BBA 2007

PRINCIPLE OF MACROECONOMICS

CHAI JIA NI
960411-14-5238
202409

DECEMBER 2015
CONTENT
N
O

CONTENT

PAGES

Introduction

2-3

Task 1

4-13

Task 2

14-23

Task 3

24-37

Conclusion

38-39

Reference

40

Coursework

41-45

Introduction
One of the main ideas that economist John Maynard Keynes introduced is the idea that
the number one driver of the economy is demand. If we can measure the economy in

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terms of what everyone spends, then we can estimate the level of production in our
economy. We measure the economy using GDP.
Saving is important to the economic progress of a country because of its relation to
investment. If there is to be an increase in productive wealth, some individuals must be
willing to abstain from consuming their entire income. Progress is not dependent on
saving alone; there must also be individuals willing to invest and thereby increase
productive capacity.
What distinguished financial institutions from other firms is the relatively small share of
real assets on their balance sheets. Thus, the direct impact of financial institutions on the
real economy is relatively minor. The indirect impact of financial markets and
institutions on economic performance is extraordinarily important. The financial sector
mobilizes savings and allocates credit across space and time. It provides not only
payment services, but also enables firms and households to cope with economic
uncertainties by hedging, pooling, sharing and pricing risks. An efficient financial sector
reduces the cost and risk of producing and trading goods and services and thus makes an
important contribution to raising the standard of living. The authors begin their analysis
by considering how an economy would perform without a financial sector and then
proceed to introduce a simplified financial sector with direct financial transactions
between savers and investors. Financial intermediaries are introduced which transform
the direct obligations of investors into indirect obligations of financial intermediaries

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which have attributes that savers prefer. This approach emphasizes how the financial
sector can improve both the quantity and quality of real investment and thereby increase
income per capita. The authors then consider the role of government in supporting an
efficient financial sector.

Task 1 The financial sector is one of the major elements of the circular flow of income
and spending.
4.1 Draw a diagram showing the financial sector and the other four major elements of
the circular flow of income and spending. On the same diagram show the four leakages
from the circular flow and the three injections into the circular flow.

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4.2 Explain how households and firms are linked by incomes and expenditures and how
expenditure is divided into consumption, investment, government, purchases and net
exports.
Gross domestic product (GDP) is the monetary value of all the finished goods and
services produced within a country's borders in a specific time period. Though GDP is

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usually calculated on an annual basis, it can be calculated on a quarterly basis as well.

GDP includes all private and public consumption, government outlays, investments and
exports minus imports that occur within a defined territory. Put simply, GDP is a broad
measurement of a nations overall economic activity.
The goods and services produced by business firm for country household brought
income to us. Some is paid by rent and interest, because the natural resources that is
own by household used to rent or sold to firm. The profit is balance after deducted from
cost of production.
The total income from household is called as gross domestic income. Things that we are
clear is, domestic income is equals to domestic product, because payments equal to the
value of what is produced and sold are paid out to the households.
The OECD defines GDP as "an aggregate measure of production equal to the sum of the
gross values added of all resident, institutional units engaged in production (plus any
taxes, and minus any subsidies, on products not included in the value of their outputs).
GDP by Industry can also measure the relative contribution of an industry sector. This is
possible because GDP is a measure of 'value added' rather than sales; it adds each firm's
value added (the value of its output minus the value of goods that are used up in
producing it). For example, a firm buys steel and adds value to it by producing a car;
double counting would occur if GDP added together the value of the steel and the value

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of the car. Gross output (GO) measures sales at all stages of production and therefore
involves some degree of double counting. Because it is based on value added, GDP
also increases when an enterprise reduces its use of materials or other resources
('intermediate consumption') to produce the same output. The more familiar use of GDP
estimates is to calculate the growth of the economy from year to year (and recently from
quarter to quarter). The pattern of GDP growth is held to indicate the success or failure
of economic policy and to determine whether an economy is 'in recession'.
One of the main ideas that economist John Maynard Keynes introduced is the idea that
the number one driver of the economy is demand. If we can measure the economy in
terms of what everyone spends, then we can estimate the level of production in our
economy. We measure the economy using GDP.
GDP stands for gross domestic product. It's the official measure of the total output of
goods and services in the economy. The definition of GDP is as follows: it is the total
market value of all final goods and services produced during a given time period within
a nation's domestic borders.
The word 'domestic' (in 'gross domestic product') means that we're only counting things
that are produced within our domestic borders, whether they are produced by Americans
or by foreigners. It doesn't matter. Nothing that is produced outside of our domestic
borders gets counted in the GDP.

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The diagram above shows simplest imaginable economy, because households will use
the money earned in buying firms products and services. This is called consumption.
4.3 Explain the relationships between injections and leakages in the circular flow.

