Assignmen2 Essay Example

8ASSIGNMENT 2

Assignment 2 DB-BB 106

Assignment 2 DB-BB 106

Question 1

The aggregate demand and aggregate supply model of is applicable in explaining how different macroeconomic factors affect the economy, both in the short-run and in the long-run. The model shows how the entire output of the economy changes, under different circumstances that affect the economy. The model’s basis is the interaction between demand and supply in an economy, and the real GDP of an economy is used as the measure of the state of equilibrium. The macroeconomic factors would therefore shift the economic performance, either positive or negatively, and the changes are measured using the aggregate demand/supply (Evans, 2009). The following diagram is an illustration of the aggregate demand (AD)/ aggregate supply (AS) model.

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Figure 1: The aggregate demand/ aggregate supply model. Source: Google images (2014).

  1. A Political/ election campaign

A political or election campaign increases the government’s demand for goods and services. Its effect is an increase in government spending, which stimulates the economy by creating a higher supply of the goods and services to meet the extra demand. Under the situation of a political campaign, therefore, the aggregate demand and aggregate supply would increase, and the point of equilibrium (real GDP), which is the point of intersection between AD and AS, would shift upwards and the right (Evans, 2009).

he following diagram illustrates how AD, AS, and Real GDP would change during a political campaign.

Real GDP 2

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Real Domestic output

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Real GDP 1

Figure 2: The effect of a political campaign on the aggregate supply and aggregate demand. Source: Author, 2014.

The above graphical illustration shows that the real GDP would shift from point 1 to point 2 (increase). However, the effect would be in the short-run. After the political campaigns, the demand for the goods and services by the government would reduce to the level where it was prior to the campaigns. In the long-run, therefore, the equilibrium would shift back to “Real GDP 1).

2. Increase in spending on Infrastructure

The immediate (short-run) effect of the government increasing its spending on infrastructure would be similar to the effect of political campaigns on the economy. The demand for construction materials, labor, and construction machines would increase. The income levels of the people who would get the employment opportunities would increase. Such people would have a greater spending confidence, a factor that would increase the prices of commodities (Evans, 2009). Their demand for goods and services would also increase. The increase would shift AS1 to AS2.

In the long run, however, the economy would retain the real GDP2, and it would not shift back to real GDP 1. The reason is infrastructural development has the ability of retaining long-term economic development, due to its aspect of permanence. Roads, for example, would increase the accessibility that suppliers would have to different markets, a factor that would sustain a high supply of goods and services in the long-run. The following diagram shows the effect of the increase in infrastructural spending on the economy.

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Figure 3: Effect of increase in infrastructure spending on the economy. Source: Google images (2014).

3. An Increase in International Economic Turbulence

In the presence of an international economic turbulence, the foreign markets for exportation would shrink. The government’s foreign earnings would reduce, and it would resort to taxation as the main funder of its budget because of unreliable international trade (Evans, 2009). Increase in tax would reduce the income, and this would further reduce the demand of goods and services, and their supply (Evans, 2009). P1 would shift to P2 (negative change) because of low demand. In the long-run, thus after the economic turbulence, the real GDP would return to normal. The real GDP would decrease, and there would be negative shifts in AD1 and AS1 as the following graph shows.

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Figure 4: The macro-economic effect of increase in international Economic Turbulence. Source: author (2014).

4. Depreciation in the foreign exchange rate value of the economy’s currency

When the foreign exchange rate of the economy’s currency depreciates, the government would respond with deflationary policies, for example, reducing the amount of currency in circulation (Evans, 2009). The spending power/confidence of the consumers would reduce because they would have less money in their disposal. The demand and supply of goods and services would reduce, reducing the country’s real GDP and prices as figure 4 (above) shows. The effect would, however, be short-term. When the currency exchange rate appreciates, the government would increase the amount of its currency in the economy (Evans, 2009), and this measure will return the level of economic activity to the previous state.

5. A fall of business confidence within the economy

A fall in business or investor confidence would reduce the amount of supply of goods and services in the economy. In the short term, the economy would have a scenario whereby there is a high demand, but a low supply. In the long-run, however, the government would introduce measures to increase investor confidence, for example, reducing taxation, or subsidizing the cost of land for the investors. Such measures would attract more investors in the economy, and increase the amount of supply and the real GDP (Evans, 2009).

Question 2

Newspaper article: “Trade Balance Swings to Deficit in April” by Mitchell Neems.

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Price of exports

In the article, Mitchell Neems (the reporter), explains that Australia’s balance of trade between exports and imports reduced to a deficit in April 2014. The balance fell by a deficit of $122 million, and Neems explains that whereas Australia’s imports for the month rose by 1%, its exports reduced by 2%. Theoretically, a perfect balance of trade is achieved when the amount of exports is equivalent to the amount of imports. It is likely that the demand for Australia’s exports may have decreased, and increasing competition from the supplier of similar goods and services could the major cause. The deficit balance of trade is an indication that the real GDP for Australia reduced for the month, because the economy imported more goods than it exported to other economies. Neems (2014), explains that in March, the economy had registered a balance of trade with a surplus of $902 million. The forecast for April was a surplus of $510 million (Neems, 2014). The $122 million deficit, therefore, indicates that Australia’s economy faced problems with its foreign markets in April. Australia may have increased the prices of its exports, a factor which reduced the quantity of exports that other countries demanded, leading to the deficit.

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Real Domestic Output

References

Evans, G.R. (2009). “The Aggregate Demand-Aggregate Supply Model”. Hmc.edu. Retrieved on

June 8, 2014 from http://www2.hmc.edu/~evans/chap2.pdf

Neems, M. (Business Reporter). (June 5, 2014). “Trade Balance Swings to Deficit in April

2014”. The Australian. Retrieved on June 8, 2014 from http://www.theaustralian.com.au/business/economics/trade-balance-swings-to-deficit-in-april/story-e6frg926-1226944195761