ECO82001 â€“ ECONOMICS AND QUANTITATIVE ANALYSIS
SHORT WRITTEN RESPONSES -- MACROECONOMICS
WORD LIMIT: 250 words (max.) for each question
Reference : - Hubbard, RG, Garnett, A, Lewis, P & O'Brien, AP 2015, Essentials of Economics, 3rd edn, Pearson, NSW. ISBN: 9781486022847.
Prepare short written responses for the following five (5) questions. Answers for each question must not exceed 250 words.
Question 1 (5 marks)
Explain why real GDP might be an unreliable indicator of the standard of living.
Question 2 (5 marks)
Why does unemployment arise and what makes some unemployment unavoidable?
Question 3 (5 marks)
Consider the following statement: â€˜When the average level of prices of goods and services rises, inflation risesâ€™? Do you agree or disagree? Explain.
Question 4 (5 marks)
What is the aggregate demand (AD) curve and why does it slope downwards? Explain.
Question 5 (5 marks)
What is the long run aggregate supply (LRAS) curve and why is it vertical? Why does the short run aggregate supply curve slope upwards?
Question 1: Real GDP
According to Hasan and Raza (2012), real gross domestic product (GDP) is defined as the value of ultimate products and services that are produced within a particular year when prized at a price of a given base year. Dorado (2000) points out that the rate of real GDP growth reveals how fast an economy is growing whereas real GDP rates per individuals tell how the standard of individuals is changing with time. Arun et al. (2016) note that since it is possible to compute real GDP for every individual in dissimilar years, real GDP per individuals shows the worth of products and services that an average individual can enjoy.
However, the real GDP cannot adequately be a reliable indicator of peoples’ standard of living for a number of reasons. First, real GDP does not sufficiently show the true health condition of a country. Kumar and Li (2016) point out that the GDP measures a country’s economic wellbeing since it is determined by the prevailing market value of all ultimate products and services. This may give misleading information of a nation’s living standard yet most economists currently agree that the real GDP measures are significantly limited to help gauge a country’s overall health in addition to the country’s population. Another problem arises when incorporating real GDP to compare living standards for countries. First, the real of one nation must be altered into alike currency units as another country’s real GDP. Additionally, products and services across the countries under comparison must be valued at similar prices.
Question 2: Unemployment
Unemployment has continued to be on the rise globally because of four main reasons. First is demand deficient. When overall demand is insufficient to purchase all the products and services produced within an economy, when all economy’s resources are incorporated, managers often become pessimistic about the future of their firms. For this reason, they lay off some of their employees to cut down their overhead expenditures. Secondly regards structural issues. Dorado (2000) notes that this kind of unemployment is often experienced due to discrepancy/incongruity of skills in labour market. Some of the well-known causes of mismatch in economies include occupational and geographical immobilities, technological changes, and structural changes within the economy. Another reason for the rise in unemployment regards real wage unemployment. Hasan and Raza (2012) point out that classical unemployment occurs if wages in a competitive employment market are pressed beyond the equilibrium. Some of the forces that can push wages that high include trade unions and minimum wages policies. Lastly, unemployment can arise due to voluntary unemployment. In some cases, people may decide to remain unemployed as opposed to accepting the job offers available.
While several attempts have been made to curb the unemployment issue, some of the above unemployment cases are unavoidable. According to classical economics, it is predicted that that unemployment ought to vanish whenever the total number of jobs available equals/exceeds the number of labourers (Arun et al. 2016)). Nonetheless, this does not happen in reality. Additionally, even if what measures are incorporated to curb unemployment within an economy, economists have proved mathematically that whereas a new equilibrium will be created, at least some unemployment would rise within any economy. Lastly, some people choose to be out of employment thereby contributing to unemployment within n economy. As such, voluntary unemployment is unavoidable.
Question 3: Inflation
Kumar and Li (2016) define inflation as increase in the average prices of products and services within a macroeconomy. The average price of goods and services can increase when some costs have really fallen, and the extent to which the rise is displays one’s personal buying situation is dependent on how closely the basket of products and services within the individual’s index matches his/her buying patterns. Hasan and Raza (2012) add that when the price level of particular goods and services rises within an economy, the average costs of all commodities and services within the economy is increase. Owing to the fact that inflation is computed as the proportion increase in a nation’s price level for some duration of time, an increase in price levels result in the occurrence of inflation.