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The diagram shows the closed economy. An economy in which no activity is conducted
with outside economies. A closed economy is self-sufficient, meaning that no imports
are brought in and no exports are sent out. The goal is to provide consumers with
everything that they need from within the economy's borders. An economy that does not
interact with the economy of any other country. A closed economy prohibits imports and
exports, and prohibits any other country from participating in their stock market. There

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have been many examples of closed economies throughout history, but very few closed
economies exist today. also called autarky.
The first leakage that is equals to tax revenue paid by households minus transfer
payments received by government is net taxes. Transfer payment including pension,
retiring benefit, assistance for poverty families. We will think that these are income but
actually it is tax rebate. The second leakage is saving, that is consider as income for
country. However, these are not used to pay taxes or to spend.
Saving process of setting aside a portion of current income for future use, or the flow of
resources accumulated in this way over a given period of time. Saving may take the
form of increases in bank deposits, purchases of securities, or increased cash holdings.
The extent to which individuals save is affected by their preferences for future over
present consumption, their expectations of future income, and to some extent by the rate
of interest.
There are two ways for an individual to measure his saving for a given accounting
period. One is to estimate his income and subtract his current expenditures, the
difference being his saving. The alternative is to examine his balance sheet (his property
and his debts) at the beginning and end of the period and measure the increase in net
worth, which reflects his saving.

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Total national saving is measured as the excess of national income over consumption
and taxes and is the same as national investment, or the excess of net national product
over the parts of the product made up of consumption goods and services and items
bought by government expenditures. Thus, in national income accounts, saving is
always equal to investment. An alternative measure of saving is the estimated change in
total net worth over a period of time.
Saving is important to the economic progress of a country because of its relation to
investment. If there is to be an increase in productive wealth, some individuals must be
willing to abstain from consuming their entire income. Progress is not dependent on
saving alone; there must also be individuals willing to invest and thereby increase
productive capacity.
The portion of disposable income not spent on consumption of consumer goods but
accumulated or invested directly in capital equipment or in paying off a home mortgage,
or indirectly through purchase of securities.
The savings and shares are raising program income from savings and shares is
advocated within both the financial sustainability paradigm and poverty alleviation
paradigms.
Cutting Costs to Create Big Savings

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"Get paid what you're worth and spend less than you earn. Make sure you know what
your job is worth in the marketplace, by conducting an evaluation of your skills,
productivity, job tasks, contribution to the company, and the going rate, both inside and
outside the company, for what you do. Being underpaid even a thousand dollars a year
can have a significant cumulative effect over the course of your working life. However,
no matter how much or how little you're paid, you'll never get ahead if you spend more
than you earn. Often it's easier to spend less than it is to earn more, and a little costcutting effort in a number of areas can result in big savings. It doesn't always have to
involve making big sacrifices."

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4.4 Explain the role of financial sector.

What distinguished financial institutions from other firms is the relatively small share of
real assets on their balance sheets. Thus, the direct impact of financial institutions on the
real economy is relatively minor. The indirect impact of financial markets and
institutions on economic performance is extraordinarily important. The financial sector
mobilizes savings and allocates credit across space and time. It provides not only
payment services, but also enables firms and households to cope with economic
uncertainties by hedging, pooling, sharing and pricing risks. An efficient financial sector

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reduces the cost and risk of producing and trading goods and services and thus makes an
important contribution to raising the standard of living. The authors begin their analysis
by considering how an economy would perform without a financial sector and then
proceed to introduce a simplified financial sector with direct financial transactions
between savers and investors. Financial intermediaries are introduced which transform
the direct obligations of investors into indirect obligations of financial intermediaries
which have attributes that savers prefer. This approach emphasizes how the financial
sector can improve both the quantity and quality of real investment and thereby increase
income per capita. The authors then consider the role of government in supporting an
efficient financial sector.
Firstly, as an intermediary agent, we helped to transfer the flow of fund from savers to
investors. Savers wont buy machines or office directly, but they will have bank
deposits, bank will help these savers to buy securities. This condition is also the
investment in the diagram.
Secondly, the role we are playing in redirecting flow of funds between private sector
and government. If there is no financial sector, government will need to balance the
budget every year. From the diagram, net taxes is equals to government purchases.

