How Recession Works - Assignment Example

Part A 1. a. i. At a point inside the production possibility curve the opportunity cost is zero. This is due to the fact that at this point the resources are underperforming. The resources can be used in a more effective way without affecting the other resources as in the case where machines can be used in a more effective way without affecting the production of food highlighting that there is no opportunity cost and the resources are underperforming. ii. Factors which helps to improve the efficiency of the resources and helps to produce more goods or service using the same resources results in the a shift in the production possibility curve. For example, development of technology shifts the possibility curve outwards highlighting change in efficiency. Producing goods at the production possibility curve shows the most efficient point and any point other than it calls for the economy to move towards efficiency. Any point inside the curve represent inefficiency and wastage of resources as the economy is under producing. Any point outside shows growth in efficiency to produce more using the same resources. The concept of production possibility was developed due “to the concept of scarcity”. (PPF, 2010) The unlimited wants depleted the natural resources forcing the economy to manufacture products which will provide them with the maximum advantage and help to achieve efficiency. This model thereby highlights an important fact that production has a limit in every economy and the economy needs to decide what it wants to produce and in what quantity. b. i. This is a positive statement because it brings forward a statement which can be true or false. Since, the statement highlights the positive mood and is concerned about what in which doesn’t require any approval or disapproval it is a positive statement. ii. This is a positive statement because the value judgement is not desirable. It brings forward a statement which can be true or false. Since, the statement highlights the positive mood and is concerned about what in which doesn’t require any approval or disapproval it is a positive statement. The statement shows a fact which can be truthful or false which requires validation and shows a positive light. iii. This is a normative statement because the value of judgement is desirable. It shows that interest rates in labour government are higher than in coalition bringing forward a judgement that coalition is better. This statement requires approval or disapproval which makes it a normative statement. 2. a. Ms Apple marrying her cook diminishes the GDP of that particular economy because while calculating GDP household work is not included. These measures are not included in the Gross Domestic Product because These transactions “doesn’t lead to the production of new goods and services “. (Deng, 2009) These transaction like intermediate goods don’t have a market value These goods “are not produced locally rather imported”. (Deng, 2009) If transactions like intermediate goods are included “it will result in counting the value of goods twice as it is counted when the goods are finally produced and intermediate goods would mead double counting”. (Deng, 2009) Used goods have already been included so selling it again will result in counting twice. This thereby results in the problem associated with the calculation of GDP as household work represents a large proportion of the GDP and not including it in the calculation reduces the GDP to a large extent. Further, by not including household work which has arisen due to the efforts of the cook results in the definaton of GDP to be vague and incomplete. b. The table looks as follows Year Nominal GDP ($ Billion) Real GDP (1998 $ Billion) Price Index (1998 = 100) Inflation (% of price index) Real GDP per capita (1998 $) Population (millions) 1997 547.1 420.8 98.8 1.3 22982 18.31 1998 648 540 100 1.2 34989 18.52 1998 767 590 100.2 1.3 31471 18.75 3. a. The society with their unlimited wants and desires have made natural resources scarce. The rapid growth in population, changes in the technology, increased investments in human societies all have created a concept of scarcity. This has been aided further by the desire to grow quickly. This has made many important resources to dry up and countries are looking towards other to fulfil those desires. This has forced countries to develop a model where they produce goods they are efficient at so that the benefit can be accrued to the society. Production Possibility Frontier is a tool which helps the countries to decide the areas that will help them achieve efficiency. Economies looks for development which will help them move their efficient frontier line beyond. To achieve this different technology and mechanism are used so that it reap better benefits. Even a study supports it as it states that “technical efficiency of a firm can be achieved by establishing a relationship between production and potential production possibilities”. (Herrero & Pascoe, 2002) This demonstrates that technical efficiency helps a firm to develop and provides new alternatives where the production possibility curves moves rightward or outward thereby increasing efficiency. This increases the value of the curve as changes in technology will