Macro and Microeconomics Issues - Essay Example

Macro and Microeconomics Issues Reduction in production of oranges and proposal for increase in ethanol production Reduction in production of oranges will increase the price of orange in the market. In an economy goods can be substitute for each other in consumption. Therefore, other fruits could be substituted for oranges in the daily consumption of people. It is like Pepsi as a substitute for Coke or vice versa. The consumer would go for Coke or Pepsi whichever is available in the absence of other one. A study by Kumar et al (2011, p.1) revealed “the estimated income elasticities vary across income classes and are lowest for cereals group and highest for horticultural and livestock products. The analysis of price and income effects based on the estimated demand system has suggested that with increase in food price inflation, the demand for staple food (rice, wheat and sugar) may not be affected adversely but, that of high-value food commodities is likely to be affected negatively.” The increase in price of orange due to supply constraints would lead to increase in prices of other fruits in general. Poor people tend to spend more on bread, a staple food item in spite of price increase by reducing their consumption of other food which cost more. This phenomenon is called as ‘Giffen’s Paradox’. Giffen’s paradox is not applicable in the case of orange, as it is not a staple food in poor households. Demand for orange cannot be considered inelastic. Silberberg and Walker(687) observe “When the price of the Giffen good changes, therefore, not only does the income term outweigh the substitution term for the Giffen good, but a similar result is produced for the cross effect on the other commodity.” Therefore, increase in price of orange will lead to increase in price of other fruits like grapes or apples due to substitution effect. The increase in price or orange induces farmers to increase area under crop for oranges which is expected to increase the production of oranges to the normal level of demand in economy. However, when the farmers have other alternative of producing corn or other grasses, may be at a lesser cost of production for manufacture of ethanol, the scenario with regard to supply pattern changes drastically. President George W. Bush called for the United States to reduce its gasoline consumption by 20% in the next decade. Considering the growth rates in consumption of gasoline, reduction in consumption of gasoline is very difficult. He proposed an increase in ethanol produced from corn and the stalks and leaves from corn and other grasses. Therefore, the proposal of ethanol production is to compensate the reduction in gasoline consumption by 20% and expected growth in consumption of gasoline. Cassman and Liska (18) stated, “a convergence of valuation between petroleum and agricultural commodities such that food prices are likely to rise substantially. While countries with adequate resources to support an expansion of biofuel crop production will benefit from this convergence, developing countries and regions that consistently experience food shortages or rely on food imports will face greater food insecurity.” This means ethanol is going to be an important element in energy policy of the government in future. This may lead to cultivation of corn and other grasses in the areas which were hitherto used for cultivation of food crops. This implies that chances for stepping up production of oranges or other food crops are diminishing in the long run. The position could reverse only when the prices of food products sufficiently increase for the farmer to stop increasing cultivation of crops for ethanol production. Trostle (13) points out “Global consumption of aggregate grains and oil seeds exceeded production in 7 of the 8 years since 2000…And since 1999, the global stocks-to-use ratio for the aggregate of grains and oil seeds declined from about 30% to less than 15 currently – the lowest level on record since 1970.” The increase in food prices will affect the economically weaker sections of the society greatly. This will also make export of food products to other countries difficult, because the American food production in overseas markets may lose their competitive edge in terms of price. Food security in the nation would be severely affected due to increase in ethanol production. Increase in population in the developing countries forces the nations to increase production of food. On the other hand, increasing demand for energy in these countries will make them sooner or later to revisit their policy on ethanol. The conflicting demand for use of land could force the nations to formulate strategies for using waste lands for agricultural purposes. The United States should embark on national level program for effective utilization of the lands available in the country effectively for productive purposes for a sustainable growth and food security to the nation. Buying vast tracts of lands in underdeveloped Asian and African countries for converting waste lands into agricultural lands by the American corporations would increase employment potential of the local people and ensure food security for the world as a whole. Apart from increase in food production, this would also prevent soil erosion in the planet which is a major threat for environment, since rains and floods could drain soil and silt into oceans which make the lands unsuitable for agriculture over a period of time. In the long run, the country can’t afford to use fertile lands more suitable for producing food and horticultural products for the purpose of producing ethanol oriented crops. This will also severely affect animal husbandry, the growth of which is complementary to agricultural growth. Therefore, realistic policies for earmarking the available land for suitably allocating them for food and energy needs of the country would ensure sustainability of economic growth and food security in the nation. Why is frictional unemployment important to have in any economy? The time lag between unemployment and job in an individual’s career marked by ‘searching for a job’ or transitions phase involved in change of jobs, called as frictional unemployment is very critical. When a company is searching for right person to a job, simultaneously several right persons might be searing for a similar job. This mismatch is caused by multifarious factors ranging from location, work-life imbalance, lack of proper dissemination of information and communication gap. Frictional unemployment is a source of concern to the