Micro & Macro economics - Essay Example

? Macro & Micro economics    Table of Contents Summary of chapter 12 3 Summary of chapter 13 6 Summary of chapter 14 8 Summary of chapter 15 11 Summary of chapter 12 The demand caused recession is primarily triggered by fall in the aggregate demand i.e. APE. This might be caused due to a fall in the purchase of household goods, and business demands due to increase in taxes and the spread on the notion that the future times would be bad. This can also happen because of reduced government purchases of the present domestic output. The response to the increase in APA is depicted in the figure below. The line is seen to shift leftwards and repositions the IS line such that the IS curve and the APE line continue intersecting at the original GDP line. Since the decrease in need for funding the APA is matched with an increase in the funding by the nation’s producers, hence the requirement for funding remains equal to the ASF supply. The present situation is APE< GDP = ASF. There would a response from the producers by decreasing unemployment, reduction in prices and output. This will make the ASF line to move rightwards and the GDP and APE line to move leftwards. The economy attains a position which is shown in the figure. This process generates negative economic projects. The shrinkage in industries responding to the negative profits helps the economy move into a position of long run sustainable equilibrium (Ashby, “Case #4 – Demand-Caused Recession”). This case is just opposite to the above case where there is decline in the funding supply (ASF). All decreases in the ASF includes a reduction in M x V in comparison to the price index (p). During the phase, the rates of interest would be rising, tracking the point of intersection of ASF and GDP lines as they move up across the IS line. The rates of interest would remain below its original level unless and until substantial concessions on costs are able to allow profitable operations at low prices which consequently compensate for the loss in output and unemployment. The fall in the supply of funds of the country (ASF) would trigger a dramatic rise in the interest level because producers would react to the fall in sales. This would be done by the price-output adjustment which involves deflation, output, employment, interest rates and profits, until the equality is restored among the ASF, APE and GDP lines. Output and employment are expected to continue declining unless and until profits and prices rise to their original levels. The process will end with the fall in employment and output levels, rise of interest rates and thus unchanged outputs and profits (Ashby, “Case #5m – Money-and-Credit-Caused Recession”). The figure below would depict the cost push inflation. Due to a wide spread increase in the costs of production, the profit levels, employment levels and output levels would fall. This would be accompanied with the rise in the interest levels in the nation. The employment and output would continue to fall unless and until the negative economic profits can be eliminated completely and successfully. This would happen by allowing the reduction of output till the level that prices rise by the amount equal to the increase in cost (Ashby, “Case #5c - Cost-Push Inflation”). Growth problem in the economy can be explained in the diagram below. It is seen from the diagram that an increase in the output would be followed by an increase in the rates of interest. Producers would immediately react to the low demand in the economy. The rates of interest would fall along with the employment and output levels until they reach their original positions. Since the initial fall would be compensated by an offsetting rise in price levels, they would be maintained at the original positions. After returning to the original position, the economy would suffer a shock which would push down the levels of output, employment and rates of interest below their original positions leaving the price levels at their unchanged positions (Ashby, “Case #6 – The Growth Problem”). Summary of chapter 13 The figure explains the position of the economy at equilibrium. At this position GDP = APE = ASF. This is at i0 interest level and the output level is at GDP0. The vertical ASF line has a number of implications for the macro-economic coordination process of the economy. Some of these implications will be discussed in the subsequent portions of the project. It is apparent from the diagram that an increase in the APE brought about through the rightward shift in the APE line is a shock for the economy. At the present rates of interest the APE is above the ASF. There is lack of funding needed to compensate for the increase in demand. ASF remains at the same position because V and M do not change with the changes in the rates of interest. The rates of interest would only continue to rise until the increased demand gets crowded out completely. Thus increase in APE only causes higher rates of interest. It can neither spawn higher prices nor lead to the generation of higher outputs. In the same way a fall in APE would cause