help to determine the manner in which the efficiency can be improved. This is seen below Economies by using the developments look towards moving the efficient frontier more in the rightward direction. This will ensure that the resources are used in the best manner thereby reflecting on the efficiency that can be achieved. The movement will ensure that more and more growth opportunities arise and the same resource being able to be used for other purpose will affect the efficiency by increasing it. 3. b. i. The demand and supply curve looks as follows The quantity of labour at equilibrium is 61 as the quantity demanded is the same as quantity supplied. ii. If the wage rate is fixed at $20 then the quantity demanded is 47 where as the supply of labour is 75. At the equilibrium of 60 cost for the employer = 61 * 16 = $976. At the wage of $20 labour demanded is 47 so cost = 47 * 20 = $940. As a result the employers have to pay less then they used to pay at the equilibrium hence it’s a gain for the employers and they save $976 - $940 = $36. This is equal to the loss for the labour as few people find employment at the same time the total collection also reduces. 4. a. The RBA uses monetary policy to manage the cash rate. This is done through two ways. Adjusting the price of short term finance: RBA also adjusts the short term finance. It makes them costly. Commercial banks have to park more funds. This results in less money. This raises the rate to rise. Buying securities in the market: Here “the RBA buys securities which results in banks having fewer amounts to lend”. (Scilly, 2009) It reduces money. This results in rising interest rate. It is shown in the diagram below Increase in Cash Rate So, we see above how rate increase. Here the demand is kept the same. It shows how the policy is used to increase rate. b. The numeric value of Marginal Propensity to Consume is 6 as shown below Income Consumption MPC 0 5 0 10 11 6 20 17 6 30 23 6 40 29 6 50 35 6 60 41 6 70 47 6 80 53 6 90 59 6 100 65 6 ii. The table looks as Income Consumption MPC Investment 0 5 0 10 10 11 6 10 20 17 6 10 30 23 6 10 40 29 6 10 50 35 6 10 60 41 6 10 70 47 6 10 80 53 6 10 90 59 6 10 100 65 6 10 iii. Lowering the taxes will help to increase demand as the income will rise as shown in the graph below The above graph shows a shift in the curve as decrease in taxes increases the income in hand. References Deng C, “Gross Domestic Product”, 2009, retrieved on April 18, 2011 from http://www.yahoo answers.com Herrero I & Pascoe S, “Estimation of technical efficiency: a review of some of the stochastic frontier & DEA software”, Volume 15, Issue 1, page 1, 2002 PPF, “Production Possibility Frontier”, 2010, retrieved on April 18, 2011 from www.oxfordtextbooks.co.uk/orc/gillespie_econ Part B 1. Economies have to face different situations while entering into transaction with each others. This results in some economies out performing the others. This creates a cycle which every economy is a part of. Some economies experience boom when there is growth and the income multiplies rapidly but some may experience recession when the growth rate is slow and economies find people loosing jobs. Thus economies have to be placed somewhere in the business cycle and look towards devising strategies and ways to grow. In economics, recession is defined as a part of business cycle and economies experience it when the GDP decreases for two consecutive quarters (Recession, 2008). This could be a situation where the economies are having a positive GDP rate but the change in growth rate is negative for consecutive quarters. Despite the growth rate being negative doubts have been raised in relation to the validity of the definition of recession as it doesn’t consider the following The definition doesn’t shows the importance of unemployment which could have happened much before the decrease in GDP thereby ignoring an importance aspect of GDP which could result in inflation (Moffat, 2010) The definition requires two quarters of decrease in GDP so if a recession happens for a short duration of time like 10 months then it might be a case where information about recession is noticed only after it has happened thereby making it difficult to use ways to come out of recessionary conditions. (Moffat, 2010) This brings forward to the fact that various factors like unemployment rate, industrial production, wholesale sales, retail sales, and real income helps to identify whether an economy is moving towards recession or not. A major reason which makes an economy fall into recession is the loss of consumer confidence in the market. The loss of consumer confidence affects the demand for good as people start to save for the future. People expect the income level to fall as a result of which the demand falls as shown below The graph shows that the loss of consumer confidence has decreased the demand of goods as seen from the shift in the demand curve to Qd2 from Qd1. This creates a situation where investment reduces as industries look to avoid more investment as the companies have the required resources to produce the goods demanded. This creates more unemployment leading to further loss of confidence thereby leading towards a recession. The decrease in consumer confidence dents the growth rate as witnessed by