Introductory Economics: Principles of Trade and Taxation - Essay Example

 1a. Price elasticity of demand (PED) is the extent to which quantity demanded changes to a change in price (Bamord, Brunskill, Cain, Grant, Munday, Walton 2002). When PED of a good is between 0 and 1 then it is said to have inelastic demand with the good being more inelastic the closer the value is to zero. Hence according to the given study the price elasticity of demand for petrol in the short run as well as in the long run is inelastic because their PED lie between zero and one. 1b. The short run PED is smaller or relatively inelastic than the long run PED because it is often easier to switch between products in the long run than in the short run (Perloff 2003). The reason for PED being elastic in the long run is that consumers may switch to alternate fuel sources such as gasoline or they may use alternate methods to travel other than private transport such as travelling in public buses. Consumers also take time to adjust to price changes (Grant 2000). In the short run if the price of petrol increases consumers will still demand petrol because it takes time to adjust their demand for petrol to a change in its price. 1c. As the PED of petrol is inelastic a rise in price will cause total expenditure on petrol to rise too. When demand is inelastic, price and total expenditure (also total revenue) move in the same direction (Sloman 2007). For example let us assume that the price of petrol rises in the long run from $4 to $5. At $4 total expenditure on petrol was $400 with consumption being 100 liters of petrol at PED of 0.2. Given the PED formula: PED= % change in quantity demanded % change in price At PED of 0.2, given a price of $5 quantity demanded for petrol will fall by 5 liters to 95 liters. The total expenditure after the price increase would be $5*95= $475 (more than $400). Hence this shows that as price is increased total expenditure will also increase if demand is inelastic. 2. Carbon tax is a form of pollution tax. It is levied on the amount of carbon content emitted by fossil fuels. Carbon taxes are used to combat the effects of a negative externality, in the form of pollution, caused by emission of carbon content when fossil fuels are burnt (Dowdey 2007). When imposing a carbon tax, the government decides on a fixed price on one ton of carbon released, a tax is then imposed on the fossil fuels such as coal, petrol, natural gas as well as electricity. Carbon tax has many advantages. The purpose of a carbon tax is to reduce the effect of greenhouse gases by controlling carbon emissions from fossil fuels. The effect of a carbon tax is shown in the following diagram: The diagram shows that levying a carbon tax increases the cost of production. Hence the same quantity of goods is produced at a higher price. The carbon tax shifts the supply curve AS to AS’ by the amount of tax. As can be seen from the diagram the equilibrium point also moves from E to E’. The new equilibrium position is at a higher price and a lower quantity compared to the previous equilibrium position E. Hence the carbon tax is able to control carbon emissions from fossil fuels (as the price of carbon related goods increases less of these goods is demanded and less is consumed leading to a reduction in carbon emission). The tax revenue generated from this can then be used by the government on developing the infrastructure or it may be transferred back to the society in the form of social benefits. A carbon tax makes alternative sources of energy, which are more environmental friendly, such as wind power to be competitive with energy obtained by burning fossil fuels. Hence people find it cheaper to use alternate sources of energy rather than burning fossil fuels. A carbon tax can be quickly implemented by the government without any delay. A carbon tax is easy to understand. The government only needs to decide on a fixed rate per unit of carbon. This can then be converted into kilo watt hours for electricity (Dowdey 2007). Although carbon tax is favored because of its foreseeable nature, there are a number of disadvantages associated to it too. The most important drawback is that it is very hard to decide the optimal level of tax that should be imposed. The level may either be too high or too low. As a result the tax may have to be adjusted many times to before the optimal level is decided upon. A carbon tax has a regressive nature. The burden of a carbon tax falls more heavily on poor consumers than on rich consumers. This is because the rate is fixed a poor person will spend a large portion of income on electricity (pays more tax as a percentage of income) whilst a rich person spends a small proportion of income on electricity (pays less tax as a percentage of income). Even when the tax is levied there is no guarantee that the demand will fall. Demand for electricity is relatively inelastic because it is a necessary service that people consume. As a result it is very unlikely that demand for electricity will fall drastically to an increase in price due to the imposition of a carbon tax. If this happens then the carbon tax does not play its role in reducing carbon emissions. Finally as carbon tax is after all a tax it is not favored by the society as its income is spent in paying the tax. It is also not favored by politicians because imposing the carbon tax may anger their voters meaning a loss of votes in the future elections (Parliamentary Library Web Manager 2010). 