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Task 2
3.1 Explain what is meant by unemployment and inflation.
The trade-off between inflation and unemployment was first reported by A. W. Phillips
in 1958and so has been christened the Phillips curve. The simple intuition behind this
trade-off is that as unemployment falls, workers are empowered to push for higher
wages. Firms try to pass these higher wage costs on to consumers, resulting in higher
prices and an inflationary buildup in the economy. The trade-off suggested by the
Phillips curve implies that policymakers can target low inflation rates or low
unemployment, but not both. During the 1960s, monetarists emphasized price stability
(low inflation), while Keynesians more often emphasized job creation.
The experience of so-called stagflation in the 1970s, with simultaneously high rates of
both inflation and unemployment, began to discredit the idea of a stable trade-off
between the two. In place of the Phillips curve, many economists began to posit a
natural rate of unemployment. If unemployment were to fall below this natural rate,
however slightly, inflation would begin to accelerate. Under the natural rate of
unemployment theory (also called the Non-Accelerating Inflation Rate of
Unemployment, or NAIRU), instead of choosing between higher unemployment and
higher inflation, policymakers were told to focus on ensuring that the economy
remained at its natural rate: the challenge was to accurately estimate its level and to

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steer the economy toward growth rates that maintain price stability, no matter what the
corresponding level of unemployment.
Okun's Law describes a clear relationship between unemployment and national output,
in which lowered unemployment results in higher national output. Such a relationship
makes intuitive sense: as more people in a nation work it seems only right that the
output of the nation should increase. Building on Okun's law, another economist, A. W.
Phillips, discovered a relationship between unemployment and inflation. The chain of
basic ideas behind this belief follows: as more people work the national output
increases, causing wages to increase, causing consumers to have more money and to
spend more, resulting in consumers demanding more goods and services, finally causing
the prices of goods and services to increase. In other words, Phillips showed that
unemployment and inflation shared an inverse relationship: inflation rose as
unemployment fell, and inflation fell as unemployment rose. Since two major goals for
economic policy makers are to keep both inflation and unemployment low, Phillip's
discovery was an important conceptual breakthrough, but also posed a troublesome
challenge: how to keep both unemployment and inflation low, when lowering one
results in raising the other?

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he NAIRU has been extremely difficult to pin down in practice. Not only are estimates
of it notoriously imprecise, the rate itself evidently changes over time. In the United
States, estimates of the NAIRU rose from about 4.4% in the 1960s, to 6.2% in the
1970s, and further to 7.2% in the 1980s. This trend reversed itself in the 1990s, as
officially reported unemployment fell. In the latter half of the 1990s, U.S. inflation
remained nearly dormant at around 3%, while unemployment fell to around 4.6%. In the
later Clinton years many economists warned that if unemployment was brought any
lower, inflationary pressures might spin out of control. But growth in these years did not
spill over into accelerating inflation. The United States, apparently, had achieved the
Goldilocks stateeverything just right!
What sustained this combination of low inflation and low unemployment? Explanations
abound: a productivity boom, the high rates of incarceration of those who would

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otherwise fall within the ranks of the unemployed, the openness of the U.S. economy to
world trade and competition, among others.
The full story, however, has to do with class conflict and the relatively weak position of
workers in the 1990s. Both the breakdown of the Phillips curve in the 1970s and the
recent disappearance of the natural rate of unemployment are in essence a reflection
of institutional and political changes that affect the bargaining strength of working
peoplein other words, their ability to organize effective unions and establish a decent
living wage.
If the economy experienced a rise in AD, it will cause increased output; as the economy
comes closer to full employment, we also experience a rise in inflation. However, with
the increase in real GDP, firms take on more workers leading to a decline in
unemployment ( a fall in demand deficient unemployment). The Phillips curve relates
the rate of inflation with the rate of unemployment. The Phillips curve argues that
unemployment and inflation are inversely related: as levels of unemployment decrease,
inflation increases. The relationship, however, is not linear. Graphically, the short-run
Phillips curve traces an L-shape when the unemployment rate is on the x-axis and the
inflation rate is on the y-axis.
Imagine with me that five years ago the economy was in recession. In the town of
Ceelo, we find that Bob's low-rider lawn service is struggling. Customers have cut their

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budgets and have canceled service. Responding to a slower economy, Bob has had to
lay off workers, who are now looking for work elsewhere. At Margie's Cake Walk,
things are about the same. Fewer consumers are buying cakes, and when they do, they're
buying smaller ones. Margie has had to lay off workers to keep her costs down. In fact,
businesses across the economy are in a similar situation - unemployment is 8%, which
is higher than usual. Prices for goods and services are going up slowly, as measured by
an inflation rate of 1%.
Now imagine that this year the economy is growing rapidly. Bob's lawn service is
booming and his work force is very busy. Because of the strong economy, he's had to
hire additional workers. At Margie's Cake Walk, everyone is working overtime baking
and decorating cakes, and Margie has had to hire additional employees as well.
Businesses all over the economy are enjoying the good times, and there is a shortage of
workers available. Unemployment is 3%, and prices for goods and services are going up
quickly as measured by a 5% inflation rate.

