Principles of Economics - Essay Example

?Principle of Economics Table of Contents Table of Contents 2 Question 1a 3 Question 1b 5 Question 2 6 Four Phases of Business Cycle 6 Exchange Rate Fluctuation 9 Uncertainty in Confidence Level 9 Uncertain Job Creation 10 External Environment 10 Changes in Policies 10 References 12 Question 1a Gross Domestic Product (GDP) is conceptually referred as the process of measuring the value of all manufactured and traded goods as well as services in the national market, within a specific time period. Theoretically, it is the amount of National Income (NI) and it is produced within a country. It includes all the private as well as public consumptions occurred within the given territory for a defined period of time, viz., yearly, quarterly or monthly. It signifies the current state of any economy and is commonly measured on a yearly basis (Haggart, 2000). As stated in Sloman & et. al. (2012), various policymakers and economists use GDP as the measure of economic well-being. Countries are also often graded according to their GDP values in order to decode their economic development in comparison to other economies in the global network (Sloman & et. al., 2012). However, an in-depth understanding to the concept reveals that economists cannot or most justifiably should not focus only on measuring GDP when quantifying the progress of an economy. In other words, there are certain limitations possessed by the concept of evaluating national progress or development depending exclusively on GDP. For instance, GDP has often been criticised to lack in measuring the outputs of all services as well as goods. As a result, the values of few goods as well as services go unrecorded; thus, understating the nation’s economic growth. There are mainly two reasons for GDP to lack in recording goods as well as services. For example, when people tend to perform their own labour work without involving a third party, the manpower invested or otherwise marketed is not recorded in GDP statics. Illustratively, if parents hire a babysitter for their baby, the service cost is counted as the part of GDP; but, if the parents decide to stay back at home and deliver their services to take care of their baby, the countable opportunity cost of hiring a professional is not considered as the part of the GDP. At the national level, hen similar attributes remain uncounted or ignored to be measured appropriately, the national activities remain understated and the true value of economic production becomes erroneous (Sloman & et. al, 2012). Similarly, GDP calculation procedure also does not take into account the currency flow generated through illegal trading that is commonly attributed as ‘underground economy’. Underground economy specifically comprises of illegal and undeclared transactions. The transaction could be illegal in the forms of drugs trading, prostitution and smuggling among others. Again, the transaction can be stated as undeclared only in the sense that they are not exposed for the tax purpose and hence, remain unidentified in the GDP calculation procedure (Sloman & et. al., 2012). It is in this context that GDP lacks accounting for intangible variables sourced within the nation to ensure the well-being such as health, happiness, and woes. It also does not include environmental impacts of production functions practiced within the economy, additionally ignoring the unequal distribution of health (Sloman & et. al., 2012). Notably, one major problem faced by economists when measuring well-being or similar intangible variables by using GDP is that it does not include population of a nation into an account. If these variables are taken into account, countries like India and China, those have greater volume of population, shall be better off in comparison to Australia, which is much advanced than the mentioned nations in terms of technology, infrastructure and other production function variables. Again, as per the common principles of GDP, when the production increases it may be attributed to the technological advancement. On the contrary, if increase in production forces the worker to work harder or for longer hours, the resulting benefits are considered to be less. Under such conditions, leisure time, health and happiness can be attributed with the pleasant working condition and the desirable good of the labor force of the economy. However, these variables cannot be included in GDP figures as they are extremely difficult to be quantified and also to be place on a comparable value (Freiling, 2013). Hence, owing to these limitations, GDP cannot be considered as an exclusive tool for measuring the well-being of the people. It can therefore be concluded as true that GDP cannot be considered as a good measure of economic welfare, while GDP should be viewed in the context of the effective measure of output and income. Question 1b Aggregate demand is the total amount of spending on goods as well as services produced in an economy within a given period of time. Principally, it consists of four elements, viz., consumer expenditure (C), investment spending by company on capital goods (I), government expenditure on publicly delivered goods and services (G), expenditure in exports (X) and expenditure on the foreign goods and services (M) (Sloman & et. al., 2012). Mathematically, it