1 a) Explain what you understand by the concept GDP and the three ways that it can potentially be measured.
Gross Domestic Product (GDP) refers to the measurement of the monetary value of all the final services and goods manufactured within a country over a specific period of time, usually a year. The GDP measures the total economic activity of a country in terms of its total output. Therefore, it is used to measure an economy’s size. There are three methods of measuring GDP. These methods include the Production Approach Method, Income Approach Method, and the Expenditure Approach Method. The Expenditure Approach evaluates the total sum of all finished goods purchased in an income.
GDP = Consumption + Investment + Government Spending + Net Exports
On the other hand, the Income Approach considers the final income generated by the produced goods and services using the formula below.
GDP = Sales taxes + Total National Income + Net Foreign Income + Depreciation
Lastly, the Production Approach considers the total value added to a commodity during the process of production.
b) Explain the difference between nominal GDP and real GDP as mentioned in the article.
Whereas nominal GDP is calculated using the prevailing market prices of the commodities and services, the values of the real GDP are adjusted to factor in inflation. Therefore, this means that the difference between the real and nominal GDP is the inflation factor on the value of the commodities and services produced within the economy.
c) Mr. Wolf refers to GDP being higher if measured using purchasing power parity (PPP). Explain the concept of PPP.
The Purchasing Power Parity concept seeks to compare the exchange rates between two currencies through the use of a basket of goods. The Purchasing Power Parity is a concept that seeks to compare currencies of different economies based on the price of identical goods. The PPP theory states that the prices of similar goods in two countries should be at par or in equilibrium over time. The exchange rates of two different currencies should be at equilibrium when the purchasing power of the two countries is similar.
d) According to Mr. Wolf, what are the driving forces behind the relatively good growth rates within the world economy? Explain his thinking on this matter.
Mr. Wolf attributes investment, subdued inflation, low real and nominal interest rates as well as fiscal policies to be the driving forces behind the world’s economy good growth rates. Mr. Wolf believes that an increase in investments especially in the Eurozone results in an overall increase in an economy's GDP. Reduced inflation rates imply that a reduction in the uncertainty of an economy thereby encouraging investments. Low real and nominal rates imply that investors can confidently invest in the financial market. Employment of proper fiscal policies by governments stimulates economic growth.
2. In the short-run, there are certain risks to the growth of the world economy, according to the article.
a) List and explain what these risks are.
I. Fall in Stock Markets: a prolonged decline in stock markets limit investments resulting in a decline in a country’s GDP. High asset prices limit productivity.
II. Elevated Levels of Debt: The Growth levels of debt, especially in the Eurozone, poses risks to the frontier and emerging markets as they can no longer access cheap credit and low-interest rates.
III. Bad Politics: The emergence of bellicose politicians such as Donald Trump who institute protectionist policies that limit cross-border interactions, which hinder economic activities and growth.
IV. Wars and Conflicts: Conflicts between powerful nations such as between the USA and China is a major risk to global economic growth. Wars between countries producing oil such as between Iran and Saudi Arabia could cripple the global energy markets severely hitting global growth prospects.
b) In words, explain the difference between Real and Nominal Interest Rates, Use an appropriate formula in your answer
Nominal Interest Rate refers to the interest quoted on loans and bonds. While the nominal interest rate does not take into account inflation, the real interest rate gives the real rate of the bond after adjusting it for inflation. The formulas below can be used in calculating the Real and the Nominal Interest Rates.
Real Interest Rate = Nominal Interest Rate –Inflation Rate
Nominal Interest Rate = Real Interest Rate + Inflation Rate
c) In the long-run, what are the main factors that tend to cause sharp slowdowns in the world economy? Are any of these risks possible in the next period? Explain your answers.
Disruptive politics, wars, inflation shocks, and financial crises are the major factors causing slowdowns of the global economy. Some of these risks are also possible in the next period. Financial crises slow down the global economy as it freezes financial markets, affects employment, spending, and output. Politics often initiate protectionism and implementation of certain policies limit international trade and thereby slowing down economic growth. Inflation shocks result in devaluation. Inflation contributes to the rigidity of economies whereby when prices become inflexible, demand is weakened and this has an overall effect of decreasing production and output. The effects of wars among nations may have long-term consequences as it affects the economic relationships of the warring countries. All these factors pose risks that limit global economic growth in the long run.
3. With reference to Figure 2:
a) How would you describe world economic growth in GDP from 1990 to 2017? Do you see any patterns or differences over different time periods? Explain your answer.
In the late 20th Century and early 21st Century, the economic growth in GDP has not been normal but it has been phenomenal. The economy has been characterized by financial crises and wars. Attempts to recover from these conditions are the reason why the economic growth has experienced both periods of booms and recession. There are various patterns that characterize economic growth for the said period. There are periods when the growth projections are high and those when they are low. The patterns can be described as moving slowly implying little or no growth and then suddenly having a spike, especially in the decreasing direction. This implies that economic growth has been slow, crises and wars cause a sharp decline in growth then recovery attempts to stabilize the economy.
b) What was the Great Depression and the Global Financial Crisis, Figure 2 refers to? What is the difference between a depression and a recession?
The Great Depression occurred from 1929 to 1939. It was an economic downturn of the industrialized world that commenced after there was a crash in the stock market. This crash made Wall street panic and some investors were wiped off. During the period, there was a huge decline in industrial output as investment and consumer spending dropped since unemployment levels were o the rise as a result of the company laying off workers.
