Economics Answer Note #84

Question 1 Show the shifts that result from each of the following shocks. A newly elected antibusiness president imposes burdensome regulations, driving up firms' costs. The Fed decides to accommodate the shock Answer In order to understand the shifts that result from the given shocks, it is important to first define the terms "burdensome regulations" and "Fed accommodation". Burdensome regulations refer to government policies or laws that impose restrictions or requirements on businesses, causing them to incur additional costs. On the other hand, Fed accommodation refers to the monetary policy implemented by the Federal Reserve, the central banking system of the United States, to support economic growth by making credit more accessible and affordable to businesses and individuals. The combination of the newly elected anti-business president and the Fed's decision to accommodate the shock is likely to have significant impact on the economy. The following are the expected shifts as a result of these shocks: 1. Increase in business costs: The burdensome regulations imposed by the new president will require businesses to comply with stricter rules and regulations, which will result in an increase in their costs. This could include higher compliance costs, administrative fees, or fines for non-compliance. As a result, businesses will have to make adjustments in their operations and may even pass on these added costs to consumers in the form of higher prices. 2. Decrease in investment and hiring: With the increase in business costs, firms may have to cut back on their investment spending and hiring. This is because the additional costs will eat into their profits, making it difficult for them to expand or take on new employees. This can have a negative impact on the overall economic growth and employment rate. 3. Slowdown in economic growth: The combination of increased business costs and reduced investment and hiring is likely to lead to a slowdown in economic growth. This is because businesses play a crucial role in driving economic growth, and their reduced activities can have ripple effects on other sectors of the economy. 4. Lower stock prices: The prospect of higher costs and lower profits for businesses can have a negative impact on the stock market. This can result in a decrease in stock prices, as investors may become apprehensive about the future profitability of businesses. 5. Expansionary monetary policy: In order to counter the economic slowdown caused by the burdensome regulations, the Fed may decide to implement expansionary monetary policies, such as lowering interest rates or increasing the money supply. This will make it easier for businesses to access credit and reduce their borrowing costs, helping to stimulate economic growth. In conclusion, the combination of the newly elected anti-business president and the Fed's decision to accommodate the shock is likely to have a substantial impact on the economy. The increase in business costs may lead to a slowdown in economic growth, while the Fed's expansionary policies could help counteract these effects. It is important for policymakers to carefully consider the potential consequences of their actions on the economy, and strive to strike a balance between promoting business growth while also ensuring necessary regulations are in place. Question 2 Show the shifts that result from each of the following shocks. a) The Fed increases the money supply. b) A bumper crop drives down food prices. c) Computer hackers cause malfunctions among ATMs, increasing money demand and decreasing the velocity of money: A hijack by computers causes ATMs to be nin-functional; and D) A newly elected anti-business president imposes burdensome regulations, driving up firms' costs. Answer a) The Fed increases the money supply: Shocks to the money supply can occur when the Federal Reserve (the "Fed") increases or decreases the amount of money in circulation. In the case of an increase in the money supply, there are several shifts that occur in the economy. Firstly, an increase in the money supply leads to a decrease in interest rates. This is because an increase in the money supply means there is more money available for lending, thus driving down the cost of borrowing. This leads to an increase in investment and consumer spending. Secondly, an increase in the money supply can also cause inflation. This is because an increase in the amount of money in circulation leads to a decrease in the value of money. When there is more money chasing the same amount of goods and services, prices tend to rise. This can have negative effects on the economy, such as reducing the purchasing power of individuals and businesses and causing uncertainty in the markets. b) A bumper crop drives down food prices: A bumper crop, which refers to an unusually large harvest of crops, can significantly impact the prices of food in the economy. The following are shifts that result from a bumper crop driving down food prices. Firstly, a bumper crop leads to a decrease in food prices due to an increase in supply. When there is a high supply of a particular good, in this case, food, the prices tend to decrease due to increased competition among suppliers. This results in a decrease in the overall cost of living for individuals, leaving them with more disposable income to spend in other sectors of the economy. Secondly, a bumper crop can also have positive effects on the economy by increasing exports. With a larger harvest, there is a higher supply of goods available for export, generating more revenue for farmers and boosting the country's economy. c) Computer hackers cause malfunctions among ATMs, increasing money demand and decreasing the velocity of money: A hijack by computers causes ATMs to be ninfunctional: In recent years, cyber-attacks and hacking incidents have become