In this section, I will provide a comparison of the inflation rate and economic growth of Belgium and the Eurozone. The inflation rate is defined as the percentage change in the price index from the preceding period. It captures the rate of change of prices calculated on a monthly or annual basis. The data on the inflation rate for Belgium and the Eurozone are presented below which I obtained from the news release of Eurostat (2013).
Meanwhile, economic growth is defined as the increase in the capacity of the economy to produce goods and services, compared from one period to another. To compare the economic growth between countries, the GDP or GNP per capita is used.
The transaction of firms produce of intermediate goods are accounted as part of investment (I) if purchased by other firms in the economy since intermediate goods are used by firms to produce the final goods and services in the economy. Intermediate goods include machineries where are products of firms that are further used to produce final products.
The transaction whereby the firms face a rise in inventories of final goods is accounted as part of the investment (I) component.
The transaction of the government to set up new ministry buildings is accounted as part of government purchases (G) since the transaction involves the spending of the government to acquire construction materials as well as labor expenses.
The Belgians purchase of Chinese solar panels is accounted as part of imports (IM) of Belgium.
Briefly explain the following:
- Is a second-hand car counted in GDP? Why (not)? The market value of the second hand car is no longer counted as part of GDP since GDP takes into account the market value of the final goods and services produced within the country for a given period. This implies that if the brand new car is produced in 2000, then it is accounted as part of GDP of the producing country in the year 2000. If it is sold in 2010 as second-hand car, it is not part of the GDP in 2010.
- Are dividends counted in households’ personal disposable income? Why (not)? Yes. Personal disposable income is computed as National Income minus corporate profits plus personal dividend receipts plus interest adjustment minus taxes plus noninterest transfers. Hence, dividends are counted in households’ personal disposable income.
- Is GDP per capita a better measure of economic activity than GDP? Yes, if it involves a comparison of economic activity between countries. GDP per capita also reflects the purchasing power of each individual in the economy, which is not captured by GDP.
- Give one general drawback of GDP as an indicator. One general limitation of using GDP as an indicator is that it does not take into account the economic wellness and health of a country. Nevertheless, it is a good indicator of economic progress.
Assume the Economy is Currently in a Recession
i) How should the Central Bank change the money supply in the money market in order to help the economy out of the recession? How do we call this type of policy? If the economy is in recession, the Central Bank implements expansionary monetary policy as it tries to expand or increase the money supply in the economy. The Central Bank’s primary tool to affect the money supply is the open market operation. Open market operation is conducted through the buying and selling of various financial instruments that include treasury bills, bonds as well as foreign currencies. In the case of the conduct of expansionary policy, the Central Bank buys financial instruments from the public, thereby increasing the quantity of money in circulation. The increase in the public’s money holdings will eventually boost spending in the economy thereby increasing economic activity.
ii) Indicate the effects of that policy on the money-market diagram.
iii) Explain how the policy affects the real economy.
The expansionary monetary policy affects the real economy through its impact of the financing conditions of the economy. The increase in money supply lowers the level of nominal interest rate, thereby reducing the cost of borrowing. This eventually increases the level of investment and consumer spending. Increase in investment implies increase in the demand for labor by the firms, hence resulting to higher level of employment and output in the economy.
Show in the same graph the effects of the following changes:
Step 1: a rise in autonomous consumption. (please see graph above, answer is highlighted in red)
Step 2: a fall in the marginal propensity to tax (i.e., the tax rate).
Assume that the new equilibrium income is higher than income at full employment. Describe the economic situation. Show on the graph.
