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Measuring GDP and Economic Growth

Measuring GDP and Economic Growth

A small economy produced the following final goods and services during the given month: 3 million kilograms of food, 50 000 shirts, 20 houses, 50 000 hours of medical services, one motor car plant and two tanks.  Calculate the value of this output at the following market prices.

    • $1 per kilogram of food.
    • $20 per shirt.
    • $50 000 per house.
    • $20 per hour of medical services.
    • $1 million per motor car plant.
    • $50 000 per tank.

Mark works part time at Pizza Hut and earn an annual wage of $15  000.  He sold 4000 pizzas at $5 per pizza during the year.  He was unemployed part of the year, so he received unemployment benefits of $30 000.  During the year, Mark bought a used car for $1000, using the expenditure approach, how much has Mark contributed to GDP?

Suppose the economy has been in a recession and everyone is asking when it will recover.  To find an answer to the state of the economy’s heath, a television reporter interviews Terence   Asaud, a local car dealer. Asaud says, “I do not see any recovery. This year our second quarter sales were down on the first quarter. In the third and fourth quarters we then sold a lot more cars than the second quarter, but sales in both these two quarters are still down on what they were in same quarter last year.” Is Mr. Asaud correct?  Are his observations with the peak, recession, trough or expansion phase of the business cycle?

Jobs and Inflation

Australian Bureau of Statistics reported the following data for 2015:

Labour force participation rate: 69.6 per cent

Working-age population (in thousands people): 18,429,726

Employment-to-population ratio: 65.2

  • Calculate the labour force.
  • Calculate the employment.

In New South Wales in October 2015, the labour force was 3,803,200 and 200,500 people were unemployed. In November 2015, the labour force decreased by 300 and the number employed increased by 2,900.

  • Calculate the unemployment rate in November 2015.

CPI and Inflation

Suppose your market basket for the university education considered of only four items (fictitious costs) listed in the following table, with quantities of each fixed in both periods indicated in the notes below the table.

Item

2003

 

2004

 

Tution and Fees1

                   $2 500

                        $3 000

Room and board2

                   $6 000

                         $6 200

Books3

                  $1  000

                               $10

Soft drinks4

                      $150

                             $200

tuition for 2 semesters

Payment for nine months

Twenty books of 800 pages with full colour

One hundred 350 ml coca-colas

Using 2003 as your base year, what is the percentage change in the university education price index?  

What are the three criticisms of the CPI?

Quantity Expansion (QE) of Money in the European Union (EU)  

On March 9 2015, the European Union (EU) commenced quantity expansion of money, Euro (€). The European Central Bank (ECB) has increased the quantity of money by 60 billion euro every month in the open market in an attempt to support the economy of EU countries. The large increase in the quantity of money is expected to have significant impacts on a range of economic sectors in the EU and global financial markets.   

Jobs and Inflation

Analyse how the quantity expansion of euro money is likely to affect money supply, interest rate, investment and consumption, and economic growth in the EU.  Draw relevant graph(s) for your analysis.

Discuss how the quantity expansion of euro money would change the value of euro, exchange rate (depreciation or appreciation) against other currencies, and exports and imports in the EU.  How would this contribute to EU’s current account balance and would this improve the competitiveness of the EU economy in the global market?

The United States is likely to Raise Interest Rate soon

The U.S. Federal Reserve chairman, Dr Janet Yellen, has signalled that the United States is likely to raise its interest rate as US economic indicators has improved. On the other side of the world, however, the interest rates in many other countries including the EU and Australia are on hold at their lowest level ever.

Explain, in the short run, how and why an increase in US interest rate is likely to change the flow of funds between the United States and Australia.

Using a graph, explain how an increase in US interest rate is likely to affect loanable funds supply and interest rate in Australia. Also, analyse how the change in loanable funds supply and home loan interest rate are likely to influence housing demand, house prices, and household debt burden in Australia.