The Global Financial Crisis started in July 2007 as a result of a liquidity crisis. The crisis was as a result of US investors losing confidence in the worth of sub-prime mortgages. A huge amount of capital was injected into the financial markets by the US Federal Bank. This resulted in stock markets around the globe crashing and they turn out to be exceedingly volatile.
A recession is a phase of decline in the business cycle characterized by unemployment, a decline in output, GDP, income and production and lasts for a few months. On the other hand, depression is a persistent period of recession that results in a noteworthy decline in employment and income. Whereas recession occurs frequently striking in different countries at different times, depression despite being rare strikes the entire global economy.
c) Figure 2 makes reference to the first and second oil shocks. Briefly explain the background to these shocks and what happened to the price of oil and its subsequent impact on the world economy.
The first oil crisis occurred in 1973 when oil producers in Arab executed an embargo. The price of oil was quadrupled to about $12 per barrel and exports to Western Europe and the United States were prohibited. The value of the US dollar declined and earnings from exports of OPEC countries was eroded. This resulted in a period of steep recession and high inflation as oil prices were relatively high.
The second oil crisis took place in 1979 following the Iranian Revolution between 1978 and 1979. The Iranian oil industry was brutally damaged by the increased levels of social turmoil resulting in great loss of output. Between 1980 and 1988 the Iran-Iraq war heightened instability in the region. The price was stabilized in 1981 to $32 per barrel. By 1983, rather than a shortage, there was an oversupply of oil.
Increased oil prices resulted in a decrease in the GDP of the oil exporting and importing economies. These economies experienced aggregate supply and demand shocks. Increased oil prices resulted in a decrease in industrial production. Economies experienced high unemployment, soaring inflation, and crash in stock markets.
d) Use an aggregate supply and aggregate demand diagram to show what happened to the demand and price of oil when these shocks struck. Explain what you have drawn
Aggregate Demand Diagram
General Price
Level AS
GP1
GP2
AD1
AD2
Y2 Y1
Real GDP
A decrease in aggregate demand for oil results in a contraction in quantity supplied. The overall effect is a reduction in GDP.
Aggregate Supply Diagram
General Price AS2
Level
AS1
GP1
GP2
AD
Y2 Y1
Real GDP
A decrease in the aggregate supply for oil led to a contraction of aggregate demand lowering the level of equilibrium of the GDP.
Article Number 2
1. Based on the information in the article, draw a supply and demand diagram for butter showing how demand and supply have changed over the recent years to produce the situation described in the diagram. Make sure to explain your diagram and to label your axes properly along with the various demand and supply curves.
Demand and Supply diagram for butter
Price S
P2
P1
D1 D2
Q1 Q2
Quantity
As per the above diagram, despite there being an increase in price and demand for butter, the supply for the same remain fell. This resulted in high prices but low quantities.
2. What do you think was the rationale of the European Union in paying farmers not to produce milk?
Adverse climate conditions reduced the farmer’s ability to sustain their business making some go out of business. Therefore, the EU pays farmers not to produce milk in a bid to offer income support to farmers, help them maintain decent standards of living as well as help them reduce their increasing debts.
3. Explain in words and by means of an appropriate formula, what you understand by the price elasticity of supply.
Price Elasticity of Supply (PES) is used to measure the relationship between a change in the amount supplied of a given commodity when the price of the commodity changes. It is the fraction of the proportion variation in capacity supplied to the proportion adjustment in price. Price elasticity of supply is always positive since the law of supply states that the amount supplied is directly proportional to the change in price.
4. From the information contained in the article, is the price elasticity of supply of butter high or low? Explain your answer with reference to the article.
Price elasticity of supply of butter is low. Butter prices are on the rise, however, producers are unable to increase output. Despite the increase in demand for butter, following consumers’ demand for natural products, the supply of the same is limited. Farmers are unable to shift their production in a bid to take advantage of the increasing prices of butter. Therefore, supply is inelastic since farmers cannot change production in the given time period to cater for increasing demand that has resulted in high butter prices.
5. Given that retailers and food manufacturers have been reluctant to pass on price increases to consumers of butter, what does this indicate about the market structure of this industry?
This industry exhibits a perfect competition market structure. This is because farmers sell homogeneous products (dairy products). The prices of commodities change freely as they are influenced by the interplay between demand and supply. Increased demands result in increased prices despite there is a limited supply. The farmers are more concerned about their relationship with customers rather in making supernormal profits.
6. Explain, in words and by means of a formula, what you understand by the cross-price elasticity of demand.
Cross price elasticity of demand (XED) measures the sensitivity in the amount demanded of one commodity X following the change in the price of a related commodity Y. It shows us the relationship between two commodities. The commodities may either be substitutes or complements. Substitutes exhibit a positive cross elasticity of demand whereas compliments exhibit a negative one.
7. Assuming butter prices go up, which products are likely to benefit from such a price increase and which will not? Explain your answer.
Substitutes of butter such as margarine will benefit from an increase in the prices of butter. If the prices of butter increase, consumers will go for margarine thus demand margarine and in turn, its price will go up. Complements of butter such as bread will not benefit from an increase in the prices of butter. Increase in the prices of butter will result in a decrease in the demand for bread resulting in a decrease in the prices of bread.
Article Number 3