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3.2 Explain the three types of unemployment and economic cost of unemployment.
DURING the recent downturn, the unemployment rate in America jumped from 4.4% to
10%. Economic growth has since pepped up. But unemployment is nowhere near precrisis lows: Americas rate, at 6.2%, is still 40% higher than late 2006. Economists are
raising the spectre of structural unemployment to explain this puzzle. What is it?
In the study of economics, unemployment is most simply defined as the state in which
people are without work but are actively seeking employment. Unemployment is often
used as a measure of the overall health of the economy. As such, it is a well-studied
subject. Economists break unemployment down into three primary categories:
structural, frictional, and cyclical. These categories encompass both involuntary
unemployment and voluntary unemployment which can occur when a person is laid off,
fired, or willingly leaves a job.
Economists often refer to three types of unemployment: "frictional", cyclical and
structural. Cold-hearted economists are not too worried about the first two, which
refer to people moving between jobs and those temporarily laid-off during a downturn.
The third kind refers to people who are excludedperhaps permanentlyfrom the
labour market. In econo-speak, structural unemployment refers to the mismatch
between the number of people looking for jobs and the number of jobs available. It is
bad news both for those who suffer from it and for the society in which they live. People

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out of work for long periods tend to have poorer health than average. The structurally
unemployed also squeeze social-security budgets.
Structural unemployment in advanced economies has been rising for decades, as jobs in
industries like mining and manufacturing have withered. In Britain between 1984 and
1992, employment in coal mining fell by 77% and in steelmaking by 72%.
Communities that were built around a single profession were devastated. Many of the
people affected only had experience of a specific, high-skill job. They did not have the
skills or attributes needed to be successful in many service-sector jobs (such as working
in a call centre or in a restaurant). Hence they were structurally unemployed. A different
problem may be afflicting advanced economies today. The downturn was truly nasty
and has lasted for years. Many people gave up looking for a job and withdrew from the
labour force. In America the number of these discouraged workers jumped from
370,000 in 2007 to 1.2m in 2010. (Today it is twice its 2007 level.) Those who have
been unemployed for more than a year are only one-third as likely to find a job as those
unemployed for fewer than six months: employers believe that those unemployed for
shorter periods of time are more motivated and skilled. Long-term unemployment can
thus turn into structural unemployment.
But structural unemployment is not simply a product of economic busts. Karl Marx
(who considered himself an economist) referred to a reserve army of labour. Marx
argued that capitalism depended on people being out of work. The jobless, clamouring

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for employment, would ensure that workers were too scared to push for wage rises.
Capitalists relied on the unemployed to keep their costs down. Marx exaggerated,
though most economists would accept that a certain level of unemployment is
inevitable: an attempt to achieve full employment would stoke massive wage inflation.
Whatever its causes, governments have to understand structural unemployment.
Economic growth alone will not be enough to get everyone into work. Supply-side
reforms, such as job training (known by wonks as active labour market policies) are
also needed.
Cyclical Unemployment
Over time, the economy experiences many ups and downs. That's what we call cyclical
unemployment because it goes in cycles. Cyclical unemployment occurs because of
these cycles. When the economy enters a recession, many of the jobs lost are considered
cyclical unemployment.
For example, during the Great Depression, the unemployment rate surged as high as
25%. That means one out of four people were willing and able to work, but could not
find work! Most of this unemployment was considered cyclical unemployment.
Eventually, unemployment came down again. As you can see, at least part of
unemployment can be explained by looking at the cycles, or the ups and downs of the
economy.

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Cyclical unemployment is a type of unemployment that occurs when there is not enough
aggregate demand in the economy to provide jobs for everyone who wants to work. In
an economy, demand for most goods falls, less production is needed, and less workers
are needed. With cyclical unemployment the number of unemployed workers is greater
that the number of job vacancies.
Frictional Unemployment
Frictional unemployment is another type of unemployment within an economy. It is the
time period between jobs when a worker is searching for or transitioning from one job
to another. Frictional unemployment is always present to some degree in an economy. It
occurs when there is a mismatch between the workers and jobs. The mismatch can be
related to skills, payment, work time, location, seasonal industries, attitude, taste, and
other factors. Frictional unemployment is influenced by voluntary decisions to work
based on each individual's valuation of their own work and how that compares to
current wage rates as well as the time and effort required to find a job.
Frictional unemployment occurs because of the normal turnover in the labor market and
the time it takes for workers to find new jobs. Throughout the course of the year in the
labor market, some workers change jobs. When they do, it takes time to match up
potential employees with new employers. Even if there are enough workers to satisfy

