Shift in Aggregate Demand and Supply, Quarterly Movements in GDP of a Country - Assignment Example

Name: Professor: Subject: Economics Date: Question 1 The intersection between is the initially equilibrium level. Figure 1: Leftward shift in aggregate demand a) An increase in interest rate leads to higher cost of borrowing for investment. As a result, investment, consumption, and aggregate demand would decline. In the short-run, aggregate demand curve would shift to the left consequently reducing price and real GDP. However, the long-run situation is that the economy will return to full employment as lower price of resources cause an outward shift in aggregate supply curve. b) An increase in private domestic investment has the impact of shifting aggregate demand to the right accordingly increasing output from in the short-run. Price also rises from P1 to P2 as shown in figure 2 below. Figure 2: Rightwards shift in aggregate demand The economy will not settle at point . Instead, AS will shift to the left due to increased cost of production and the declining profits. Eventually, the economy will settle at a higher price but lower demand. c) An increase in goods and services tax result in leftward shift in AS curve given that GST is levied on transactions along the production process and tend to increase price as shown in figure 3. Equilibrium changes from X to Y. Figure 3: Leftwards shift in aggregate supply As price increases, it is accompanied by a decline in demand. This is illustrated by a leftwards shift in AD curve from AD to AD1. It means that the economy will not settle in equilibrium point but correct itself to settle finally in long run equilibrium point . d) Appreciation in foreign exchange rate of the economy’s currency occurs when there is an increase in domestic currency following foreign currency weakening. Exports will decline because they are expensive. On the other hand, imports become cheaper. An increase in imports coupled with a declining export demand result in a fall of aggregate demand. Real GDP and price will decline in the short-run as demonstrated by figure 1 above. Nonetheless, this will change in the long run as export market is revived by low price. e) A fall in real estate prices has a direct impact on homeowners in the sense that it reduces their wealth and eventually lowers consumer confidence. At the same time, people will be reluctant to borrow or even spend on risky investment. As such, there will be a leftward shift in short-run aggregate demand from AD to AD1 accompanied by lower output and price level as shown in figure 1. Eventually, investors come in to invest in real estate with the expectation that price will change in the future. This drives the supply curve outwards to settle the economy at equilibrium output of . f) When main exports of a country fall in price, demand for the goods would increase in international market. Conversely, a rise in price of imports leads to low demand for imports. The outcome is an increase in aggregate demand represented by a rightward shift in AD curve similar to figure 2. Real GDP and price will increase in the short-run. In the long-run, rising exports and declining imports lead to high inflation and high cost of supplies. As a result, AS curve will shift to the left settling the economy at a higher price. Question 2 Quarterly movements in GDP of a country are important because they show a business cycle hence is applied in positioning an investment. Recession is a period when a nation is experiencing two successive negative quarters of economic growth. Question 3 A market-based economic system relies on the interaction between forces of demand and supply hence government interference is minimum. The system is not self-stabilizing and is subject to failure because of instability in the market hence requires rules, constraints, and monitoring. Question 4 An increase in savings because of commitment to pay debt means that autonomous consumption has declined. The impact is a decline in aggregate expenditure followed by a fall in gross domestic product as illustrated in figure 4 below (Sexton, 746). This will, however, change in the long run as other investors borrow the saved money for investment. In that case, aggregate expenditure will increase thereby prompting GDP to rise again. Figure 4: Keynesian model On the flip side, a sustained increase in private investment spending causes aggregate expenditure to shift outwards. The new equilibrium output will be at a higher level of GDP. Question 5 In the case of a risk, distribution of outcome is already known i.e. through past statistical records. On the other hand, the distribution of outcome is unknown in uncertainty due to high uniqueness of the event. While interest rate is the cost of borrowing funds, exchange rate is the value of one currency in terms of another i.e. . The unexpected internal or external event that shifts aggregate demand upwards or downwards is classified as demand-side shock. The unexpected event that causes the aggregate supply curve to shift is termed as supply-side shock. An example is a rising cost of production caused by demand for higher wages. Trade deficit arises when imports are more than exports. Conversely, net foreign debt is the gross foreign debt minus non-equity assets held by a reserve bank and other lending institutions by residents to non-residents of a country. Question 6 An increase in money supply causes interest rate to decline in response to a rightward shift in money supply from to as shown in figure 5 (Reinert 258). A decline in interest rate motivates people to borrow because of low cost of borrowing. Eventually, output will increase due to rising investment. A rising output triggers companies to employ more people to cope with the rising output. The rise in employment has a positive impact on income level thus aggregate demand will shift to the right. This is accompanied by high prices. Figure 5: Increase in money supply Question 7 Professionals and market economist monitor several economic and business indicators with a view of understanding position of the economy in a business cycle as well as trend of output. In brief, it is about the health of a nation. Some of these economic indicators comprise of employment level, inflation rate, consumer price index, investor activity, debt level, and bottom line. All these elements determine growth or shrinkage of output. Question 8 Depreciation represents decline in value of a currency relative to another currency. Under this situation, a country’s exports become attractive in international market. This improves balance of trade of a country. Currency appreciation indicates the strengthening of a currency relative to another currency. It is not necessarily a bad thing because it promotes upgrade of industries, increase domestic purchasing power, and attain structural balance. Besides, it helps to propel an economy to the level of advanced economy. Question 9 An expansionary policy is intended to expand money supply in an economy through additional government expenditure or decreasing inflation. An increase in money supply leads to lower nominal and real interest rate. Consequently, people would resort to borrow more money because of low cost of credit. The policy is appropriate for an economy that is in recession. By increasing government expenditures, demand will increase consequently eliminating recessionary gap. On the other hand, cutting taxes adds disposable income hence increases aggregate demand in the economy. Question 10 Under flexible exchange rate, forces of demand and supply of a currency are critical. A high demand for a currency triggers exchange rate to rise. On the contrary, low demand for a country’s currency reduces the exchange rate. In summary, fluctuation of exchange rate due to operation of flexible exchange regime automatically affects exports and imports. By extension the rise and fall in exports and imports, has a direct effect on current account. This process continues until a point of equilibrium is attained. Flexible exchange rate, therefore, keeps changing in line with the situation in the market. While fiscal policy is very effective under fixed exchange rate, monetary policy is effective under flexible exchange regime. Works Cited Reinert, Kenneth. An Introduction to International Economics: New Perspectives on the World Economy. New York: Cambridge University Press, 2011. Sexton, Robert. Exploring Economics. Mason, OH: Cengage Learning, 2010.   Read More