Similarly, since inflation can be considered as a sustained rise in the general price levels for goods as well as services, a rise in inflation has been found to imply that every dollar that one owns purchases a smaller proportion of goods and services as compared to deflation conditions. This proves that the worth of a dollar is never constant whenever there is inflation. For this reason, it can be concluded that a rise in the average prices of goods and services within an economy lead to inflation and the vice versa is true. To this end, I agree to the statement that “When the average level of prices of goods and services rises, inflation rises.”
Question 4: Aggregate Demand (AD) Curve
An aggregate demand curve is a graphical representation of the total quantity of services and goods that are demanded within an economy at different levels of prices. The curve is as shown below.
There are four main reasons why the aggregate demand curve has a downward-sloping trend. First, is the wealth effect. The curve is drawn under the supposition that governments in any economy hold the supply of money constant. According to Arun et al. (2016), it is possible to think of the money supply within an economy as representative of the economy’s wealth at all moments. When the price level rises, Dorado (2000) observes that the economy’s wealth declines in value due to the fact that the buying power money declines. As consumers become poorer, they minimize their purchases of all products and services.
The second reason behind the downward-sloping trend regards effects of interest rate. As price levels rise, firms and households need more to handle their commercial exchanges. Nonetheless, money supply is kept fixed. The rise in demand for a fixed money supply causes the cost of money, which is the interest rate, to increase. Hasan and Raza (2012) add that as the interest rate increases, spending, which is sensitive to interest rates, will fall. Hence the inverse relationship between the demand for real GDP and the price level. Third reason concerns net exports. As an economy’s price level increases, foreign-made commodities become comparatively less expensive so that demand for imports rises. Lastly is that it is assumed that all components of aggregate demand, with the exception of imports, are inversely associated with the price level.
Question 5: Long Run Aggregate Supply (LRAS) Curve and Short Run Aggregate Supply (SRAS) Curve
Aggregate supply, in economics, is defined as the total supply of services and goods that companies/firms within an economy are willing and able to sell at a particular price. For that reason, an LRAS curve is a graph showing the various quantities of actual goods and services in the long-run that firms will be able to supply at the different prices. It is as shown below.
Adapted from Kumar and Li (2016).
From the diagram above, it is clear that the LRAS curve is perfectly vertical. According to Dorado (2000), the perfect vertical nature of the curve indicates the economist’s belief that the variations in the aggregate demand just cause temporary alterations on the total output of an economy. Furthermore, in the long-run, it is assumed that all factors, except labour, technology, and capital, are optimal.
On the other hand, SRAS curve has an upward sloping curve. There are two main reasons behind the upward-sloping nature of the curve. First, the aggregate supply curve is drawn by the incorporation of nominal variables, like nominal wage rate. Arun et al. (2016) note that in the short run, an economy’s nominal wage is often fixed. For this reason, rise in price implies higher profits that justify the increase in the economy’s output expansion. Secondly, by the economists’ alternate model, aggregate supply curve rises because certain nominal input costs are kept constant/fixed within an economy’s short-run and as out-put increases, more production processes face bottlenecks. Similarly, during demand levels, several production processes do not fully use their capital. For this reason, production can be increased minus significant diminishing returns.
Arun, S, Shankaran, B, & Jayadev, M 2016, ‘Investment Value of Analyst Recommendations: Evidence from the Indian Stock Market’, South Asian Journal of Management, vol. 23, no. 2, pp. 7-24.
Braun, M 2016, ‘How Do Investment, Fundamentals, and Stock Prices Relate Around the World?’ Emerging Markets Finance & Trade, vol. 52, no. 12, pp. 2772-2789.
Dorado, B S 2000, ‘Social entrepreneurship: The process of creation of microfinance organisations in Bolivia’, A Review of Microfinance, vol. 12, no. 6, pp. 89-111.
Hasan, A, & Raza, M 2012, ‘From microfinance to the building of local institutions: The origins and evolution of the micro-credit programme of the OPP's Orangi Charitable Trust, Karachi, Pakistan, Karachi: Oxford University Press.
Kumar, P, & Li, D 2016, ‘Capital Investment, Innovative Capacity, and Stock Returns’, Journal of Finance, vol. 71, no. 5, pp. 2059-2094.