Economics 1

Contents

TOC o “1-3” h z u HYPERLINK l “_Toc377805392” Under what conditions might government intervention, in an economy improve the market outcome? give an examples why and how the government can intervene PAGEREF _Toc377805392 h 1

HYPERLINK l “_Toc377805393” – When there is exploitation of the larger society by the few commercial individuals. PAGEREF _Toc377805393 h 1

HYPERLINK l “_Toc377805394” Suppose that the residents of Vegpia spend all of their income on cauliflower, broccoli and carrots. In 2009 they buy 100 heads of cauliflower for $200, 50 bunches of broccoli for $75 and 500 carrots for $50. In 2010 they buy 75 heads of cauliflower for $225, 80 bunches of broccoli for $ 120 and 500 carrots for $100. If the base year is 2009 what is the CPI in both years? What is the inflation rate in 2010? PAGEREF _Toc377805394 h 3

HYPERLINK l “_Toc377805395” Describe three problems that make the consumer price index an imperfect measure of cost of living PAGEREF _Toc377805395 h 3

HYPERLINK l “_Toc377805396” It does not take into consideration the change in quality PAGEREF _Toc377805396 h 4

HYPERLINK l “_Toc377805397” 3.CPI does not put into consideration improvement in technology PAGEREF _Toc377805397 h 4

HYPERLINK l “_Toc377805398” Referring to statistics Canada’s web site PAGEREF _Toc377805398 h 4

HYPERLINK l “_Toc377805399” 6.in order to support the Canadian dollar, suppose the bank of Canada buys an amount of Euros from some major commercial Canadian banks (a type of operation the bank of Canada rarely undertakes). PAGEREF _Toc377805399 h 7

Under what conditions might government intervention, in an economy improve the market outcome? give an examples why and how the government can interveneThe market forces are always believed to bring the market back to equilibrium: this is the premise of free trade. However there is always need for government intervention when the following happens:

– When there is exploitation of the larger society by the few commercial individuals.

This can be done by hoarding commodities in order to create an artificial shortage of the good and increase the price (Wolf, 1993). If left unsolved this can lead to demand pull inflation where too little goods are chased by a lot of money.

– When the rights to property and safety for the people has been tampered with.

The responsibility of the government is to ensure that all the goods and services offered to the public are up to standard and do not pose any harm or danger to the people. If the consumption of some commodities pose any physical or psychological harm to the people the government has to intervene.

– When there is lack of equality and monopolization of markets.

Equality in a market is when there is equal access to inputs and equal access to market. The actions of one producer should not hinder those of another producer at any point of the production or distribution process (Wolf, 1993). Monopolies are sometimes formed as a result of mergers and amalgamations of many firms. This has to be controlled and closely monitored by the government as monopolies are known for exploitation and not catering for the welfare of its clients.

Generally in a market there is usually an equilibrium point that is comfortable and efficient for both the consumers and the producers. All the above factors tamper with the equilibrium point and the market does not clear, this leads to market failure. The government in this case has to intervene by setting a price for the commodities or supplying more of the goods into the market and bringing the price down to the initial equilibrium point.

A good example is the money market, when there is inflation in the country, the Canadian dollar will depreciate against the American dollar and there will be a high demand for the Canadian dollar, the government will have to buy off all the excess money and in the process fiscal and monetary policies will lead to appreciation of the dollar.

Suppose that the residents of Vegpia spend all of their income on cauliflower, broccoli and carrots. In 2009 they buy 100 heads of cauliflower for $200, 50 bunches of broccoli for $75 and 500 carrots for $50. In 2010 they buy 75 heads of cauliflower for $225, 80 bunches of broccoli for $ 120 and 500 carrots for $100. If the base year is 2009 what is the CPI in both years? What is the inflation rate in 2010?CPI is the change in the cost of goods over a period of time (Hall, 2009). In this case we are using 2009 as the base year, so the reference will be the prices that were in 2009.

2009- Cauliflower 200/100 = $2.00

Broccoli 75/50 = $1.50

Carrots 50/500 = $0.10

(2.00 + 1.50 + 0.10) = (3.60 / 3.60) × 100 = 100

CPI1 = 100

2010 – Cauliflower 225/75 = $3.00

Broccoli 120/ 80 = $ 1.50

Carrots 100/500 = $0.20

(3.00 + 1.50 + 0.20) = (4.70/ 3.60) × 100 = 130.56

CPI 2 = 130.56

The inflation rate between the two years will be:

CPI 1 –CPI 2 = 130.56 – 100 = 30.56% is the inflation

Describe three problems that make the consumer price index an imperfect measure of cost of livingchange in preferences

CPI does not take into account the changes in the tastes and preferences of the consumers. CPI is mostly measured using a specific good basket that is considered to be of the basic commodities that almost all households consume. The most common and famous brand is picked and is used to calculate. However the one thing that CPI does not consider is the natural behavior of consumers (Baker, 1998). When good become expensive they shift from using those goods and start using others and if it is possible to completely do away with it then they will.

It does not take into consideration the change in qualityThe commodity can have an increase in price over time because it has improved in its quality with time. In order for a firm to produce high quality products it has to use better inputs and improved technology increasing the production cost (Hall, 2009). This will automatically increase the price of the final product. The difference in the quality of the goods is not considered by CPI. There will be inflation even if the quality of goods that the consumers are purchasing, are more standard and better than they previously were.

