The Global Economy - Essay Example

Explain how the unemployment figure is derived. What limitations are associated with this measure as an indicator for the level of unemployment? Based on the process undertaken by the Bureau of Labour and Statistics (BLS) (2006), the first stage is to classify individuals into three categories: employed, unemployed, and out of the labour force. For an individual to belong in a certain category, criteria have to be satisfied. It is imperative, therefore, for the agency to acquire all necessary details pertaining to all individuals included in the data extraction. After determining the number of individuals per category, the unemployment rate can be computed. Basically, the unemployment rate is treated as the ratio of the individuals unemployed over the number of individuals classified in the labour force. It has to be noted that the students and other individuals out of the labour force are excluded from the computation. According to the BLS (2006) there are several constraints that affect the accurate computation of unemployment rate. The agency cited four important considerations that can affect the outcome of such calculation. First, the computation for the unemployment rate is manifested through surveys. Personnel from the BLS queries individuals on their employment status through guidelines presented in the survey. The truthfulness of the gathered data is a concern because some individuals tend to provide false information. Second, the presence of underemployed individuals is an important aspect. Definitely, underemployed individuals can be classified as both employed and unemployed. It is important though to correctly classify their contribution to the employment rate. Third, unprecedented economic events affect unemployment rate. It is critical to identify the different economic circumstances that can instantly change the rate of unemployment. Finally, the instruments used by BLS have to be updated and conform to the new standard that ensures accurate computations. Time changes the situation and logically affects the method in which calculation for the unemployment rate is approached. Indeed, changes in the environment, specifically, the approaches used in computing for such information have to be greatly considered. Using an AD/AS diagram, explain why a low unemployment level may present a threat to inflation. Are there other constraints in the economy that could add to inflationary pressures? Explain. Aggregate Demand Aggregate Supply Diagram Inflation Aggregate Demand 5% 3% Aggregate Supply According to McTaggart (2003) aggregate supply is defined as the total supply of goods and services by a national economy in a certain figure of time. On the other hand, aggregate demand is the total demand of national economy for a certain period of time. Basic Economics suggests that the increase in price will directly affect supply and adversely affect demand. Thus, in the AD and AS diagram, AD follows a negative scope and AS illustrates a positive slope. All economic activities affect both AS and AD. This reality is important to understand before appraising the effects of all economic circumstances in other aspects. For the government, having low unemployment rate is a primary goal. Definitely, it is important for all individuals to have quality employment and for those not in the labour force to have ample opportunities to be employed. As the unemployment decreases, it is expected that most households have income. This results to higher demands and will eventually increase AD. The increase in AD generally improves the Gross Domestic Product (GDP) since household consumption will also increase. Also, the income of the government is boosted because taxes in income will increase in the same manner as the taxes imposed on goods and services. In contrast, it has been noted that the decrease in the unemployment rate will have an effect to inflation. Inflation is defined as the increase in general prices as measured with the baseline of purchasing power. Usually, inflation is caused by the supply of money and the demand power of consumers. Keynes presented as better interpretation in which inflation is caused by low unemployment. The term is called demand pull inflation which is attributed to the low unemployment rate and increase in demand. It was explained that as unemployment decreases, the number of households with potential spending power increases. This will ultimately increase the demand for goods as the availability of money expands. Given that the supply remains the same, the increase in demand will allow suppliers to increase prices creating a bidding process instead of a natural exchange. Although low unemployment is a good indicator, its adverse effect to prices of goods and services is established. The presence of unemployment balances the economy and allows that purchase to be done based on the prevailing market prices. Using a money market diagram, show and explain what action the Reserve Bank of Australia (RBA) may take to curb any inflationary threat. Money Market Diagram Inflation Interest Rate 4% 2% Money Supply The Reserve Bank of Australia (RBA) is the country’s central bank and primarily functions to: stabilise the currency of Australia; maintain full employment in Australia; and sustain economic prosperity and welfare of the Australians. In practice RBA focuses on the primary objective, which is to control inflation through monetary policy. The current objective is a policy of inflation targeting aimed at maintaining the annual inflation rate at between 2-3%, on average, over the cycle. Basically, RBA has the capacity to influence the level of inflation through different policies and activities. Increasing the interest rates raises the costs of borrowing for consumers and businesses. This action tends to curb demand and ultimately bring down rising inflation and keep inflation from rising further. When supply exceeds demand, producers can lose the power to raise prices and maintain profitable prices for their goods and services, causing deflation. This can provide adverse effects to the economy. Lowering interest rates can encourage consumers and businesses to borrow money that can be invested in some industries. The presence of several players in the markets boosts supply and will relatively and several companies will eventually drive down the prices of goods and services because of inflation. RBA sets the overnight bank lending rate, which serve as basis for the rate banks charge each other to borrow money for one night. That rate does not directly affect the rate of borrowing for consumers or businesses. The rate, however, serves as a benchmark or a standard that affects borrowing costs in the entire economy. Other rates normally follow the direction of the overnight lending rate. For instance, after RBA implements rate hike, credit card rates and mortgage rates will definitely rise even though the central bank does not directly affect those rates. Using appropriate diagrams show and explain the impact of the RBAs action on the level of expenditure, real GDP and the price level in the economy. The fiscal strategy formulated by RBA is designed to stabilise the economy. Primarily, the economy revolves around money and spending. Fiscal strategies determine the supply of money that is needed to be circulated in the economy. Once the equilibrium of money level is ascertained, RBA can create mechanisms to inflation tendencies. In addition, RBA promotes the equity in the level of spending among economic entities. Part of the goal of RBA’s strategies is the improvement in the purchasing power of economic entities without raising the prices in the market. RBA has to ensure that the level of exchange rate is controlled. Specifically, improving the exchange rate will increase the purchasing power of importers and also local consumers. Also, decreasing the exchange invites investors because cost of operation will decrease. These strategies are crucial because Australia needs the participation of the global economy. RBA needs to identify the right decision when it comes to the exchange rate. It is imperative to maintain ample penetration of foreign investments and also develop the spending power of local consumers and importers. Finally, RBA needs to control the interest rate because it helps determine the correct GDP. Real GDP is dependent on the prevailing price in the market. Realistically, interest rates affect the price of goods and services in the market. It is possible that RBA provides a ceiling and floor for interest rates to ensure that the changes in prices will be accurately covered by the GDP. Aside from the GDP, controlling interest rates can boost borrowing and improves spending. References Australian Bureau of Statistics. (2006). “Unemployment rate.” Date retrieved: 25 September 2006, from: McTaggart et al. (2003). Economics. Sydney, Australia: Pearson Higher Education. Mishkin, F. (1995). The Economics of Money, Banking, and Financial Markets. New York: Harper Collins Reserve Bank of Australia. (2006) “Goals and objectives.” Date retrieved: 25 September 2006, from: Read More