This paper seeks to analyse the predictions put forth by the Research Department at Schmeckt Gut regarding the development of the average income, the inflation rate development, and the tariff rates on imports. The analysis is made based on the demand and supply relationship and uses the Phillip’s curve and Laffer curve to show how the concepts are related to each other. The analysis is followed by recommendations for the management on how to utilize the predictions to plan company strategy.
A tariff is an example of a government policy that limits the imports into a county. It is a government tax on imports. The impact of the tariff on the imports depends on the size of the country with respect to if the country’s policies can affect world prices or not (Welch & Welch, 2016). An increase in the tariff rate can affect the demand and supply within the importing country. The exporter of the product does not change the price of the exports and thus the domestic price of the goods being imported will rise depending on the rate of the tariff (Baker & English, 2011). In response, the domestic producers that compete against these imports will also raise their domestic prices since the imports’ domestic price will have risen.
The domestic producers stand to benefit in the event of an increase in the tariff rate because their products get a higher price, an occurrence that allows them to increase production and sell more goods (Alvarez-Cuadrado & Poschke, 2011). This represents a movement along the supply curve. These producers also get a more surplus. However, it must be noted that despite this being the general observation in terms of tariff increases, there are tariffs that can raise the cost of materials and other components used in production. On the other hand, an increase in the tariff rate affects the domestic consumer differently.
The consumer’s decision on the quantity they can consume is driven by the price of the goods. The consumer’s equilibrium thus shifts in response to the changes in pricing. Suppose the price of beef increases from $2 a pound to 3$ a pound, the ratio of marginal utility of the beef to its price changes because of the increase in price. This implies that the individual will buy less beef and perhaps spend more money in purchasing another commodity, say pork because it is cheaper than beef. This phenomenon is known as the substitution effect and it occurs when the relative price of a commodity changes and the money income of the individual remains constant (Samuelson & Marks, 2012). The figure below illustrates the substitution effect. If the price of the beef were to decrease, the individual may still buy more beef at the expense of another commodity say pork if the latter’s price and the money income remain constant.
As shown in the figure, AB is the original budget line. X and Y are pork and beef respectively. Q is the original point of equilibrium before the shift in price, and a tangent of the budget line to the indifference curve. At that point, Q, the consumer buys beef at ON and pork at OM. When the price for beef increased, the new budget line became A1B1, which is a new tangent to the indifference curve at Q1. That new point effectively becomes the consumer’s new equilibrium position. The purchase of beef decreases to ON1 and that of pork increases to OM1.
If the tariff rate were to reduce, the opposite would happen. The price of the domestic products would reduce. However, the price of the imported product may remain constant and with lower tariffs, the products may be supplied in large quantity and sold at an even lower price (Baker & English, 2011). This may force the domestic competitors to adjust their products to prices that may inconvenience them. For example, the diagram below illustrates a change in the indifference curve if the commodity price decreases. Commodity X and Y represent beef and pork respectively. The decline in price of beef corresponds to the shift of the budget line to AB2 from AB1 and from AB3 to AB4. The shift is brought about by any event except the price of the good or service that produces an increase or decrease in the quantity of the good or service (Malhotra, 2014). In this case, the event is the change in tariff rates.
If the popularity of the imported goods increases the price of the substitute good increases. The curve will thus move to the right. The curve can also move to the right if the price of the substitute good increases, which in this case is the domestic product, and if the price of the complement good decreases. Thus, domestic consumers are affected by the tariff rates applied on imported goods. They are forced to pay higher prices for both goods, domestic and imported, and can reduce the quantity of the goods they buy or consume (Jones, 2014). This results in a movement along the domestic demand curve, and the consumers also incur the costs of the consumer surplus (Jones, 2014).
A typical market graph will show that the consumption effect of the tariff results in the loss of consumer surplus for the consumers that opt out of using certain products because the tariff rate raises the domestic price despite the willingness of the foreigners to sell the commodities at a lower price. The effect of an increase in tariff rate on the production is that domestic high costs of production will be discarded for the lower cost imports.
In a country with a monopsony control in the market an increase in the tariff rate can see a gain from the terms of trade (Siddaiah, 2010). The increased tariff rate will reduce the quantity of the imports and thus the exporters will lower their price signaling a movement along the supply curve for exports. The tariff only serves to separate the supply and demand in that the price for importing goods is lower than the price the exporters will receive by the amount of the tariff (Razin & Vosgerau, 2012). The figure below illustrates the effects of a tariff on a supply curve.
S0 and D0 are the initial supply and demand curves that intersect at P0Q0. St represents the supply curve after the introduction of the tariff. At PtQt, the market clears. Consequently, lesser goods are produced as the consumers pay higher prices (Razin & Vosgerau, 2012).