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every job opening, it takes time for workers to learn about these new job opportunities,
and for them to be considered, interviewed and hired.
When Cindy graduates from college, she begins looking for work. Let's say it takes her
four months to land a new job. During this time, she is frictionally unemployed.
Structural Unemployment
Structural unemployment is one of the main types of unemployment within an
economic system. It focuses on the structural problems within an economy and
inefficiencies in labor markets. Structural unemployment occurs when a labor market is
not able to provide jobs for everyone who is seeking employment. There is a mismatch
between the skills of the unemployed workers and the skills needed for the jobs that are
available. It is often impacted by persistent cyclical unemployment. For example, when
an economy experiences long-term unemployment individuals become frustrated and
their skills become obsolete. As a result, when the economy recovers they may not fit
the requirements of new jobs due to their inactivity .

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Task 3 Explain how changes in each of the determinants:

(1) resource prices

Natural resource prices increased rapidly during the first decade of this century, mainly
propelled by rapid increases in world GDP, especially of the US, China, Brazil, and
other fast developing countries. These prices then stabilized and many declined due to
the world recession brought on by the financial crisis in 2008.

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Some examples illustrate the magnitude of the price movements. Nominal copper prices
quadrupled from 2001, despite a sharp fall in 2008, peaked around 2010, and declined
by about 25% since that peak. Oil prices increased from $20 a barrel in 2002 to more
than $140 a barrel in 2008, and have been in the range $100-$120 since then. Natural
gas prices in most of the world increased several fold since 2000, and have been flat for
the past couple of years. At the same time, natural gas prices in the US have fallen by
more than 2/3 since their peak a few years ago.
The resource prices paid for the use of labor, capital, land, and entrepreneurship affect
production cost and the ability to supply a good. If resource prices increase, then
production cost is higher and the sellers are inclined to offer less of the good for sale. If
resource prices decrease, then production cost is lower and the sellers are inclined to
offer more of the good for sale.
his determinant category is based on the relation between resource price, production
cost, and the price level. Changes in a resource price affects the cost of production. A
higher price means higher cost and a lower price means lower cost. Changes in
production cost then affect the prices that sellers are willing to accept to sell goods and
services, which subsequently affects the overall price level. Greater production cost
means higher product prices and a higher price level, and lower production cost means
lower product prices and a lower price level.

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(2) technology
As companies demand more sophisticated technology to help manage their businesses,
the cost to develop and produce applications will likely increase. Customized programs
that meet the specific needs of a business are becoming more popular as companies
engage the services of functional and technology consultants. These experts can
determine the type of solutions necessary to help the business run smoothly and
efficiently. Companies such as SAP produce technology solutions for virtually every
part of industry. SAP and similar firms routinely send to their clients functional
consultants familiar with the type of business and technology consultants who know
how to engineer the solutions.
Technological change, technological development, technological achievement, or
technological progress is the overall process of invention, innovation and diffusion of
technology or processes.[1][2] In essence technological change is the invention of
technologies (including processes) and their commercialization via research and
development (producing emerging technologies), the continual improvement of
technologies (in which they often become less expensive), and the diffusion of
technologies throughout industry or society (which sometimes involves disruption and
convergence). In short, technological change is based on both better and more
technology.

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The other focal area for Rensselaer's department of economics is technological change,
the dynamic process at the root of economic growth. The bulk of economic growth 87.5% according to Nobelist Robert Solow's (1957) initial estimates, stems from
technological change: improvements in efficiency and effectiveness of industry. And
Solow's estimates do not even correct for the "hedonic" price changes needed to account
for improvements in products' features and quality, nor for the development of new
goods and services. To understand how to achieve the kinds and amount of economic
growth we desire, we must understand technological change and its role in the
industries where it occurs.

Technological change has many facets. Technological change includes, as well as

creation of new products, quality improvement and efficiency gains for existing
products. Cars, lighting, computers, software - these and in fact nearly all products have
been improving in quality while their manufacturing costs remain constant or
decreasing; the economy is improving. Knowledge diffuses across countries and
regions, between industries and companies, across universities and researchers.
Employees learn the skills that help with current generations of technology, and those
skills similarly spread geographically and between people. The processes of technology
creation in scientific teams and in companies' plant-floor work teams determine how
quickly new technology emerges. Technological success brings a financial reward to

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companies, which - if they keep succeeding ahead of the competitors - increase their
market share. Companies' sizes and traits in turn affect the types and amounts of their
innovation, affecting technological progress. These and other matters must be
understood, to be able to design appropriate policy, to understand industry competition,
to understand growth.
Rensselaer's Economics department brings together a world-class group of researchers
on these issues. Together our team is making strides in understanding all of the above
issues. The faculty involved edit journals, organize large numbers of conferences,
present their work at the leading economics conferences, and publish in the most
prestigious of outlets for economics papers
(3) taxes and subsidies