Discuss how and why an increase in US interest rate is likely to affect the value of Australian dollar and exchange rate (depreciation or appreciation) against the US dollar. Also, discuss how the change in exchange rate is expected to influence Australia’s exports, imports and the current account balance (improve or worsen).

Exchange Rate and Balance of Payments

  • For each of the following situations, indicate the direction of the shift of the supply or the demand curve of the domestic currency, the factor causing the change and the resulting movement of the equilibrium exchange rate for the domestic currency.
  • The domestic country’s exports become more popular overseas.
  • The domestic country experiences a recession, while other nations enjoy economic growth.
  • Inflation  rates accelerates in the domestic country, while inflation rates remain constant in other nations.
  • Real interest rates in the domestic country rise, while real interest rates abroad remain the same.
  • Tourism from the domestic country increases sharply because of fare war among countries.

In July 2015, Australian dollar is trading at US$0.75 per Australian dollar and the interest rate in Australia is currently 2 per cent a year. It is forecast that the US will increase its interest rate some time later this year.   

If the interest rate in the US increases to 3 per cent a year, how is it likely to affect the flow of funds between Australia and the United States and the exchange rate of US dollar against Australian dollar (depreciation or appreciation)?  What is likely to happen to the current account balance of the United States?  (5 marks)

Balance of Payments

The table gives some information about the US international transactions in a year.

Explain and calculate the current account balance.  (2 marks)

Explain and calculate the capital account balance.

Did the US official reserves increase or decrease? Explain.

Was the US a net borrower or a net lender in this year? Explain your answer.

Measuring GDP and Economic Growth

Measuring GDP and Economic Growth

(a) The value of the produced output at the given market price is:

$ [(3,000,000 * 1) + (50,000 * 20) + (20 * 50,000) + (50,000 * 20) + (1 * 1,000,000) + (2 * 50,000)]

= $ (3,000,000 + 1,000,000 + 1,000,000 + 1,000,000 + 1,000,000 + 100,000)

= $ 7,100,000 = $ 7.1 million

(b) Mark’s annual wage at Pizza hut = $15,000.

His income from selling pizzas = $5 * 4000 = $20,000

Unemployment benefits received by Mark = $30,000

Mark bought the used car for $1000.

In the expenditure approach, the components considered in the GDP are consumption, investment, government spending and net exports (Dornbusch, Fischer and Startz, 2013).

Hence, Mark’s contribution to the GDP will only consider his consumption expenditure.

Mark’s contribution to GDP is $1000.

(c) Mr. Asaud is correct. According to the estimates of car sales provided by him, the economy does not seem to be recovering any time soon. The car sales which translate into GDP are experiencing a negative growth relative to the previous year. Assuming that it is the same for other commodities as well, it can be stated that the economy is in a phase of recession (Dornbusch, Fischer and Startz, 2013). This is because it is a peiod of economic decline, that is, negative economic growth in terms of the representative commodities. However, sales of cars solely do not determine the demand or the GDP of the economy. It may also be the case that the country is in a recovery phase but it is not instantly reflected in the sales of cars, evidently because cars are luxury commodities (Dornbusch, Fischer and Startz, 2013).

Job and Inflation

Labour force participation rate: 69.6%

Working age population (in thousands people): 18,429,726

Employment to population ratio: 65.2

(a) The labour force participation rate is given as,

Labour force / Working-age population (Dornbusch, Fischer and Startz, 2013)

? Labour force = Labour force participation rate * Working-age population

= (69.6 / 100) * 18,429,726,000

= 12,827,089,000

(b) The employment is given as,

18,429,726,000 * (65.2 / 100) = 12,016,181,000

(c) October 2015:

Labour Force = 3,803,200

Unemployed = 200,500

November 2015:

Labour force = 3,803,200 – 300 = 3,802,900

Unemployed = 200,500 – 2,900 = 197,600

The unemployment rate in November 2015 is,

(197,600 / 3,802,900) * 100%

= 5.20%

CPI and Inflation

The total price or cost of university education in 2003 is,

Jobs and Inflation

$ (2500 + 6000 + 1000 + 150) = $9650

The total price or cost of university education in 2004 is,

$ (3000 + 6200 + 10 + 200) = $9410

? the change in the university education price index is $(9410 – 9650) = –$240

The percentage change in the university education price index is (–240 / 9650) * 100% = 2.49%

Thus, there is decrease in the university education price index by 2.49%.

