Written assignment—Read news article below and answer all questions Essay Example
The aggregate expenditure model presents the total consumption as an equation of consumption, government expenditure, exports and investment. In regards to consumption, it is a sum of two types of consumer consumption. These include the autonomous consumption and that which depends on disposable income. The second part depends on the marginal propensity to consume (MPC) and marginal propensity to save (MPS). MPC and MPS add up to a whole. This implies that the consumers can either consume or save the disposable income. In this regard, average propensity to consume (APC) and average propensity to save (APS) will denote the amount of disposable income consumed or saved respectively.At equilibrium the aggregate expenditure should be sufficient to purchase the aggregate production.
An increase in consumer confidence will go a long way to increase the level of equilibrium output and employment. The middle and low income households often have higher MPC. These two will increase expenditure in the market leading to an increase in demand. In efforts to meet and capitalize on this rise in demand, the producers in the market will increase output. This also signifies an increase in employment due to the additional labor producers will hire to sustain increased production activity. Therefore, the increased consumer confidence will lead to an increase in the equilibrium output and employment. On the other hand, the high income households which have higher MPS will also cause the aggregate expenditure to rise. This is in terms of amount of disposable income they choose to invest in the stock market or other sectors of the economy.
On the other hand, the exports will suffer due to a rising Australian dollar. The exports denominated in the Australian dollar will become expensive in comparison to substitutes in the foreign domestic market. The households will also require additional units of the local foreign currency resources to purchase Australian dollars for payment during purchase of Australian goods. In the end, the exports will reduce and will weigh down the aggregate expenditure.
The Aggregate Demand — Aggregate Supply (AD-AS) model
The Aggregate Demand — Aggregate Supply (AD-AS) model states that AD will be equal to AS at equilibrium. By definition, AD denotes the demanded goods whereas AS the amount of goods presented to the market for purchase across the various price levels. The rise in consumer confidence will trigger an increase in demand in the market as the households look up to better returns in the future about their financial situation. The middle and low income households constitute the majority in an economy. With a high MPC, the two will have incentives to spend disposable income. This will cause the aggregate demand curve to shift to the right. As a result, there will be an increase in the output to attain equilibrium where the AS curve intersects the new AD curve (Robinson 2016 page 125). This will also contribute to an increase in the employment necessary to attain this new output level. Increase in demand will also lead to an increase in the price level.
Since the Australian economy is about to attain full employment, the producers will find it difficult to attract and hire additional labor to meet the increased output level. This will cause the labor costs and consequently the production costs to increase. It will also reduce the profits for producers. As a result, the AS-curve will move to the left due to the effect of producers cutting back on production in reaction to diminishing profits. The result will be an increase in unemployment as producers lay off extra labor. The prices will also increase due to the scarcity of supply in the market.
On the other hand, the Chinese economy has been recording fast growth rates, as highlighted by Meyer (2016). This often comes with improved welfare for the citizens as they acquire higher spending power through increase income. This increase in foreign income will possibly cause the Australian producers to reconsider reducing production. They will carry on with the increased output level. However, this will require exporting the surplus output to the Chinese market to capitalize on the increased consumer purchasing power in the Asian country. Therefore, the AS-curve will move to the right resulting in an increase in price, output, and employment levels.
The gradient of the AS-curve increases in the short run. However, in the long run, it becomes vertical and thus cuts both the short term AS and AD curves. At this point, it equates the potential output to the total output. This will also imply an increase in output level coupled by a decrease in price levels. It follows that the employment levels will increase due to the extra manpower required to sustain an increased output level.
In the above case the increase in consumer confidence has triggered changes in the prevailing situation in the economy. However, this is as far as holding other factors constant. In this case, the increase in consumer confidence could possibly increase demand in the market. However, this is subject to the existing household debts. Households incurred massive debts in the past and are yet to meet these obligations. In this case, the households could choose to settle existing debts to decrease accrued interest. As a result, the increase in disposable income will not cause an increase in demand due to the channeling of disposable income towards debt settlement. The households will not have their spending power increased. In this regard, the AD-curve will remain unchanged. As a result, the producers will not have incentives to increase production and will maintain the current production output. Therefore, the level of employment will witness no change since producers will not require additional labor for the existing level of output. This will imply the price level also remaining stagnant.
There is also the possibility of a slow down in the Chinese economy. This will leave the economy without options for increased demand. In the opposite scenario, an expanding Chinese economy would have provided Australian producers with the incentives to increase production for export to the Asian consumers. However, the economic slow down will imply no changes in the spending power of Chinese households. The Australian producers will not increase production implying that the output will remain unchanged. Like in the above, the producers will not require extra labor and employment will be stagnant at the current level. This will also be the case with the prices.
In this context, the increase in consumer confidence will have minimal effects if any at all on the price, output and employment levels. The portion of disposable income necessary to trigger an increase in aggregate demand will go towards servicing debts. Therefore, it is only possible that the aggregate demand could increase upon the households’ completion of extinguishing debts.
Meyer, J., 2016, “Consumer confidence hits near three-year high”, The Age
Robinson, M., 2016.The coverage of aggregate expenditure ceilings.OECD Journal on Budgeting, 15(1), pp. 125-145.
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