the real interest rate Money Supply Expansionary policy increase money supply rapidly in an economy Credit Growth Expansionary policy increase credit growth as more money is available hence more loans are available at a lower interest rate Question 10 Flexible exchange rate is where a country’s currency is allowed to fluctuate in value as a result of demand and supply forces in the foreign exchange market. Flexible or floating exchange rate regime is self-correcting in the sense that changes in demand and supply will be corrected by the market without the intervention of the government or any other authority. If a country has a negative balance of payment, the value of the currency falls making exports from the country cheap and importing using the currency expensive. Cheap exports will increase demand in the international market resulting in increase in value of the currency to correct trade deficits and currency depreciation (Floyd, 2009). The central bank can reduce money supply in situations where the currency depreciates in value to make the currency valuable thus correcting the problem of expensive imports. If the currency appreciates in value, increase in supply of the currency in the market will lower the value of the currency thus stimulating demand for the country’s exports in the international market. Increased supply will reduce interest rates in the money market making it affordable to borrow. Cheap money and increased exports will ultimately grow the economy and improve standards of living. Flexible exchange rate helps a country’s central bank to monitor and stabilize the value of its currency to improve and maintain a positive balance of payment and also spur economic development (Floyd, 2009). References Abel, A., & Bernanke, B. (2008). Macroeconomics. Pearson/ Adison Wesley. Floyd, J. (2009). Interest Rates, Exchange Rates and World Monetary Policy. London: Springer Science & Business Media. Knight, F. (2006). Risk, Uncertainity and Profit. New York: Cosimo Inc. Mckenzie, M. (2006) Aggregate Demand and Aggregate Supply Analysis: Macroeconomic Schools of Thought Read More