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Marginal subsidies on production will shift the supply curve to the right until the
vertical distance between the two supply curves is equal to the per unit subsidy; when
other things remain equal, this will decrease price paid by the consumers (which is
equal to the new market price) and increase the price received by the producers.
Similarly, a marginal subsidy on consumption will shift the demand curve to the right;
when other things remain equal, this will decrease the price paid by consumers and
increase the price received by producers by the same amount as if the subsidy had been
granted to producers. However, in this case, the new market price will be the price
received by producers. The end result is that the lower price that consumers pay and the
higher price that producers receive will be the same, regardless of how the subsidy is
administered.

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When the government provides a supply-side subsidy to the producers of a product, the
supply curve shifts to the right and the demand curve remains the same. Because they
are being subsidized, producers are encouraged to produce more of a product and are
able to do so for less. The price of an environmentally conscious vehicle drops and more
are produced. In practice, a supply-side subsidy will cause the demand for a green
vehicle to increase.
When the government provides a demand-side subsidy to consumers, it encourages
them to purchase a given product. For example, a tax rebate to consumers who purchase
a green car will in theory cause the demand curve for environmentally conscious
vehicles to shift up and to the right, while the supply curve stays the same. Because
consumers will be paying less, producers can actually increase the price because
producers can charge more and consumers are being artificially encouraged to purchase
green cars, producers are encouraged to produce more. The price and the quantity
produced both increase.
(4) prices of other goods

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Supply elasticity increases with Ease of switching to production of other goods from same resources
Ease of storage
Number of suppliers in market - ability to go out of business, Barriers to entry/exit
The ability to use other resource inputs
The amount of time available to respond to a price change.
Spare capacity - ability to change production with existing resources
The quantity supplied of the given commodity depends not only on its price, but also on
the prices of other goods. Increase and Decrease in prices of other goods shifts the
original supply curve of given commodity.
(i) Increase in Price of other goods:

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When prices of other goods rises, then production of such other goods become more
profitable in comparison to the given commodity. As a result, supply falls from OQ to
OQ1 at the same price OP. It leads to a leftward shift in the supply curve from SS to
S1S1.
(ii) Decrease in Price of other goods:
Fall in prices of other goods make production of the given commodity more profitable
and it increases its supply from OQ to OQ1 at the same price OP. It leads to a rightward
shift in the supply curve from SS to S1S1.
(5) producer expectations
When talking about supply, there are two terms that get used quite a bit: supply and
quantity supplied. These two terms have two very different meanings. When economists
talk about quantity supplied, they are referring to one particular price point and one
particular quantity, so a single point on the table or the graph. When economists talk
about supply, they are referring to the entire table or graph.
If we take a look at any supply equation, table, or graph, well notice that there are two
variables: price (P) and quantity supplied (QS). These two variables are what we use to
construct our supply model; we take a look at the effect of price on the quantity
supplied. We call these variables endogenous variables because they are variables inside

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of our model. Whenever we alter an endogenous variable, we move along the curve. So
a change in price will cause a change in quantity supplied, moving you along the supply
curve. So for example, if we change our price from Pa to Pb, we would move along the
curve from point a to point b. Correspondingly, the quantity supplied that were
referring to goes from Qa to Qb.
Producers can predict what the sells of a product will look like and will use this to
determine when and how to sell their products.
Shifter Shifts Supply
If a producer expects the price of a good to rise in the future the producer will store the
goods now in order to sell it for a higher price in the future.
Then if the price is expected to drop, producers will place goods on the market
immediately in order to make a profit before the price drops.
Side Note
Expectations of higher prices will reduce supply now and increase supply later (sell
more at its highest price)
Expectations of lower prices will increase supply now and reduce them later. (sell as
much as possible before price decreases)

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Examples
One example would be clothing because as the seasons change, demand for certain
clothing do as well. Before winter, producers will expect sales of summer clothes to do
down so then they want to sell all of it immediately before the weather changes.
Another example is wine, usually the longer wine is aged, the more expensive it will be.
Therefore, producers will want to store as much as possible in order to be able to sell it
at the highest price later.
Price in agricultural supply equations is usually the expected price. In general, models
of agricultural supply response assume that their representation of producer
expectations is correct. If this assumption is wrong, the supply response parameter will
have embodied within it an estimate of the expected price distortion, biasing the
estimated parameter. Furthermore, no effort has been made in existing models to allow
for heterogeneous price expectations. In almost every supply model, one price estimate
is used to represent the price expectations of hundreds or thousands of producers, which
could masks a wide range behavior among heterogenous producers. Rather than
assuming the models representation of producer expectations is correct, the goal of this
paper is to use revealed producer behavior to assist in the estimation of producers
expected prices. To explicitly address producers formation of the expected price, this
study jointly estimates the supply equation and the price expectation equation. The

