Autonomous Spending Multipliers - Assignment Example

?Econ Assignment- 6 Questions QUESTION a. On the basis of the provided information, the equilibrium value of real income in this economy can be calculated by adding investments, government spending, net exports and consumptions, excluding or subtracting imports. Here, in this case, autonomous consumption expenditures, autonomous investment totals, autonomous government expenditures and autonomous net export expenditures amounted to 5000, 500, 2000 and -600 respectively. Therefore, the equilibrium value of real income in this economy will be [5000+500+2000+(-600)] = 6900. b. The autonomous spending multiplier can be estimated as 6.99, [i.e. 1/(1-0. 0.8571) = 1/0.1429 = 6.99] with the marginal propensity to consume valued as 0.8571 (Economicae, “Autonomous Spending Multipliers”). c. Based on the provided information, the total government expenditures amounted to 2000 and the equilibrium value of real income in this economy has been calculated to be 6900. Thus, the amount of an increase in government spending that would lead to a 1000 increase in real income would be (6900+1000-2000) = 5900. d. The tax rate which needs to change so as to generate a 1000 increase in real income would be [(0.30/6900)*1000] = 0.04 (approximately). In this regard, the simple household income tax rate is 0.30, equilibrium value of real income is 6900 and the increase in real income is expected to be 1000. As household real income and tax rates are identified to be inversely correlated, to generate an additional real income of 1000, the tax rate will be required to be reduced by 0.04, i.e. to 0.26. QUESTION 2 Let’s assume that in the late 1970s, the U.S. economy was operating at potential output with a natural rate of unemployment of 4 percent. In June 1979, OPEC was able to triple the price of crude oil. This led to a (leftward/rightward) ___leftward_____shift of the ___demand____curve. As a result, the aggregate price level (increased/decreased) ___increased____indicating a (fall/rise) ____rise___ in inflation. Additionally, actual output (rose above/fell below) ____fell below___potential output causing unemployment to (fall/rise) ______rise__. This combination of inflation and output is referred to as ______stagflation___. The newly appointed Chair of the Federal Reserve, Paul Volker, responded by decreasing the money supply, resulting in (decrease/increase) __increase_______in interest rates. This led to a (leftward/rightward) ____leftward__ shift of the _____supply_______ curve. As a result, the aggregate price level (increased/decreased) _____increased_____indicating a (fall/rise) ___rise__in inflation and (increase/decrease) _____decrease___in unemployment. In addition, Ronald Regan became president in 1981. His administration cut the tax rate and increased government spending, resulting in new levels of government deficits. This led to a (leftward/rightward) ___rightward___shift of the ___demand___ curve. As a result, the aggregate price level (increased/decreased) __increased____ indicating a (fall/rise) ___rise____ in inflation and unemployment to (fell/rose) ______fell___. QUESTION 3 a. The concepts of ‘off-shoring’ or ‘offshore outsourcing’ is fundamentally related with the shifting of production to any overseas subsidiary by a multinational firm. Moreover, it can also be described as conducting trade in the form of goods and/or services in different foreign nations. With regard to an offshoring model, it can be affirmed that the higher relative wage of skilled labors in the foreign country would eventually result in higher degree of skilled-labor intensiveness in the home country. Similarly, it is to be affirmed that the lower relative wage of high skilled labors in the home country would make skilled-labor intensive related actions less expensive in comparison with the foreign country. Thus, it can be stated that the home country labor market would desire to undertake its different production activities at the lower margin of the value chain for a given product (Chang, “The Economics of Offshoring”). b. It can be apparently observed that a uniform augmentation particularly in the tariff structure along with the tariff level will reduce the quantity of products to be outsourced. It is to be affirmed that the slicing of the value chain would get affected if Home uniformly increases its tariff level along with a considerable increase in the cost of importing all goods or services from abroad. This can be justified with reference to the fact that the slicing of the value chain would reflect the aforesaid aspect as increased cost, resulting in a rightward shift of the demand curve. With this concern, Home would be able to enlarge a set of events to encompass incrementally high valued activities; whereas, the set of high value outsourced activities would shrink. With reference to the provided value-chain diagram, it can be affirmed that the slicing affect of the value chain might impose extensive impact upon different activities conducted by Home while conducting various sorts of offshore production activities. In this similar context, the various activities embrace research and development, component production, assembly and marketing along with sales. c. By using demand diagrams along with relative labor supply that have been portrayed for both Home as well as Foreign countries, depicting the effect of transformation, especially in Home tariffs, certain changes can be viewed towards the relative wage in each country. In this similar concern, it can be apparently observed that an enlargement in the set of production activities performed at Home raises the average skills intensity of Home production. This particular facet is most likely to ultimately enlarge the comparative demand for skilled labor at Home. Likewise, as Foreign tends to conduct lower skill-intensive actions, the average skill intensity of foreign production would decrease. Moreover, the relative stipulation for