Reflective Report for Economics Studies

Introduction

In this report, I am going to reflect on two economic questions; 1. COVID-19 impact on my country’s economy. 2. How policymakers intervene markets due to macroeconomic fluctuation. I will discuss in detail the Aggregate Demand and Supply, in both long run and short term. I will also review the factors that cause a shift in the Aggregate Demand and Supply and the equilibrium output.

Q1. a) Draw a graph that shows the short-run aggregate supply, long-run aggregate supply, and aggregate Demand. Describe the equilibrium point and show (i) equilibrium output (Y1), and (ii) equilibrium price level (P1)

P                                                     LRAS

SRAS

P1

AD

Y1                                                            Y

Aggregate Demand- it’s the total Demand for goods and services at a given time. When price decreases, the demand increases because the commodity is cheaper than others in the market, therefore the AD curve slopes downward from left to right on an aggregate demand and supply curve.

Aggregate Supply- the total amount and goods firms are willing and able to supply at a given time. In Supply, the effect on price is different in short-run Supply and long-run Supply. The long-run supply curve shows the relationship between the price level and the real GDP supply.

The long-run Supply (LRAS) is static and vertical on a curve because the GDP is only affected by employment, the level of technology, and the capital stock (factories, machinery, etc.), and these factors are not affected by the price level. Therefore the long-run Supply is vertical because it is not affected by the price level (Murphy, 2017).

The short-run Supply (SRAS) is affected by changes in nominal wages, labor productivity, and commodity price shifts. The SRAS curve slopes upward from left to right (Murphy, 2017).

Q1 (b). Owing to the outbreak of COVID19, the export market of country A has decreased. On your graph in (a) above, describe in detail the effects of lower exports on the equilibrium in the short run, labeling the new equilibrium and price level Y2 and P2, respectively.

P                                                     LRAS                             SRAS2

SRAS 1

P2

P1

AD

Y2             Y1                                                            Y

COVID 19 has affected all business sectors, including the export and import markets. There has been a decrease in both exports and imports; therefore, the international market is still at equilibrium, apart from those goods that do not get consumed locally, e.g., flowers. The decrease in flower exports will lead to an increase in their Supply (SRAS) at any given price level.

Q2 (c), Based on your result in part (b), what is the impact of lower wages on real wages in the short run? Explain.

According to Feenstra, Ma, & Xu (2019), International trade has two effects on the labor market, which then causes a fluctuation in wages. First, imports increases completion to the local firms and may cause some to exit. Second, exports expand the market to other firms causing them to grow, thus creating more jobs and increasing the real wages. Reduction in trading leads to an increase in Supply, therefore the cost of production is reduced. Reducing the cost of production means reducing inputs and reducing labor, therefore people lose their jobs, and the real wages reduce.

Q1 (d) show, with a new graph, how the economy will return to its original equilibrium in the long run if the government does not intervene. Explain.

P                                       LRAS2     LRAS 1                         SRAS2

SRAS 1

P2

P1                                                                A

AD

Y2           Y 1                                               Y

The government should ensure that there is a balance of trade to avoid effects on the long-run aggregate supply. If there are no exports, then the government should place bans on imports. This way, those firms with excess Supply due to a reduction in exports will have a local market, that is, the consumers who were importing their goods. If the government does not intervene, there will be a trade deficit that will result in the loss of jobs, thus unemployment. Unemployment, as I discussed in (a) above, is one of the factors that cause a shift in the (LRAS) Long-run aggregate supply. In the short-run aggregate supply, the number of employments is fixed; therefore, employment is fixed. Price and quantity shifts from the previous (LRAS), point A to a new (SRAS) at point B (Esponda, & Pouzo, 2019). In this case, firms make losses because of a decrease in Demand; this causes exit by the market, thus unemployment. In the long-run, the new SRAS becomes the new LRAS at point B, firms operate with lower Demand, they minimize their output to match the Demand, they make smaller profits, but the market is still at the equilibrium because the firms are producing what the market is able to consume.