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empirical application is a pooled time-series cross-section data analysis of U.S. wheat

and corn supply data at the county level.
(6) the number of sellers in the market affect supply

A change in number of sellers causes the supply curve to shift. This can be illustrated
using the positively-sloped supply curve for Wacky Willy Stuffed Amigos presented in
this exhibit. This supply curve captures the specific one-to-one, law of supply relation
between supply price and quantity supplied. The number of sellers is assumed to remain
constant with the construction of this supply curve.
ood's own price: The basic supply relationship is between the price of a good and the
quantity supplied. Although there is "Law of Supply", generally, the relationship is
positive, meaning that an increase in price will induce an increase in the quantity
supplied.

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Prices of related goods: For purposes of supply analysis related goods refer to goods
from which inputs are derived to be used in the production of the primary good. For
example, Spam is made from pork shoulders and ham. Both are derived from pigs.
Therefore pigs would be considered a related good to Spam. In this case the relationship
would be negative or inverse. If the price of pigs goes up the supply of Spam would
decrease (supply curve shifts left) because the cost of production would have increased.
A related good may also be a good that can be produced with the firm's existing factors
of production. For example, suppose that a firm produces leather belts, and that the
firm's managers learn that leather pouches for smartphones are more profitable than
belts. The firm might reduce its production of belts and begin production of cell phone
pouches based on this information. Finally, a change in the price of a joint product will
affect supply. For example beef products and anani sikim leather are joint products. If a
company runs both a beef processing operation and a tannery an increase in the price of
steaks would mean that more cattle are processed which would increase the supply of
leather.
Anytime buyers and sellers come together, a market is created. It may be in the
supermarket, it may be a phone call to Home Shopping Network, or it may be logging
on to Amazon.com. Buyers are careful about how much they are willing to pay for a
product, often shopping around for the best price for their money. Suppliers respond in
the same way by moving to a price where there are no leftovers or shortages.

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Buyers of the cookies will be willing and able to purchase more cookies at a low price
and fewer cookies at a high price. This happens because, at higher prices, cookie buyers'
dollars purchase less than at lower prices. Economists call this the income effect.
Cookie consumers are more willing to buy cookies at low prices. At high prices, cookie
consumers look for other products to buy instead, such as ice cream, Popsicles, or candy
bars. Economists call this the substitution effect.
Determinants of Supply
Elements besides price which determine the available amount of a product or service.
Examples of determinants of supply in a business consist of the price of raw material,
production costs, taxes and duties, subsidies and any other factor relating to the end
supply of a good or service.
Supply determinants are five ceteris paribus factors that are held constant when a supply
curve is constructed. They are held constant to isolate the law of supply relation
between supply price and quantity supplied. When the determinants change they cause a
change in the location of the supply curve. In effect, supply determinants can be said to
"determine" the position of the supply curve.

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Conclusion
The trade-off between inflation and unemployment was first reported by A. W. Phillips
in 1958and so has been christened the Phillips curve. The simple intuition behind this
trade-off is that as unemployment falls, workers are empowered to push for higher
wages. Firms try to pass these higher wage costs on to consumers, resulting in higher
prices and an inflationary buildup in the economy. The trade-off suggested by the
Phillips curve implies that policymakers can target low inflation rates or low
unemployment, but not both. During the 1960s, monetarists emphasized price stability
(low inflation), while Keynesians more often emphasized job creation.

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Anytime buyers and sellers come together, a market is created. It may be in the
supermarket, it may be a phone call to Home Shopping Network, or it may be logging
on to Amazon.com. Buyers are careful about how much they are willing to pay for a
product, often shopping around for the best price for their money. Suppliers respond in
the same way by moving to a price where there are no leftovers or shortages.
If we take a look at any supply equation, table, or graph, well notice that there are two
variables: price (P) and quantity supplied (QS). These two variables are what we use to
construct our supply model; we take a look at the effect of price on the quantity
supplied. We call these variables endogenous variables because they are variables inside
of our model. Whenever we alter an endogenous variable, we move along the curve. So
a change in price will cause a change in quantity supplied, moving you along the supply
curve. So for example, if we change our price from Pa to Pb, we would move along the
curve from point a to point b. Correspondingly, the quantity supplied that were
referring to goes from Qa to Qb.
The resource prices paid for the use of labor, capital, land, and entrepreneurship affect
production cost and the ability to supply a good. If resource prices increase, then
production cost is higher and the sellers are inclined to offer less of the good for sale. If
resource prices decrease, then production cost is lower and the sellers are inclined to
offer more of the good for sale.

