The Recovery and Investment Plan to Rebuild the American Economy after Recession - Essay Example

Micro – economic essay Inflation is merely an increase in the average level of prices in an economy over a period of time i.e. it is the change in the costs of living. When the general price level goes up, each unit of currency purchases fewer goods and services. Inflation consequently reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy (Peter B. 2003, Shostak, PhD, Frank March 2, 2002). The Boskin commission states that accurate measures in the costs of living are among the most useful and important data necessary to evaluate economic performance. The living cost change between two periods indicates how much income people would have needed in the previous period given the price of goods and services available then. For example if a family with $15,000 income in 2000 would have needed $45,000 in 1999, then the cost of living has dropped by two thirds. The commission argues that the complexity of the dynamicity of the economy should not be reasons to bemoan the difficulties in the construction of an accurate cost of living index. It highlighted sources of possible bias and further suggests improvements to the various official statistics currently used as proxies for changes in the cost of living like the consumer price index that measures the cost of purchasing a fixed market basket of goods and services. The CPI is calculated, while keeping the weights fixed through time, by attempting to measure changes from one month to another in prices of the same or quite closely related goods and services. But this weights would no longer reflect what consumers are actually purchasing because through consumption baskets change in part because of changes in the relative prices of goods and services. Where the purchases are made also do change just like consumers do change their purchases. The current methodology suffers from outlet substitution bias that insufficiently takes into account the shift to discount outlets. This occurs when shifts to lower price outlets are not properly handled. The quality change bias also comes into play when improvements in quality, such as efficiency are measured inaccurately or not at all. Many of the current products are efficient that those from recent years as they are dramatic improvements hence more durable and subject to less need for repair. A better quality product in replacing its counterpart will cost more hence the change in price is due to quality change and not inflation. The same is true with the introduction of a new product. People tend to add the new product and not replace the old with new. There is new product bias in the CPI as to some extent new products is excluded from the basket or are included after a long lag. Substitution bias also occurs because a fixed market basket fails to reflect the fact that consumers substitute relatively less for more expensive goods when relative prices change (Shostak, PhD, Frank March 2, 2002). A fixed – weight measure of output fixes the weights i.e. determines how much output is really worth in terms of other goods in a past benchmark year. Everything we produce today contributes to gross domestic product (GDP) according to what it was worth in that benchmark year, now 2000. Thus if a car costs $20,000 today but costs $15,000 in 2000, then that car contributes $15,000 to real GDP, regardless of its current price. Chain weights, on the other hand, move the benchmark along as we move through history. Under chain weights, a computer in 1995 is worth the average, or chain, of what it costs to buy it in 1994 and 1995. The advantage of the chain-weighting system is that it avoids the rewrites of economic history that come under the benchmark year (fixed-weight) system. They give us; therefore, a number is that is much more likely to be right the first time (Shostak, PhD, Frank March 2, 2002). Kiley and Michael 2008 define unemployment as the condition in which people able and willing to work are actively seeking work but are unable to find any. Since world war II, employment has been a stated goal of many governments and full employment is not synonymous to a zero rate of unemployment since at a given time, the rate of unemployment will include some people who are between jobs and not unemployed in any long – term basis. There are different types of unemployment including structural unemployment, cyclic unemployment, and frictional unemployment. Structural unemployment is that employment arising from the absence of demand for the workforce available. It is as a result of either change in technology (for example the replacement of typewriters by computers resulted in the closure of typewriter factories and the workers in these factories had to seek alternative employment) or change in tastes (for example if bagpipes become unpopular then workers in these factories will be laid off) (Peter B. 2003). Shostak, PhD, Frank, 2002 define frictional unemployment as that unemployment arising naturally in an economy from people moving from one job to another, shifts between careers, and shifts in locations. This kind of unemployment may be as a result of people entering the workforce from school, people re – entering the workforce after raising children, people changing employers may be due to quitting or being fired (for reasons beyond structural ones), changing interests leading to career change, and people relocating to other geographical areas where they end up being unemployed. During recessions, this kind of unemployment tends to reduce as people are afraid of quitting their current jobs given the poor chances of