3.CPI does not put into consideration improvement in technologyCPI does not put into consideration changes in the technology. This is because technology leads to change in taste and preference especially in the contemporary world (Baker, 1998). Currently technology is changing at a very high speed; this only renders CPI as inaccurate when it is used to measure the level of inflation in an economy. CPI is only effective where the level of technology has no impact on the production and consumption patterns.

Referring to statistics Canada’s web sitea). which three provinces had the greatest real GDP per capita in 2008?

Ontario

b). calculate the shares of each of these provinces in Canada’s real GDP in 2008

  Region 2008 GDP Share

Canada1 1,583,164 100%

Newfoundland and Labrador 29,425 1.86%

Prince Edward Island 4,665 0.295%

Nova Scotia 34,685 2.19%

New Brunswick 28,226 1.783%

Quebec 310,687 19.624%

Ontario 596,722 37.691%

Manitoba 51,241 3.24%

Saskatchewan 54,776 3.46%

Alberta 262,864 16.603%

British Columbia 199,228 12.584%

Yukon 1,990 0.126%

Northwest Territories 4,280 0.27%

Nunavut 1,518 0.0959%

Outside Canada 665 0.042%

c). in which province was the consumer price index the highest in each of the years 2006 to 2009? Can you think of an explanation?

Alberta, because it has the fastest increasing population and there is a high demand for goods and services to cater for the needs of the increasing market.

5. Consider a closed economy. Use the supply and demand for loanable fund model to predict the effects of the following events on interest rates and investment. Label graph completely for full marks

a). The government introduces a tax credit for savings accounts of up to $5000 per year

Red represents the demand for loanable funds while the blue represents the supply for loanable funds from people’s savings (Sexton, 2011). The point where the two intersect represents the equilibrium point where the amount saved is equal to the amount borrowed for investment.

The supply will increase and the supply curve will shift to the green line.

b). The government a tax credit for savings accounts of up to $5000 per year, and at the same time it repeals an investment tax exemption provision

The demand for loanable funds will increase and there will be a shift in the demand curve from the red one to the yellow one. The supply of loanable funds will have increased and the green curve will be its new curve. This will lead to a new equilibrium point. The interest rates will remain the same but the equilibrium quantity will increase.

c). The government raises the tax rates

An increase in the taxes will decrease the rate of investment and decrease the demand for loanable funds. This will shift the demand curve from the red line to the purple line and there will also be a decrease in interest rates charged (Sexton, 2011).

d). The government issues bonds worth $10 billion

This will decrease the supply of loanable funds as more people will withdraw their cash in order to purchase the bonds. This will shift the supply curve inwards from the blue line to the brown line. The interest rates will increase.

6.in order to support the Canadian dollar, suppose the bank of Canada buys an amount of Euros from some major commercial Canadian banks (a type of operation the bank of Canada rarely undertakes).

a. when the bank of Canada purchases Euros from the commercial banks, it means they are willing to make Euros more available to the public at a cheaper price. It will increase the quantity of money that is in supply in the economy. This has the immediate effect of making the Canadian dollar to appreciate. However in the long run forces of the market will bring the value back to the equilibrium point. This is because a strong currency in the long run leads to a trade deficit and in order to bring the balance of trade to equilibrium there must be some form of depreciation.

b. if the bank of Canada does not wish to affect the money supply, it can increase the reserve requirement and limit the amount of money that the commercial banks can advance to the public in the form of loans. This will ensure that the currency swap does not affect the quantity of money that is circulating in the economy.

References

Baker, D. (1998). Getting Prices Right: The debate Over the Consumer Price Index, Columbia Publishers

Hall, E. R. Lieberman, M. (2009). HYPERLINK “http://books.google.co.ke/books?id=q5S1uMWg-WUC&pg=PA229&dq=loanable+fund+model&hl=en&sa=X&ei=i1hLUpHYC4f80QXrzYCoBg&ved=0CEsQ6AEwBQ”Macroeconomics: Principles and Applications: Principles and Theory, Macmillan Publishers

HYPERLINK “http://www.statcan.gc.ca/start-debut-eng.html/Economic_accounts/gross_domestic_product/summary_tables”http://www.statcan.gc.ca/start-debut-eng.html/Economic_accounts/gross_domestic_product/summary_tables

Sexton, L. R. (2011). HYPERLINK “http://books.google.co.ke/books?id=37NKvBnugLcC&pg=PA360&dq=loanable+fund+model&hl=en&sa=X&ei=i1hLUpHYC4f80QXrzYCoBg&ved=0CDQQ6AEwAQ”Exploring Macroeconomics, 6th edition, Oxford University Press

HYPERLINK “http://books.google.co.ke/books?id=nRPYOUTcB-4C&pg=PA35&dq=government+intervention+in+markets&hl=en&sa=X&ei=y1dLUuSiJbSg0wXPsoDwBQ&ved=0CDsQ6AEwAg”Wolf, C. (1993). Markets or Governments: Choosing Between Imperfect Alternatives, Pearson Press Print, NJ