The Impact of Increasing Import Prices With Respect to Economic Variables - Research Paper Example

Q a) GDP at current market & Base year Prices GDP is the Gross Domestic Product and depicts the value of goods and services produced within a country during a given period (usually one year). The measurement of the value of goods and Services produced within the borders of the country during last one year is expressed through different methodologies. The methodologies include Production Approach, Income Approach as well as expenditure approach however what is most important is the fact that all three commonly used methodologies present the GDP at price levels i.e. at current market price and at constant market prices. GDP at current market prices shows the values of the goods and services at the current market prices whereas GDP at the base price i.e. in this case it is 2000 shows the values of all the aggregate products valued at fixed base year prices. The depiction of GDP at some base price is basically done in order to measure the value of the nominal GDP of any country i.e. the impact of inflation is not discounted while expressing nominal GDP. The difference between the GDP at two price levels therefore reflects the inflationary pressures over the economy any country. The first curve i.e. in blue color therefore depicts GDP at current market price whereas GDP at 2000 prices depicts prices at base price. Both the curves depict the GDP at two different price levels. b) At current market prices, the GDP is at its highest during the year 2004 whereas it is at its lowest during the year 2001. During 2004, US economy experienced consistent growth with almost over 4%, on average, growth rates during each quarter. This has mainly due to the strong demand created through business spending, the sector which witnessed almost double digit growth during the period whereas consumer spending was increasing too i.e. it showed an improvement of more than 4% during the year. Similarly, new jobs were created and employment level fell sharply which not only stimulated spending but also increased the income level of individuals. Similarly, increase in consumer spending resultantly caused increase in the business sector when business expansion was witnessed as it has been discussed earlier. However, what is also important to discuss, here is the fact that inflation during this period was at high level i.e. the current price level was high therefore the GDP at current market prices was at its highest' Similarly, in year 2001, GDP at current market prices was lowest because US was hit by the terrorist attacks on 9/11 which significantly damaged its economy as most of its stock exchanges closed down for substantial period of time. Secondly, price level was relatively at lower level as compared to the base year i.e. 2001 was just one year after the base year of 2000 therefore it was at the lowest level since at the base price GDP growth rate was around 6 - 7% whereas it showed negative growth from 2000 to 2001 at current market price level. c) Index Value in 2000 = 100 Annual change in GDP in real terms during 2004 = 15% Therefore the value of Real GDP during 2004 would be $115. This is achieved by taking into consideration the growth/decline in GDP from year 2000 to 2004. During this period, the total annual growth in GDP in real terms was 15% therefore if GDP, in 2000, is 100 therefore with a growth rate of 15%, it will be 115 in year 2004. d) Real GDP in 1998 = 7% Real GDP Growth in 2008 = 6% Considering these figures, the real GDP declined by 1% during last 10 years. The figure is estimated by taking into account the growth rates observed during the two periods. However, it is also critical to understand that the real GDP growth varied during this period and a year on year calculations would have provided a better indication. Further, since the calculations are in the real term therefore the impact of inflation has not been taken. e) The presentation of GDP figures either at current market prices or in real term bases may be misleading and may not present the true and correct picture of the living standards of Masses. First of all, GDP only measures the value of goods and services produced by an economy, within its borders, during a given period and in no way depicts the real economic progress made in terms of the improvement in the standard of life therefore GDP is not considered as the yardstick for measuring the quality of life. Similarly, it also does not take into account the standards of living i.e. it just indicates what has been produced therefore considered GDP as the indicator of the standard of life is not rational. Further, most of the countries measure GDP into nominal terms i.e. GDP figures do not take into account the changes in the price levels and in order to measure the impact of economic progress, economists often have to subtract the impact of inflation from the GDP to assess the real progress made by an economy. It is also critical to understand that when per capita GDP i.e. total GDP divided by total population, it provides a somewhat distorting figure because per Capita GDP and hence per capita income does not necessarily mean that every individual of the economy is earning that much per year. Further, it is also critical to understand that while calculating GDP, economists often do not take into account the so called underground economy. Underground economy is not a documented economy and economic agents often engage into this in order to avoid certain taxes or regulations. Since the output levels of such economic transactions are not known therefore such output levels are not taken into the calculations of GDP. It therefore, can be concluded that the changes in GDP levels either at current market price or fixed prices