Economics Assignment

Question 1

• The single largest source of total revenue of New Zealand’s government is tax revenue which is around 91 percent of the total core revenue of the treasury. For the financial year ended June 2012, the total tax revenue is $55.1 billion.
• The single largest source of total expenditure of New Zealand’s government is social security and welfare which is around 32 percent of the total core expenses of the treasury. For the financial year ended June 2012, social security and welfare expense is $22 billion.
• The total operating balance of New Zealand’s government before gains and losses is negative i.e. $ (9.2 billions)
• The net debt of New Zealand government is worth $ 50.7 billion (Treasury.govt.nz, 2012).
• Price stability is one of the five major macroeconomic objectives which also include sustainable economic growth, full employment, balance of payment equilibrium, and equitable distribution of income and wealth. Price stability tends to avoid both inflation and deflation. It ensures stable and predictable conditions which allow economic agents to take decisions smoothly and effectively. Thus pursing price stability objectives help promotes stable economic growth by allowing producers to make efficient decisions of production and resource allocation. Price stability can also ensure high employment rates in consistent with the high, sustainable economic growth rate. Price stability doesn’t even tend to conflict with balance of payment objective. Inflation-controlling monetary policies, which are meant to promote stability, discourage imports and encourage exports thus maintaining the balance of payment. Finally, price stability also contributes in equitable distribution of wealth and income by preventing arbitrary redistribution that often arises in inflationary and deflationary environments thus saving the weakest socioeconomic group from the hazards of inflation.
• If increase in GDP is overcome by increase in pollution, economic growth won’t leave the economic agents better off. Similarly, in the given case of China and New Zealand, higher economic growth of China is being backed with high pollution rates, as compared to that in New Zealand. Given this information, one can expect that Chinese residents are worse off, or at least not considerably better off, as a result of growth-related initiatives in the economy. Accounting of GDP can also be biased as it doesn’t account for pollution. Indeed, some of the environmental degradation may tend to increase GDP, for instance, polluted air may force people to wash more clothes, paints buildings more often, etc. Such activities tend to boost GDP of the country (Rittenberg and Tregarthen, 2009). Thus, polluting environment of China should be controlled in order to have the Chinese residents enjoy the economic growth else their economic wellbeing will be worse off, on the average.
• 1. To determine whether the country is in recession or not, the data to be used includes GDP growth, unemployment level, and inflation. If the GDP shrinks, unemployment rises, and inflation is unfavorably high, the country can be expected to be in recession.
  2. In recession, the economy of the country shrinks i.e., GDP growth is at substantially low levels or may be negative growth in severe circumstances. The unemployment rises to a very high level followed with high layoff rate across the organizations. Not only this, inflation rises and prices become unstable. Economic agents have to suffer in regard to their optimization decisions and living conditions also tend to worse off since aggregate demand decreases substantially in recession.

• The government can take two initiatives to aid in recession phase of the country. First it can either decrease tax rate. For instance, if the prevailing tax rate is 25 percent it can be decreased to the rate enough to direct the spending on the upward track i.e. 20%. The tax rate is supposed to be decreased to the level when government is not facing fiscal deficits which can substantially reduce its spending in the coming periods. The second possible initiative is to increase the government spending. This will increase aggregate demand and thus boost the economy again.

Question 2

• The two sector model describes the pattern of circular flow in an economy between the two sectors households and firms. In this basic version of the circular flow model, it is assumed that there is no government and external sector. The circular flow in two-sector model exists in two forms: Real flow of income and Money flow of income, that’s how it reflects the difference between income and money. In the income flow, or can say real flow of income, the households supply the factors of production to the firms in the form of land, labor, Capital and Enterprise. The firms, in return, provide the households with goods and services that are produced using these factors of production. In the money flow, or can say money flow of income, the money flows from the firm to the households in the form of rent, wages, interest and profits. Since households are the suppliers of factor of productions, firms pay income to households for utilizing those factors. Similarly money flows from the households to the firms since households pay firms the money in exchange of goods and services bought from the firms. That is the consumption expense of household is the income for firms. Thus the two sectors interact by exchanging money and income at different stages.

Year	Nominal GDP	Real GDP
2011	2025	2025
2012	2700	2700

Both nominal and real GDP have been increased in year 2012 by the same amount and rate since prices are same for both the years i.e. there is no inflation.