The Laffer curve can be used to show the relationship between the tax rate (tariff rate) and the revenue collected by the government. The curve also relates to supply because it demonstrates how production of a good or service can be reduced when the tax imposed on production is gradually increased. According to the Laffer curve the revenue collected by the government increases when the taxes on processes or products increase. However, as the taxes continue to increase the revenue can reached a peak point after which it starts to reduce with increment in the rate. This happens because production is slowed or stopped because all earnings from the business trickles to the government, making the project infeasible.
The more the money is taken out of a business in terms of taxes, the less money it has to invest in its operations (Mundell & Adams, 1982). The business will be more likely to close down production in a country and relocate to another locality or move all the activities of the business altogether. At such a point it ceases to make sense to an investor to inject their capital into a business when a huge chunk of their profits is taken out in form of taxes. Therefore, according to the Laffer curve, the predictions that had been made need adjustment (Mundell & Adams, 1982). A rise in the tariff rates to higher figures will reduce the income an individual receives from their business (Loshin, 2012). Fewer goods will be imported into the country. The taxable income will be reduced significantly because of the lower supply, and other factors such as tax evasion or avoidance.
As inflation increases, the wage growth also increases. Inflation refers to the rate of increase in prices of goods over time. The rate of inflation represents just how much more the expensive essential goods or services become in relation to time. If the inflation rate increases, and the income remains constant, then the purchasing power will reduce by a similar rate because the consumer can afford to buy less (Rashid & Antonioni, 2014). The increase in price as already discussed with respect to demand and supply will lead to a movement along the demand curve. On the other hand, when prices are very low to a point of deflation, which is the opposite of inflation, the purchasing power of the consumer may still not be exercised fully because the consumer holds off from making any purchases because they are hoping that the prices will drop even lower (Mitchell, 2012). Deflation translates to slow or no economic growth and this can move governments to maintain low interest rates for prolonged periods to ensure that financial institution have adequate liquidity (Gagnon, 2011).
Thus, a manageable inflation rate can help to promote economic growth, which translates to higher increases in income for individuals. When the consumer predicts that prices are likely to rise in future, they will be more willing to spend or make purchases sooner. The expectations of firms and individuals play a significant role in determining the rate of inflation. If higher prices are anticipated, wage negotiations and contractual adjustment of prices can result. Once these provisions have been effected it is possible to determine future inflation (Gillespie, 2014).
The supply and demand also determine the rate of inflation. Supply shocks can disrupt the production by raising the costs and this can result in cost-push inflation, which reduces the overall supply of goods and services (Larson & Gray, 2011). Consequently, there will be an increment in prices as a result of the decrease in supply. Demand shocks, which include rallies in the stock market, or policies of expansion like lower interest rates or increased government expenditure can boost the demand albeit temporarily (Baker & English, 2011). Similarly, if the increase in demand exceeds the capacity of production, there will be a resultant strain on resources, which creates a demand-pull inflation (Welch & Welch, 2016). In manageable rates of inflation, say between 3-5%, the income can increase too in a similar ratio. A higher inflation rate of over 7.5% may not necessarily result in an increase in the income. Income increase may come about after a contractual agreement that can be effected irrespective of the increased rate of inflation.
The Laffer curve can be used to show the relationship between the tax rate (tariff rate) and the revenue collected by the government. The curve also relates to supply because it demonstrates how production of a good or service can be reduced when the tax imposed on production is gradually increased (Tuerck, 2015). According to the Laffer curve the revenue collected by the government increases when the taxes on processes or products increase. However, as the taxes continue to increase the revenue can reached a peak point after which it starts to reduce with increment in the rate (Van der Ploeg, 2010). This happens because production is slowed or stopped because all earnings from the business trickles to the government, making the project infeasible.
A typical market graph will show that the consumption effect of the tariff results in the loss of consumer surplus for the consumers that opt out of using certain products because the tariff rate raises the domestic price despite the willingness of the foreigners to sell the commodities at a lower price. The effect of an increase in tariff rate on the production is that domestic high costs of production will be discarded for the lower cost imports (Wollenberg, Moeliono, Limberg, Iwan, Rhee, & Sudana, 2006).
It is difficult for any company to avoid the effects of increasing costs. An increase in inflation rate can have a significant impact on the operating costs of the company. the problem is compounded even further for companies in a capital intensive industry such as the one in which Schmeckt Gut operates. This is so because neglecting the capital needs of the company can make it quite difficult for the company to compete with other companies in the sector (McCain, 2012). It is crucial for these companies to factor the threat posed by the demand for capital in their competitive strategy. However, the good news is that it is possible to increase or improve the company’s competitive advantage despite an increase in the inflation rate (Rich, Jones, Heitger, Mowen, & Hansen, 2012).