the bank failures and real estate bubble burst which affected most world economies. This decreased the consumer confidence in the banking system leading to banks failure. Slowly economies are finding ways to build back consumer confidence and to ensure so government has a huge role to play. Government to ensure that the economies come out of recession needs to look towards ways of increasing the money supply. While devising this mechanism economies need to look at ways where pumping more economies don’t result in inflation as this could impact the economy very strongly. (Harris, 2010) 2. The growth rate as shown by the US economy highlights the start of a recessionary period. The recessionary period started due to the real estate bubble and engulfed all economies around the world. There are various factors which show that the US economy is slowly moving towards recession. Some of the factors which highlights that the US economy is moving towards recession are as follows The GDP of US has slowed down compared to its growth rate over the previous year. The figures highlights that the GDP of US in Q4 for 2007 was 0.6% which was matched with the growth rate shown in Q1 of 2008 which stood at 0.6%. (Fairfax, 2007) This phase highlights the beginning of the recessionary phase as the growth rate then turns negative. This phase has also been shown in the graph below (GDP Data, 2010) The graph above shows that the GDP for US has fallen compared to the previous year highlighting the start of recession in US. This is further substantiated by other factors which has an effect on GDP US have witnessed a growth in unemployment. The article justifies this as 200,000 people have become jobless. This highlights the loss of consumer confidence in the economic system. Further analysis of the unemployment rate shows that around 1.6 million people have lost job in US and the economy fears a growth rate in unemployment of 1%. (Unemployment rate, 2010) This is making it difficult to sustain a high GDP thereby pushing the economy further into recession. This has been further shown in the graph below (Unemployment rate, 2010) The chart highlights the growth in unemployment rate in US which further substantiates the fact that the US economy is moving towards recession. This is based on the past trends which show that rise in unemployment rates results in recession. US entering into recession are also seen by the decrease in sales. This is based on the decrease in both wholesale and retail sale. People fear an economic downturn and prepare to save for the future. This is shown in the chart below (USIP, 2010) The above graph shows that the sales have decreased. This is because of the loss of consumer confidence which will further push the economy into a downturn as people prepare for the future. This results in a decrease in investment thereby affecting the industrial production rate. This shows that the economy is moving towards recession and requires ways to combat it. Finally the US economy is witnessing a loss of consumer confidence. The article presents the fact the US economy has lost consumer confidence to such an extent that it stands at the lowest most point. This is an area which shows that the US economy is moving towards recession. This has further been affected by the government policies which have not helped to regain consumer confidence. Thus, the different factors highlights that the US economy is moving towards recession. The different factors which have a role in determining recession highlight similar facts. The findings from different direction shows that the US economy is moving towards recession and the impact has been so severe that it will require stringent government rules to ensure that the economy is able to come out of recession. 3. The commentator provides official benchmark to the people so that they are able to identify the manner in which the economy is able to grow. The commentator by putting forward that the official benchmark doesn’t reflect the correct value wants to state that the government looks to conceal the actual figures so that the consumer confidence doesn’t gets affected. This is done with the intention that consumer feel that the economy is growing and takes steps to ensure that their confidence grows (Desmond, 2009) The government while disclosing the benchmark which has been undervalued is done with the intention that consumer confidence is regained. In the mean time the government looks to deploy different methods to ensure that the economy recovers. This gives the government the required time to ensure that their strategies reap the true results. This has helped the government as it allowed then to take steps in the right direction which is highlighted form the growth rate witnessed by the economy (Desmond, 2009). The government while using this method is able to ensure that the consumer confidence is regained. Using this way ensured that the consumer confidence is regained in the system. This helps the economy as a change in consumer perception creates a positive mood and thereby helps to increase demand for the products in the economy. This is a way which helps to deal the recessionary period to a certain extent and helps the economy to revive in the mean time thereby enabling the government to