leftward movement of the APE line. This would lead to the drop in the rates of interest. It can neither cause deflation nor lead to a recession. This figure would demonstrate the implications of a leftward or rightward shift of the ASF line away from the GDP. In such a case the price levels would change. In case the banks supply excess money in the economy such that ASF exceeds the GDP, the ASF line would shift rightwards. This will lead to a fall in the interest levels and a rise in the APE till the point when the ASF=APE. At this point both APE and ASF exceeds the GDP. The extent of demand for funds would be more than the output at this point. Businesses confronting with this demand would increase their prices as it is assumed in classical economics that they would be satisfied with their present level of output because they operate at the profit maximizing output levels. With the rise in prices, the ASF and APE falls. The rises in prices continue till the time when the interest rates, APE and ASF come back to their original positions. In the same way the rise in ASF leads to deflation or a fall in the level of prices. The output and employment remain unaffected and there is a temporary rise in the rates of interest and then a fall again. A fall in the APE would cause a fall in the rates of interest for restoring the APE to its original position. In the same way fall in the ASF would cause a fall in the prices in order to restore the ASF to its initial position. However, these adjustments take a lot of time and when the changes in prices and rates of interest occur during that time businesses are confronted with high demands. They respond to the situation through increasing their output and employment. This situation is in conformance with the classical theory with the mild surges in the output and employments (Ashby, “Classical Analysis and Policy”). Summary of chapter 14 It is seen that decentralized macroeconomic coordination is brought about by the independent decisions of numerous households, businesses and the government. This would occur through the individual entities responding to their shortages or surpluses and suppliers responding to the excess or insufficient demands for their outputs. However, some people do not remain satisfied with the resulting levels and rather look forward to government interventions so that the level of employments, interest rates, outputs and prices can be impacted upon. Monetary policy is one such tool which is used by the Federal Reserve as a deliberate use of open market operations to adjust the reserve requirements and altering the discount rates for exerting an influence on the level of prices, interest rates, output and employments. The Fed makes changes and manipulates its policy tools for inducing changes in the supply of money in the nation (Ashby, “Monetary Policy”). In terms of the interest rates, prices and employments, the policy tools of Fed allow the Reserve Bank to influence the rates of interest directly. The Fed is able to have influence directly on the federal’s funds rate and the interest rates of banks due to the effects that the Fed’s activities have upon the reserves of the banks. Fed can only have influence over the prices and employment indirectly by engineering money and credit options in order to enhance employments. However, it cannot increase employment without causing reasons for instability in prices. Also it may not be able to curb inflation without creating unemployment for a period of time (Ashby, “Monetary Policy”). The phenomenon of business cycles must be explained in this context. There are numerous reasons because of which an economy can go through business shocks. One of the main reasons can be due to external shocks. Time consuming and stable mechanism of adjustments arising due to external shocks is likely to create cyclical movements in the process of adjustments. The occurrences of shocks in the economy can generate cyclical movements in output, employment, prices and interest rates, but with variable frequencies and severities. It is not possible for the Federal Reserve to simultaneously promote the goals stable prices, elimination of unemployment, stabilizing rates of interest and maximizing outputs. That is why it is suggested that the Fed must try and pursue maximizing employment along with the coordination of a carefully planned fiscal policy. It can also pursue a policy of attaining lone term rates of interest rather than using its policies to stabilize prices. Fed uses its tools like open market purchases, cuts in reserve requirements, and reduction in discount rates with the view of enhancing supply of money (Ashby, “Monetary Policy - Ease”). This is said to be the proper response to the fall in ASF because of a decline in M x V, which has moved the ASF line leftwards. The policy would be able to restore the line to its original position and hence avoid the fall in output and employment that would have occurred otherwise (Ashby, “Monetary Policy - Ease”). The figure depicts the case in which the growth problems can be curtailed. The problems need an accommodating supply