Defining Market Clearing Model - Assignment Example

Macro and Microeconomics affiliations Macro and Microeconomics Chapter Review questions Q Why do economists build models? Economists build models with the idea that these models can reveal something about a general pattern regarding whatever they are studying. Models are also used to help economists in the understanding and testing of economic theories. Economists seek to project future outcomes with these models by using available data. Through analysis of the previous economic data, models can be used to estimate roughly future projections when other policies and factors are held constant or where they can also be determined. Q. 2. Define what a market clearing model is and outline when it is adequate to assume the market clears. A market clearing model is described as the situation in which prices adjust to attain an equilibrium demand and supply. These models are relevant in cases where the market prices are not fixed. However, in the actual market prices are assumed to be fixed. For example, in magazine publishing firms, prices remain constant for three to four years. However, macroeconomists adopt a flexible price assumption when dealing with long-run issues. This assumption is because prices changes in the short-run do not affect the market in a significant way like in the long-run. Problems and identification Q. 3. Explain using the model of demand and supply how a decrease in frozen yogurt prices affect the quantity and price of ice creams. You need to identify the endogenous and exogenous variables in your answer. Given that the demand of ice cream depends on the consumer income and the price of frozen yogurts. Qd = D (Price ice cream; P frozen yogurt; Income) The supply function for the ice cream is a function of the ice cream price. Qs = P ice cream At market equilibrium, Qs = Qd. The exogenous variables are the price and income while the endogenous variable is the price of the ice cream. The decrease in the price of the frozen yogurt makes the demand curve for ice cream to shift inwards from point D1 to point D2. The shift in the demand curve causes a decrease in price and quantity at the new equilibrium P2Q2. The graph illustrates the resultant effects due to the fall in the price of frozen yogurt. Q. 4. What is the frequency of the change in the price of your haircut? What is the implication of your answer on the usefulness of market clearing models in the analysis? The change in the price of haircuts is rare as haircut prices tend to remain constant for several years regardless of the demand and supply for haircuts and barbers. When analyzing the market for haircuts, economists would assume a market clearing model with an unrealistic flexible price. The market clearing model is sufficient for long-run analysis as haircut prices are fixed over the short-run. Chapter Two: Problems and Applications Q. 5. Q. 6. a. 1- Nominal GDP = (P automobile * Q automobile) + (P bread * Q bread) Nominal GDP = ($50.000*100) + ($10*500,000) = $10,000,000 2- Real GDP2010 = (Pcars 2000 * Qcars2010 ) + ( Pbread2000 * Qbread2010) Real GDP2010 = ($50,000 * 120) + ($10 * 400,000) = $10,000,000 3- Implicit Price Deflator2010 = Nominal GDP2010 / Real GDP2010 = 1 4- CPI2010 = ( Pcars2010 * Qcars2000 ) + ( Pbread2010 * Qbread2000 )/( Pcars2000 * Qcars2000 ) + ( Pbread2000 * Qbread2000 ) CPI 2010 = 1.6 b. Automobile: prices rose by 20 percent from $50,000 to $60,000 c. Capital goods prices are only included in the gross domestic product deflator but not on the CPI index. This inclusion and exclusion happen because the purchase of capital goods is not for consumption. Imports are only included in the CPI index and excluded from the gross domestic product as they form part of the consumption basket that do not influence the GDP. According to Laspeyres index, the goods basket is fixed in the CPI though it changes annually in the gross domestic product deflator. The determination of the most appropriate measure for actual inflation is dependent on several factors. Where the relative prices continuously change, that is the price of product X as compared to product Y, the CPI, and the GDP inflators act inversely. The GDP deflator significantly underestimates the inflation while the CPI inflator greatly overestimates the inflation. Where the economy imports more goods than exports, the CPI deflator is preferable than the GDP deflator. The GDP deflator is a more necessary approach where the economy produces more capital goods. In any economy, it is crucial for the Parliament and the relevant policy makers to analyze the countries production and import approaches before settling on an approach. However, I would advocate for the use of the CPI deflator as it presents a clearer outline of the economies cost of living. Q. 8. a. The decrease in the real GDP is as a result of the decline in income production in Wonderland. The failure to operate for a month indicates that the shareholders will also receive fewer returns that will increase their levels of consumption. Due to this factors, output, income, and consumption decrease pulling down the GDP. b. The increase real GDP results from the increased production of wheat that leads to increased consumption. The