ECO10004 Economic Principles

GDP of a nation signifies market values of final goods and services produced within the country. In the computation of GDP, only final goods are included (Agénor and Montiel 2015). For the given economy, steel is used as an intermediary to produce cars.  Therefore, in calculating GDP, the value of steel is not included. Other goods and services such as iPods, Cars and legal services are included. The respective values are obtained from the product of goods and services.  GDP is the sum of the values of goods and services. GDP for the given closed economy for the year 2016 is obtained as $14200000.

3. Unemployed. The person is unable to retain position because of lack of skills. The unemployment problem that the person is facing is called structural unemployment.

4. The person is not in the labor force. As the person is engaged in full time study he is not considered as a member of the labor force.

5. The unemployment rate provides a measure to understand prevalence of unemployment in the economy (Bernanke, Antonovics and Frank 2015). The rate of unemployment express number of unemployed person as a percentage of total labor force.

Given the information, number of unemployed person = 500

Size of the labor force = Number of employed + Number of unemployed

= 8000 + 500

= 8500

Labor force participation rate reflects the portion of working age population who are either employed or are actively looking for employment.

Consumer price index is a simplified measure for comparing the price of basket of goods in current year relative to a base year (Heijdra 2017). The CPI is obtained as 87.5. This implies basket of good that cost $100 in 2005 costs $87.5 in 2015.

7. The first reason for downward sloping aggregate demand curve is the wealth effect described by Pigou. A fall in price level increases real income inducing people to spend more and hence, a higher aggregate demand. The second reason is the interest rate effect as explained by Keynes. A decline in price level lead to a fall in interest rate. A low interest rate means higher investment and higher aggregate demand (Uribe and Schmitt-Grohé 2017). The third reason for downward sloping aggregate demand curve is derived from the Mundell-Fleming’s model of exchange rate. Price and interest rate by influencing exchange rate affects aggregate demand.

8. The pessimistic view about future economic growth reduces confidence of consumers. This discourages consumers to consume more. Consumption being one of the major component of aggregate demand, a decline in consumption decreases aggregate demand a shifts the aggregate demand curve to the left (Johnson 2017).

9. A decrease in export cause a decrease in export earnings. Export affects aggregate demand curve through the term net export (Export – Import). As export decreases, net export declines as well. This leads to a fall in aggregate demand (Mankiw 2014). The decline in aggregate demand is reflected from a leftward shift of the aggregate demand curve.

10. In reference to the given article, the weak household sector likely to reduce consumption. The slow-down of construction sector reduces the prospect of employment causing a fall in wage share. The two components of GDP mostly influenced are consumption and investment.  A decline in household consumption and investment reduces aggregate demand.

The figure above explains equilibrium adjustment process. The long run equilibrium point is at A. This is the point where long run aggregate supply, aggregate demand and short run supply meets at a point. The maximum potential output of the economy is Y_E. Weak household sector weakens consumption and investment. This reduces aggregate demand to fall as reflected from an inward movement of aggregate demand curve from AD₁ and AD_2. In the short run the economy moves from point E, lowering the price level and GDP to P₁ and Y₁ respectively. The low price and low wage reduces cost of production (Dullien et al. 2017). This encourages firms to increase production by raising their profit share. The short run supply curve thus shifts rightward from SRAS to SRAS₁. The new equilibrium point is C, where potential output is reached but at a lower level of price. The low price in the long run gradually increase aggregate demand. The process continues unless the economy reaches to its original long run equilibrium point A with a potential output level of Y_E and corresponding price level of P_E.

References

Agénor, P.R. and Montiel, P.J., 2015. Development Macroeconomics Fourth edition. Economics Books.

Bernanke, B., Antonovics, K. and Frank, R., 2015. Principles of macroeconomics. McGraw-Hill Higher Education.

Dullien, S., Goodwin, N., Harris, J.M., Nelson, J.A., Roach, B. and Torras, M., 2017. Macroeconomics in Context: A European Perspective. Routledge.

Goodwin, N., Harris, J.M., Nelson, J.A., Roach, B. and Torras, M., 2015. Macroeconomics in context. Routledge.

Heijdra, B.J., 2017. Foundations of modern macroeconomics. Oxford university press.

Johnson, H.G., 2017. Macroeconomics and monetary theory. Routledge.

Mankiw, N.G., 2014. Principles of macroeconomics. Cengage Learning.

Uribe, M. and Schmitt-Grohé, S., 2017. Open economy macroeconomics. Princeton University Press.