At such a point, it ceases to make sense to an investor to inject their capital into a business when a huge chunk of their profits is taken out in form of taxes. Therefore, according to the Laffer curve, the predictions that had been made need adjustment. A rise in the tariff rates to higher figures will reduce the income an individual receives from their business (Fitzpatrick, Nguyen, & Cayan, 2015). Fewer goods will be imported into the country. The taxable income will be reduced significantly because of the lower supply, and other factors such as tax evasion or avoidance (Keller, 2014).
The Laffer curve can be used to show the relationship between the tax rate (tariff rate) and the revenue collected by the government. The curve also relates to supply because it demonstrates how production of a good or service can be reduced when the tax imposed on production is gradually increased. According to the Laffer curve the revenue collected by the government increases when the taxes on processes or products increase (Colombatto, 2015). However, as the taxes continue to increase the revenue can reached a peak point after which it starts to reduce with increment in the rate. This happens because production is slowed or stopped because all earnings from the business trickle to the government, making the project infeasible.
Inflation affects companies in an industry differently thus it would be prudent of the managers if they conducted a strategic cost analysis through all its processes up to the point where the product reaches the consumer (Kay, 2003). This will prompt the company to develop its value chain and assess the long-term shifts in its cost components. After this is done, the company can then factor in a prediction of future inflation rate into its costs and that of its competitors. For example, if the company is currently operating at an inflation rate of 3%, the management can factor a rate of 7.5% into its costs and those of its competitors and thus design a strategic maneuver that will place it at a better position to weather any increases in costs stemming from inflation (Loshin, 2012). Such as strategy will help the company to avoid a competitive pricing trap in case it wants to bear the lowest production costs in the industry, intensify its sales in a particular market segment, or achieve product differentiation.
A typical market graph will show that the consumption effect of the tariff results in the loss of consumer surplus for the consumers that opt out of using certain products because the tariff rate raises the domestic price despite the willingness of the foreigners to sell the commodities at a lower price (Groizard, Marques, & Santana, 2014). The effect of an increase in tariff rate on the production is that domestic high costs of production will be discarded for the lower cost imports.
Whereas wage increase may be a contractual clause among other provisions such as hours and working conditions, inflation can bring about laxity in work. Working conditions, for example, may be characterized by restrictive work practices, which of course hamper labor productivity improvement — practically the only source of real wage gains (Gattiker, Carter, Huang, & Tate, 2014). Lessened productivity, in turn, contributes to the inflationary situation of “too few goods.” On the other hand, an increase in income say by 5% can be inflatory. This is especially true when the agreed-upon increase in wages or income for workers goes beyond the gains from production (Colombatto, 2015). This phenomenon will deteriorate the unit labor cost appearance of the firm. The firm will thus seek to recover the added costs from the customers (Cavallo, Galiani, Noy, & Pantano, 2013). The result is that the prices of commodities will increase and this may lower the demand of the commodity as illustrated by the Phillip’s curve above.
Conclusion
An increase in the tariff rate can affect the demand and supply within the importing country. The exporter of the product does not change the price of the exports and thus the domestic price of the goods being imported will rise depending on the rate of the tariff. In response, the domestic producers that compete against these imports will also raise their domestic prices since the imports’ domestic price will have risen. However, it must be noted that despite this being the general observation in terms of tariff increases, there are tariffs that can raise the cost of materials and other components used in production. On the other hand, an increase in the tariff rate affects the domestic consumer differently. The consumer’s decision on the quantity they can consume is driven by the price of the goods. The consumer’s equilibrium thus shifts in response to the changes in pricing. Consequently, high tariff rates will affect the demand and supply of the imported goods because it directly influences the price of the commodity. If the tariff rate were to reduce, the opposite would happen. The price of the domestic products would reduce. However, the price of the imported product may remain constant and with lower tariffs, the products may be supplied in large quantity and sold at an even lower price. Therefore, an increase in income does not necessarily trigger an increase in inflation rate. On the other hand, an increase in inflation can lead to a decrease in income from a higher value or rate to a lower one. Hence, a prediction of a 7% increase in the inflation rate can see the increase in income drop from 5% to 3%.
The more the money is taken out of a business in terms of taxes, the less money it has to invest in its operations. The business will be more likely to close down production in a country and relocate to another locality or move all the activities of the business altogether. At such a point, it ceases to make sense to an investor to inject their capital into a business when a huge chunk of their profits is taken out in form of taxes. Therefore, according to the Laffer curve, the predictions that had been made need adjustment. A rise in the tariff rates to higher figures will reduce the income an individual receives from their business. Fewer goods will be imported into the country. The taxable income will be reduced significantly because of the lower supply, and other factors such as tax evasion or avoidance.
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