of money increase with the view to sustain employment and output in the economy. In such a state the economy would need more amount of funds for conducting higher level of sales required for maintaining the higher output levels and for the firms which are now required to make more payments for the excess incomes that are earned. This requires the Fed to increase its money supply in order to increase the ASF sufficient enough to attain output growth (GDP) (Ashby, “Monetary Policy - Ease”). This is illustrated in the diagram below. In case of an external shock it is assumed that the economy has been operating at a GDP (say GDP0), which is lower than the previously attained level. This requires the Federal Reserve to introduce monetary policy in order to boost the GDP from its lower position to that of GDP1. This policy would be considered to be effective only as long as the rates of interest can be brought down sufficiently from its original position in order to ensure response from demands which are sensitive to interest rates like business investments. It can be used for boosting the APE to its original levels. However, it must be realized that in case the rates of interests are not very high and the demand is not found to be very responsive to changes in interests then an autonomous fall in APE would create inconsistency problems. The problem can be that the attainable fall in interest levels might not be consistent with the required fall in the interest levels. In such a case fiscal policies in the form of tax cuts and enhanced government purchases would move the APE line rightwards and to an extent such that the GDP line and the IS curve would intersect at an interest level which is attainable (Ashby, “Inconsistency Problem”). Summary of chapter 15 The following figure would depict the concept of balance of payments in nations. It has two components, namely the current account and the capital account. The figure reflects the balance of USA with that of European Union nations which use the euro monetary unit. It is assumed that the Df is larger as compared with Sf, which is reflected through the fact the US has been the most attractive destination for foreign financial investments for the European countries. The high level of Df compared to the Sf has been holding the value of dollar high such that America has been having deficits in their current account with Europe. The balance in current account would cause an impact on the APE level or the total demand for American products. Increase in the global exchange value (€/$) would cause an upward movement along the Sc and Dc lines. An upward movement along line Dc would mean a fall in the American exports and the upward movement along the Sc line would necessarily mean a rise in the imports of the same. Thus rise in the exchange value, i.e. (€/$) would mean a fall in APE. In the same a rise in the above ration would necessarily imply an increase in APE (Ashby, “Balance of Payments”). The value of dollar and euro can fluctuate freely, however there are certain implications on the economy under the pegged system of interest rates. But it is seen that rise in the rates of interest could curtail the fall in the exchange value of the dollar. This rise would automatically make the US an attractive destination for indulging on foreign investments. This would consequently move the line Ds towards the right which depicts the demand of European countries for dollars. The S$ line would consequently move towards the left. The reason being the dollars supply includes those funds which are headed for making financial investments in Europe. Also the interest rise in America would be able to attract those dollars and retain them in the home country. Therefore there must definitely exist a particular degree of increase in US rates of interest which would be sufficient to move the S$ and D$ lines just to the extent which would close the gap or the excess dollar supply, which would otherwise cause depreciation of the dollar. This is shown in the figure above. The particular interest level in the United States, keeps the D$ and the S$ crossing at the pegged rate of exchange. In fact a set of GDP combinations and level of interests are there which would keep the euro price of dollar unchanged at its officially pegged. When these combinations are mapped they form a line which is known as the balance of payments line. On this line the foreign exchange value of dollar remains the same along any point on the line value (Ashby, “Pegged Rates and Domestic Policy”). Reference Ashby, D. B.. Case #4 – Demand-Caused Recession. 2011. Macroeconomic shocks: insufficient demand cases. July 21, 2011. < http://home.teleport.com/~doctorashby/09money12.pdf>. Ashby, D. B. 2009. Classical analysis and policy. July 21, 2011. < http://home.teleport.com/~doctorashby/09money13.pdf>. Ashby, D. B.. Monetary Policy. 2009. Policy interventions. July 21, 2011. < http://home.teleport.com/~doctorashby/09money14.pdf>. Ashby, D. B.. Balance of Payments. 2009. International issues. July 22, 2011. < http://home.teleport.com/~doctorashby/09money15.pdf>. Read More