3. The one-off payments announced by the Australian government in 2009 were to stimulate demand in the economy that had been severely hit by the global recession. The effect of these five one-off payments was to shift aggregate demand in the economy and increase spending. This can be illustrated by a diagram: The diagram shows that at the initial demand curve (represents the economy in the recession) the equilibrium point E is at a low quantity demanded. This represents that aggregate demand in the economy is low due to the effects of the global recession. The government is trying to raise the demand in the economy by providing one-off payments to the people. The demand curve AD’ represents this situation. With the help of these one-off payments the government is trying to encourage the low and middle income households to spend in the economy. Due to the global recession households have reduced their spending. The Australian government is trying to reverse this situation by stimulating demand. As can be seen from the demand curve AD’ intersects the supply curve AS at E’ which represent a higher consumption level than E. In order to understand the full effect of these one-off payments we must assume that the when the government paid these there was a shift in aggregate demand from AD to AD’. When people start to demand more and the aggregate demand shifts to AD’ firms will need to employ more labor to increase production in order to meet the demand increase. As people will get jobs they will be able to spend more and improve their standard of living. The recession that is prevalent in the economy will be countered and the economy would again start moving up again. 4a. 4b. The short-run equilibrium GDP and price level is obtained where the aggregate demand curve and the aggregate supply curve intersect. The diagram below illustrates: As indicated by the graph the short-run equilibrium real GDP is 500 trillion yen and it occurs at a price of 95 yen. 4c. According to the question Japan has a potential GDP of 600 trillion yen. The short-run equilibrium real GDP however is only 500 trillion yen. Hence there is a difference of 100 trillion yen. This difference is known as the recessionary gap because the potential GDP is higher than the actual short-run equilibrium real GDP. 5. Monetary policy is a tool used by the central bank to accomplish its goal such as low unemployment, economic growth and low inflation rate. Reserve Bank of Australia (RBA) is responsible for implementing the monetary policy in Australia. The goals of RBA include stability of Australian currency, achieving full employment and economic growth. The medium-term target of RBA is to control inflation. RBA tries to keep an inflation rate of 2-3% each year. It is the job of the bank to keep the cash rate fixed or near a specified level. In order to keep the cash rate fixed, RBA makes use of its open market operation to influence the supply of money in the economy. The cash rate has a strong influence on other interest rates. If the monetary policy is changed it will lead to a change in the cash rate that will result in a change in the interest rate structure. The Reserve Bank Board is responsible for making the monetary policy. This Board holds meetings every month except in January. During these meetings there is a discussion on the Australian and international economies and the situation prevailing in financial markets at home and abroad. Based on these discussions a monetary policy is decided upon that best achieves the goals of RBA (About Monetary Policy). a. The last Board meeting was held on 6th September 2011. During the meeting the Board analyzed the financial markets situation in the world and economic growth potential in America and Europe. The unemployment rate was approximately 5% while the inflation was near its 2-3% target. In the meeting it was decided to retain the cash rate at 4.75 percent. The Board also decided to stick with its current monetary policy. b. The last monetary policy change occurred in the Board meeting held on 2nd November 2011. In the meeting it was decided to increase the cash rate from 4.5 to 4.75 percent. The reason provided by the governor of RBA, Glenn Stevens (2010), was: For some time, the Board has held the stance of monetary policy steady, which has resulted in interest rates to borrowers being close to their average of the past decade. This allowed some time to observe the early effects of previous policy changes and to monitor the uncertain global outlook. The Board is also cognisant of differences in the degree of economic strength by industry and by region. However, the economy is now subject to a large expansionary shock from the high terms of trade and has relatively modest amounts of spare capacity. Looking ahead, notwithstanding recent good results on inflation, the risk of inflation rising again over the medium term remains. At today's meeting, the Board concluded that the balance of risks had shifted to the point where an early, modest tightening of monetary policy was prudent. References: Bamford, C., Brunskill, K., Cain, G., Grant, S., Munday, S., Walton, S. (2002). AS Level and A Level Economics. Cambridge, United Kingdom: Cambridge University Press. Dowdey, Sarah. (2007). How Carbon Tax Works. Retrieved from http://science.howstuffworks.com/environmental/green-science/carbon-tax3.htm Grant, S.J. (2000). Stanlake’s Introductory Economics, 7th Edition. Longman. Reviewed by Parliamentary Library Web Manager. (2010). Carbon taxes. Retrieved from http://www.aph.gov.au/library/pubs/climatechange/responses/economic/carbontax.htm Perloff, Jeffrey M. (2003). Microeconomics, 3rd Edition. Berkeley, California: Addison-Wesley. Sloman, John. (2007). Economics, 6th Edition. Pearson Education India. Stevens, Glenn. (2010). Media Release. Retrieved from http://www.rba.gov.au/media-releases/2010/mr-10-26.html Read More