1. Cut in official cash rate i.e. the contractionary monetary policy, increases the market interest rates which encourage people to invest more in bonds and don’t hold cash with them. This reduces consumption spending and thus aggregate demand curve shifts left. As a result, real GDP decreases and so the general price level as shown in the following diagram.
2. Increase in levels of innovation, efficiency and productivity of companies encourages them to produce more as they face lower cost and enjoy more efficiency than before. This increases production and thus aggregate supply curve shifts right. As a result, real GDP increases and general price level decreases as shown in the following diagram.

• When households put debt before spending, they tend to reduce their spending and use the income to repay their debt. The result is decrease in aggregate demand as shown in the above figure in part 1.

Question 3

Year	CPI	Growth
Sep-11	1162
Sep-12	1171	0.77%

 (a) The target band of inflation set by Bank of New Zealand (RBNZ) is between 1 and 3 percent. However, the given CPI growth rates lies outside the range and is even below than the lower value. One of the main reasons of this low inflation rate is the overvalued NZ DLR. Another reason must be the inflation targeting approach of monetary policy followed by RBNZ.

• Since kiwifruit is an important component of New Zealand’s CPI basket, decrease in supply of kiwifruit will raise the CPI index. CPI growth rate can represent the inflation rate of the country if price changes in consumption basket comprise substantially large part the overall price changes since CPI reflects just the price level of consumption goods and not the general price level. Though, CPI growth rate is often used as a good proxy of inflation especially when consumption is being considered as the target component of GDP.

1.Unemployment rate =             Unemployed workers

                           Total Labor force

                        Labor force = Unemployed + Employed = 2,393,000

                        Unemployment rate = 175,000 / 2,393,000 = 7.31 percent

 

            Labor force participation rate =                   Labor force       

                                    Working age population

                        Working age population =                  2,393,000 + 1,103,000 = 3,496,000

                        Labor force participation rate =          2,393,000 / 3,496,000 = 68.45 percent

2.Costs of unemployment include loss of current output, loss of skill and motivation, social exclusion and loss of freedom, psychological harms, subverting of family life, loss of social values and responsibility, ill health and reduced life expectancy, and increase in crime rate. These are individual, social, national, and welfare cost of unemployment at micro and macro level respectively (Mitchell, 2012).

Question 4

• Running a budget deficit has both pros and cons. Though, modest borrowing meant to invest in infrastructure upgradation, education, or other growth oriented project is important due to the benefits that from these investments are expected to pay more than the interest accrued on the debt. Another advantage of budget deficit and thus high borrowing as a resultant is the military advantage to be gained by the nation. Mainly if the nation is at war, it needs to borrow to pay for its armed forces to attain security. The main disadvantage of the budget deficit is that the government must pay interest on loans. Budget deficit restricts the amount of money that the government can spend in the future. Any revenue that the government has to pay on its future interest payments reduces the amount of revenue that it can spend on other projects. The government may not be able to take out future loans tofund new projects that produce better results than the projects that it ran a current deficit to fund. Secondly, too much government borrowing can cause harm to the economy by raising market interest rates. This crowds out the private investment and tends to shrink the profitable investment opportunities as well as production.
• One of the two main causes of inflation is the increase in aggregate demand relative to aggregate supply. Second main reason is increase in money supply which leads to the depreciation of local currency. Increase in money supply decreases interest rate and thus households prefer to hold more cash to be used for spending. Since people have more money to spend, consumption increases more than the income and thus increases the inflation. The main monetary policy tool to be used by RBNZ is the official cash rate. By undertaking open market operations and / or increasing the cash rate, primarily in short term government securities, RBNZ controls the availability of settlement funds and hence the interest rate paid on overnight deposits. The shrinkage in liquidity increases the market interest rates and reduces the demand for credit. Thus in the short term, official cash rate has effects on money market and investment market only thus decreasing the interest sensitive consumption and investment.
• Monetary policy has its effect on goods and labor market too in the long run, along with the money market and investment market, but in terms of the prices and not in terms of the income and employment levels. In the short run, many economies have an intricate system of contracts that doesn’t literally allow considerable adjustments in wages and prices in response to a more rapid growth of money and credit in short term. Secondly, expectations sluggishly adjust to the changes in monetary policy. This sluggish adaption also adds inflexibilities to wages and prices due to which changes in money and credit growth can have an outsized initial effect on output, notwithstanding up to 2 years, before the economy entirely reacts to monetary policy actions. Similarly in the labor market, employments contracts are renegotiated and expectations also adapt in the long run, thus wages and prices go up owing to the increase in demand while most of the change in output and employment is washed-up. Over the longer run, decrease in growth of money and credit, as a result of contractionary monetary policy, leads to decrease in inflation with slight, if any, durable effect on real GDP. Thus, monetary policy does count in the short run but in the longer run it is quite indifferent in terms of GDP growth and employment. That’s why in the long run monetary policy finally affects inflation (Labonte, 2012).

