Economics for Business:568354

Question:

1.- write a 3,000 word report to the Board of Director of Schmeckt Gut in which you address the following:

2.- Do you think you can match the different projections? For example, do you think that a 5% increase in income is associated with a 10% tariff rate and a 2% inflation rate? You need to predict how changes in average in income, tariffs, and inflation would impact on the average demand. In this case, you need to run regressions once again.

Pick 4 scenarios/projections  and apply a multinear regression analysis

i.e. Conducting a multiple linear regression (in log linear form) which is Log Y = α + β1X1 +β2X2 +β3X3 + β4X4. The log is in base e so you need to put in Excel the formula = LN (average demand).

Excel spreadsheet to be separate to this report

3.- Discuss supply, demand and aggregated demand and aggregated supply, the Philipps Curve and the Laffer curve in relation to findings above in analysis

i.e.  What impact would the different predictions of income development, inflation rate development and tariff rate development have on the potential demand of Schmeckt Gut?

Answer:

Answer 1

The Consumer Price Index (CPI) is a measure of the general price level in an economy which is estimated by taking the weighted averages of the prices of a representative basket of consumption goods and services. It represents the cost of living of the individuals in an economy at a point of time (Mankiw, 2012). The inflation rate is defined as the rate of change in prices from one year to the other. Thus the annual rate of change in CPI represents the annual inflation rate of an economy (Dornbusch, Fischer and Startz, 2013).
The Consumer Price Index (CPI) and the Inflation Rate for Australia over the period 2005 to 2015 is given as follows:

Source: www.abs.gov.au, Catalog No: 6401

The Average Weekly Earnings is defined as the weekly earnings of individuals on an average over a certain point of time.

The Average Weekly Earnings and the growth rate of Average weekly earnings in Australia for the period 2005 to 2015 is given as follows:

Source: www.abs.gov.au, Catalog No: 6302

The following figure shows the inflation rate and the weekly earnings growth rate for Australia over the period 2005 – 2015:

Over the period 2005 to 2015, both the inflation rate and the growth rate of average weekly earnings has been fluctuating rapidly. The inflation rate started off at a considerably high level in 2005 and then dropped steeply in 2007 only to register a steep rise in 2008. Over the entire period the inflation rate is oscillating and does not follow any specific pattern. The growth rate of average weekly income was high towards the beginning. It was constant till 2007 after which it declined sharply to recover in the following period. From mid-2008 to mid-2010 the average weekly income has been consistently growing. It fell steeply in the following period. In the recent years, the average weekly income has declined considerably in the Australian economy. The rapid changes in both inflation rate and average weekly income during the phase can be partially attributed to the global financial crisis.

It is evident from the given figure that on an average the inflation rate and the growth rate of average weekly income move in the opposite direction, that is, as the inflation rate increases, the average weekly income register a negative growth rate and as inflation falls, the growth rate of average weekly income increases. This inverse relationship between the two variables is justifiable. As inflation increases, the purchasing power of individuals falls (Dornbusch, Fischer and Startz, 2013). Moreover, a rise in the price levels will reduce the demand for commodities. A reduction in demand in turn translated into a reduction in labour demand. Consequently the wage rate falls and the average weekly income in the economy also falls (Blanchard and Johnson, 2013).

Answer 2

(a) The Gross Domestic Product of an economy is given as:

GDP = C + I + G + X – M

Where,

C: Consumption Expenditure

I: Investment Expenditure

G: Government Expenditure

X: Exports

M: Imports

(Dornbusch, Fischer and Startz, 2013)

When the price of iron ore which is a major export product increases substantially, the export demand for iron ore will fall will fall both in the international market as well as the domestic market. Exports form a positive component in the GDP of the economy. Thus, when the demand for exports falls, the aggregate demand in the economy will fall (Blanchard and Johnson, 2012). This will lead to a fall in the aggregate supply to re-establish equilibrium in the Australian economy. Thus the GDP will fall. When aggregate demand falls, given the supply, the general price level will fall. This is shown in the following diagram:

In the above figure E represents the initial equilibrium. As the export demand in the Australian economy falls, there is a fall in the aggregate demand in the economy. This is represented by a shift of the aggregate demand curve from AD to AD’. Given that the aggregate supply curve AS remains constant, the new equilibrium is established at E’. At the new equilibrium, the quantity demanded falls from Q* to Q’ and the price falls from P* to P’. Thus the real GDP falls and the general price level also falls (Mankiw, 2012). Here the change in the real GDP and the general price level is a result of a change in aggregate demand.

