CHAPTER 10: Economic Fluctuations

Transcription

1 CHAPTER 10: Economic Fluctuations 1a. Column 1 (real interest rate): 11, 9, 7, 5, 3, 1; Column 2 (total investment): 100, 150, 200, 250, 300, 350. b. - c. At a 5 percent real interest rate, $250 million in investment will be undertaken since there are 250 projects of $1 million each that have a real rate of return equal to or greater than the 5 percent real interest rate. 2a. A rise in consumer confidence raises personal consumption, increasing aggregate demand as shown by the shift from AD 0 to AD 1 in Figure 10.2 in the chapter. The result is a higher equilibrium price level and a higher equilibrium real output. b. A rise in Canadian interest rates reduces investment as well as the consumption of durable goods, decreasing aggregate demand as shown by the shift from AD 1 to AD 0 in Figure 10.2 in the chapter. The result is a lower equilibrium price level and a lower equilibrium real output. c. An increase in tax rates on high-income households reduces disposable incomes and therefore personal consumption. Aggregate demand decreases, as shown by the shift from AD 1 to AD 0 in Figure 10.2 in the chapter. The result is a lower equilibrium price level and a lower equilibrium real output. d. A rise in government purchases increases aggregate demand, as shown by the shift from AD 0 to AD 1 in Figure 10.2 in the chapter. The result is a higher equilibrium price level and a higher equilibrium real output. e. A boom in the American economy raises Canadian exports, increasing aggregate demand, as shown by the shift from AD 0 to AD 1 in Figure 10.2 in the chapter. The result is a higher equilibrium price level and a higher equilibrium real output. f. A fall in the value of the Canadian dollar against the US dollar makes Canadian exports less expensive in the rest of the world and makes imports into Canada more expensive. Net exports therefore rise, increasing aggregate demand, as shown by the shift from AD 0 to AD 1 in Figure 10.2 in the chapter. The result is a higher equilibrium price level and a higher equilibrium real output. g. A major tumble in the economies of Canada s trading partners reduces Canadian exports to these countries, decreasing aggregate demand, as shown by the shift from AD 1 to AD 0 in Figure 10.2 in the chapter. The result is a lower equilibrium price level and a lower equilibrium real output. 3a. A rise in wages for Canadian workers pushes up production costs, causing a short-run decrease in aggregate supply as shown by the shift from AS 1 to AS 0 in Figure 10.6 in the chapter. The result is a higher equilibrium price level and a lower equilibrium real output. b. Higher labour productivity means that Canadian economic resources can produce more at every price level, with a greater potential output than before. This causes a long-run increase in aggregate supply, as shown by the shift from AS 0 to AS 1 in Figure 10.7 in the chapter. The result is a lower equilibrium price level and a higher equilibrium real output. Chapter 10 92

2 c. Lower corporate income taxes increase incentives to work and save, which means that households provide more economic resources than before. Real output rises at every price level and potential output is greater than before. The result is a long-run increase in aggregate supply, as shown by the shift from AS 0 to AS 1 in Figure 10.7 in the chapter. The result is a lower equilibrium price level and a higher equilibrium real output. d. A reduced amount of land decreases resource supplies, pushing down real output at every price level, with a lower potential output than before. This causes a long-run decrease in aggregate supply, as shown by the shift from AS 1 to AS 0 in Figure 10.7 in the chapter. The result is a higher equilibrium price level and a lower equilibrium real output. e. A lower oil price pushes down production costs, which leads to a short-run increase in aggregate supply as shown by the shift from AS 0 to AS 1 in Figure 10.6 in the chapter. The result is a lower equilibrium price level and a higher equilibrium real output. f. A higher value of the Canadian dollar in terms of the U.S. dollar reduces input prices and production costs. This causes a short-run increase in aggregate supply as shown by the shift from AS 0 to AS 1 in Figure 10.6 in the chapter. The result is a lower equilibrium price level and a higher equilibrium real output. 4a. The equilibrium price level is 120 and the equilibrium real output is $240 billion. b. At a price level of 140, the economy's real output of $270 billion exceeds real expenditures of $200 billion. This means that more is produced than is purchased in the economy, causing an unintended increase in inventories. The result is a reduction in prices until real output and real expenditures are equal at a price level of 120. If the price level is 110, the economy's real expenditures of $260 billion exceed the real output of $220 billion. Because more is purchased than is produced in the economy, there is an unintended decrease in inventories. This leads to an increase in prices until real output and real expenditures are again equal at a price level of 120. c. The equilibrium price level falls to 110 and the equilibrium real output declines to $220 billion. Because real expenditures are reduced by $40 billion at each price level on the aggregate demand curve, the shift is known as a decrease in aggregate demand. This could be caused by an increase in personal taxes that reduce personal consumption or it could be caused by lower incomes in other countries, which reduce net exports. d. The equilibrium price level falls to 110 and the equilibrium real output expands to $260 billion. Since real output expands by $40 billion at each price level (suggesting that the economy's potential output has also increased by the same amount), the shift is known as a long-run increase in aggregate supply. This could have been the result of a greater labour force due to population growth or the result of a reduction in government regulation of business. 5. With a fall in injections, total injections fall short of total withdrawals. Flows into the income-spending stream are therefore less than flows out. As a result, the income-spending stream slows down, so that spending and output fall until a new lower equilibrium real output is reached where total injections and total withdrawals are equal. Using aggregate demand and aggregate supply, a fall in injections (either I, G, or X) causes a decrease in aggregate demand, as portrayed by the shift from AD 1 to AD 0 in Chapter 10 93