Question 5

• Balance of merchandise = Exports of goods – Import of goods

                                                = 48,358 – 45,635

                                                = NZ$ 2,723 million

Balance of merchandise	2,723
+ Exports of services	13,874
– Imports of services	-14,813
+ Balance on income	-10,487
+ Balance on current transfers	-329
Current account balance	-9,032

• Capital account balance = Capital inflows – Capital outflows

                                                       = 2,317 – 1,718

                                                       = NZ$ 599

Current account balance	-9,032
Capital account balance	599
Financial account balance	12,495
Balance of payment		4,062
Net errors and omissions		-4,062

 

• American farmers don’t want the trade barriers to be removed on the imports from New Zealand because lifting the trade barrier on imports will open up the competition from foreign country, New Zealand here. That would result in decrease in local prices of primary producers in America which is a disincentive for American producers and will reduce their profitability. Thus, due to the threat of competition, which they will face if primary products easily imported, American farmers do not want international trade barriers lifted on primary produce entering the United States. However, since New Zealand is the exporter of the primary produce, farmers in New Zealand lobby to remove trade barriers on imports of these produces entering the U.S. market so they can have earn foreign exchange earnings from the exports to U.S.
• By lifting trade barriers between U.S. and New Zealand, both countries can allocate their resources and choose their output level of the primary produce more efficiently. Trade barriers always decrease output as producers can’t make optimal choices in the presence of trade barriers. Thus, by removing the trade barriers, there will be positive effect on overall output.
• There are some factors against globalization in the South Pacific nations. The free movement of goods and passengers between islands may spread infectious diseases.With limited resources and exports, high transport costs due to geographical remoteness, and an increasing number of destructive tornadoes (believed to be fallout of global warming), many South Pacific nations depend on development aid from abroad to sustain their economies and a fairish quality of life for their populace. Besides, With New Zealand’s best primary produce going offshore to countries carrying well heeled consumers, the remainder comes back for itself, and the unsellable, insalubrious produce is sent to the Pacific; this “food inequality” is an unpleasant aspect of globalization (Edwardes and Frizelle, 2009).
• The Big Mac index is “the exchange rate that would mean that hamburgers cost the same in America as in New Zealand. The index reflects that absolute purchasing power parity doesn’t exist between U.S. and New Zealand and the U.S. dollar has been consistently overvalued relative to the New Zealand dollar. The reason is high trade barriers on primary produce in the United States. This devalues New Zealand dollar against U.S. and thus leads to purchasing power disparity between these two countries (Pakko and Pollard, 2003).

References

Edwardes, B. and Frizelle, F. (2009). Globalization and Its Impact on The South Pacific. Journal of the New Zealand Medical Association, 122 (1291).

http://www.treasury.govt.nz

Labonte, M. (2012). Monetary Policy and the Federal Reserve: Current Policy and Conditions. Retrieved from: http://www.fas.org/sgp/crs/misc/RL30354.pdf

Mitchell, B. (2012, Jan 13). The costs of unemployment – again. (Web log comment). Retrieved from: http://bilbo.economicoutlook.net/blog/?p=17740

Pakko, R. M. and Pollard, S. P. (2003). Burgernomics: A Big Mac™ Guide to Purchasing Power Parity. Retrieved from:  http://research.stlouisfed.org/publications/review/03/11/pakko.pdf

Rittenberg, L. and Tregarthen, T. (2009). Principles of Microeconomics, V. 1.0. NY, United States: Flat World Knowledge, L.L.C.