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Reference

Textbook BBA 2007

http://economics.about.com/od/supply-and-the-supply-curve/ss/The-

Determinants-Of-Supply.htm
http://www.sptimes.com/News/111600/NIE/How_the_market_affect.shtml
http://www.dummies.com/how-to/content/the-economic-relationship-between-

quantity-supplie.html
http://www.economics.rpi.edu/pl/economics-technological-change
http://www.becker-posner-blog.com/2013/08/technological-change-and-naturalresource-prices-becker.html

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BBA 2007
PRINCIPLE OF MACROECONOMICS
COURSEWORK

CHAI JIA NI
960411-14-5238
202409

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DECEMBER 2015

1.

How will the System Accommodate Change? Explain carefully.

Market systems are dynamic: Consumer preferences, technology, and supplies of

resources all change. This means that the particular allocation of resources that is now
the most efficient for a specific pattern of consumer tastes, range of technological
alternatives, and amount of available resources will become obsolete and inefficient as
consumer preferences change, new techniques of production are discovered, and
resource supplies change over time. Can the market economy adjust to such changes?
Suppose consumer tastes change. For instance, assume that consumers decide
they want more fruit juice and less milk than the economy currently provides. Those
changes in consumer tastes will be communicated to producers through an increase in
spending on fruit and a decline in spending on milk. Other things equal, prices and

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profits in the fruit juice industry will rise and those in the milk industry will fall. Selfinterest will induce existing competitors to expand output and entice new competitors to
enter the prosperous fruit industry and will in time force firms to scale downor even
exitthe depressed milk industry.
The higher prices and greater economic profit in the fruit-juice industry will not
only induce that industry to expand but will also give it the revenue needed to obtain the
resources essential to its growth. Higher prices and profits will permit fruit producers to
attract more resources from less urgent alternative uses. The reverse occurs in the milk
industry, where fewer workers and other resources are employed. These adjustments in
the economy are appropriate responses to the changes in consumer tastes. This is
consumer sovereignty at work.
The market system is a gigantic communications system. Through changes in
prices and profits, it communicates changes in such basic matters as consumer tastes
and elicits appropriate responses from businesses and resource suppliers. By affecting
price and profits, changes in con-sinner tastes direct the expansion of some industries
and the contraction of others. Those adjustments are conveyed to the resource market.
As expanding industries employ more resources and contracting industries employ
fewer, the resulting changes in resource prices (wages and salaries, for example) and
income flows guide resources from the contracting industries to the expanding
industries.

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This directing or guiding function of prices and profits is a core element of the
market system. Without such a system, a government planning board or some other
administrative agency would have to direct businesses and resources into the
appropriate industries. A similar analysis shows that the system can and does adjust to
other fundamental changesfor example, to changes in technology and in the prices of
various resources.
2.

Please describe microeconomics and macroeconomics.

Microeconomics is the part of economics concerned with individual units such

as a person, a household, a firm, or an industry. At this level of analysis, the economist

observes the details of an economic unit, or very small segment of the economy, under a
figurative microscope. In microeconomics we look at decision making by individual
customers, workers, households, and business firms. We measure the price of a specific
product, the number of workers employed by a single firm, the revenue or income of a
particular firm or household, or the expenditures of a specific firm, government entity,
or family. In microeconomics, we examine the sand, rock, and shells, not the beach.
Macroeconomics examines either the economy as a whole or its basic
subdivisions or aggregates, such as the government, household, and business sectors. An
aggregate is a collection of specific economic units treated as if they were one unit.

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Therefore, we might lump together the millions of consumers in the U.S. economy and
treat them as if they were one huge unit called "consumers."
In using aggregates, macroeconomics seeks to obtain an overview, or general
outline, of the structure of the economy and the relationships of its major aggregates.
Macroeconomics speaks of such economic measures as total output, total employment,
total income, aggregate expenditures, and the general level of prices in analysing
various economic problems. No or very little attention is given to specific units making
up the various aggregates.
Figuratively, macroeconomics looks at the beach, not the pieces of sand, the
rocks, and the shells.
The micromacro distinction does not mean that economics is so highly
compartmentalized that every topic can be readily labelled as either micro or macro;
many topics and subdivisions of economics are rooted in both. Example: While the
problem of unemployment is usually treated as a macroeconomic topic (because
unemployment relates to aggregate production), economists recognize that the decisions
made by individual workers on how long to search for jobs and the way specific labour
markets encourage or impede hiring are also critical in determining the unemployment
rate.

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