use effective methods. Also the fact that world base their production on US makes it important for the country to ensure that they are able to provide information in such a manner that the development of other economies doesn’t get affected. This is also one of the reason which has made the US economy release figures which are conservative and ensure that other economies of the world don’t gets affected. This was an instance taken by Fed as they concealed some information but instead their strategy back fired as other economies had to face it which resulted in the world going into a downturn. The different economies witnessed a sharp decrease in GDP which hampered the progress and brought about a change in the policy of the Fed to ensure that correct information is provided to the public and economies. This is thus a part of the confidence building measure adopted by Fed. The major objective the Fed looks towards achieving through this method is to ensure that the demand for the goods and services doesn’t fall and it provides the appropriate time and structure which the different economies can look to achieve through it. Thus the Fed by using a method where they didn’t disclose all information helps to ensure that the economies are able to delay the recession at the same time provide the necessary time to give the necessary impetus which will help to build confidence and ensure that the economy doesn’t fall into the shock of recession. 4. The commentator by tight rope wants to state that reducing the interest rate continuously increases the fear of inflation. This could hurt the economy more as recession plus inflation will dent the consumer confidence to a large extent and will result in large scale decrease in industrial production. This is based on the phenomenon that decreasing the interest rates makes it easy for the industrialist to avail loans as the rate of borrowing is low. This makes people to borrow more money and thereby increases output which finally gets translated into increased demand (Inflation, 2011). This is depicted in the graph below The above graph highlights the fact that reducing the interest rates makes it easy to borrow thereby increasing the supply of money as depicted by the movement in the supply curve from IS1 to IS2. This gets transformed into increase demand as shown below The graph shows that increasing the money supply due to reduction in interest rates increases the demand of the product as seen by the rightward shift in the demand curve. This thereby helps the economy to ensure that it grows. But the same conditions backfire in case of recession. In case of recession the demand for the product is already low as the consumer confidence is weak. Decreasing the interest rate should make it easy for the people to borrow and ensured that their demands are met but this could turn otherwise. It could be a situation where the decrease in interest rate but the demand for goods doesn’t rises. This will thereby make more money chasing few goods and will result in creating an inflationary condition. The graph below also highlights the inflation rate in US and the manner it has affected the growth trajectory. The above chart shows that inflation is growing and is a concern for the Fed. Reducing the interest rates further as the economy has been doing will instigate the inflation rate to rise further and will create a vicious cycle which will further push the economy into recession. This is an area of concern but since the Fed has this tool to ensure that the demand for the products rises and the consumer confidence is regained thereby it makes it important that the Fed uses it carefully Inflation should be looked by the Fed as a major hurdle in their path of expansionary recovery and needs to take steps in this direction. The Fed needs to weigh the benefits and demerits of reducing interest rate and the effect it will have on different economies and the consumer and then take a stance as to what needs to be done. References Desmond, M. 2009. What is a depression anyway? Retrieved on April 15, 2011 from http://www.forbes.com/2009/01/14/economy-recession-depression-biz-wall-cx_md_0114depression.html Fairfax, Recession: is US having one. 2007. Retrieved on April 19, 2011 from http://www.smh.com.au/articles/2007/10/14/1192300601557.html GDP Data. US GDP Data. 2010. Retrieved on April 19, 2011 from http://www.rpsoft2000.com/consulting/US-Statistics/GDP-1990-2010.htm Harris, T. How Recession Works. 2010. Retrieved on April 19, 2011 from http://www.howstuffworks.com/recession.htm Inflation. When inflation starts to hurt. 2011. Retrieved on April 19, 2011 from http://www.livemint.com/2011/01/04202350/When-inflation-starts-to-hurt.html Moffat, M. How can you tell when there is recession. 2010. Retrieved on April 19, 2011 from http://economics.about.com/cs/businesscycles/a/depressions.htm Recession, What is Recession, 2008, retrieved on April 19, 2011 from http://getanswers.co.in/what-is-recession USIP, United States Industrial Production. 2010. Retrieved on April 19, 2011 from http://www.tradingeconomics.com/Economics/Industrial-Production.aspx?Symbol=USD Unemployment rate, US Unemployment rate recent history, 2010. Retrieved on April 19, 2011 from http://www.data360.org/dsg.aspx?Data_Set_Group_Id=248 Read More