BUS104: Firm & Macroeconomic Perspective- Economics Assessment Answers

Economics Assignment

Part 1: Firm Perspective

1. Explain using a diagram what would happen in the market for car tires if at the

same time there was an increase in the prices of rubber used in the production of tires and a decrease in the price for cars. Explain the effects on price and quantity. (10 marks)

2. In a perfectly competitive market for apples explain would happen in the short

run to the market and to individual producers if the price for pears went up. Demonstrate your answer using a diagram. With reference to the same diagram show what would happen to the market and individual producers in the long-run. (10 marks)

Part 2: Macroeconomic Perspective

1. In Japan, potential GDP is 600 trillion yen and the table shows the aggregatedemand and short-run aggregate supply schedules.

a) What is the short-run equilibrium, real GDP and price level?

b) Does Japan have an inflationary gap or a recessionary gap? What fiscalpolicy can be used to correct this gap?

Let us analyses the consequences of the two events occurring in the car tires market simultaneously.

1. There was an increase in the prices of rubber used in the production of tires. An increase in the price of key input will lead to reduce the supply of car tires. The supply curve for car tires will shift to the left.
2. A decrease in the price of cars: The demand for cars will increase due to the fall in the price. Consumers will have an incentive to buy more cars. An increase in the demand for cars will in turn increase the demand for car tires. The demand curve for car tires will increase and shift to the right.

Thus there will be simultaneous leftward shift of the supply curve and a rightward shift of the demand curve. Let us analyze graphically:

DD is the demand curve and SS is the supply curve for the car tires. A was the initial equilibrium point with P* as the equilibrium price and Q* as the equilibrium quantity. An increase the price of rubber used in car tires will lead to shift the supply curve to the left. The supply curve shifts leftwards from SS to SS’. On the other hand an increase in the demand for cars will lead to shift the demand curve for tires to the right. The demand curve shifts from DD to DD”.B is the new equilibrium point in the market for car tires. At the new equilibrium point, the equilibrium price will increase from P* to P** but the direction of the change in equilibrium quantity remains indeterminate. It depends on the relative magnitude of the shift of the demand and supply curve (Smriti Chand, 2016)

Apples and pears are assumed to be substitutes to each other. An increase in the price of pears will lead to increase the demand for apples. The demand curve shifts to the right from DD to DD” .Market equilibrium price now becomes to P. The producers in competitive market act as price takers and hence their demand curve is D=AR=MR. The individual producers does not have any market power and there by no control over price. They determine the profit maximizing output at the point where Price (same as Marginal revenue) equals to marginal cost. The individual producers earn positive economic profit in the short run as shown by the green shaded rectangle.

This positive economic profit will attract other firms to enter in the market because free entry and exit are allowed in the competitive market. As a result the market supply curve will shift to the right from SS to SS” and then market price will come down. The entry of new firms will continue until all the positive economic profit is being eliminated. The long run equilibrium price for apple will be set at the minimum point of ATC. Firms will earn only normal profit in the long run. No firms will have any incentive either to enter or to exit in the long run (Roger A. Arnold, 2008).

1. Short run equilibrium real GDP is obtained at the point where Real GDP demanded equals to Real GDP supplied in the short run. From the above table , it can be said that short run equilibrium occurs at the price level of $95 because at this price level , real GDP demanded = real GDP supplied = 500

The short run equilibrium real GDP 500 trillion yen and the equilibrium price level =95

1. The potential GDP is 600 trillion yen but the actual real GDP is 500 trillion yen.

It implies that Japanese economy is operating below the potential level. There is a output gap called the recessionary gap. Here the recessionary gap = 600-500=100 trillion yen

Expansionary fiscal policy can be used to correct the recessionary gap. Government expenditure and the tax are the primary tools of expansionary fiscal policy. An increase in G or a decreasing tax will lead to stimulate the aggregate demand and boost the economy to move to the potential level (William A. McEachern, 2011).

Italian economy is reported to sink back to recession in 2012. A contraction of economic activities is witnessed across the economy. Estimated study reveals that Italian economy is recorded a contraction of 2.4% during 2012. Unemployment rate has reached to double digit. The consumer spending has reduced to a significant extent. A continuous weakness in aggregate demand pulls the economy in recession. This can be shown with the help of following diagram:

Economic collapse continued in 2013 in Italy. The condition of Greece was also bad but Italy was literally not manageable. The economic indicators mentioned above clearly indicate that the economy still remains weak and feeble. Economic contraction was forecasted at -1.5% in 2013. Economic growth tells only a little part of the story. There was massive job loss due to cut back in Industrial production. Unemployment rate has shown an upward trend continuously. Consumers had more pessimistic view about the economic outlook and this was reflected by the drastic fall in consumption expenditure. Automobile industry, one of the most promising industries in Italy has shown a 40% decline. The weakness in aggregate demand continues for another more year – the economy has moved further away from potential level. The economy further moves from AD to AD’ and produce lesser output at Y2.

At the bottom line, despite the third largest economy in Eurozone, Italian economy has entered into deep recession. Actually the above sources and other economic data confirm that economic crisis continues to be worsening in Italy in 2013. Political leaders have proven their inability to implement the required reform to bring back macroeconomic stability. Structural problems also remain intense during this period. Improving the situation of the economy became a huge challenge to the leadership (Hans-Jürgen Schlamp.2013).

Based on the above graph it can be said that

In January 2013, the unemployment rate was 11.3%

In July 2013, the unemployment rate was 12.1%

Labor force participation rate in Jan-13

(20000000/40100000)*100= 49.87531%

Labor force participation rate in July-13

(27000000/40900000)*100 = 66.01467%

An increasing labor force participation rate will exert an upward pressure on the unemployment rate. This is because the marginally attached workers are back to the labor force and come under the computation of official measure.

1. All the key macroeconomic indicators provide strong indication that the Indian economy is in the expansion phase of the business cycle. The movement of the components of aggregate demand confirms the economic boom in India during the recent times. The high rate of GDP growth signifies good economic health of the economy. India now is considered as the world's fastest-growing economy in the world (Michelle Cohan, CNN,2016).