The three criticisms of the CPI are (Dornbusch, Fischer and Startz, 2013):

(i) There is a substitution bias in the construction of the CPI.

(ii) The CPI does not consider new products. The consumption basket remains the same which may not be the case actually.

(iii) The CPI does not take into account the changes in the quality of the commodities in the consumption basket. This may produce biased results.

Quantity Expansion (QE) of Money in the European Union (EU)

(a) The expansion in the quantity of money affects all the macroeconomic parameters of an economy. The effects are shown in the following diagram:

As a result of the expansion of the quantity of money, the money supply curve shifts to MS’ from MS. Thus the money supply will increase. As the money supply increases, given the money demand MD, the interest rate falls from r to r’ as shown in the figure. Interest rate is the cost of investment. Thus as the interest rate falls, the cost of investment will also fall. Hence, the level of investment will increase. Again, as the supply of money in the economy increases and the interest rate falls, the opportunity cost of holding money falls (Dornbusch, Fischer and Startz, 2013). Thus people will increase their demand for money. The increased demand for money translates into increases demand for output. Thus there will be an increase I the consumption level of individuals. Consequently, as consumption and investment increase, the GDP of the economy will increase. This will ultimately lead to economic growth (Dornbusch, Fischer and Startz, 2013).

(b) The quantity expansion of money reduces the interest rate in the economy. Thus, capital will flow out of the economy to other countries with higher interest rate and returns. This naturally reduces the value of euro. There will hence be a fall in the exchange rate, that is, the exchange rate for euro will appreciate against other currencies. As the exchange rate appreciates, the relative price of commodities exported by the European economy increases. This leads to a fall in the demand for exports. Again, foreign commodities become relatively cheaper. Hence the demand for imports increases. Thus, the net exports of the economy will fall. This will lead to a decline in the current account balance of the European economy. Thus the current account will be negatively affected (Krugman, Obstfeld and Melitz, 2012). The ultimate result of this would be deterioration in the competitiveness of the European economy in the global market.

CPI and Inflation

(c) As the interest rate in U.S. increases, the return prospective on investment in the US economy increases. On the other hand, in the economy of Australia, the interest rate is at the lowest level. Thus investment in Australia would not yield potential returns. Thus capital and funds will flow out of the Australian economy and into the U.S. economy. The flow of funds would be largely diverted from Australia to U.S. as a result of the increase in the interest rate in U.S. The U.S. economy as compared to the Australian economy would be a more efficient investment option for potential investors.

(d) As the interest rate in U.S. increases, funds will flow out of Australia into the U.S. market. Thus, the level of capital available in the Australian economy will fall (Krugman, Obstfeld and Melitz, 2012). This will in turn lead to a fall in the supply of loanable funds in the Australian economy. The fall in the supply of loanable funds would generate an excess demand in the market for loanable funds, thereby leading to a rise in the interest rate. This is shown in the following diagram:

As the supply of loanable funds falls from S to S’, given the demand D there is excess demand for loanable funds in the Australian economy. Thus the interest rate rises.

As the interest rate rises, the demand for loanable funds would fall. In the absence of enough funds in the market, the affordability of people wanting to buy houses will fall and hence their demand for houses will also fall. A fall in the demand for houses will lead to a fall in the housing prices in the Australian economy. Accordingly, the amount of money that individuals owe banks on account of loan will fall, that is, the housing debt burden will fall (Krugman, Obstfeld and Melitz, 2012).

