The Reduction of Consumption Function in Economy - Term Paper Example

 «The Reduction of Consumption Function in Economy» A. Answer: The article entitled “Hog’s breakfast” talks about the Canadian government’s effort to influence the price of the hogs in the market in order to support farmers. As the financial crisis worsens, the Canadian government gives farmers incentive to curb down the supply of hogs in the market through the Federal Cull Breeding Swine Program with an allocated budget of $50 million. Figure 1.1 illustrates the situation of the hog industry in Canada. According to the article, the hog industry is a “Cinderella” story, in that it has become successful in a decade years which is to last a decade. This success, as apparent in the shift of the supply curve rightward is associated with the “lower feed costs, good farm conditions, and healthier hog population (Corcoran 2008).” This decrease in production costs has increased the supply in the market. Coupled with the increased supply in the market, Canada’s low dollar has made it attractive to the US market as it has made exports. Figure 1.2 shows the relative increase in demand due to Canada’s low dollar advantage in the producers’ exports to the US. This increased demand, coupled with the increase supply in the market has contributed to the growth in the hog market in the country. However, during the last couple of years, the market for hogs has turn against the farmers. When the United States has posed some regulation that requires Canadian hogs to be labeled as Canadian pork, according to the article “most US meat packers do not need or want the expense of adding a separate production line to handle Canadian products. As illustrated in figure 1.3, the effect of this regulation is a decrease in the demand for Canadian hogs, signified by a leftward shift in the demand curve. While this could signify a lower equilibrium output, this also results in lower prices. These lower prices have hurt the farmers in the process. Due to this, the Canadian government sees the curbing of supply of the hog market a better way to address the problem of lower prices. As is illustrated in figure 1.4, decreasing the supply or making the supply curve shift leftward decreases the quantity produced but drives up the price by making the product scarcer. In order to influence the price, an allocated $50 million aims to give incentives to farmers in order to produce fewer hogs. “Paying farmers to kill their farm animals may well be a first. For each breeding sow or ‘teaser boar’ -- farming is an X-rated business -- slaughtered since last November up till last Monday, farmers can apply for a $225 payment, even if that animal was sold into the commercial pork market. The same $225 will be paid for hogs killed beginning last Monday, although those hogs cannot be sold commercially. Either they go to a food bank operation (somehow) or to a rendering plant for animal feed (Corcoran 2008).” The decrease in the supply in the hog market is seen to be a solution for a much longer term, as the supply of the current hog market is not the only supply reduced, but the supply of future hogs as sows are aimed to be killed. According to the article, “The objective is to reduce the Canadian breeding hog population by 10%, although the actual reduction could be higher. As of Jan. 1, there were 1.5 million breeding sows in Canada. The $50-million could take out as many as 220,000 sows, implying a reduction of 15%. The real aim of the program is to reduce the birth of future piglets. Each sow produces about 20 piglets a year over three or four years. If 200,000 sows are eliminated under the program, that theoretically means four million fewer little piggies going to market in each of the next three years. That assumes, although nobody will know, that the removed breeding sows were not already past their prime, in which case Ottawa is paying hog farmers to do nothing (Corcoran 2008).” Figure 1.5 gives an example illustration of the market for the hog industry. With the lower demand, the level of the marginal costs and the level of the average costs being considered, these are the reasons for the hurt that the farmers experience in their operations. According to the article, over the last few years input costs most especially feeds have risen which increases both the marginal costs and average costs of raising hogs. “While not as big a factor as the dollar, the third cause of the hog market meltdown turns out to be farm policy. Prof. McEwan says about 65% of the cost of raising pigs is in feed -- corn, barley, grains. Feed prices have skyrocketed in the last two years -- the product, hog farmers believe, of the biofuels programs pushed by governments in Canada and the United States (Corcoran 2008).” According to the article, the main cost of the increase in the input costs such as feed is the government’s program of rewarding farmers to produce biofuels instead of grains, which makes the grains scarcer. This increase in scarcity of grains drive the costs of feeds up, which contributes to the farmers’ costs of raising pigs. By influencing the price of the hogs by making them scarcer through the program, the government aims to help the market. The increase in the price of the hogs, as illustrated in figure 1.6 from its current situation in figure aims to counter the effect of the increase in average costs to farmers due to increase in the input costs when raising hogs. By increasing the price by curbing supply, the government can aid farmers for better profitability of operations through the program. As the paper aims to explore the farm policy through microeconomic analysis with the use of supply and demand, while the policy seems odd, that is to reward people not to produce, this is based on sound economic reasoning and proper understanding of the forces of supply and demand. As pork is considered a commodity where there are plenty of farm producers who are too small to influence the price, the Federal Government’s effort of intervening in order to influence the price to help the farmers can be seen as a good government intervention in the market to protect certain industries. II. Article title: A spent force A. Question: What are the effects of credit crunch in the economy? B. Answer: The article entitled “A spent force” from the Economist