Econ Chapters Review - Assignment Example

CHAPTER 7 Aggregate demand for funding (ADF) represents the demand for funds in an economy that will be able to purchase the GDP. Whenever AggregatePlanned Expenditures (APE) is equal to GDP, the Aggregate Supply of Funding (ASF) will represent the ADF. As there is a mismatch between APE and GDP; for instance if APE is less than the GDP level, the producers will need an additional amount of funding to sustain their operations and ADF exceeds the level of APE due to producer’s demand being unfulfilled. Thus it can be deduced that ADF is always the larger of APE or GDP. If there is a disparity between the level of APE, GDP and ADF, then an automatic macroeconomic coordination process gets under the way by bridging the gap between the levels of those variables. When ASF and ADF become unequal, macroeconomic stabilizers will maintain the equilibrium level through the process called funding adjustment. Similarly if there is an imbalance in GDP and APE, producers of goods and services will make output-price adjustment that closes the gap between GDP and APE. To understand the notion of funding adjustment, we first need to divide the domestic consumers into three groups. In the first group, we include individuals who have sufficient money balances to cover for their planned expenditures. The second group comprises of individuals who have insufficient balance to cover for their planned expenditures. The final group of individuals includes individuals who have more than sufficient balance to cover for their planned expenditures. The second group can finance their purchases through either borrowing or reducing their GDP purchases. The third group can utilize their excess funds by lending them and earning a profit or either increasing their planned expenditures. In an economic scenario where ASF equals ADF, the second and third group will not be cognizant of the economic imbalance; however, they will be aware of their individual funding situations. The amount that the second group is willing to borrow exactly equals the amount that the third group is willing to lend through their excess funds. Hence this process will not impact the level of interest rates in the economy. In the case if ADF exceeds ASF, the second group will fulfill their funds demand by borrowing and the third group will lend their excess funds. The financial intermediaries such as banks and financial institutions will play a central role by taking the funds from third group and lending them to the second group. Since the funds available in the hand of the third group are lesser than the fund demanded by the second group, the financial institutions will raise the interest rates which will attract more individuals from the third group. As the level of interest rates rise, ASF increases whereas APE and ADF fall below their original levels. They will meet at a point where ASF equals ADF thus bringing the economy into equilibrium. CHAPTER 8 Generally, the firms have a U-shaped average cost curve which implies that the average cost falls when we increase the quantity at low levels of output and they start to increase at higher level of outputs due to managerial inefficiency. The firms marginal cost curve shows the additional cost a firm incurs to produce one more unit of output. The marginal cost is lesser than the average cost when the average cost curve is falling whereas when marginal cost is greater than average cost, the curve starts to increase. The whole process is illustrated in the figure below: Figure 1: Average and Marginal Cost Curves The optimal condition of output occurs at the level of the output where Marginal Revenue (MR) equals Marginal Cost (MC) and as a result of which the firm generates a positive economic profit. The existence of economic profits in the industry will attract new firms to join the industry and avail the opportunity of earning profit. As the number of firms in the industry increases, the individual demand curve of the firm shifts to the left resulting in zero economic profit which thus prevents new firms to enter into the industry. If Demand Increases: If the demand of the firm increases, it will experience a rightward shift in its Average Revenue (which is the demand curve) and MR Curve. As the MR curve shifts to the right, there is an insufficient optimal level of output produced by the firm therefore it increases its output to a level where new MR and MC intersect together and hence we see an increase in output and price levels. This process generates positive economic profits for the firms in the industry. The whole process is portrayed in the figure below: Figure 2: An increase in demand The positive economic profits in the industry will eventually attract new firms and the industry will expand until the AR and MR lines are pushed back to their original positions. The larger number of firms in the industry increases the output and prices are shifted back to their original level. If Costs Decrease The firm can enjoy cost reductions due to increased labor productivity and technological advances. As a result of this, the Average Cost Curve falls down significantly and the level of output where MC and MR curve intersect shifts to the right. Moreover, the firms will now reap greater level of economic profits due to cost advantages. This again attracts the new firms to enter into the industry and shifts the AR and MR curve to the left direction. The new AR curve will intersect the new AC curve thus indicating a decline in prices and a total increase in industry output although the individual outputs have remained constant. CHAPTER 9 The domestic producers of output can generally be classified into three categories. Let’s assume, Group A composes of firms which have sales equal to their current production. Group B comprises of firms with excess demand (sales exceeding the level of current production). Group C will be facing an insufficient demand for their output (Current level of production greater than sales). This division of firms in the industry can better assist us in comprehending the output-price adjustment at macro level. Consider the scenario when the economy is operating at a level where GDP = APE = ASF. As we learned in the previous chapter that the firms which are operating with excess demand will respond by raising product prices and the output levels. Similarly, Group C with insufficient demand will reduce their product prices and output level. We know that the final impact of an excess demand is an increase in output whereas the insufficient demand results in a decreased output. When APE = GDP, the insufficient demand faced by Group C will exactly equal the excess demand faced by Group B. In such a condition, we can expect that impact stemming from Group C will exactly offset the impact produced by Group B. Furthermore, as there is no change in total output (GDP) and Price Level, ADF and ASF will remain the same thus there will be no pressure on interest rates to get altered. The second scenario can be thought of when GDP < APE = ASF. Under such circumstances, producers are facing a fully funded demand as APE = ASF whereas this is greater than the aggregate level of output (GDP). Since APE is greater than GDP, there is a net excess demand. The Group B will respond by increasing the output level with an increased price to meet the excess demand. On the other hand, Group C will counter by decreasing the price level and reducing the output. However, the net impact of Group B will be higher than the Group C since there is an excess demand in the economy. Hence we will observe a net increase in output (GDP) and price level. The increase in price level will impair the level of ASF which in turn leads to rising interest rates. In addition to that, the level of APE also gets affected by interest rates as consumers who were borrowing to finance their planned expenditures will curb their consumption thus we see a decline in APE until it matches the level of GDP. CHAPTER 10 Macroeconomic shock refers to the unexpected change in one of the significant variables than have profound influence on the dynamics of the economy. The excess demand cases or macroeconomic shocks pertaining to that involve either an increase in APE, an increase in ASF or a decrease in GDP. All these shocks feature a common characteristic that is all three will have a funding demand that will exceed the aggregate output (GDP) of the economy (GDP < APE = ASF). A demand caused expansion results when the level of APE rises dramatically. This unexpected increase in demand might emanate from domestic sources which include households, businesses or government or it might increase due to foreign investment. The fiscal policy can also stimulate the level of APE when the government plans to increase its expenditures. The economy proceeds into a position where GDP = ASF < APE. The funding problem becomes apparent in the economy thus causing the interest rates to rise. When the interest rates rise, the APE falls and ASF rise until the level of APE becomes equal to ASF. Now the economy has moved to a situation where GDP < APE = ASF or it can be said that there are too many dollars chasing too few goods. As learned in the previous chapter that the producers will respond by increasing the level of output and prices which leads to an increase in interest rates. This phenomenon as a result bridges the gap between these variables and the economy moves to a condition where GDP = APE = ASF. In addition to that, the inflated price level also restore to their original level since positive economic profits will attract the entry of new firms and thus will cause the price level to decrease. The economy has now moved to an equilibrium condition where interest rates, employment level and output have increased and price levels have remained unchanged. Read More