workers, companies as well as economy in a larger perspective. When the demand and supply situation in a country is unfavorable to the employers they would prefer to make compromise and give training to the available personnel rather than spending time and resources in search of ‘ideal match’, to avoid production loss. On the other hand Gronau (290) stated “Since the length of service is directly related to the level of unemployment, one would expect wage demands (and hence the change in general wage rate) and unemployment to be inversely related.” If the pace of economic growth is robust, the increase in demand mitigates the effects of frictional unemployment in general. Development of transferable skills by a person could ensure transfers within the same company to other departments or make change of job easier. Diversity in work place is an important factor which could reduce frictional unemployment if the workers are trained to understand the cultural and social background of the coworkers and respect their sentiments. Counseling facilities provided to the workers by the employment or government agencies need to be utilized effectively by the people under the spell of frictional unemployment. Uniformity in dissemination of information with regard to the jobs available, the attributes necessary and the experience required in relation to them is very important for proper understanding in identifying the appropriate opportunities without any difficulty. Though the standardization could not be achieved completely in this respect in view of multiplicity of disciplines, grades and specialization, common parameters relating to jobs in a particular category acceptable to most of the employers or industry associations and understandable by majority of the workers would improve the situation considerably. In most of the cases relocation choices are not fully explored both by the employers or employees to the disadvantage of both. Moving cost to the employee and recruitment and training cost to the employer play an important role in making strategic management decisions. If the views of the employer and employee converge in this respect, solution could be reached easily. Diamond (798) stated “The rate at which workers are offered jobs with different moving costs depends on the decisions of other workers as to which jobs to refuse.” If the procedure for exploring relocation options and possibilities is formalized within the organization it will mitigate the hardships to the employers and employees. Providing assistance to the employees in overcoming their personal difficulties would go a long way in cementing the employer-employee relationship for a sustainable growth in the long run. For example, if the source of frictional unemployment is transfer of one’s spouse working in different company, the company can explore the possibilities of providing employment to spouse to avoid labor turnover due to this reason. Alternatively, the worker could be transferred to a branch which is nearer to the spouse’s place of employment. Providing facilities to the workers for recreation, sports and encouraging family functions by the management would enhance their sense of belonging and increase their productivity. Recognition of their talents in various spheres encourages them to pursue their activities close to their heart. This will also increase their job satisfaction. Frictional employment is therefore a welcome feature in an economy which improves flexibility in employment and underlines the importance of employer employee relationship both of which are essential for economic growth. Why hyperinflation has such a devastating impact on economies Inflation is a double edged sword. Mild inflation is a feature of economic growth. Monetary policies of central bank of a country aim at taming inflation through adjustment in bank rate and supply of money without impairing growth process. When economy is overheated the fiscal and monetary policies aims to regulate the pace of economic growth to keep inflation under control. Rapid pace of economic growth results in higher level of employment generation. Increase in the rate of this growth leads to increased consumption resulting in more demand for products. The need for increasing supply of goods in tune with rising demand causes investments in establishment of new manufacturing facilities by private enterprises which increase opportunities for further employment in economy. This is facilitated by mobilization of savings in the system. The multiplier effect caused in this process needs to be regulated for a sustainable economic growth. The fiscal policies of a government aim at balancing growth and inflation through taxation and government spending. However, for a government to intervene effectively in the economic process in a situation of economic slowdown, accumulated fiscal deficit needs to be at lower level with debt to GDP ratio and balance of payments position comfortable. Huge accumulated fiscal deficit, higher rates of interest and precarious balance of payments position with very high debt to GDP ratio are the important constraints which will affect the efficacy of fiscal management by the government. Increase in the interest rates further under such situation will not be effective to achieve the intended results of the central bank also. On the other hand this might be ineffective in curtailing inflations which arise due to several factors such as supply side constraints, natural disasters or energy crisis due to international oil prices. On the other hand, the monetary measures could be counter-productive by affecting economic growth of the country and lead to stagflation, a situation where inflation co-exists with stagnation. The purchasing power parity of the currency will be severely affected which makes imports costlier. In addition to the other factors, if a country depends predominantly upon imports for its energy sources it will add fuel to inflation and result in hyperinflation. Clarida and Gertler (363) observed “By taking preemptive steps to avoid high inflation, a central bank can reduce the likelihood of having to engineer a costly disinflation. Second, a central bank that establishes a clear commitment to controlling inflation may be able to maintain low inflation for far less cost than if it did not have this reputation.” Increase in money supply and reduction interest rate to avoid recession and stimulate economic growth could lead to mismatch of money available in the system and output in economy. This will lead to cost overrun in government projects requiring