Income and Output Are Identical - Assignment Example

INTRODUCTION TO MACROECONOMICS According to the fundamental identity of national income accounting, income and output are identical. Why, then, is national income not equal to GDP? (topic: Measuring GDP) In measuring the gross domestic product in a country, emphasis is often placed on the total amounts of goods produced within a country. Production activities in a country are often facilitated by domestic and international investors (Gottheil 2008, p. 21). They general output, when compiled is what becomes the gross domestic product of a country. On the other hand, national income is calculated as a summation of all the incomes generated by the nationals of a country irrespective of whether their production activities are within a country or in another country. It is always expected that when citizens of a country invest outside a country, they can repatriate the profits accrued from these investments back to their countries. In this perspective, it becomes evident that in as much as a country can have a higher recording of its gross domestic product, it may not be reflected on the national income; this is because, some of the people that take part in the production activities are experts and investors from other countries, who later repatriates the products accrued back to their countries (Gottheil, F. 2008, p. 56), something that is responsible for the differences in the levels and amounts of national income and gross domestic product in a country. 2. The IS model implies that a dollar of government spending has a larger impact on equilibrium output than does a dollar of taxes. Explain. (topic: the IS relation) Government expenditure refers to the process by which a government creates money to spend on projects that are meant for public consumption. During expansionary monetary policies, the movement often find itself with increased money supply that it invests on these projects. This process is important because it tends to reduce the rate of unemployment in a country, which is an undesirable macroeconomic issue. From the above argument, it becomes evident that the dollar for government spending is of greater importance compared to the dollar of taxes, which tends to moderate on the level of economic activities happening in a country including the activities defined in government expenditure. In government expenditure, the dollar is essential in determining the amounts of inputs that can be purchased towards the production of goods and services. On the other hand, the dollar of taxes regulates the amounts of goods and services being purchased in a country such that to increase the amount of consumptions, the taxes tend to reduce. In such a move, people, often find themselves with increase money incomes. however, the dollar for government spending remains to have a great impact on the level and amount of government spending compared to the dollar of taxes. 3. Assume that the economy is in equilibrium when the interest rate rises. Explain, step-by-step, how the components of expenditure adjust to bring the economy to its new equilibrium. (Topic: the IS relation) Rising interest rates in an economy are aimed at correcting some of the economic challenges that could affect the economy in various unexpected ways. Some of them include in increase in inflation rates, which are always undesirable in all economies across the world. With an increase in money supply in the economy, one of the things that happen in order to restore the economy to its new equilibrium is a decrease in people’s expenditure. Many people and businesses always shrink from taking business loans because they tend to have minimal returns. In such a move, the decreased money supply forces households and businesses to shrink their particular expenditures to a point where the economy begins to realize the need to encourage the need for people to participate in business activities. 4. If taxes are reduced, will most people save more or less than before? Does national saving rise or fall? Explain. (Topic: the IS relation) When taxes reduce, it often means that people have more money incomes at their disposal than before. One of the effects is that peoples buying power increases because they can afford more shopping baskets than before. Another important event that can happen when taxes reduce is that the increased money incomes may prompt an increase in the amount of savings because some people may predict some unexpected economic activities that may require their money that is saved. Additionally, an increase in savings may mean an increase in investments because people may find themselves having more money to invest in business with increased returns. On the other hand; a reduction in taxes may not necessarily mean an increase in national savings; instead, it may prompt an increase in government expenditure because the government is a better position to manage many public projects because of reduced prices of inputs needed for the establishment of these projects. 