dated October 16th 2008 talks about the financial crisis and its effect on the spending of the whole US economy. According to the article, there are “ominous signs that the crisis will have a big impact on spending (2008, 1).” In order to assess the effects of crisis on the spending of the US economy, we apply some macroeconomic tools for analysis. The credit crunch in the economy, as a result of inappropriate lending has been apparent up until now, even when the effects are expected to tone down after the government has given bailout efforts to rescue banks. While a function of the consumption side of the economy remains reliant on credit for purchases, this financial crisis definitely has some effects as apparent in our multiplier model. Figure 2.1 shows a multiplier model, where the national output is a function of the consumption, investments, government spending, and net exports in an economy. When credit crunch occurs, loans become less available or less affordable which curbs down people’s consumption through credit that is offered by banks and other financial institutions. The reduction in the consumption does not reduce the national output by the face value of the amount, but the amount multiplied by a multiplier. The multiplier in the economy is determined by dividing 1 by the marginal propensity to consume (for every given dollar, how much goes to be spent) (Samuelson and Nordhaus 2004, 496). When the marginal propensity to consume is not present in our analysis due to insufficient data, we know for sure that the effect of this decrease in consumption due to less availability of credit has a multiplied effect to the economy. “Since then the influence of debt has probably grown as the economy has become more credit-intensive. Consumer and home-equity loans equalled 26% of annual personal consumption in the 1990s; they recently reached 36%. In the 1980s about half of homeowners had a mortgage; now about two-thirds do, says Ivy Zelman, a housing consultant (Economist.com, 2008).” Decreasing the consumption function is one, but there is another function that is affected with this financial crisis; the investment function of the economy is also affected. The availability of loans from banks has become tightened in such a way that either the cost of capital increases which makes loans more expensive or the requirements for loan applications have become more stringent. Businesses have to two different ways to raise cash for their operations. For one, there is equity which comes from the money of private and public investors in the form of stock or ownership in the company. The other comes in the debt, either through commercial papers traded by different investors in the bond market, or debt from banks and different financial institutions. As these sources of cash become harder to access and more expensive to businesses, investments that come in the form of expansion of these businesses’ operations in the form of acquisition of additional capital assets will be lower for the economy. “Meanwhile, the demand for bank credit by companies shut out of the commercial-paper market is straining balance-sheet capacity. In theory the government’s $250 billion rescue package for banks, levered ten-to-one, could support $2.5 trillion of lending (total credit in the economy was $27 trillion as of June 30th). But no one expects so large an effect because banks are trying to delever and will probably build their reserves in anticipation of more loan losses as the economy worsens (Economist.com, 2008).” As in the consumption function, the reduction in the investment function in the economy results in a multiplied effect. The expenditure multiplier, the same multiplier that is used in the consumption function which is measured by dividing 1 by the marginal propensity to consume determines the effect of the reduction in investment. This does have a significant effect on output. The article points out a bailout effort on the side of the government in the amount of 250 billion to aid banks during these times. Money supply in the economy is determined by the reserve requirements for banks, which determines how much is loanable to the public, which makes a flow of the fund among generations of banks. However, even with this amount of 250 billion, according to the article, only few believe that the effect can be levered to ten times, or 2.5 trillion in order to help banks. As the article has pointed out, the effect of this bailout will not be that great as banks will increase their reserves to absorb more losses to come due to the foregoing crisis. This bailout can be considered an increase in government spending. However, as the government channels these funds into the bank, banks have the discretion to channel these to public to increase consumption. Because government spending does not have an immediate effect to stimulate consumption in the economy, the effect is not so magnified to influence general spending. Even with the increase in government spending with the bailout, the decrease in both the consumption and investment as a result of credit crunch affects the aggregate demand in the whole economy. As the aggregate demand is a function of consumption, investment, government spending and net exports, the reduction in both the consumption function and investment function denote a shift leftward in the aggregate demand curve in the economy (figure 2.3). The interaction of the aggregate demand and the aggregate supply in the economy determines the price level, unemployment rate and the output in the economy. While the rest of the economy have become overly reliant with debt such that a number of homeowners have zero or negative equity for their houses, the credit crunch will continue to have, as the article has pointed out, a huge effect on the economy’s output. The shift in the aggregate demand leftward denotes a downward shift in output. And as in any other case where output is reduced, while the price level drops, the accompanying event of higher unemployment rate follows. Works Cited Corcoran, Terence. “Hog’s Breakfast.” Financial Post. 16 April, 2008. 15 December 2008. Samuelson, Paul and William Nordhaus. Economics. International ed. Philippines: McGraw Hill, 2004, 496. The Economist. “A Spent Force.” Economist.com. 16 October, 2008. 15 December, 2008. Read More