Normal macro-economic equilibrium is shown by the vertical line AS. At the point shown by AS, the economy will be at optimum output and almost everybody who needs a job is employed. However the macroeconomic equilibrium represented here is one of a recession. The AD curve intersects the AS curve in an area of significant unused productive capacity. Capacity utilization is low and the unemployment rate is relatively high.
This is the situation the United States finds itself currently in. The decrease in aggregate demand has been caused by a whole range of factors, but the fallout from the sub-prime mortgage crises is mostly to blame. It is very difficult for businesses and consumers to access credit, that this has negatively affected aggregate demand. Continued expansionary monetary and fiscal policies such as low interest rate environment, stimulus money are the key to kick-starting aggregate demand and getting the United States out of the recession.
Explain the long run adjustment in the case of a demand-side recession. Also explain why the conservative view places so much emphasis on the role of competition in this adjustment process. Write 250 words for your explanation.
Fig.2
During a recession, aggregate demand goes down until a certain price level at which consumers realize goods are cheap and start buying again. This ends the recession. The conservative view places so much emphasis on the role of competition in the adjustment process. Policies which stimulate competition amongst firms such as market liberalization and reduction of taxes, and barriers etc are advocated for by conservative economists. Competition in the market stimulates supply of more goods and services, at better quality and low prices. This will induce higher aggregate demand and an expansion in economic activity.
Employers will hire more workers, and this will have positive knock on effect on the whole economy. As depicted in fig.2 aggregate demand will increase from AD0 to AD1. At the same time Aggregate supply will face an increase from AS0 to AS1. Firms will be compelled to produce more goods at the lowest possible cost possible, but of course this depends on the individual market structure respective firms work in. One is the adjustment of each firm to the appropriate factory size that maximizes long-run profit. The other is the entry of firms into the industry or exit of firms out of the industry, to eliminated economic profits or economic losses. The end result of this long-run adjustment is different for the two market structures based on the fact that perfect competition has equality between price and marginal revenue, while monopolistic competition does not
Draw and illustrate why the Keynesians take issue with the conservative view of long run adjustment. 250 words
Keynesian economics asserts the importance of the aggregate HYPERLINK httpwww.investorglossary.comdemand.htm demand for goods as the driving factor, especially in downturns. Keynesian economics advocates government intervention, or demand-side management of the economy, to smooth out the bumps in business cycles and achieve full employment and stable prices. To stimulate the economy according to Keynesian economics, government intervention takes the form of government spending and tax breaks. To curb HYPERLINK httpwww.investorglossary.cominflation.htm inflation, Keynesian economics believes government should cut spending and HYPERLINK httpwww.investorglossary.comraise.htm raise taxes. The Keynesians take issue with the conservative view of long-run adjustment for a number of reasons.
Firstly the time it takes for conservative long-run adjustment policies to work maybe very long at a time people need help immediately. Conservative economists are of the view that, One advantage of automatic stabilizers is that the effects occur without the necessity of government action, which means that there is no delay, or lag, because of political controversies, administrative problems, or difficulties in determining whether the time has come to act. Keynesians will argue that this non-interventionist attitude will not always work.
Fig.3
Increase in government spending, tax breaks, will spur aggregate demand, thus move the economy out the rescission from Y1 to point Y2.
Illustrate and explain the case of a stagflation recession and how this relates to the problems of global climate change and peak oil. 250 words.
In economics terms stagflation is an inflationary period accompanied by rising unemployment and lack of growth in consumer demand and business activity. The graph below illustrates the situation during stagflation. Aggregate supply and aggregate demand fall, but prices increase.
source HYPERLINK httpwelkerswikinomics.comblog20080225stagflation-a-blast-from-the-past-could-mean-trouble-for-us-economy httpwelkerswikinomics.comblog20080225stagflation-a-blast-from-the-past-could-mean-trouble-for-us-economy
In the case of the United States, peak oil prices drove the country to almost a period of stagflation. Between 2007 and 2009 oil prices rose to record highs, the result was this cause a supply side shock. Cost of production went up, because the high price of oil which is incurred during the production and transportation is passed onto consumers. In turn aggregate demand will fall as a result of the increase in the price of goods.
The effects of all these start a vicious cycle to a recession and to stagflation. Consumers cut spending, and businesses shed jobs to offset any losses incurred. The result is higher prices and high unemployment. The underlying problem of all this is that the worlds oil deposits are slowly getting dwindling. There is thus a need to find alternative cleaner energy forms, to avoid oil price shocks and also stop climate change. As long as the world economy remains largely dependent on oil, this phenomenon will continue to again and again in the years to come.