surplus wheat is stored for future considerations or sold to earn the region increased exports. c. The decrease in the real GDP decreases due to reduced workers. With fewer workers, firms produce fewer products that result in reduced economic growth. d. The real GDP decreases due to the increased layoffs. When firms reduce their employees, production decreases followed by the reduction in income levels affecting the economy negatively. e. The established environmental regulations decrease the firms’ production while improving the environmental standards. The decreased production reduces real GDP while the improved environment has no effect on the GDP. f. The students increased the labor force and subsequently the production of goods that resulted to improved real GDP. g. With increased parent-children involvements, labor hours are decreased which lowers the total production reducing the real GDP Chapter 9. Questions for review Q2. The magazine price is fixed in the short-run but flexible in the long-run. There is no definite answer regarding the price behavior of the magazines. Assumptions state that increased price fluctuations would result in decreased magazine purchase. Q4. The short-run effect of an increase in the money supply causes a higher price level than the initial equilibrium. Due to the high prices, there will be a boom in the provision of goods as resources will be considerably lower compared to the returns. Due to these fluctuations the real GDP will be higher in the short-run than in the long-run equilibrium. The employment levels will be greater than the full employment capacity while the unemployment levels are way below the natural rate. The resulting real wage values will be much lower than the subsequent long-run equilibrium levels. In the long-run, the price levels are above the initial long-run price equilibrium. The firms are not willing to produce more goods and avoid a surplus supply seeking to produce at the equilibrium output. In the long run when the market is at equilibrium the market will be experiencing a full employment capacity while wages reduce to the equilibrium levels. However, nominal wages remain at a higher level than the previous equilibrium and interest rates are maintained at a constant level with the initial equilibrium. Problems and Applications Q2. a. The Bank of Canada would cause a downward shift in the aggregate demand curve by reducing the country’s money supply. Considering the equation MV = PY a decrease in the supply of money M while V is held constant causes the nominal output PY to decreases. For any value of P, the level of Y is lower. b. In the short-run, price levels are considered to be fixed with a flat aggregate supply curve. In the short-run, price levels are not affected by changes in the quantity. Due to flexible prices in the long-run, a decrease in the price level restores the economy to full employment. With the assumption that V is constant, the effects of a five percent reduction in the money supply can be estimated using ΔM/M + ΔV/V = ΔP/P + ΔY/Y. Given that the price levels are fixed in the short-run a five percent decrease in money supply will cause a five percent reduction in output. However, with flexible prices in the long-run. A five percent reduction in money supply would lead to a five percent reduction in the price level. c. Okun’s rule designates the negative connection concerning the real GDP and unemployment levels. The levels of unemployment and output move in different directions. In the short-run, a decrease in output results in an increase in unemployment. Quantitatively, with a constant V, a five percent decrease in output results in a 2.5 percent decrease in unemployment. There is no resultant change in output and unemployment in the long-run following a fall in production. d. The national income accounts are represented in the savings formula as follows S= Y – C – G. With a decrease in the levels of Y a subsequent decline in the levels of S is experienced. When Y is restored, then S is also restored to its previous level. Q3. a. An exogenous decrease in money velocity An exogenous decrease in money velocity leads to the inward shift of the aggregate demand curve. In the short-run, output falls due to the fixed nature of prices. To maintain optimum levels of employment and output, the Bank of Canada needs to increase the aggregate demand that offsets the decrease in velocity. Through an increase in the supply of money, the aggregate demand curve shifts outwards restoring the initial equilibrium. b. An oil price exogenous increase. An outward aggregate supply curve shift is witnessed in the short-run following an exogenous increase in oil prices. The Bank of Canada should increase the supply of money to maintain a desired employment rate and an equilibrium output and demand. A surge in money quantity would shift the total demand curve outwards. The economy attains a new equilibrium with a higher price level and no changes in output from the supply shock. The Bank of Canada cannot influence price levels in the short-run and equilibrium is attained in the market through self-regulations in the long-run. However, waiting for a market regulation can cause prolonged levels of recession Read More