can be expressed as AD = C+I+G+X+M, where the actual growth is the percentage annual increase in the national output actually produced (Sloman & et. al., 2012, pp. 444). The major determinants of the fluctuation in the rate of actual growth in short run are variations in the growth of aggregate demand. Thus, a rapid rise in the aggregate demand will force the firms in a nation to increase output and thereafter, reducing limp in the economy. Similarly, a fall in aggregate demand will tend the firm to hold extra stocks of unsold goods. Owing to the fact it can be concluded that the rapid rise in aggregate demand curve will lead to a higher growth rate of the producing firms in the short run. It is worth to be noted in this regard that a recession is reflected by the downfall in aggregate demand. However, the rapid changes in the aggregate demand cannot prolong the level of the growth over a number of years in an economy and thus remains constricted in the short-run. Thus, as a result of the rise in the actual output, there must be a substantial rise observed in the potential output, otherwise rise in the actual output will eventually come to an end. In brief, the rate of potential growth limits the rate of actual growth over the long-run period, as can be observed from the diagram below (Sloman & et. al., 2012). Fig. 1: Aggregate Demand and Aggregate Supply (Sloman & et. al., 2012, pp. 444) Question 2 Four Phases of Business Cycle The inconsistent level of economic activity that is experienced by an economy for a long-run period is generally addressed with the application of the business cycle model. In other words, the cycle of booms and recession is referred to as business cycle or trade cycle (Sloman & et. al, 2012). There are four phases of business cycle named as (a) upturn, (b) expansion, (c) peaking out, (d) slowdown, recession or slump As can be observed from the below diagram (Sloman & et. al, 2012, pp. 416). Fig. 2: The business cycle (Sloman & et. al., 2012, pp. 416) Conceptually, in the upturn phase, the contracting and stagnant economy begins to recover and the growth in the actual output resumes. Correspondingly, in the expansion phase, identified by the strong economy, where firms start making money and the demand for goods as well as services increases. In the expansion phase, the economic growth is assumed to be at its highest speed. The economy is also booming and the gap between the actual and potential output narrows. The peaking out phase is characterised further by the end of expansion or the prosperity phase. The growth slows down or ceases subsequently. Again, in the peaking out phase, businesses attempt to decrease its spending and begin reducing their costs related to production. As the demand for the goods as well as services decreases, workers in industries or more precisely in firms are likely to face retrenchment issues in this phase. In the final stage of recession or slowdown phase, economic demand is substantially reduced when there is no growth at all or even when a decline in the output is witnessed. In this phase, the overall decrease in the goods as well as services, results in the decrease of overall GDP level, which further results in high level of unemployment (Booke, n.d.). Corresponding to the general point of view of economic fluctuation is a natural phenomenon. All countries therefore have to notice ups and downs regarding the economic development. To be specific, continuous ups and downs can be observed when the real GDP change of the UK is closely analysed. The recent figures in this regard states the fact that the UK experienced a sustain growth till 2008. It is duly notified in the figure that UK faced a sharp economic downfall in the year 2009 owing to the occurrence of global economic crisis and recession. Additionally, it can be stated that economic growth has been weak since the end of recession in the UK as assumed in the business cycle model. In accordance to the fact, the annual GDP of the nation has also been less than 2% after the UK faced recession (Riley, 2012). A critical evaluation of the scenario thus reflects that the falling housing prices had affected the country’s wealth and led it to face a contraction in new housing building. Subsequently, with the rising unemployment rate, there was a sharp fall witnessed in the consumer confidence. The fear that liquidity trap might come in future or the increase in the price of goods as well as services, further motivated the consumers to save more and thus, resulting in a contraction in the economy (Krugman, 2013). There are various factors accountable for the irregular as well as inconsistent depiction of the business cycle in the present business scenario, which includes competitive business environment and changing market conditions due to globalisation and advent of technologies at a rapid and continuous pace. It has been thus identified that there are five major factors responsible for the inconsistent projection of business cycle observed within an economy, which include exchange rate fluctuations, uncertainty in confidence level, uncertain job creation, external events and changes in policies. Exchange Rate Fluctuation The phases in the business cycle change with the alterations in the exchange rate. Conceptually, exchange rate is an important factor accountable to