does not reflect correctly on the standards of livings in any country. Question#2 a) Determinants of Economy Activity in modern economy There are different factors which determine the economic activity in a modern economy. The following section will discuss those determinants in detail however, it is also important to understand that the key determinants are often the same however some additional determinants are also discussed. Land Land is probably the only factors of production or determinant of economy activity which is not man made. However, it is also important to understand that land does not only include the surface area available but economists often include air, oxygen and almost all the natural resources which are available freely to the human beings. Land is important determinant of economy activity because by using capital, labor often produces wealth from the land. This wealth however can be in different forms such as agriculture produce, industrial output, natural resources etc. Land is one of the biggest sources of producing raw materials for an economy It is also critical to understand that land is a passive factor of production and its supply, in any given economy, do not change i.e. supply of land is always fix therefore increasing population can result into diminishing marginal returns produced from the use of land. Further, increasing use of it can result into inefficient allocation of resources due to its limited supply. It is also important understand that land is a free resource available to every citizen of the country and as such use of it is freely available at no cost. However, it is also critical to know that through value addition, land can contribute significantly to the economic activity because it is often considered as the basic requirement for other factors of production to contribute to the economic activity in an economy. Labor Labor refers to the human physical and often mental activities involved in the creation of wealth. Labor is often referred to the human resource available to any economy to perform physical as well as mental jobs to increase the output level in economy. It is argued that the in pursuit of the desires, men often attempt to exert his efforts. However, in economics, labor refers to any physical exertion for the production of wealth. As against land, labor is often considered as the active determinant of economic activity in an economy as it is basically the labor which converts the raw material into the finished goods through value addition process. Capital Land and labor are considered as the primary sources of economic activity in any country. With the combination of land and labor the wealth is generated into any economy. However, there is another factor of production which contributes to the economic activity called Capital which is often considered as a form or use of wealth. Capital is basically defined as the wealth attributed to land and labor to produce further wealth therefore in effect, capital is a secondary but one of the essential sources of economic activity in a country. Question# 2 b) Money plays one of the most significant roles in modern economy as it serves many important purposes. Due to its critical significance and importance, there have been many efforts to exactly determine the amount of money in an economy. Keynes's theory According to Classical economists, money serves only as a medium of exchange therefore the amount of money in an economy is determined by the amount of transactions required to be completed with money. Further, how much an individual would like to keep will depend upon the level of income therefore under classical theories of economics, the demand for money is the function of the income. However, later on it was also realized that the money also serve as a store of value i.e. it can help to earn money on money that is interest. Therefore, Keynes added another dimension to the demand for money by adding the speculative demand for money. Keynes' theory of demand for money is therefore based on the fact that the amount of money is determined by either transactive demand for money or speculative demand for money. Transactive Demand It is believed that a time lag is involved in between the income as well as expenditure of an individual therefore in order to meet the expenditure during that time lag; people often keep a certain portion of their income in the form of cash. Such cash or money are kept to meet the day to day expenditures of the individuals. Thus, the transactive demand for money largely depends upon the income level i.e. higher the income level, more will be the money into economy therefore if transactive demand for money is considered in isolation, keeping all other variables constant, then it will determine the amount of money in a modern economy. However, as discussed above that individual often keep money for the speculative purposes also because money can provide an opportunity to earn interest on it. Accordingly, as Keynes discussed that an individual can keep his wealth in two forms i.e. either in cash or in bonds. The wealth held in the form of bonds is subject to price fluctuations therefore there is always a possibility of capital gains or losses. When an individual anticipate that due to price fluctuations, there are going to be capital losses than he would prefer to keep his wealth in cash rather than in bonds. However, the individuals do so on the assumption that when prices will favorable, they will prefer to keep more bonds than cash. It is therefore outlined that besides keeping money for transaction purposes, individuals would also keep the money for speculative purpose. However, it is also critical to understand that the quantum of money held for speculative purposes also depend upon the prevailing