(b) As a favorable set of weather conditions leads to a substantial rise in Australian agricultural output, the aggregate supply in the economy is going to increase (Dornbusch, Fischer and Startz, 2013). Given the aggregate demand, the level of output, that is, the gross domestic product will also increase. When aggregate supply increases and aggregate demand remains constant, the price level will fall. This phenomenon is illustrated in the following diagram:

At the initial equilibrium E, the price level is P* and the real GDP is given by Q*. When the aggregate supply increases due to an increase in the supply of agricultural output, the aggregate supply curve shifts from AS to AS’ as shown in the figure above. The new equilibrium is established at E’. At the new equilibrium, the quantity increases from Q* to Q’. On the other hand, the price level falls to P’ from P*. Thus when agricultural output increases, given the aggregate demand, the real GDP will increase and the general price level will fall. Here the change in the real GDP and the general price level is a result of a change in aggregate supply (Dornbusch, Fischer and Startz, 2013).

(c) When the government spends a significant sum of money in developing a broadband network across the country, there will be an increase in the general government expenditure in the economy. Government expenditure is a positive component in the gross domestic product of an economy. Thus when the government expenditure increases, the aggregate demand in the economy will rise. In order to establish equilibrium output, the aggregate supply will also rise (Blanchard and Johnson, 2012). Thus the real GDP will increase. On the other hand, as the aggregate demand rises, given that the aggregate supply curve remains the same, the price level will rise. This is shown in the following diagram:

At the initial equilibrium E, the general price level is P* and the real GDP is Q*. When the government expenditure increases, the aggregate demand shifts from AD to AD’. Given that the aggregate supply curve AS remains constant, the new equilibrium is established at E’. Thus, the price level increases from P* to P’ and the level of output increases from Q* to Q’. Thus, an increase in government spending will increase the real GDP and the general price level by augmenting the aggregate demand in the economy. The change is due to a change in the aggregate demand (Mankiw, 2012).

(d) Import is a negative component in the measurement of the gross domestic product of an economy, that is, as imports rise, the aggregate demand in the economy will fall leading to a fall in the GDP. When the price of oil which is a product that is substantially imported, falls, the demand for oil imports in the Australian economy will fall (Dornbusch, Fischer and Startz, 2013). Thus the import demand will rise and this will lead to a fall in the aggregate demand in the economy. In order to generate equilibrium output, the aggregate supply will fall leading to fall in the gross domestic product. Thus real GDP will fall. Again, as the aggregate demand falls, there will be a fall in the general price level in the economy. This is shown in the following diagram:

At the initial equilibrium, the price level is P* and the equilibrium quantity of output is Q*. When the import demand increases, the aggregate demand falls as represented by a shift in the aggregate demand curve from AD to AD’.  At the new equilibrium E’, the price level falls from P* to P’ and the equilibrium quantity falls from Q* to Q’. Thus there is fall in the general price and level as well as the real GDP due to a change in the aggregate demands in the Australian economy (Blanchard and Johnson, 2012).

REFERENCES

Blanchard, O. and Johnson, D. (2012). Macroeconomics. 6^th ed. New York: Pearson Education.

Dornsbusch, R. Fischer, S. and Startz, R. (2013). Macroeconomics. 12^th ed. New York: McGraw Hill Education.

Mankiw, N. (2012). Macroeconomics. 8^th ed. New York: Worth Publishers.