getting another. Cyclic unemployment is the form of unemployment resulting from the unemployment rate moving to the opposite direction as the GDP rate i.e. when GDP is small, unemployment is high. It is defined as workers losing their jobs as a result of business cycle fluctuations in output i.e. the normal up and down movements in the economy as it cycles through booms and recessions over time. Full employment is the acceptable level of unemployment above 0% with the discrepancy resulting from the existence of non – cyclical types of unemployment. Above 0% unemployment is acceptable and necessary for the control of inflation. It’s defined in micro economics as when the economy is employing all of its available resources i.e. capital goods and capital resources are at their highest and most efficient within the economy. Statistics from the Bureau of Labor Statistics show that people with income below the median generally spend at least 100% of their after tax income while those in upper income brackets save substantial portion of their after tax income. The permanent income hypothesis states otherwise i.e. consumers spend an amount that is proportional to their earning no matter the level of income. It means that a person earning $50,000 would spend the same proportion of that income even if the income was $500,000. The hypothesis assumes that the people at the low income have temporarily experienced a decline in their income, usually it is higher. Some may be on temporal unemployment or perhaps they are tired. Similarly, those at the higher income levels are temporarily there as their income is usually lower. Suppose a consuming unit usually earns $10,000 per year then income drops to $7,000 for one year with expectations of recovery in the coming period. Consumption will decline and the unit would borrow in anticipation of the resumption. In case of a permanent reduction, then the consumer will cut on spending and switches will involve a probable move to a less expensive house, now suppose there is a temporal increase in earnings to $15.000 from a bonus reward, spending will increase but it will be foolish to move to a more expensive house if the earnings are expected to get back to normal. Robert and Vittorio, (1994) define marginal propensity to consume as an empirical metric that qualifies induced consumption, the concept that an increase in personal consumption comes into play with an increase in disposable income. It is the proportion of additional income that an individual desire to consume. For example, if a household’s marginal propensity to consume is 0.84 and it earns an extra $1000 then it will spend $840 and save $160. Obviously the household can’t spend more than the available $1,000. Mathematically, marginal propensity to consume is expressed as the derivative of the consumption function with respect to disposable income. Consumption function is a mathematical function developed by Keynes that describes consumer spending. It is further used to calculate total consumption in an economy and is made of autonomous consumption that is not influenced by current income and induced consumption that is influenced by the economy’s income level. Its also known as absolute income hypothesis as it only bases consumption on the current income and ignores potential future income. The American Recovery and Reinvestment plan was a response to the late 2000s recession with a primary objective of saving and creating jobs almost immediately. The secondary objectives were to provide temporary relief programs for those most impacted by the recession and invest in infrastructure, education, health, and green energy. It included direct spending in infrastructure, education, health, and energy, federal tax incentives, and expansion of unemployment benefits and other social welfare provisions (Davey and Monica, 2009). The rationale for the recovery and investment plan was from Keynesian theory that argues that during recession, the government should offset the decrease in private spending with an increase in public spending in order to save jobs and stop further economic deterioration. However, a Keynesian economist Paul Krugman while supporting the law criticized it for being too weak as it did not cover even a third of the spending gap (Krugman, Paul, 2008). The plan is justified enough as the economy is driven by employment hence the creation of jobs is a good incentive to the economy. With infrastructure, jobs will be directly created as there are many roads, bridges, pipes and more that need fixing and building that will require so many workers. Health care costs are meant to be affordable under the plan and it will help the unemployed remain insured while creating jobs at the same time. An improvement in education will keep the teachers in school and help make college more affordable to the Americans. Advancement in technology will help maintain the country’s leadership position in the global economy and be able to compete and recover. References Kiley, Michael J. (2008). "Estimating the common trend rate of inflation for consumer prices and consumer prices excluding food and energy prices" (PDF). Finance and Economic Discussion Series (Federal Reserve Board). Tobin, James, American Economic Review, march (1969), "Inflation and Unemployment" Robert J. Gordon (1988), Macroeconomics: Theory and Policy, 2nd ed., Chap. 22.4, 'Modern theories of inflation'. McGraw-Hill. Shostak, PhD, Frank (March 2, 2002). "Defining Inflation". Mises Institute. Retrieved September 20, 2008. Robert Barro and Vittorio Grillio (1994), European Macroeconomics, Macmillan Publishers. ISBN 03335777647. Read More