(e) As the U.S. interest rate rises, funds will flow out of Australia into the U.S. economy. This will reduce the value of the Australian dollar in the global market. Thus the exchange rate will fall, that is, there will be an appreciation of the currency. The fall in the exchange rate will increase the relative price of Australian exports. Thus the demand for exports will fall. On the other hand, the import demand generated in the Australian economy will increase. Thus there will be a fall in the net exports of the economy of Australia. There will hence be a fall in the current account balance of the economy, that is, the current account would be adversely affected or worsen (Krugman, Obstfeld and Melitz, 2012).

Quantity Expansion (QE) of Money in the European Union (EU)

Exchange Rate and Balance of Payments

(a)

1) As the domestic country’s exports become more popular overseas, people will buy more from the domestic economy with the domestic currency available internationally. Thus the supply of domestic currency will increase. Thus the exchange rate will fall.

2) If there is a recession in the domestic economy, the demand for domestic currency will fall because the potential growth in the economy declines. Funds will flow out of the economy to the other growing economies. Hence the exchange rate will fall.

3) When inflation rate accelerates in the domestic economy, the relative price of commodities in the domestic economy rises. Thus people will require more funds to purchase the products. This leads to an increase in the demand for domestic currency. Thus the exchange rate also rises.

4) When the real interest rates in the domestic economy rise, funds will be directed to the domestic economy from the rest of the world. Thus there will be an increased demand of domestic currency. This will lead to an increase in the exchange rate.

5) When tourism from the domestic country increases, there will be a reduction in the demand and an increase in the supply of domestic currency because people will exchange the money. Hence, the exchange rate will fall (Krugman, Obstfeld and Melitz, 2012).

(b) As the U.S. interest rate rises, funds will flow out of Australia into the U.S. economy. This will increase the value of the U.S. dollar against the Australian dollar and in the global market. Thus the exchange rate will rise, that is, there will be a depreciation of the currency. The increase in the exchange rate will reduce the relative price of U.S. exports. Thus the demand for exports will rise. On the other hand, the import demand generated in the U.S. economy will decrease. Thus there will be a rise in the net exports of the economy of U.S. There will hence be a rise in the current account balance of the economy, that is, the current account would improve (Krugman, Obstfeld and Melitz, 2012).

(c) The current account balance of an economy is given as the sum of the trade balance, that is, net exports, the net income from abroad and the net current transfers (Krugman, Obstfeld and Melitz, 2012). Thus the current account balance for U.S. is given as:

Exports of goods and services – Imports of goods and services + Net interest income + net transfers

= $ (1853 – 2561 + 121 – 123) billion

= – $710 billion

Thus the current account balance in U.S. is negative.

(d) The capital account balance represents the net change in the financial assets of an economy in a given period of time. The capital account balance of U.S. is given as (Krugman, Obstfeld and Melitz, 2012),

Foreign investment in the U.S. – U.S. investment abroad

= $ (955 – 300) billion

= $655 billion

Thus the capital account balance for the U.S. economy is positive.

(e) From the estimated current account and the capital account balance, the balance of payments for the U.S. economy is,

$ (–710 + 655) billion = –$55 billion

Thus the U.S. is running a net balance of payments deficit. In order to compensate for the balance of payments deficit, the central bank will have to provide the official reserves. Thus the U.S. official reserves will decrease (Krugman, Obstfeld and Melitz, 2012).

(f) The net interest income of the U.S. economy is $121 billion. This implies that the U.S. economy receives more interest income from abroad than it pays. Thus, the total fund lent out by the U.S. economy is more than the total fund borrowed. This indicates that the U.S. economy was a net lender this year (Krugman, Obstfeld and Melitz, 2012).

References

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

Krugman, P., Obstfeld, M. and Melitz, M. (2012). International Economics: Theory and Policy. 9th edn. New York: Pearson Education.

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