Intermediate Macroeconomics and Macroeconomic Coordination - Assignment Example

CHAPTER 04 (MACROECONOMIC COORDINATION) We know that when GDP, APE & ASF are unequal, than an interplay occurs (Macroeconomic coordination process) which bridges the gap between these variables. If there is a disparity between ADF & ASF, there will be an automatic reaction among money users & suppliers which restores the magnitude of these variables to equality generally known as funding adjustment. Similarly, if there is a difference in the values of GDP & APE, it will trigger the suppliers of goods & services to act together and bring the figure close to equality. This process is called output-price adjustment. The purchasers of the domestic output can be classified into three groups. Group 1 involves individuals having sufficient money to fund their planned expenditures. Group 2 comprises of individuals having insufficient money to fund their planned expenditures. The final group (Group 3) consists of individuals who have a surplus of money to fund their planned expenditures. Group 2 can acquire funds by begging, borrowing or reducing their planned expenditures. In a similar fashion, Group 3 can utilize their excess funds either by donating, lending or increasing their planned expenditures. Intermediaries such as banks and financial institutions exist to streamline the process between Group 2 and 3 by borrowing from Group 3 and lending them to Group 2 to meet the specific needs of each group. At the equilibrium point of ADF = ASF, the members of Group 2 and Group 3 are unaware while the amount that Group 2 is willing to borrow exactly equals the amount of money that Group 3 is willing to invest. In the case if ADF>ASF which implies that Group 2 is willing to borrow more than the amount that Group 3 is willing to invest intermediate groups play a key role by increasing the interest rates which will attract the depositors to increase the amount of fund they are willing to provide to the banks. The interest rates are increased to an extent where exactly the demand of all the borrowers is met and thus narrowing the gap between ADF & ASF and causing them to become equal. A funding adjustment occurs in an opposite way if the ADF < ASF (interest rates declining). Once the funding adjustment process has accomplished its task by equalizing the variables ASF & ADF, than one of the following situations might be prevailing in the economy. The outcome can be either; “GDP = APE = ASF” or “GDP < APE = ASF” or “APE < GDP = ASF”. Before understanding the gist of the output-price adjustment process it is imperative to divide the firms into their respective categories. Group 1 will comprise of those firms who have sufficient demand equal to their annual production rates. The second group which we will call as Group 2 will consist of those firms who are facing an excessive demand implying that they have a demand over their annual production rate. The Group 3 will consist of firms which are facing a demand curve which is below their production rates. We will assume that the firms operating in Group 1 are having zero economic profits and they have GDP = APE. Therefore the price-output adjustment process occurs in Group 2 and Group 3. When GDP = APE, the firms will be unaware of this equality but they will be cognizant of their respective demands. Group 2 will be facing an excessive demand and thus will respond by increasing the prices and output level. Similarly, Group 3 which is having an insufficient demand will counter by decreasing the output and price level. The increase in output & price on Group 2 exactly offsets the decrease in output & price level in Group 3. This causes the GDP & Price level to remain persistent thus making the ASF = ADF which further maintains the interest rates. In the scenario if GDP < APE = ASF, the firms will be unaware of the equality and they do not know that there is a net excessive demand. The Group 2 will be facing an excessive demand thus it responds by increasing the output level & prices. Group 3 with an insufficient demand reduces the price and output level down. However in these circumstances, the magnitude of excessive demand faced by Group 2 is greater than the magnitude of insufficient demand faced by Group 3. Hence, the final outcome does not offset each others demand but rather there will be a slight increase in net prices for a temporary period. The GDP rises to a point where all the variables equalize thus causing the interest rates to increase from their original level. Similarly, in case of “APE < GDP = ASF”, the GDP decreases and causes the interest rates to decline. CHAPTER 05 ( MACROECONOMIC SHOCKS: EXCESS DEMAND CASES) Macroeconomics shock cause a disruption between macroeconomic variables and makes them unequal thus unsettling the economy. Here we will elucidate the cases macroeconomic shocks pertaining to an excessive demand. There are generally three cases of excessive demand caused shock in the macroeconomic coordination process but we will be discussing two of them in our précis. First case is of an increase in APE. This rise in demand may be due to increase in domestic or foreign demand in the economy. The increase in demand due to rise in APE can be explained from the above graph. The APE line shifts to the right causing it to be greater than GDP & ASF. It will bring about a funding crisis thus inducing the interest rates to move in upward direction while bringing the APE down to a level which makes the APE equals to ASF. The APE reduces down because the cost of borrowing has become more expensive and people become restrictive in their spending decisions. At this span of time only APE & ASF have restored to equality while the GDP differs from both of them. Eventually, the process that we learned in the last chapter comes into play when GDP restores to equality by an increase in interest rates and a temporary price hike. The second shock can be triggered by an increase in ASF. An increase in ASF can be attributed to three reasons. Either the rise in M x V is greater than the rise in price level. It can be also due to the reason that M x V is to rise and Price Level to fall down. Finally, it is also possible when M x V were to fall lesser than the fall in Price levels. As we know that to increase the factor M, the banks are required to increase their lending to household and business sector. But we know that without a substantial demand for funds, the banks can not increase their lending’s. Therefore, they first need to stimulate the demand for APE in order to increase M. Assuming that banks have been successful in creating a substantial demand and thus increasing in M, we find that ASF increases which shifts its graph to the right (GDP = APE < ASF). When ASF is greater than APE, there is an insufficient demand for goods & services as compared to the supply of funding available for it. This causes the interest rates to go down, thus making the borrowing cheaper and inducing the APE to increase & ASF to fall down to a level where APE= ASF. This gives rise to a new level for these three variables where (GDP < APE = ASF). The inequality in GDP Level causes a temporary slash in price levels while interest rates moving down to bring the economy to equality (GDP = APE = ASF). CHAPTER 06 ( MACROECONOMIC SHOCKS: INSUFFICIENT DEMAND CASES) The shocks produced during macroeconomic activity are not limited to excessive demand but there are certain shocks also produced to insufficient demand for goods and services in the economy. The case for insufficient demand can be illustrated by the equation (APE < GDP = ASF). The first case is of demand caused recession which reduces the aggregate demand in the economy thus shifting the APE curve to the left direction. Such a reaction can be sparked off in the economy due to higher taxes imposed by a new fiscal policy. Similarly, another cause for a decrease in ASF can be due to the fact that government has reduced its expenditures in the economy thus reduced the Aggregate expenditures. When APE decreases, the APE line shifts to the left making the equation as APE < GDP = ASF. As we learned in the previous chapter, we find that this situation prompts the suppliers to respond by decreasing the output and prices. The extent to which the suppliers reduce prices causes the ASF line to shift rightward since we are assuming that M x V must be greater than the Price Level. The output will however cause the APE and GDP curve to shift leftward. The rightward moving ASF and leftward moving APE & GDP will meet at a certain point below the level of current interest rates. Thus we can deduce that interest rates will fall in the above situation and the economy will reach at a point where GDP = ASF = APE. The above process will generate net negative economic profits that will further shrink the GDP. The prices and output will continue to decrease until all the negative profits are eliminated form the economy. The second case that we will be expounding for macroeconomic shock pertaining to insufficient demand relates to cost push inflation. Many of the businesses often face rising cost structures and they try to pass on these expenses to the customer by increasing the product prices while reducing the output level. When Price Level increases, we can observe a decrease in ASF thus shifting its graph on left. Similarly, the economy will experience a decrease in APE & GDP since the output level has fallen considerably. Once all three graphs have shifted leftward, we are faced with interest rates moving in the upward direction. Read More