Q1 (e) suppose the government decides to increase expenditure on new equipment,

1. What component of aggregate Demand will change? Explain

Consumption price will increase. Government spending on modern equipment will improve the quality of goods and services, thus increase in Demand, and the service industry will attract new customers because of faster and more efficient technology (Wang, Wei, Yu, & Zhu, 2018).

1. What is the impact on long-run aggregate supply? Explain

The long-run aggregate supply will is affected by wages, capital, and technology. The government spending on new equipment is advancement in technology, which will increase Supply in the long run. Therefore labor will be replaced with technology, and the LRAS curve will shift to the right.

Q2. How will policymakers intervene in the markets due to macroeconomic fluctuations?

Macroeconomic fluctuations occur when there is a shift in inflation, which is caused by fiscal variables, wages, money credit, trade, and exchange rates. Macroeconomic fluctuations are caused by an increase in Demand, a decrease in labor, and an increase in demand for imports. Policymakers’ primary concern with the fluctuations in the fact that they could cause inflation is a sudden rise in goods and services, this results to a decrease in Demand and reduction in unemployment. Policy makers main role is to set policies that will correct fluctuations even when they appear drastically (Ferrara, Lhuissier, & Tripier, 2018). Policymakers also have to cooperate with other countries to avoid difference in prices of local products from those of other countries. Difference in prices will cause a deficit in international markets. These will reduce the imports and exports of the country and decrease the economy in the long run (Bodenstein, Guerrieri, & LaBriola 2019)..

Economic policies are approaches taken by the government. They policies they set include adjusting the levels of taxation, interest rates, money supply, labour market and national ownership. The policies are categorised as fiscal policies, supply-side policies and monetary policies. These policies are influenced by the World Bank and International Money Funds.

Fiscal policies involve changes in taxation and government expenditure, monetary policy involves changes in the money supply to alter the interest rates and change inflation, and supply-side policy increases the economic productivity.

Policies to correct inflation;

Monetary policy- the government should increase the cost of borrowing in order to discourage spending and borrowing. This will reduce the prices of goods and services thus decreasing inflation.

Fiscal policies- the government should induce more taxes, this will hike the prices of goods and reduce Demand thus reducing the demand-pull inflation.

Supply-side policies- the government should increase competiveness by giving incentives for more privatisation of firms, this will reduce the cost of business and lower the inflations.

Wages control- increase in wage over a short period of time may cause inflation. To avoid this, policies are set to regulate the increase in wages.

Money supply- the government should increase interest rates to discourage borrowing and reduce liquid supply, thus reducing inflation.

Conclusion

The governments’ first task is to ensure that the whole economy is at equilibrium, and everyone in ‘happy’. They should set policies that are effective enough to correct the fluctuations and prevent an economic decrease. Economists should also ensure that they don’t just adopt policies when they collaborate with policymakers from other countries and device ones that are applicable to our economy. Completely different policies from those of other countries will cause a deficit in international trade, therefore economists should find the balance between collaborating with our neighbours to allow international trade and adopting policies that do not solve our economic problems.

References

Bodenstein, M., Guerrieri, L., & LaBriola, J. (2019). Macroeconomic policy games. Journal of Monetary Economics, 101, 64-81

Ferrara, L., Lhuissier, S., & Tripier, F. (2018). Uncertainty fluctuations: Measures, effects and macroeconomic policy challenges. In International Macroeconomics in the Wake of the Global Financial Crisis (pp. 159-181). Springer, Cham

Murphy, D. (2017). Aggregate Demand and aggregate supply.

Feenstra, R. C., Ma, H., & Xu, Y. (2019). US exports and employment. Journal of International Economics, 120, 46-58.

Esponda, I., & Pouzo, D. (2019). The industry supply function and the long-run competitive equilibrium with heterogeneous firms. Journal of Economic Theory, 184, 104946.