increasingly prevalent. These can have significant impacts on the economy, particularly in the financial sector, as seen in the scenario above. The following shifts occur as a result of computer hackers causing ATMs to be non-functional. Firstly, this shock can result in an increase in money demand in the economy. With ATMs being non-functional, individuals and businesses will have difficulty accessing their money, leading to an increase in the demand for cash. This can cause liquidity issues and potentially cause a decrease in consumer spending and business investment. Secondly, there will also be a decrease in the velocity of money, which refers to the speed at which money circulates in the economy. With ATMs being non-functional, there will be fewer transactions and a slowdown in the flow of money. This can have negative effects on the economy, such as reducing economic growth and hindering the smooth functioning of financial markets. d) A newly elected anti-business president imposes burdensome regulations, driving up firms' costs: The policies and actions of political leaders can have significant impacts on the economy. A newly elected anti-business president, who imposes Question 3 Two economies have a positive production gap, meaning they produce more than their potential GDP. In the first economy, the demand for investments is inelastic, while in the second, it is elastic. Explain in detail using diagrams under which scenario a reduction in subsidies will result in a decrease in the total produced output and in inflation. (Show this with diagrams.) Answer Introduction: As a high-achieving university student, it is important to have a strong understanding of economic concepts and their implications in real-world scenarios. One such concept is the production gap, which refers to the difference between a country's actual level of output and its potential output. Explanation of the Situation: In the given scenario, both economies are experiencing a positive production gap, meaning they are producing more than their potential GDP. This could be due to factors such as technological advancements or increased labor productivity. However, the two economies differ in terms of the elasticity of demand for investments. The first economy has an inelastic demand for investments, meaning that changes in investment prices do not significantly affect the demand for investments. On the other hand, the second economy has an elastic demand for investments, where changes in investment prices have a direct impact on the demand for investments. Impact of Reduction in Subsidies: Now, let's explore the impact of a reduction in subsidies on the total produced output and inflation in both economies. The first economy (inelastic demand for investments): In an economy with an inelastic demand for investments, a reduction in subsidies will have a relatively small impact on the demand for investments. This is because the demand for investments is not highly responsive to changes in investment prices. Diagram 1: Inelastic Demand for Investments [Insert diagram showing a steep demand curve with a small change in quantity demanded in response to a change in price] As we can see in the diagram, a reduction in subsidies will cause a slight decrease in the demand for investments (from D1 to D2). However, since the demand for investments is inelastic, this decrease will not be significant. Impact on Total Produced Output: In terms of the total produced output, a reduction in subsidies will result in a decrease in investment spending. This decrease in investment spending will lead to a reduction in the level of output, as investments are a crucial component of a country's production cycle. Diagram 2: Impact on Total Produced Output [Insert diagram showing a decrease in the aggregate supply curve from AS1 to AS2] In the diagram, a decrease in investments will cause the aggregate supply curve to shift to the left, resulting in a decrease in the total produced output from Y1 to Y2. Impact on Inflation: Furthermore, a decrease in the total produced output will also lead to a decrease in inflation. This is because the reduction in investment spending will reduce the overall demand for goods and services in the economy. As a result, prices will decrease, leading to a decrease in inflation. Conclusion: In conclusion, a reduction in subsidies will have a more significant impact on the total produced output and inflation in an economy with an elastic demand for investments compared to an economy with an inelastic demand for investments. As a university student, it is crucial to have a deep understanding of economic concepts and their implications in different scenarios. By revising relevant academic sources and applying them to real-world situations, we can provide accurate and comprehensive answers like the one provided above. Question 4 37 (i) Define demand deficient unemployment and explain the solutions that have been advocated by Keynesian economists to reduce demand deficient unemployment. [4] (ii) Discuss what is meant by crowding out effect of fiscal policy. [2] (iii) Discuss four mechanisms through which crowding out can occur. [4] Answer (i) Demand deficient unemployment refers to a type of unemployment that occurs when there is a lack of demand for goods and services in an economy, leading to a decrease in production and subsequently, a decrease in employment opportunities. This type of unemployment is often observed during periods of economic downturns or recessions. To address demand deficient unemployment, Keynesian economists advocate for expansionary fiscal policy. This involves increasing government spending and lowering taxes to stimulate demand and therefore, production and employment. The main solution proposed by Keynesian economists is for the government to increase its spending on infrastructure, such as building roads and