have an impact on trading activities, consumption level and investment functions among others. In this respect, with an increase in the exchange rate of currency of a country is likely to adversely affect the business, trading and investment operations within the nation and vice versa. Accordingly, the fluctuation in the exchange rate will change the phases of business cycles (Duarte & et. al., 2007). Uncertainty in Confidence Level The business cycle models are further based on confidence level of consumers and businesses in an economy. The fluctuation in business cycle is also observed as dependent on the confidence level towards a stabilised and sustainable future. In an economy, where there is an increase in the confidence level amid businesses and people, the trends are very likely to signify improved consumption, investment and employment opportunities. To be mentioned, the aforementioned factors are the major drivers of improving economic activity. In this regard, a fluctuation in these factors can be assumed to have a strong affect on the business cycle (Leduc, 2010). Uncertain Job Creation Business cycle depicts a fluctuating tendency due to uncertainty in the rate of job creation in an economy. The rate of employment, in this context, can be observed to have a significant impact on the business cycle. Business cycle and rate of employment are interrelated as the amount of wages paid to workers and the business profits are interdependent. In this regard, wages and profits reveal the appropriate procedure on the basis of which, income is distributed in an economy. Respectively, a change in income distribution is most likely to affect the business cycle (Haan & Sedlacek, 2013). External Environment The business cycle is based on different external factors, which include crisis situation, political conflict and other external activities that may adversely affect business operations on a global context. In this respect, there are different international events that may cause a direct impact on investments, trading and business activities within the global context (Teara, 2012). Changes in Policies The business cycle phases of countries further seem to differ due to various factors, which include political along with economic policies. The changes in the policies in an economy will affect business cycles as the economic activities, which include trading as well as investment and are based on policies formulated by the government of a country. In this regard, monetary along with fiscal policies are recognised to affect economic activities substantially, which in return shall impact the business cycle of the economy to a considerable extent (Ganong & et. al., 2013). In this respect, it can be comprehended that the aforementioned factors are majorly responsible for inconsistencies and irregularities of business cycles in an economy. References Booke, R., No Date. Traits of the Four Phases of the Business Cycle. Small Business. [Online] Available at: http://smallbusiness.chron.com/traits-four-phases-business-cycle-26258.html [Accessed November 12, 2013]. Duarte, M. & et. al., 2007. Exchange Rates and Business Cycles across Countries. Economic Quarterly, Vol. 93, No. 1, pp. 57-76. Freiling, N., 2013. The Shortcomings of GDP as a Measure of Economic Growth. Hans Economic. [Online] Available at: http://hanseconomics.com/2012/01/29/the-shortcomings-of-gdp-as-a-measure-of-economic-growth/ [Accessed November 12, 2013]. Ganong, P. & et. al., 2013. The Decline, Rebound, and Further Rise in SNAP Enrolment: Disentangling Business Cycle Fluctuations and Policy Changes. Harvard University. [Online] Available at: http://www.hks.harvard.edu/jeffreyliebman/ExplainingTrendsInSNAPEnrollmentAugust2013.pdf [Accessed November 11, 2013]. Haggart, B., 2000. The Gross Domestic Product and Alternative Economic and Social Indicators. Introduction. [Online] Available at: http://www.wikiprogress.org/images/THE_GROSS_DOMESTIC_PRODUCT_AND.pdf [Accessed November 12, 2013]. Haan, W. J. D. & Sedlacek, P., 2013. Inefficient Continuation Decisions, Job Creation Costs, and the Cost of Business Cycles. Papers. [Online] Available at: http://www.wouterdenhaan.com/papers/bc-costs.pdf [Accessed November 11, 2013]. Kalyan City Life, 2013. 4 Phases of Business Cycle in Economics with Diagram. Four Phases of Business Cycle. [Online] Available at: http://kalyan-city.blogspot.com/2011/06/4-phases-of-business-cycle-in-economics.html [Accessed November 12, 2013]. Krugman, P., 2013. Why Is The Liquidity Trap? Free Exchange Economics. [Online] Available at: http://www.economist.com/blogs/freeexchange/2013/10/monetary-policy-2 [Accessed November 12, 2013]. Leduc, S., 2010. Confidence and the Business Cycle. Economic Letter. [Online] Available at: http://www.frbsf.org/economic-research/publications/economic-letter/2010/november/confidence-business-cycle/ [Accessed November 11, 2013]. Riley, G., 2012. Understanding the Economic Cycle. Introduction. [Online] Available at: http://tutor2u.net/economics/revision-notes/as-macro-cycle.html [Accessed November 12, 2013]. Sloman, J & et. al., 2012. Economics. Pearson Education Limited. Teara, 2012. Story: Business Cycles. Page 3 - Causes and Consequences of Fluctuations. [Online] Available at: http://www.teara.govt.nz/en/business-cycles/page-3 [Accessed November 11, 2013]. Read More