3 Figure 10.2 in the chapter. The result is a lower equilibrium real output as well as a lower equilibrium price level. 6. This statement is true. In the long run, it is changes in an economy's potential output that are most important in determining how much real output can vary. Changes in potential output are related to aggregate supply rather than aggregate demand. In particular, they are caused by changes in aggregate supply factors associated with resource supplies, productivity, and government policies. 7. When an economy is below its potential output, the aggregate supply curve has a flattened slope. A $100 million decrease in aggregate demand therefore causes a relatively large reduction in real output and a relatively small reduction in the price level. In contrast, the AS curve has a steep slope when the economy is above its potential output. In this case, the same $100 million decrease in aggregate demand has a smaller impact on real output and a larger impact on the price level. 8a. FIGURE 10A-1 Binonia s Production Possibilities The decision to produce more shovels and fewer milkshakes is illustrated in the left-hand graph by a movement from point e to point f on Binomia s initial production possibilities curve, PPC 0. Because Binomia is devoting a larger proportion of its economic resources to the production of capital goods, this enhances the future expansion in its production possibilities, as illustrated by the shift from PPC 0 to PPC 1 in the graph. b. With more economic resources, Binomia's production possibilities expand. This is illustrated in the left-hand graph by the shift from PPC 0 to PPC 1. c. With a technological innovation in the production of shovels, Binomia's production possibilities expand as illustrated by the shift from PPC 3 to PPC 4 in the right-hand graph. Unlike the shifts shown in the left-hand graph, this trend involves only a rightward movement in the curve, rather than an upward Chapter 10 94

4 and rightward shift, since only the potential production of shovels is affected. 9a. 48 (= 72/1.5) years b (= 72/27) percent c. Because population doubles every 24 (= 72/3) years, it will double approximately 4 times in 100 years. 10a. In 2008, Ergonia s labour productivity is $ (= $500 billion/8 million workers). In 2009, it is $ (= $540 billion/8 million workers). b. Ergonia s rate of productivity growth is 8 percent [= (($ $62 500)/$62 500) x 100]. 11. Since 2000, relatively low Canadian interest rates have led to high levels of Canadian investment. Combined with rising levels of educational attainment for Canadian workers, this raised labour productivity. At the same time, the proportion of Canadians in the labour force is rising due to higher participation rates, especially for young people. 12. Economic expansion is associated with a positive change in real GDP while economic contraction is linked with a negative change. Based on the data in the table, the Canadian economy expanded between 1983 and 1990, between 1992 and 2008, and in The economy contracted in 1982,1991, and Peaks occurred when the change in real GDP moved from being positive to negative: between 1990 and 1991 and between 2008 and Troughs occurred when the change in real GDP moved from being negative to positive: between 1982 and 1983, 1991 and 1992, and 2009 and a. Since the consumption of durable goods depends on households' disposable income it moves down during contractions and up during expansions. b. As in the case of durable goods, the consumption of nondurable items depends on households' disposable income, so it moves down during contractions and up during expansions, though less than in the case of durable goods. c. Recall that planned investment depends on business expectations which tend to be optimistic when output is rising and pessimistic when real output is falling. Therefore planned investment tends to fall during contractions and rise during expansions. d. Exports depend on foreign incomes. Given that business cycles in various countries tend to move together, exports usually fall during contractions and rise during expansions. e. Because imports depend on domestic incomes, they fall during contractions and rise during expansions. f. The demand for labour tends to move in the same direction as real output. Therefore wage rates tend to be pushed down during contractions and pushed up during expansions. g. Equilibrium output tends to move down during contractions, which must associated with positive unplanned investment, and up during expansions, which must associated with negative unplanned investment. 14. Industries that produce discount consumption items do well during Chapter 10 95

