Okun's Law, Aggregate Expenditure And Car Market: Economic Analysis

Question 1 
Following table are the data for the Australian economy (β=1.6) in four selected years. Using Okun’s law, fill in the missing data in the table.
Year Actual Unemployment
Rate (%) Natural Unemployment
Rate (%) Potential
GDP Real GDP
2001 (a) 5 8000 7872
2002 5 (b) 8100 8100
2003 4 4.5 (c) 8266
2004 4 5 8250 (d)

Question 2 

An economy is described by the following equation
Cd=14400+0.5(Y-T)-40000r, Ip=8000-20000r,
G=7800, NX=1800, T=8000
a)Find the numerical equation relating planned aggregate expenditure (PAE) to output (Y) and to real interest rate (r).
b)The real interest rate is 0.133, find short-run equilibrium output.
c)Potential output, y*, equals 40,000. What real interest rate should be Reserve Bank set to bring the economy to full employment?

Question 3 

The demand for car in a country is given by D=12 000-200P, where P is the price of a car. Supply domestic car production is S=7000+50P.
a)Assuming economy is closed; find the equilibrium price and production of cars.
b)The economy opens to trade. The world price of cars is 18 units. Find the domestic quantities demanded and supplied, and the quantity of imports or exports. Who will favour the opening of the car market to trade, and who will oppose it?
c)The government imposes a tariff of one unit per car. Find the effects on domestic quantitative demanded and supplied, and on the quantity of import or export. Who will favour the imposition of the tariff and who will oppose it?

Question 4

Use the following economic data to calculate private saving, public saving and national saving.
a)Household saving =20, business saving=40, government purchases of goods service=10, government transfers and interest payments=10, Tax collection=15, GDP=220.
b)GDP=600, Tax collection=120, Government transfers and interest payments=40, Consumption expenditures=450, Government budgets surplus=10

Okun's Law

Following table are the data for the Australian economy (β=1.6) in four selected years. Using Okun’s law, fill in the missing data in the table.

Year	Actual Unemployment Rate (%)	Natural Unemployment Rate (%)	Potential GDP	Real GDP
2001	(a)	5	8000	7872
2002	5	(b)	8100	8100
2003	4	4.5	(c)	8266
2004	4	5	8250	(d)

Okun’s law refers to an inverse relationship that exist between unemployment and gross domestic product (GDP) (Ball, 2017). As unemployment increases by 1% above the natural level, the gross domestic product decreases by 2-4% from its potential GDP (Coibion, 2017).

1. Find Actual Unemployment Rate using Okun’s Law Formula in 2001:

 X 100%= -2(Actual unemployment Rate-Natural Unemployment Rate)

According to Okun’s Law, the output gap in this case is 1.6%. The potential GDP is 1.6% above Real GDP, the Cyclical unemployment is -0.8% and since Natural Unemployment is 5% then the Actual unemployment 5.8%.

1. Find Natural Unemployment Rate using Okun’s Law Formula 2002:

X 100%= -2(Actual unemployment Rate-Natural Unemployment Rate)

                                                           0 = - 10 + 2b

                                                           10 = 2b

                                                            =b

                                                            b = 5%

According to Okun’s Law the output gap is equal to zero. The potential GDP equals the Real GDP Level of $8100. The cyclical unemployment equals to zero, hence the Natural unemployment equals to Actual unemployment of 5%.

1. Find Potential GDP using Okun’s Law Formula 2003:

X 100%= -2(Actual unemployment Rate-Natural Unemployment Rate)

                                                         (8266- c)100 = -2(-0.5)

                                                          826600 – 100c = c

                                                          826600 = 101c

                                                         c = 8184.15

According to Okun’s Law the Cyclical unemployment is 4 - 4.5%= -0.5%. The output gap is 1%, Real GDP is 1% above the Potential GDP. Therefore, the Potential GDP 100/101% X 8266 = 8184.15 

1. Find Real GDP using Okun’s Law Formula 2004:

X 100%= -2(Actual unemployment Rate-Natural Unemployment Rate)

                                              (d - 8250)100 = -2(1)8250

                                                100d – 825000 = - 16500

                                                          100d = 825000 – 16500 

                                                           d = 8085

According to Okun’s Law the Cyclical unemployment is 4 - 5%= - 1%. The output gap is 2%, Potential GDP is 2% above the Real GDP. Therefore, the Real GDP 100/102% X 8250 = 8085 

In Conclusion, most economies suffer inefficiencies such as inflation, unemployment and government laws and hence they cannot realize full employment and utilize maximum resources and operate at potential gross domestic product, these therefore brings the existence of an output gap which is the difference between Real GDP and Potential GDP (Arthur, 2018).

2. An economy is described by the following equation

Cd=14400+0.5(Y-T)-40000r, Ip=8000-20000r,

G=7800, NX=1800, T=8000

1. Find the numerical equation relating planned aggregate expenditure (PAE) to output (Y) and to real interest rate(r).

Planned Aggregate Expenditure = C + I + G + NX (Arthur, 2018).

Where: C is Consumption Demand

             I is the Government Planned Investments

            G is the Government Expenditure

            NX is the Net Exports. They are deducted from the Aggregate Expenditures.