skillful labor would become quite lower particularly at Foreign. QUESTION 4 As per the illustrated scenario, it can be observed that both the book industry and the table industry are interrelated. The conditions that apply to the context are that the labor is mobile between the two industries; however, the short-run capital is immobile. This further denotes that even if the increase in labor force takes place in one industry, it shall have a considerable effect on the labor market structure of the other industry as producers might intend to shift their liability of increased labor to the other industry, given the fixed or insignificant change in the wage structure of the firm. This can be further explained more comprehensibly with reference to the given illustration of the labor and wage supply curve for the book industry and the table industry. To be noted, the labor and wage supply curve for the book industry can be witnessed to be forward bending which explains that wage and labor, these two factors are inversely related to each other. Therefore, due to immigration, when the percentage of labor in the book industry increases, the wages to be rendered by the producers decreases substantially. To be represented diagrammatically, Correspondingly, due to immigration of laborers, it is quite likely that firms in the book industry will have to experience a substantial leap in the labor force. Assuming that the current labor force stands at L1 and the wage rate stands at W1, the equilibrium can be identified as Lo (L1 W1) on the VMPL curve. As a matter of fact, the firms will always desire to remain on the VMPL curve to maintain its equilibrium position by shifting the wage rates under the given condition that labor forces are mobile and changes in their percentage flow increases are uncontrollable by the firms. Therefore, when the aggregate number of labor increases to Lnew, in order to maintain their profit margin in the VMPL curve, the firms in the book industry will reduce their wage per unit from W1 to Wnew. This will further cause a substantial shift in their equilibrium position. Hence, assuming that variables will remain fixed, the new amount of labor employed, i.e. Lnew, shall replicate a substantial increase. Contextually, as in the book industry, laborers do not enjoy the flexibility to bargain their wage or take the advantage of substitute or incentive effects, as in the case of a backward-bending labor supply curve, the increased number of labor will have to sustain at the minimized wage by the firm, with the objective to maintain its profit margin in the equilibrium position. On the other hand, as the labor supply curve of the table industry can be witnessed as backward-bending, it can be evidently affirmed that the labor force in this industry enjoys greater bargaining power than the laborers in the book industry. In this kind of labor market conditions, workers tend to choose their working hours not being obligated under contractual terms and posses the liberty to decide upon their working hours. Additionally, worker in this kind of industry structure perceive that working for longer hours will reward them with increased wages, while leisure time might increase their opportunity cost of working. Correspondingly, workers are also treated as ‘utility maximizing agents’ in this industry structure, whereby a greater flow of laborers is quite likely to be welcomed by the producers with the expectation that greater participation of workers will result in significant augmentation of their productivity. Under such conditions, the firms are quite likely to keep increasing the wages to a certain extent in order to keep motivating the laborers to render higher working hours. However, after continuous increase in the wage, the laborers shall start reducing their working hours given the substitution effects. For instance, if the labor force increases due to immigration in the table industry, it is quite likely that the firms will absorb the greater number of laborers to enjoy greater productivity, increasing the wage rate simultaneously until the point WX. However, given the prevailing conditions where the labor is also shifted from the book industry to the table industry, as the laborers are mobile, it is likely that the percentage of labor supply will keep rising above the wage rate of WX. Ultimately, the continuous increase in the wage rates, after a period, will in turn affect the intentions of the workers to deliver greater working hours to produce a larger volume of product and attain increased income. This shall further hamper the producers’ interest to increase the production, as the laborers shall decipher reluctance in rendering greater working hour, which is quite likely to motivate the producers to use the mobility of the laborers and shift the excess number of laborers in the book industry. This will lead to differing effects in the short-run and in the long-run. Referring to the above discussed changes to be observed in the labor supply of the table and the book industry, it can be affirmed that the output of books and tables will experience similar changes in their quantity during the short-run. For instance, in order to maintain its profitability, with the increased aggregate wage and the increased labor supply, the book industry will also aim at increasing its output at a larger scale. Illustratively, if the firms witness 1 unit change in their total production cost due to increase in their aggregate wage, the firms will intend to increase their output by above 1 unit. On the other hand, in the short-run, the table industry will enjoy greater participation of the increased labor force due to the substitution effect which in turn will yield greater output quantity. However, in the long-run, where the output of the book industry will keep increasing because of the absence of any substitution effect advantage to the laborers, the output of table industry is likely to decline owing to the minimizing