5 contractions, since, as household incomes fall, sales for these industries increase. Industries that produce capital goods tend to do well during expansions, because more optimistic business expectations cause sales of capital goods to rise. 15a. Sales of romance novels tend to fluctuate in opposition to the business cycle, with sales rising during economic downturns when many individuals have more free time on their hands. b. Registrations with online dating services tend to fluctuate in opposition to the business cycle, with registrations rising during economic downturns when many individuals have more free time on their hands. c. Lipstick sales tend to fluctuate in opposition to the business cycle, as many individuals choose to purchase relatively inexpensive beauty products rather than high-priced fashion items. 16a. An inflationary gap is reduced by a fall in aggregate demand, which occurs when government purchases are decreased. Similarly, a recessionary gap is reduced by a rise in government purchases. b. Higher personal and corporate tax rates decrease household incomes - either directly through changes in disposable income or indirectly by reducing corporate profits. In either case, a rise in tax rates causes a fall in aggregate demand, which reduces an inflationary gap. Likewise, a recessionary gap is reduced by a fall in personal and corporate tax rates. c. A rise in interest rates leads to lower planned investment and the consumption of durables. Aggregate demand therefore decreases, reducing an inflationary gap. Similarly, a fall in interest rates reduces a recessionary gap. d. With a higher value of the Canadian dollar in terms of the US dollar, Canadian exports are more expensive in other countries and foreign imports are cheaper in Canada. Net exports therefore fall, which decreases aggregate demand and reduces an inflationary gap. Likewise, a lower value of the Canadian dollar reduces a recessionary gap. Internet Application Questions 1a. Answers are found in the introductory summary of main economic indicators. b. - c. Answers are outlined in the text of the publication. 2a. Answers are found in links to 'Summary Tables', 'Tables by subject', 'Economic accounts' and 'Gross domestic product'. Two tables are needed: 'Gross domestic product, expenditure-based' and 'Implicit chain price indexes, gross domestic product'. Each relevant figure in the first table must be adjusted using the appropriate price index in the second table. b. Values for C, I, G, and (X-M) can calculated as percentages of real expenditures, defined as GDP in reference-year dollars (again leaving out investment in inventories). 3a. Answer found in links to 'Data', 'Gross Domestic Product', '6549' (Gross Domestic Product at 1992 prices, expenditure-based). Click on 'Qtly Chapter 10 96