            T is Taxes

            r is Interest Rates

            Y is the Output (Real GDP)

Given Cd= 14400+0.5(Y-T)-40000r,

           Ip = 8000-20000r,

           G = 7800

           T= 8000

Aggregate Expenditure

           NX= -1800

P A E=    

PAE = (14400 + 0.5(Y-8000)-40000r) + (8000-20000r) +7800 – 1800

   = 24,400 - 60000r +0.5Y

1. The real interest rate is 0.133, find short-run equilibrium

                      =24,400 - 60,000(0.133) + 0.5Y

                      =16,420 + 0.5Y

                       -16420= 0.5Y

                       Y = (32,840)

1. Potential output, y*, equals 40,000. What real interest rate should be Reserve Bank set to bring the economy to fullemployment?

PAE =Y* Equate and find the real interest rate.

                        40000 = 24400 - 60000r + 0.5(40000)

                        40000 = 44400 - 60000r

                        40000-44400= -60000r

                       -4400=-60000r

                       -4400/-60000=r

                        0.073 x 100

                        r =7.33%

According to Vines and Wills (2018) in order to bring the economy to equilibrium at full employment potential, the Reserve Bank must set the real interest rate. This particular case it must be set at 7.33% .

3. The demand for car in a country is given by D=12 000-200P, where P is the price of a car. Supply domestic car production is S=7000+50P.
4. Assuming economy is closed; find the equilibrium price and production of

In a Closed economy at Equilibrium Condition, DEMAND = SUPPLY

                                               12000-200P=7000+50P

                                               12000-7000=50P+200P

                                               5000=250P

                                               P=5000/250

                                               Price= 20

             Production of Cars = 7000 + 50(20)

                                            = 7000+ 1000

                                           = 8,000

1. The economy opens to trade. The world price of cars is 18 units. Find the domestic quantities demanded and supplied, and the quantity of imports or exports. Who will favor the opening of the car market to trade, and who will opposeit?

   When the World Price of Cars is 18 Units, the Domestic Quantities Demanded becomes

                                                   12000-200(18)

                                                   12000- 3600

                                                   8400

When the world price of Cars is 18 Units, the Domestic Quantities Supplied becomes

                                                       7000 + 50(18)

                                                       7000 + 900

                                                       7900

Total quantities imported will be 8400-7900

                                                     = 500

The domestic Consumers will be in favor of the opening of the car market to trade because at this price they will be willing to import more quantities cars as compared to high cost of production and prices of cars locally. On the other hand, the Domestic producers will be against the opening of the car market to trade because at this price it would lead to reduction in production and consequently lead to reduced profits.

1. The government imposes a tariff of one unit per car. Find the effects on domestic quantitative demanded and supplied, and on the quantity of import or export. Who will favor the imposition of the tariff and who will opposeit?

Government tariff imposition has an effect on the price and it increases the price of car from 18 to 19 units.

Domestic Quantities Demanded = 12000-200(19)

                                                          12000-3800

                                                          8200

   Domestic Quantities Supplied  =  7000 + 50(19)

                                                          7000 + 950

                                                           7950

           Total Quantities Imported    = 8200- 7950

                                                          =250

The Domestic Producers will favor the imposition of a tariff duty this is because it reduces the number of quantities imported hence encourages the domestic production thereby leading to increase in sales volume and profit margins. On the contrary, the domestic consumers will be against tariff imposition because this would interfere with their importation power and other logistics hence they would prefer buying locally produced and available cars (Slopek, 2018).

4. Use the following economic data to calculate private saving, public saving and national saving.
5. Household saving =20, business saving=40, government purchases of goods service=10, government transfers and interest payments=10, Tax collection=15, GDP=220.

Private Savings = House hold savings + Business Savings (Suri, 2018).

                          =  20 + 40

                           = 60

Public Savings = Tax Collections – Government transfers and interest Payments (Morimoto, 2017).

                          =15 -10

                          = 5

National Savings = Private Savings + Public Savings

                            = 60 + 5

                            = 65

1. GDP=600, Tax collection=120, Government transfers and interest payments=40, Consumption expenditures=450, Government budgetssurplus=10

GDP=Consumption Expenditures + Tax collections + Private Savings – Transfer payments (Government Transfer and Interest Payments)

Y = C + T + Sp + TR

Private savings = Y – C –T + TR

                          = 600-120-450+40

                          = 30 + 40

                          = 70

Public Savings = Tax collection – (Private Savings – Transfer Payments) also called Government Spending.

                          =120-70-40

                          =10

Public Savings is also equal to Government Budget Surplus which is 10

National Savings = Private Savings + Public Savings (Abasimi, 2018).

                             = 70 + 10

                             = 80 

References

Abasimi, I. &. (2018). Determinants of National Saving in Four West African Countries. International Journal of Economics and Finance, 67-73.

Arthur, W. B. (2018). Self-reinforcing mechanisms in economics. In The economy as an evolving complex system. CRC Press.

Ball, L. L. (2017). Okun's Law: Fit at 50. Journal of Money, Credit and Banking, 1413-1441.

Coibion, O. G. (2017). The cyclical sensitivity in estimates of potential output (No. w23580). National Bureau of Economic Research.

Morimoto, K. H. (2017). Debt policy rules in an open economy. Journal of Public Economic Theory, 158-177.

Slopek, U. D. (2018). Export Pricing and the Macroeconomic Effects of US Import Tariffs. National Institute Economic Review, R39-R45.

Suri, A. &. (2018). Analysis of Trends in Gross Domestic and Household Savings and its Components in India. Studies in Business and Economics, 181-193.

Vines, D. &. (2018). The financial system and the natural real interest rate: towards a ‘new benchmark theory model. Oxford Review of Economic Policy, 252-268.