5. How does a decline in the interest rate cause an increase in investment? (topic: the IS relation) Monetary policies are used by policy makers in a country in order to increase or reduce the flow of money in an economy. At different times of the economy, policy makers in a country use monetary policies in order to manipulate interest rates to increase the amount of money that people can have for their business investments or reduce the amount in supply in a process of reducing the levels of inflation In increasing investments, it is important that people have the ability to borrow the amount saved in banks and other financial institutions to invest. In order to achieve this objective, policy makers adopt expansionary monetary policies. For instance, by reducing interest rates, banks and other financial institutions can effectively avail cheap credit to people for them to borrow and invest in different economic activities. Later, it is expected that the money that these people make from their investments can be saved in these financial instructions for other people to borrow and invest in a continuous cycle. 6. China is a large open economy with an extraordinarily high saving rate. If, as seems likely, there is a decrease in desired saving in the coming years, what effects should we expect to see on Chinas trade balance (net capital flow), domestic interest rate and actual levels of saving and investment? (Topic: open economy) China has established itself as one of the best and stable economies, something that many economists argue could make the country the next economic superpower, surpassing the United States. However, for this to happen, the Chinese policy makers need to ensure that their economic policies are stable and able to stand the test of time in the coming years. In case, the future presents an acute shortage in the mush desired savings, one of the immediate effects will be a decrease in the money available for investments. With such a move, the country’s net capital inflows will reduce because it will be forced to depend more on imports because of a reduction in domestic savings. Additionally, the level of internal interest rates is bound to reduce in order to encourage people to invest in business activities in a move that is expect to increase their levels of savings (Dolan 2007, p. 42). By increasing the amount of savings, it will be possible to encourage financial institutions and banks to increase their amounts of credit to people through expansionary monetary policies. 7. When an economy becomes attractive to global investors, sparking a capital inflow, one result is often a decrease in net exports. Why? (Topic: open economy) Generally, one of the most important functions of policy makers in a country is to develop effective policies that cause the economy to be conducive and attractive for both domestic and international investments. When the rates of inflation have been controlled effectively, an economy often tends to attract global investors, a move that increases capital inflows in a country. However, an increase in capital inflows may not out rightly increase the amount of net exports in the country. In most cases, global investors, repatriates much of the profits from these investments back to their countries, something that decreases a country net national product. In as much as the country records higher gross domestic product, the fact that repatriation of profits happens by these international investors, the level of net exports tends to reduce. The country is sometimes forced to import some of the essential products from other countries for use because what is produced is sometimes not sufficient for the economy. 8. In an open economy, an increase in saving might not cause an increase in domestic investment. Why not? Does that mean that an increase in saving is undesirable? (Topic: open economy) An open economy can be described as that in which there is an increase in economic activities among people in the domestic community as well as that from across the borders. In such a situation, goods and services and labor can easily be transferred across the borders. In an open economy, savings represent a leakage from the circular flow of income while on the other hand (Hubbard & Brien 2006, p. 65); investments are an injection because they increase the amount of money in the circular flow. From the above illustration, savings does not seem to be an undesirable activity, but very necessary for the growth of the economy; however, savings becomes desirable if economic activities encourage financial institutions to avail the saved money to businesses and people for their investments, which increases money in the circular flow. An increase in investments is important because it increased capital goods in the economy, which contribute towards production and distribution of goods and services, thus growth and development of the economy. . 9. If policymakers in an open economy want to increase the wealth of their citizens, should they seek to increase saving, or to increase investment? Explain. (Topic: open economy) Wealth creation is a matter of great concern among policy makers in a country. In most cases, some people tend to think that process of increasing wealth in a country is by creating policies that increase money supply so that people can have disposable incomes. Wealth creation is a direction function of investments. In increasing wealth, policy makers need to concentrate on establishing policies by which people can save and use their savings in order to make investments. In this case, people can buy assets that can work for them. Money that is kept in banks and other financial institutions in anticipation of emergencies for them to be used does not bring any help to the economy. Instead; money should be invested so that it can circulate in the economy (Dolan 2007, p. 53). By investing, people can increase the number of economic activities in the country, which means many get jobs and make savings, which are then reinvested again, thus increasing wealth. 