Aggregate Demand and Aggregate Supply - Assignment Example

Research Assignment Student's Name: Course Name and Number: Instructor's Name: Date Submitted: 1. Answer 1 The circular flow explains the interaction between the main sectors of an economy that is, human beings, organizations, financial institutions, the state and global trade. In a circular flow, the households and firms are the key sectors that interrelate, generate and enhance the flow of income. The firms usually provide end users with commodities, whereas the households consume these goods. The circular flow is partly closed implying that there are injections into it as well as leakages out of it. A leakage also known as withdrawal refers to the non-usage of earnings, and it is comprised of savings, tariffs and trade in. The unused revenue causes a decline of economic activities and it is shown on the right hade side in a circular flow model. On the other hand, the concept of injection refers to the economic receipt by households or a firm that does not arise because of the payments of the other. Therefore, a leakage helps to show where the income goes whereas injections help to know the sources of income. In a real economy, households mainly save the income whereas firms spend income in purchasing the investment goods. Saving thus represents a leakage while investments represent an injection. Equilibrium is, therefore, attained when leakages are equivalent with the injections. A diagram of the circular flow Equilibrium is attained when S+T+M=I+G+X Aggregate Demand and Aggregate Supply In the field of macroeconomics, equilibrium is achieved when there is an intersection between the aggregate demand (AD) and the aggregate supply (AS), and as a result, no economic forces are created. The economic forces are those of excess demand and excess supply. Excess supply represents an economic force that exerts a downward pressure on prices of goods and services. Excess demand, on the other hand, refers to economic forces that exert an upward pressure on goods and services. A diagram showing the intersection of the Aggregate demand and supply Any divergence from the equilibrium causes disequilibrium and hence an increase in prices of goods and services. The main cause of market disequilibrium is when leakages fail to match with the injections. If leakages are more than injections, more money leaves the circular flow, and this, in turn, causes a trade deficit. Otherwise, there is a reduction of equilibrium income if the level of leakages is lower than that of the injections. The correlation between the leakages and injections usually affects the economic activities of a country A research, which was done by Bourgeron& Jensen, (2001) stated that, an economy faces a greater challenge to restore its previous state that is, its equilibrium. Disequilibrium causes economic variations otherwise known as trade cycles. If the trade cycle occurs globally, most states usually experiences depression and inflation all together. However, different countries have different economic sizes, and thus, their imports as well as exports are affected differently (Gwartney et.al, 2008, 171). During the recent years, Australia has been characterized by instability of real D.This instability has been characterized by periods of activity and decline. Business cycle Diagram 2. Answer 2 Trade cycles play a prominent role in determining the government budget surplus or deficit. According to the Australian Government, the estimated budget surplus for the fiscal year 2012-2013 will be 1.5bn Australian Dollars. The Australian Government intends to focus savings on such areas as defense, large organizations, high income earners and international aid through double taxation. This government budget surplus has a widespread effect on the level of economic activity and the net income deficit. The following are some of the main benefits and limitations of the Australian Government budget surplus on the level of economic activity and the net income deficit; a budget surplus plays a crucial role of reducing the debt. This, in turn, helps to maintain the rate of interest low. A high level of interest cost usually causes a higher shortfall, which, in turn, adds to increasing interest burden. With this regards, a vicious cycle of rising debt is created. By replacing shortfalls with surplus, the Australian Government will ensure that the budget is reduced to a great extent. The Australian Government can achieve long term growth by running a surplus budget. The government can ensure that its revenue surpasses its outlays by borrowing from the private sector. A budget surplus usually enhances the state’s savings, and this, in turn, leads an increase in the sum of resources on hand to be employed in other sectors of the economy. Running Surpluses also helps to maintain a downward trend of government borrowing. This exerts a downward pressure on interest rates thereby enhancing long term economic output. Running a surplus budget will have a large impact on enhancing investors’ confidence in Australia. Minefield (2010) in his studies argued that most investors consider a surplus budget as an outcome of excellent fiscal management. Enhancing investor confidence is essential because it leads to a decline in the cost of borrowing. On the other hand, budget surplus in Australia has the effect of pushing up unemployment in the country. According to the Reserve bank of Australia (RBA), key parts of the economy among them nonmining will be substantially affected. According to RBA, the only section of the economy that will not be significantly affected by the reduction in budget spending is mining. It is projected that the building activities across Australia will remain relatively low due to the high rates of exchange. Nonmining companies will seek to adjust to these exchange rates and this will, in turn, cause the demand for real estate to fall. As the demand for property falls, the level of unemployment will rise (Brigham & Daves, 2009, P .20). According to monetarists, a surplus budget is achieved at the detriment of private expenditure (Menifield, 2010, P.118). A surplus budget is mainly financed through such aspects as levying heavy taxes, personal consumption and investment spending. This leads to a rise in interest rates and thus a fall in investments depending on savers’ approach. With this regards, competition for private financing otherwise known as crowding out effect will occur. Also, a budget surplus will lead to sustained pressure on key sectors of Australian economy, and this may cause a decline in economic growth. 3. Answer 3 Australian economy has continued to grow robustly in recent years thanks to the mining boom. Terms of trade relate to the correlations that exist between the cost of a nation’s overseas sales and the cost of its imports. Favorable terms of trade will have the following impacts on Australians 2012/2013 economy; According to International Monetary Fund (2011) a higher growth, enhanced by terms of trade benefits and vibrant investments throughout Australia will help to curb the problem of joblessness. Favorable terms of trade in Australia will reduce joblessness in two ways. First, it will cause an increase in prices of resource goods such as oil in which Australia specializes. This will in turn increase the real income and in so doing, enhance consumer spending. Second, favorable prices will motivate investors to direct their investment efforts to resource sectors of the Australian economy. This has its own multiplier effects that will help to boost employment in Australia. The changes in global economic growth on Australia’s terms of trade will cause depreciation of the Australian dollar and this will in turn push inflation. A fall of the Australian currency implies that the price of imports will shift up. Importers will thus be forced to pay higher prices in other currencies like the Euro in order to purchase the same quantity of products. On the other hand, a depreciating Australian dollar will help individuals who rely entirely on the affluence of export and import-competing industries of the Australian economy (Boyes & Melvin, 2012, P.487). References Bourgeron, P.S & Jensen, M.E.2001.A Guidebook for Integrated Ecological Assessments. New Mexico: Springer. Boyes, M & Melvin, M.2012.Macroeconomics.London: Cengage Learning. Brigham, E.F & Daves, P.R.2009.Intermediate Financial Management.Ed:10.London: Cengage Learning. Gwartney, J.D. et.al.2008.Economics: Private and Public Choice.Ed:12.London: Cengage Learning. International Monetary Fund.2011.Regional Economic Outlook, April 2011: Asia and Pacific - Managing the Next Phase of Growth. Washington D.C: International Monetary Fund. Menifield, C.E.2010.Comparative Public Budgeting: A Global Perspective. Massachusetts: Jones & Bartlett Publishers. Read More