1. Explain why real GDP might be an unreliable indicator of the standard of living.
2. Why does unemployment arise and what makes some unemployment unavoidable?
3. Consider the following statement: ‘When the average level of prices of goods and services rises, inflation rises’? Do you agree or disagree? Explain.
4. What is the aggregate demand (AD) curve and why does it slope downwards? Explain.
5. What is the long run aggregate supply (LRAS) curve and why is it vertical? Why does the short run aggregate supply curve slope upwards?
1. GDP or Gross Domestic Product of an economy is the monetary measure of market estimation of all the final products and ventures produced within the boundaries of the country. The real GDPis the value of the final goods and services produced in a particular year when valued in the context of the price of an assumed base year. However, Mankiw(2014) argued that real GDP is not capable of portraying the true health of an economy. GDP has been used to determine the market value of the final goods and services since long back. Nevertheless, modern experts argue that the GDP is a narrow parameter to determine the overall health of the economy and its people.
As opined by Evans and Honkapohja(2012), two problems arise while using the real GDP of an economy to measure the standard of living. The first problem is that while comparing the standard of living between two economies using real GDP, the real GDP of one country needs to be converted into the same currency as the other country. The second problem is that the goods and services produced in both the countries are to be valued at the same prices. Furthermore, real GDP is misleading as it does not include the household productions, and the productive activities carried out carried out in and around the house by the owners. The exclusion of these components creates a huge difference in the measurement. The real GDP does not even include the measurement of the health of the people, the life expectancy while these are important factors that affect the economic well being.
2. Unemployment in an economy can be defined as the situation where the individuals are actively seeking employment but are unable to find work. The different types of unemployment that occurs in an economy are cyclical, frictional and structural unemployment.The state of unemployment occurs in an economy due to several reasons. The main reason for the occurrence of unemployment is when the individuals leave their existing jobs in order to find a better option. Saez(2014) added that there are chances for unemployment when the skills of the workers and the income requirement do not match with the jobs available in the market. Unemployment further takes place in an economy when the workers move out for unrelated reasons. They prefer remaining unemployed until the time they find jobs in the new town.
Unemployment cannot be totally removed from an economy, asthe economy is always changing and there are always some of the individuals entering into the labour force and searching for job at any point of time. Mian and Sufi(2012) mentioned that some firms in the economy constantly expand while the other shrinks. Moreover, some regions achieve faster growth than the other regions. Therefore, temporary unemployment occurs in the economy due to the transition of the workers between firms and regions. The government of the economy can implement fiscal policies to reduce unemployment. However, the measures are incapable of completely removing it.
An example where unemployment is inevitable in an economy is the case of frictional unemployment. Due to the technical progress in the developing countries, the workers tend to quit their existing jobs in search of better job opportunities. This leads to some amount of unemployment in the country, which cannot be completely reduced.
3. Inflation can be depicted as the maintained increment in the general value level of the merchandise and services. The equilibrium cost of the products and enterprises in the market is dictated by the intersection of the demand curve and the supply curvefor the merchandise and ventures in the market.As the average level of the price for the goods and the services in the market increases, inflation rises. Weiss(2014) mentioned that the inflation is the rate of increase in the price level over a given period. Thus, an additional unit of price level than the average price level will increase the level of inflation in the economy. As the price level in the market raises, the average price of all the goods and services increases, this indicates that the inflation level in the economy also arises. As the inflation rises in the economy, the value of every dollar decreases and the consumers can purchase lesser amount of goods and services with the given amount of money. The increase in the average level of the price for the goods and the services gradually leads to hyperinflation in the economy. The hyperinflation can lead to the breakdown of the monetary system of the economy.
Figure 1: Inflation
(Source: As created by the author)
The United States Department of Labour, Bureau of Statistics showed that a loaf of bread cost 59¢ in 1988, while the same loaf of bread amounted to $1.42 in 2013. In the time span of twenty-five years, there was an increase in the price level by 140%. Thus, the increase in the average level of price of bread caused the inflation level to rise.
4. The aggregate demand curve or AD curve is the curve that indicates the total amount of goods and services demanded in an economy at a given price level. ?ahinet al. (2014) expressed the aggregate demand curve as the total amount of money exchanged for the goods and services. The curve represents the total output at a given price level since the aggregate demand is measured through the market values.
The Keynesian equation for the aggregate demand of an economy is
AD= C + I + G + (NX), where C is the consumer spending, G is the government spending, I is the private investment spending for non-final capital goods, and NX is the net exports. The aggregate demand curve is as follows:
Figure 2: Aggregate demand curve
(Source: ?ahinet al. 2014)
The aggregate demand curve considers that the money supply in constant in the economy. As the general price level in the economy increases, the purchasing power of the consumer decreases as the value of the money is lesser. Furthermore, as there is a decrease in the price level, consumers feel wealthier as they are able to purchase more with a given amount of money. Thus, the inverse relation between the price level and the total consumption as measured by the GDP causes the demand curve to be downward slopping. The aggregate demand curve is downward slopping because of the effect of the interest rate. The final factor that contributes in the downward sloping of the aggregate demand curve is the net export of the economy. As the price level increases, imported goods tend to be less expensive than the domestic goods. Therefore, the increase in the imported goods along with the decrease in the export goods reduces the net export. Hence, the aggregate demand curve is downward slopping.
5. The long run aggregate supply (LRAS) curve is a representation of the connection between the price level and the output of goods and services in the long run. As opined by Kline and Moretti (2013), the LRAS is possible output and is shifted by the factors that affect the potential output such as the capital available, entrepreneurship, capital and developments in technologies.
The LRAS curve is vertical as it indicates the potential output. According to Sargent (2013), the long run aggregate supply curve is vertical because of the fact that the adjustments in the total demand cause impermanent change in the aggregate yield of the economy.
Figure 3: Long run aggregate supply curve
(Source: Sargent 2013)
The short run aggregate supply (SRAS) curve represents the dissimilar quantities of real production in the short run that will be supplied into the market at the diverse level of prices. As the price rises, the quantity of supply also rises. Hence, there is a positive relationship between the price and the quantity supplied.
The SRAS curve is upward slopping as in the short run the adjustments in the supply curve can be carried out to some certain extent. The producers are capable of increasing the production by running operational activities for the longer hour. Hansen(2016) further opined that in the short run, it is not possible for the firms to set up new plants and thus supply can be increased to a certain level.
Figure 4: Short run aggregate supply curve
(Source: Baumann and McAllister 2015)
References
Baumann, D. and McAllister, L., 2015. Inflation and string theory. Cambridge University Press.
Evans, G.W., and Honkapohja, S., 2012. Learning and expectations in macroeconomics. Princeton University Press.
Hansen, B., 2016. A Study in the Theory of Inflation. Routledge.
Kline, P. and Moretti, E., 2013. Place based policies with unemployment. The American Economic Review, 103(3), pp.238-243.
Mankiw, N.G., 2014. Principles of macroeconomics. Cengage Learning.
Mian, A.R. and Sufi, A., 2012. What explains high unemployment? The aggregate demand channel (No. w17830). National Bureau of Economic Research.
Saez, E., 2014. Aggregate Demand, Idle Time, and Unemployment.
?ahin, A., Song, J., Topa, G. and Violante, G.L., 2014. Mismatch unemployment. The American Economic Review, 104(11), pp.3529-3564.
Sargent, T.J., 2013. Rational expectations and inflation. Princeton University Press.
Weiss, A., 2014. Efficiency wages: Models of unemployment, layoffs, and wage dispersion. Princeton University Press.
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