interest rates and there exists an inverse relationship between the demand for speculative money and the interest rates. The combine sum of transactive and speculative money determines the amount of money in a modern economy. Q#3 a) Monetarist view of Inflation According to monetarist view of inflation, the supply of money in the economy is increased through an easy monetary policy followed by Central Bank. As a result of this, the rate of interest will fall which will increase consumption expenditure, investment expenditure and to some extent government expenditure. Accordingly, the aggregate demand curve will shift and output will remain constant. Such increase in the aggregate demand will increase the price level in the economy without increasing the output. The evidence in the table suggests that money supply is increasing from year 1997 to 2001 i.e. M3 has increased by an annual growth rate from 9.4% in 1997 to 12.7% in 2001. During the period, therefore, in 1997, M3 growth rate is 9.7% whereas the retail price index increased by 7.7% however on the other hand GDP only increased by 2.0%. Similarly, during 2000, M3 increased by 28.8% whereas retail price index increased by 10.4% however, GDP i.e. output level only increased by 3.9%. b) If in any economy, price level rises due to the increase in costs of production, it is given the name of cost push inflation. The important feature of this type of inflation is that on one side the price level rises while on the other hand the level of output and employment decreases. In other words, the inflation and unemployment go side by side in such a type of inflation. It is also said that whenever the inflation is accompanied by unemployment it is accorded as stagflation. In other words, the combination of rising price levels and rising unemployment is given the name of stagflation. From year 1997 to 1998, the GDP fell by 0.6% and similarly, the unemployment level increased from 2.6% to 3.8%. This evidence suggests that there have been cost push inflation during 1997 to 1998. c) The relationship between inflation and unemployment level is defined through the Philips Curve approach. According to this approach, there is an inverse relationship between the inflation and unemployment level therefore accordingly as an economy approaches the full employment level, inflation may not damage the economy however as the economy reaches the full employment economy suffers from general increase in the price level. The Philips curve also depicts that lower the unemployment level in any economy, the higher the wages will be paid to the workers. This relationship therefore suggests that as full employment is achieved, higher wages paid to the workers will increase in the inflation due to the demand pull inflationary pressures on demand against a fixed supply. Considering the given table, for example, in year 1997 the unemployment level was 2.6% which increased to 3.8% in subsequent year. However, on the other hand, the annual change in the wages slipped from 13.6% to 9.5% suggesting that with the decrease in unemployment level, the wages paid to the workers have declined too however, contrary to theory, inflation also increased from 7.7% to 9.2%. This evidence may suggest that the Philip Curve relation may not hold empirically. d) Countries often engage themselves into the trade with foreign nations in order to fulfill the aggregate demand in economy. However, the basic theories of international trade suggest that countries often engage into such a trade based on their relative competitive advantage i.e. the opportunity cost to produce a good or service. For example, if a country A finds it more costly to produce a particular good as compared to country B then country A will purchase that good or service from country B because it cost less to purchase from country B. based on this simple principle international trade take place between two countries. However, there are certain other issues which need to be taken into consideration before making a decision to import from a foreign country. As can be witnessed from the table, import prices continue to increase during the period therefore one might take an assumption that the importing or doing international trade with foreign countries may not be beneficial to the economy. It is also critical to understand that the impact of increasing import prices shall be viewed with respect to different other economic variables such as exchange rates, interest rates as well as the overall money supply. If exchange rates move in an unfavorable manner, then home currency may start to depreciate i.e. the reduction in purchasing power of home currency in terms of foreign currency therefore in such circumstances the imports may not seem to be a wise option as it would cost higher to import than export and a country can experience deficits in its trade balance or current account. It is also critical to understand that exchange rates are partly influenced by the interest rates in the country also. If interest rates increase, the overall demand for money may increase therefore the demand for the home currency will increase too. This increase in demand will therefore appreciate the home currency against the foreign currency and imports may not seem as expensive as they may otherwise be. However, if interest rates goes down and inflationary pressures increase, the home currency will depreciate also therefore again making the imports more expensive as in comparison to exports. Though the above factors may suggest that the imports may have an adverse effect however, if cost of producing particular good or service is higher than it is economically viable to do trade with foreign countries. References Willard E. Witte. (2004). The U.S. Economy. Outlook. 79 (4), 10. Read More