10. Look at the figure bellow, which plots the base interest rate and the rate of money growth in Japan up to 2005. a. Discuss the following statement: “Monetary policy has been used to decrease the interest rate to zero in Japan. If this is not sufficient to increase demand and output, there is nothing more monetary policy can do.” Monetary policy refers to the economic instruments used in a country in the process of controlling the flow and circulation of money. Monetary policies target the rates of interest and inflation rates in ensuring general trust and price stability for the country’s currency (Dolan 2007, p. 62). Additionally, the goals of monetary policies are aimed at contributing to economic growth as well as stability, reducing unemployment and predicting other countries’ exchange rates. In Japan, just like in other countries, the use of monetary policies has been targeted at reducing the level of interest rates in a bid to increase the level of economic growth. It is important to realize this approach is the expansion approach of the policy whereby the reduced interest rates are aimed at providing cheap credit to people to entice them to increase their investments. In such a case, the policy is also used in reducing the level of unemployment by making it easy for people to borrow from banks and other financial institutions to start and run their businesses. b. Explain in general what is meant by the liquidity trap. Also discuss the implications of a liquidity trap for the shapes of the money demand and LM curves. A liquidity trap, according to Keynesian economics, can be described as a case where cash that is injected into the private banking sector through a country’s central bank fails to bring down interest rates, a situation that later renders monetary policy quite ineffective. In most cases, a liquidity trap sets in place when people, instead of spending their money begin to hoard it in anticipation of various unexpected events like wars, economic deflations as well as an insufficiency in the level of aggregate demand. Some of the commonly known attributes of liquidity trap include interest rates, which lie close to zero as well as several fluctuations that happen in money supply that fail to convert the fluctuations in the respective price levels. Fig 1. Effect of the liquidity trap on the IS-LM model (Mankiw, N. 2007, p. 31) When represented in an IS-LM model, monetary expansions tend to shift from LM to the LM’ such that it brings no effect on the outputs and equilibrium interest rates. However, when it comes to fiscal expansions as indicated by the shift from IS to the IS”, the effect is that it causes higher levels of outputs that bring no change on the interest rates. For this reason, it becomes evident that since the levels of interest rates do not change, the crowding out effect does not often arise. c. Suppose a liquidity trap exists. Graphically illustrate and explain the effects of an increase in government spending using the IS -LM model. Fig 2. the effects of an increase in government spending using the IS -LM model (Sattora 2013, p. 45) In case the central bank tends to increase the amount of money supply (M) in the economy or when there is a recorded increase in government expenditure, the line representing real money supply tends to shift outwards while the corresponding LM curve further shifts outwards. According to the graphs above, we have an LM curve that is established from M1, which is the point of low money supply. In actual sense, this becomes that initial point of equilibrium, being established at Y1 and i1. When the central bank in a country later turns to increase the amount of money in the economy, say to point M2 the resulting effect on the LM curve is that it shifts down as shown in the following diagram. Fig 3. Effect of increase money supply on the IS-LM curve (Sattora 2013, p. 47) One of the instant effects is that the level of interest rates reduces drastically from the level of equilibrium to the point of intersection at Y1 to the LM curve that is lower. This reaction is depended on argument that money markets have a tendency to adjust quickly. At this particular point, the money markets are said to be at equilibrium since the point lies on the LM curve; however, the level of interest rate is very low for the market of goods to be at equilibrium. Bibliography Dolan, E. 2007. Introduction to macroeconomics (3rd ed.). Best Value Textbooks, Redding, CA. Gottheil, F. 2008. Principles of macroeconomics (5th ed.). Thomson, Mason, OH. Hubbard, R., & Brien, A. 2006. Macroeconomics. Pearson Prentice Hall, Upper Saddle River, N.J. Mankiw, N. 2007. Macroeconomics (6th ed.). Worth, New York. Sattora, R. 2013. CLEP principles of macroeconomics (2nd ed.). 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