further creation of money which increases velocity of money. When a government resorts to printing money as an easier option to borrowing or taxation, this could result into crisis with the people losing confidence on currency and buying goods for future use by paying higher prices since money as a store of value is significantly undermined. Due to deterioration of monetary base, hyper inflationary situation takes a very long time for the economy to cool down and bottom out. Bernholz (10) stated “from the historical evidence presented that the long-term tendency of currencies towards inflation depends mainly on the monetary regime or constitution.” Hyperinflation is very complex in nature with several factors relating to economy and international phenomena at interplay makes it more unpredictable and hazardous. Since savings loses its worth very fast hoarding of assets by people increases the prices of the real assets further. Fixed and flexible exchange rates Exchange rate refers to value of one currency relative to another. The price of a currency in relation to another currency could be determined either by fixed exchange rate or floating exchange rate basis. During the era of gold standard, currencies were pegged to gold. In a fixed exchange rate mechanism, the prices of currencies are generally pegged to US Dollar and the implication is that the rise and fall of the currencies is linked to rise and fall of US Dollar. The Central bank of the country regulates the movement of exchange rate in tune with the movement of US Dollar by buying and selling the country’s currency through market operations. The official exchange rate could be revised by way of devaluation or revaluation depending upon the economic conditions and the availability of foreign exchange reserves. Adoption of fixed exchange rate ensures stability in value of the currencies in the international trade. Stability in exchange rate is important for keeping inflation under control within the country. The element of fluctuations in the value of currency is not in the control of the businesses and industries volatility in exchange rate increases risks and leads to uncertainties in business. The competitiveness of the country’s exports in the international markets increases when the local currency remains undervalued in relation to US Dollar. Maintenance of fixed exchange rate involves imposition of several restrictions on foreign exchange transactions by the government. This will lead to black market operations in foreign exchange. The question of devaluation of the peg would create panicky situation in the foreign exchange markets. There are several advantages attached to the system of fixed exchange rate. However, in the long run it is very difficult for a Central bank to manage the system. Floating exchange rate is determined by demand and supply conditions prevailing in the markets for the currencies. Most of the developed countries and developing nations are adopting floating exchange rates. Without intervention by the central bank, the exchange rate in the market is determined based on the demand and supply situation in the foreign exchange markets. Self-correction mechanism is inbuilt in the system, and it takes place automatically under floating exchange rate mechanism. For example when US Dollar becomes stronger against the local currency, the imports becomes costlier and the local goods are substituted for imported goods which in turn reduces the demand for US Dollar. Increase in demand increases employment and output locally. According to Devereux and Engel (2), “floating rates may do a better job of stabilizing output than fixed exchange rates but still may not be optimal. For one thing output may be stabilized by flexible rates but consumption may be destabilized. But, a further important feature of the model is that the choice of exchange rate system may actually influence the average levels of consumption and output, not just their variances” In the flexible exchange rate system, the central bank of a country does not intervene in the market operations on a continuous basis. Nevertheless, it intervenes under exceptional circumstances to ensure stability in the markets and avoid inflationary pressures in economy. International Economics observed “the exchange rate of Mexican Peso depreciated continuously. At the end of 1991, the Controlled Rate and Super Free Market Rate were unified into Official Rate while the Controlled Exchange Market was eliminated. Started from the end of 1994, a floating rate policy was maintained by the government, with BOM intervening in the foreign exchange market under exceptional circumstances to minimize volatility and ensure an orderly market.” This relieves pressure on the part of the central bank on day-to-day basis which increases efficiency in its monetary control operations. References Bernholz, Peter, Monetary Regimes and Inflation: History, Economic and Political Relationships, Edward Edgar Publishing Limited, Massachusetts, 2003. Cassman, Kenneth, G. and Liska, Adam, J. “Food and fuel for all: realistic or foolish?” Biofuels, Bioproducts and Biorefining, Vol. 1, Iss: 1, pp. 18-23, 23 September 2007. Devereux, Michael, B. and Engel, Charles. “Fixed vs. Floating Exchange Rates: How Price Setting affects the Optimal Choice of Exchange-rate Regime.” Working Paper 6867, National Bureau of Economic Research, Cambridge, December 1998. Web. Clarida, Richard, H. and Gertler, Mark. How the Bundesbank Conducts Monetary Policy, Ed. Romer, Christiana, D. and Romer, David, H. Reducing Inflation: Motivation and Strategy, University of Chicago Press, 1997, pp. 363-412. Diamond, Peter, A. “Mobility Costs, Frictional Unemployment, and Efficiency.” Journal of Political Economy, Vol.69, No. 4, August 1981. Gronau, Reuben. “Information and Frictional Unemployment.” The American Economic Review, Vol.61, No.3, June, 1971. International Economics. “Historial Exchange Rate Regime of Asian Countries.” The Chinese University of Hong Kong, 2000. Web. Kumar, P, Kumar, A, Parappurathu, S & Raju SS, 2011, “Estimation of Demand Elasticity for Food Commodities in India.” Agricultural Economics Research Review, Vol. 24 January-June 2011 pp 1-14, Web. Silberberg, Eugene and Walker, Donald, A. “Modern Analysis of Giffen’s Paradox.” International Economic Review, Vol. 25, No. 3, October, 1984. Trostle, Ronald. Global Agricultural Supply and Demand: Factors Contributing to the Recent Increase in Food Commodity Prices. A report from the Economic Research Service. United States Department of Agriculture, 2008. Diane Publishing Co. Read More