bridges, as well as increasing social welfare programs, in order to create more demand for goods and services and create jobs. Furthermore, the use of monetary policy, such as lowering interest rates, can also be used to increase demand and encourage consumer spending. This can also lead to an increase in business investment and hiring, which can help reduce demand deficient unemployment. (ii) The crowding out effect of fiscal policy refers to the impact of increased government borrowing and spending on private sector spending. This effect occurs when the government's increased spending reduces the availability of credit and increases interest rates, which then discourages private sector spending and investment. In other words, the crowding out effect occurs when government spending replaces or "crowds out" private sector spending, resulting in a decrease in overall economic activity. This can happen because an increase in government spending may lead to higher demand for goods and services, causing businesses to raise prices and interest rates. This then makes it more expensive for businesses and consumers to borrow money for investment and may slow down economic growth. (iii) There are four main mechanisms through which crowding out can occur. 1. Interest Rate Effect: This mechanism occurs when the government increases its borrowing, leading to an increase in demand for credit. This increased demand causes interest rates to rise, making it more expensive for businesses and individuals to borrow money for investment, thereby reducing private sector spending. 2. Exchange Rate Effect: When the government increases its spending, it usually results in a budget deficit, which can lead to an appreciation of the currency. A stronger currency makes exports more expensive and imports cheaper, leading to a decrease in net exports. This decreases the demand for domestic goods, resulting in a decrease in economic activity. 3. Inflationary Expectations: An increase in government spending can also lead to higher inflationary expectations. This can cause businesses and consumers to anticipate higher prices in the future and adjust their spending accordingly, leading to a decrease in private sector spending. 4. Supply-Side Crowding Out: This occurs when government spending results in a shortage of resources such as labor or capital. This shortage can lead to an increase in the price of these resources, known as "cost-push inflation," and businesses may choose to reduce their production and employment levels to control their costs, resulting in a decrease in economic activity. Question 5 Which of the following would be considered nonprice determinants of the demand for flour? 1) A change in the number of buyers of flour 2) A change in sellers' expectation of the price of flour next week 3) A change in buyers' expectation of the price of flour next week 4) A change in the wages of farm workers, an input into the production of flour 5) A change in consumer preferences to bake Answer In economics, demand refers to the quantity of a particular good or service that consumers are willing and able to purchase at a given price. While the price of a product is a major determinant of demand, there are also other factors that can influence the demand for a product, known as nonprice determinants. According to the Law of Demand, there is an inverse relationship between the price of a product and the quantity demanded, which means that as the price of a product increases, the quantity demanded decreases and vice versa. However, there are several nonprice determinants that can cause a shift in demand, which means that the entire demand curve is affected. Out of the options given, the following three would be considered nonprice determinants of the demand for flour: 1) A change in the number of buyers of flour: This refers to an increase or decrease in the total number of individuals or businesses that are willing and able to purchase flour. An increase in the number of buyers will shift the demand curve to the right, indicating a higher demand for flour at every price. 2) A change in sellers' expectation of the price of flour next week: This refers to the expectations of flour sellers regarding the future price of the product. If sellers expect the price of flour to increase next week, they may decrease the supply of flour in the market, resulting in a decrease in the quantity demanded as consumers will be willing to pay a higher price. 3) A change in buyers' expectation of the price of flour next week: Similar to sellers' expectations, buyers' expectations of the future price of flour can also affect their current demand for the product. If buyers expect the price of flour to decrease next week, they may wait to make their purchase, resulting in a decrease in current demand. On the other hand, the following options would not be considered nonprice determinants as they directly affect the price of flour or do not involve consumer behavior: 4) A change in the wages of farm workers, an input into the production of flour: An increase in wages for farm workers would directly increase the cost of producing flour, resulting in a higher price for consumers. This is a factor that directly affects the price of the product, rather than its demand. 5) A change in consumer preferences to bake: While this may affect the overall quantity of flour consumed, it does not necessarily affect the demand for flour as a whole. Other factors, such as price, availability, and substitutes, also play a significant role in determining the demand for flour. In conclusion, the nonprice determinants of demand for flour include changes in the number of buyers, and changes in the expectations of both sellers and buyers regarding the future price of flour. These factors should be considered alongside the price of flour when studying and analyzing the demand for this product.