2MANAGERIAL ECONOMICS Answer 1 The real economic factors as per economic theory are price level, gross domestic product of an economy, inflation rate and unemployment rate (Diewert, 2014). Thus, when more money is distributed in an economy by printing then the money supply of the economy increases. As a result, the investment and spending in the economy increase and thus the productivity of the economy increases. The income of individuals increase and along with that the employment of the economy increases because with increased investment in the economy, requirement of employment has increases. Therefore, supply of products will be more as well as demand and thus the gross domestic product of the economy in the short run will increase (Constanza et al., 2014). With everything rising, prices of products will also increase and as a result, the inflation of the economy increases. The change in the these factors in the short run due to increase in money supply will affect the aggregate supply and aggregate demand of an economy and both will rise andtake the economy to a higher equilibrium with increased output and price. Thus, the economy will develop at a faster pace. This, measure of infusing money in the economy in the short run is an effective way to give the economy a sudden boost in during a phase economic slowdown. Hence, if in short run economic factors required being increased, then printing and distribution of more money is an easy way. Answer 2 Inflation rate depends on the price level of an economy and any change in the price level changes the inflation rate. Broadly, inflation is of two types stable and unstable. Rise in price level increases the inflation rate and vice versa. Thus, rate of inflation is directly proportional to the change of price level. The price level when fluctuates frequently it gives rise to unstable inflation rate and alternatively when price level remains steady it gives rise to
3MANAGERIAL ECONOMICS stable inflation rate. However, stable and unstable inflation rates are quite significant for development of an economy as several factors of economy depends on the inflation rate. Unstable inflation rate means there is price fluctuations and regular price fluctuations makes it difficult to make market assessments and affect the cost of production and future planning will be difficult (Arlt & Arltová, 2015). It will be difficult for the government to choose suitable policies that helps in economic growth. In case of stable inflation rate, the price level remains steady and thus it is easier to assess the trend of the economy and make future decisions (Chow, 2017). The government can also make policies as per requirement without worrying about the alteration of the price level and therefore stable inflation rate is better than unstable inflation rate. Hence, a stable 5 % inflation rate is much better than average inflation rate of 4 % that fluctuates widely between 1 % and 7 %. Answer 3 Monetary policy is the instrument to adjust the economic factors to influence the economy to develop the country. Central Bank of a country implements monetary policy implemented by the Central Bank of a country. Monetary policy can be of different type and popular among them is expansionary and contractionary monetary policy. However, these two policies come under the category of active monetary policy. The active monetary policy is the policy that does not follow the conventional procedure of implementing monetary policies. Central Bank observes the day-to-day change in the factors of the economy and the depending upon the changes the bank decides its monetary policies. The active monetary policy is changed regularly corresponding to the change in the economic factors. Thus, active monetary policy is changed frequently that is in weekly and monthly basis.Furthermore, passivemonetarypolicyisthepolicythatCentralBanksimplementsfollowingthe conventional monetary policy rules. It is mostly changes quarterly, it targets long-term economic goals, it changes as per the long-term economic changes, and it is less aggressive
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4MANAGERIAL ECONOMICS than active monetary policy. Thus, passive monetary policy cannot address sudden economic shocks unlike the active monetary policy. Active monetary policy thus addresses short-term economic factors and passive monetary policy addresses long-term economic factors. Answer 4 The real GDP of the economy in the long run is $16 trillion and its unemployment rate is 5%. Now, the central bank reduces the money supply of the economy by 6%. Thus, the policy taken by the central bank is contractionary monetary policy. The contarctionary policy is implemented to fulfil the objective of pull the economy down (Blanchard et al. 2017). The fall in money supply the reduces the investment in the economy and the earning of the individuals fall. As a result, the demand in the economy will fall therefore perceiving the fall in demand the producers will reduce their production and thus the supply of the economy also falls. The reduced production causes the unemployment of the economy rises and furthers the income of the overall income of the economy falls and thus with reduced the demand and reduced supply the economy of the country falls to a lower economic equilibrium. Thus, the phenomenon has been described in the diagram given below. Due to the fall in demand the aggregate demand curve shifts left ward and the fall in supply shifted the supply curve left ward too. Thus, the price level and real GDP of the country falls even after fall in inflation rate.
5MANAGERIAL ECONOMICS Figure 1: Fall in equilibrium Source: (Created by the Author)
6MANAGERIAL ECONOMICS Answer 5 The economy has the real GDP of $16 trillion and the unemployment rate is 5%. The central bank implements expansionary monetary policy and increases the money supply of the economy by 6% (Kaplan, Moll & Violante, 2018). The increase in money supply of the economy induces the fall in interest of the economy in real terms. With increased level of money in hand, the producers will invest more and produce more. The more production will require more employment to support the increased the production. Therefore, unemployment of the economy will fall and the economy will earn more in income terms. The disposable income of the economy will rise and the individuals will consume more. Thus, with increased amount of consumption the economy will face increased amount of demand. The increased amount of the demand will rise the price level of the economy. Thus, the aggregate demand curve will shift right and the aggregate supply curve shifts right too. Hence, price level increases and thereby inflation of the country rises. The real GDP of the country increases too. Thus, with increased amount of money supply in the economy the real GDP and price level increases and equilibrium of the economy improved. The mechanism of the change in economy due to increase in supply of moneyis shown in the diagram given below. Figure1: Rise in equilibrium
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7MANAGERIAL ECONOMICS Source: (Created by the Author) References Arlt, J., & Arltová, M. (2015, August). Forecasting of the Annual Inflation Rate in the UnstableEconomicConditions.In2015SecondInternationalConferenceon Mathematics and Computers in Sciences and in Industry (MCSI)(pp. 231-234). IEEE. Blanchard, O., Ostry, J. D., Ghosh, A. R., & Chamon, M. (2017). Are capital inflows expansionaryorcontractionary?Theory,policyimplications,andsome evidence.IMF Economic Review,65(3), 563-585. Chow, G. C. (2017).Capital formation and economic growth in China(pp. 1186-1221). BRILL. Costanza, R., Kubiszewski, I., Giovannini, E., Lovins, H., McGlade, J., Pickett, K. E., ... & Wilkinson,R.(2014).Development:TimetoleaveGDPbehind.Nature News,505(7483), 283. Diewert, W. E. (Ed.). (2014).Price level measurement(Vol. 196). Elsevier. Kaplan,G.,Moll,B.,&Violante,G.L.(2018).Monetarypolicyaccordingto HANK.American Economic Review,108(3), 697-743.