a. Gross Domestic Product refers to the worth of all the products and services that a state produces within a given time. Based on the definition, the GDP of a country represents a market value of the final goods and services excluding intermediate products and services to prevent double counting (Endres 2011, p. 142). Thus, GDP measures domestic production in a year or a quarter of the year. There are three methods of measuring GDP: the expenditure, income approach, and production approach. In production or output approach, the measuring involves compiling GDP, which results in counting production sector by sector. Most countries still use this method although it presents the challenge of differentiating between final and intermediate goods. Expenditure approach represents the summation of expenditure and investments of various products and services. Consequently, the income approach involves measuring the Gross Domestic Product through summing the incomes from the households for the services offered to the customers. The main factors for payments include returns to labor and returns to capital and profits.
b. Real GDP is considered the worth of the products and services generated within a given year and valued based on the constant price. Calculation of real GDP is based on first determining the nominal GDP. Consequently, nominal refers to the worth of various products and services that a country produces within a given year. However, the prices are valued based on the existing prices within similar year.
c. Purchasing power parity (PPP) refers to an economic theory which requires comparing the currencies of different countries based on the “basket of goods” method. Based on the thought, these currencies form the equilibrium if the price of the goods in the bucket is determined based on the prices of both countries.
1 and 2 are countries
S represents exchange rates of
P1 - value of goods in country 1
P2 – value of goods in country 2
d. According to Wolf (2018), there is a relationship between politics and economic growth. However, the main factors addressed in the article include inflation and growth, fiscal policy and growth, international trade and growth, and financial development and growth. In most cases, the usual arguments for lower and stable inflation rates include a reduction in uncertainty within the economy and improvement in the efficiency of the price mechanism. There are several threats to the political orders which in turn affect economic growth. Most attractive countries that have attracted investors practice liberal democracy as it enables efficient operation of various business activities. Wolf (2018) also noted that global activities have been on the rise, which has increased demand generation for certain products and services.
2. Risks to economic growth
a. Risks of outright conflict between two superpowers, the US and China, could affect global economic growth; unsustainable growth is another risk since it elevates the debt levels and increases the prices of various assets considered crucial for economic operations. Disruptions resulting from stronger inflation, overvalued asset prices, and solvency of the big debtors, which reduce the room for manoeuvring on the fiscal policies. War is a political risk that affects the economy with the current fear associated with nuclear wars due to its magnitude of destruction.
b. Nominal interest refers to interest on loans or bonds. Thus, it includes interest rate without inflation. Real interest rate involves adjusting interest rate to eliminate various effects associated inflation. Real interest rates show a borrower the real cost of funds. Thus, nominal interest rate – inflation = real interest rate
c. Wars, financial crisis, inflation shocks, policies, and politics affect the world economy in the long-run. Wars among the oil-producing countries have been disruptive with policies and unsustainable politics playing a dominant role in increasing inflation. Politics has led to increased protectionism and irresponsible financial liberalization. Moreover, politics is considered to shape long-term policies that determine the performance of various economies.
3. Referring to the Figure
a. With the economic recession that occurred in the early 1990s, the world economy started growing again in 1991, and since the period, the economy has witnessed steady growth in each quarter. Based on the graph, there are periods in which economic growth slowed noticeably. However, at no point between 1990 and 2017 did the year-ended growth turn negative. It is notable that, while global economic growth remained positive, the slowdowns associated with various economic activities failed to reflect noticeable economic challenges.
b. From the graph, it is seen that the Great Depression occurred in 1930-1950, while the Global Financial Crises occurred in 2008. Great Depression and Financial Crisis had several similarities. During the Great Depression, there was tight monetary policy leading to failure of the banks and tightening of credit while in 2008, there were extraordinary measures to loosen the policies and ensure the provision of liquidity to the banks. A recession refers to a widespread of economic decline that for at least six months while a depression represents a severe decline that lasts for many years.
c. The first oil shock occurred in the 1970s while the second occurred in the 1980s. In the 1970s, war among the producers led to the disruption of various processes. For example, the war that occurred between Iran and Saudi Arabia left the global economy devastated due to reduction in oil supply and with increased demand; the oil prices increased which affected various operations of the economy. Unsustainable politics and policy also led to the generation of inflation, which in turn led to increased prices of basic commodities dependent on oils for manufacturing and processing. The war on oil among the producers led to protectionism and associated financial liberalization which affected the global economy.
d. When the shocks struck, oil production is reduced. As a result, there is low supply in the major world economies and subsequently increased demand. When supply is low, the demand increases which in turn lead to increase in prices.