participation of its laborers to work for greater hours at a given percentage of wage. In simple terms, marginal product of capital can be defined as the change in the output witnessed as a result from the change in the capital employed. In the short-run, when considering the structure of the book industry, it can be observed that with the increasing percentage in labor supply due to immigration, the capital employed will also increase substantially. For example, the firms in the book industry employed 20 units of labor at the wage rate of 10 units per labor. With the influence of migration, now the firms need to employ 30 laborers. Again, to maintain its equilibrium position due to the sudden change in immigration trend, the firm reduces the per unit wage to 8, i.e. the minimum wage rate. Even though this shall give a 2 unit cost advantage to the firms at the unitary level, the firms shall yet have to witness a substantial rise in its aggregate wage amounting to around, (30x8) = 240 units. Hence, the amount of capital is likely to increase in the book industry to at least 40 units for employing 10 additional laborers. Correspondingly, to obtain the profit at the fixed margin, the firms will emphasize to produce larger volume of outputs, thus resulting in an increase in the marginal product of capital, but decrease in a return on capital. Unlike the book industry, in the short-run, for the table industry, the marginal product of capital as well as the return on capital shall keep increasing with the increase in output along with the increase in the capital employed in terms of additional wages. However, in the long-run, when the laborers will restrain from rendering greater working hours due to the substitution effects, the firms in the table industry will have to experience a decline in their marginal product of capital as well as return on capital. For instance, assuming that with the wage rate increasing above the level of WX, to 40 units, 25 laborers start reducing their working hour and produce only 200 units, indicating a decline in the aggregate output by 20 units. Therefore, the additional wage or capital cost to be incurred by the table producers will be (40x25) = 1000 units, but the producers will have to sacrifice 20 units of their aggregate output. QUESTION 5 a. Source: (University of Washington, “Analysis of Tariffs and Other Barriers to Free Trade) The provided information, in the above graph, reveals the data about US motorcycle market and represents the effect of tariff on free trade. In this regard, it can be apparently observed that tariffs render a significant revenue source for the governments. A few of the nations in this entire world regard tariff as a sort of “strategic trade policy” impacting their economy by a greater level. The impact can be observed in terms of developing the financial conditions of the nations, enhancing the economy and most vitally, in augmenting free trade activities. The above portrayed graphical representation depicts several imperative aspects. These aspects encompass free trade relative price, domestic relative price after tariff and level of welfare in free trade. By taking into concern or representing free-market and tariff, the green colored line depicts free-trade equilibrium and the black colored line portrays tariff equilibrium in terms of consumption, production, imports as well as domestic and world prices (University of Washington, “Analysis of Tariffs and Other Barriers to Free Trade). b. Based on the provided information and the above portrayed diagram, the US can be regarded as a large economy in this market, because the worldwide price of a motorcycle is quite lower as compared to the US price of a motorcycle. This ultimately supports the US to gain much profit in terms of selling motorcycles to the customers resulting in making the US a large economy. In order to calculate the loss of consumer surplus as well as gains in producer tariff, two aspects. In this regard, the aspects comprise tariff and free trade impacting the world price of a motorcycle. According to the provided information, the loss of consumer surplus due to the tariff can be estimated as ($2000-$2500) = $ -500. On the other hand, the gain in producer surplus due to the tariff can be estimated as ($2500-$2000) = $500. Specifically mentioning, the tariff revenue accruing to the US government, can be estimated by taking into concern the motorcycles bought and made in the US. In this similar concern, 50,000 and 25,000 motorcycles have been bought and made in the US. The tariffs based upon these motorcycles [i.e. (50,000+25,000) = 75,000 motorcycles] can be accrued by the US government from the tariff. In order to estimate the tariff which is forward shifted on to the US economy, it can be viewed from the provided information that the global price of a motorcycle decreases with the imposition of tariff. Thus, based on this ground, it can be affirmed that as the global price is decreased, the entire tariff would be backward shifted on to foreign producers. On the other hand, it can also be stated that no such tariff is forward shifted on to the US consumers owing to the reason that the worldwide price of a motorcycle lessened due to tariff imposition (Routledge, Taylor & Francis Group, “Global Economic Issues and Policies”). Consequentially, it can be affirmed that the net welfare of the US would witness a net gain in terms of consumption, production, imports, domestic and world prices by a considerable level. Works Cited Chang, Winston W. The Economics of Offshoring. Outsourcing and Offshoring, 2012. Web. 03 Jul. 2013. < http://faculty.washington.edu/karyiu/confer/sea12/papers/Chang_w.pdf>. Economicae. Autonomous Spending Multipliers. Econ, 2008. Web. 03 Jul. 2013. . Routledge, Taylor & Francis Group. Global Economic Issues and Policies. Study Guides, 2013. Web. 04 Jul. . University of Washington. Analysis of Tariffs and Other Barriers to Free Trade. User, n.d. Web. 04 Jul. 2013. . Read More