6 D15721 Gross Domestic Product at Market Prices'. Then click on 'Go' and 'Go'. Under 'Output Format' click on '2D Line Graph', and under 'Data Conversion' click on 'Annual Average'. Then press 'Go'. You can print out the resulting graph. b. Peaks occurred in 1981 and Troughs occurred in 1982 and ANSWERS TO QUESTIONS AT THE END OF 'MAKING AN ECONOMY GROW' 1a. Many examples are possible. One illustration is the hydrogen auto fuel cell being developed by Ballard Power Systems. As this idea is further developed, the potential energy savings from its future use continue to climb. b. Once development is complete, Ballard can look forward to significant profits from either by mass-producing the fuel cell, or by licensing other companies to do so. 2. Romer's theory provides an argument in favour of strong patent protection. This is because property rights, in the form of patents, provide an incentive to create new ideas. ANSWERS TO QUESTIONS AT THE END OF THE AGGREGATE EXPENDITURES MODEL (at the Online Learning Centre) 1. In this case, using the spending-output approach, the consumption and aggregate expenditures schedules both shift up by $50 billion, which raises the equilibrium level of GDP to $1200 billion. Using the injectionswithdrawals approach, the saving schedule shifts down by $50 billion. This pushes the S+M schedule down by $50 billion, which leads to a comparable rise in the equilibrium level of GDP to $1200 billion. 2. Yes, the change in the equilibrium level of GDP would be the same if the investment schedule rose by $50 billion. In this case, using the spendingoutput approach, the investment and aggregate expenditures schedules both shift up by $50 billion, which raises the equilibrium level of GDP to $1200. Using the injections-withdrawals approach, the investment schedule shifts up by $50 billion. This pushes the I+X schedule down by $50 billion, which leads to a comparable rise in the equilibrium level of GDP to $1200 billion. ANSWERS TO QUESTIONS AT THE END OF 'ECONOMIC DEVELOPMENT' (at the Online Learning Centre) 1. In contrast to authoritarian regimes, stable democratic governments foster economic development by promoting investment in both capital and human resources. In a democratic country, it is less likely that property rights will suddenly disappear. Businesses investing in capital resources can therefore be reasonably certain that they will receive future profits from investment projects. In addition, individuals investing in human resources can be reasonably certain they will receive additional future income in payment for current education costs. Democratic governments pose possible problems for economic development as well. For example, popular demands for generous income maintenance schemes may cause an elected government to engage in high levels of public spending financed by unsustainable tax rates or budget deficits. Chapter 10 97

7 2. Given the vicious circle of poverty, per capita incomes in many countries are kept low because productivity growth is dampened by labour-intensive production. This arises from low investment in capital and human resources as well as from rapid population growth. Government initiatives to overcome this vicious circle must concentrate on promoting productivity growth, either through investment strategies or population control programs. Investment in capital resources can be promoted through measures that promote domestic saving and investment(for example, government-run pension schemes). Investment in human resources can be promoted by government initiatives that widen access to publicly funded education. Government-sponsored population control measures include laws that enforce a compulsory maximum family size (as in China) or that provide incentives to parents who choose to limit the size of their families (for example, through subsidies to those who participate in birth control programs). 3. It is true that, in the long term, economic development in low-income countries will be primarily tied to their full participation in the global economy. Moreover, one of the main factors that will help ensure this participation is trade liberalization. At the same time, many low-income countries face social and economic problems whose short-term solution depends crucially on foreign aid from high-income countries and from multilateral organizations such as the World Bank. Internet Application Questions 1. The answer is found in the links to 'What We Do'. The Bank funds its loans by borrowing in international financial markets as well as by using funds provided by member countries. 2. The answers are found in the links to 'What We Do'. A new interest rate on the Bank's loans is set every six months. The average maturity on loans is 1 to 9 years (with a grace period of 5 years). 3. A country's eligibility for loans from the World Bank and the Bank's affiliates depends on the country's per capita income valued in US dollars. Only countries with per capita incomes under about $1885 are eligible for interest-free credits from the Bank's affiliate, the International Development Association (IDA). Countries with per capita incomes between $885 and $1445 can receive a blend of World Bank loans and IDA credits. Countries with incomes between $1445 and $5225 are eligible only for World Bank loans. Once a country reaches the $5225 income threshold, the country 'graduates', and its borrowing privileges from the World Bank are phased out. ANSWERS TO QUESTIONS AT THE END OF 'FINDING THE KEY' (at Online Learning Centre) 1. If Jones conclusions are correct, then a sustained increase in growth in per capita incomes can be achieved by raising the proportion of Canadian output that goes to compensating inventors. This requires higher expenditures on R&D (through tax incentives), encouraging changes in institutions that help quicken the diffusion of new ideas (for example, by creating incentives for cooperation between business and the educational sector), and by decreasing marginal tax rates on corporate profits and personal income (especially for those in high income brackets). 2a. Using the rule of 72, it would take 720 years (= 72/.1) for the world's Chapter 10 98

8 per capita output to double. b. Using the rule of 72, it now takes 60 years (= 72/1.2) for the world's per capita output to double. Chapter 10 99