Figure 1: Demand and Supply Curve for Oil
Based on the graph, the supply of oil reduced from supply 1 to supply 2 reflecting an increment in the demand. With increased demand, the prices of oil increased globally.
Question 2
1. From the article, the supply of butter has declined to prompt increment in the demand for the butter and other products that depend on butter. The rise in demand led to increased prices in the market.
From the graph, with the deteriorating condition for milk production, the amount of support used to process better has declined from Supply 1 to Supply 2. According to the law of demand, if other factors remain equal, then higher prices of goods would reduce the demand, but the law of supply means that the higher the prices, the high quantity supplied. However, based on the case, the supply of butter has been reducing leading to increased demand in the market. The demand affected the prices of other products which depend on butter for production.
2. Production efficiency reduces if producers are burdened with increasing amount of debts (Endres, 2011, p. 89). The UK has favourable weather for milk production. However, with the liberalization of the dairy market, the prices of dairy products were depressed. The EU compensated the farmers as a form of incentive despite not producing milk with an aim to assist them to service their debts and focus on milk production. Reduction in the milk supply affected not only butter production, but also other sectors that use milk products to process other goods. Europe has a huge supply of milk with producers locked into a vicious cycle of overproduction which has to a reduction in prices far below the cost of making milk. Such practices have pushed many people out of business.
3. Price elasticity of supply (PES) refers to the measure of the responsiveness of the amount of products and service supplied to a change in price. With the changing market structures and consumer tastes and preferences, businesses need to learn how quickly and effective they can respond to the changing market conditions especially to issues associated with changes in prices. Thus, PES measure the existing link between the change in quantity supplied and change in price. The equation below can be used in calculating PES
(Percentage change in supply ÷ percentage change in price)
While the coefficient of the calculation of positive, it might range from 0. If PES is more than 1, then the supply is elastic. In such cases, producers can increase their outputs without increasing the cost. If PES is less than 1, then the supply is inelastic. In such case, the business might find it hard to change production within a given period.
4. Based on the analysis of the article, PES is less than 1. Butter industry in the UK experiences inelastic supply due to various factors. The firms operating within the industry are many but have low stock levels since most farmers stopped milk production. As a result, there are no surplus goods to sell in the market. In such markets, it is difficult to use factors of production, especially if the highly skilled workforce is needed. Moreover, with inelastic supply nature of the butter industry, percentage change in prices lead to smaller changes in quantity supplied. In the UK, the amount of supply for butter is low which affects other sectors, which depend on butter for further processing. Another proof of low PES is that the EU gives incentives to the farmers to stop production due to declining market for milk especially with the ban in Russia.
5. The market structure is perfect competition. In a competitive market, supply and demand determinants play important roles in determining the amount of goods and services produced in the markets with the businesses setting the prices in the market (Mankiw, Kneebone " McKenzie, 2011, p. 105). Theoretically, the market is ideal since it exhibits free entry and exit for the milk farmers. With several competitors in the market, the influence of one business or buyer is small and does not affect the operations of the market. In the market, both buyers and sellers are considered price takers rather than influencers. Another important feature is that the products are homogenous. Thus, there is little difference among them. The products identical with critical information on the quality and price openly available for the customers.
6. Cross price elasticity refers to the measures of responsiveness of the demand for certain goods, based on the change in the price of the related product. Thus, it involves looking at various effects of changes in the relative prices within the market on the demand patterns (Mulhearn " Vane, 2016, p. 23). With adequate understanding of the cross-price elasticity, businesses can make critical distinctions between substitutes and complementary products. Since consumption behaviours are related, changes in the price of related goods might change the prices of others. For example, increased prices of dairy led to increase in the price of pastries, croissants, and brioches.
7. French bakeries depend on butter to prepare their pastries, brioches, and croissants. Thus, if the price of butter increases, then French bakeries would increase the prices of its products to meet the cost of production. However, the demand for butter also affects vegetable oil-based spreads. Vegetable oil-based have potential health effects on the customers. Increasing prices would drop leading to a reduction in the demand for vegetable oil-based spreads.
References
Endres, A. 2011. Environmental economics: Theory and policy. Cambridge: Cambridge University Press.
Mankiw, N. G., Kneebone, R. D., " McKenzie, K. J. 2011. Principles of macroeconomics. Toronto: Nelson Education.
Mulhearn, C., " Vane, H. R. 2016. Economics and Business, Economics for Business, vol. 5 no. 7, pp. 1-34.
Wolf, M. 2018 The world economy hums as politics sours. Financial Times, 9/1/2018
