SmanjithMBA1004-1

ECON 5233 MBA 1004M1

MBA1004M1-MANAGERIAL ECONOMICS WEEK 8 HOME WORK, 6/6/2011 SKARIAH MANJITH MID-AMERICA CHRISTIAN UNIVERSITY

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ECON 5233 MBA 1004M1

C11-TQ7. Adding to table 11.1, if real GDP in 2002 were $10,048.8 billion and nominal GDP in 2002 were $10,469.6 billion, calculate the percentage change from 2001 to 2002 in nominal GDP, real GDP, and the price level. What is the value of the GDP deflator in 2002? Ans. The value GDP Deflator in 2002 is 104.20 and the price level is increase by 1.80 percent. VARIABLE Nominal GDP Percentage Change Real GDP Percentage Change GDP Deflator (Price Change) Percentage Change 2001 $10,128.0 Billion $9,890.7 Billion 102.40 2002 $10,469.6 Billion 3.26 $10,048.8 Billion 1.57 104.20 1.80

C11-AQ3. From the Bureau of Economic analysis Web page (www.bea.gov), construct a table showing the annual percentage change in real GDP, gross private domestic investment (I), nonresidential fixed investment, and residential fixed investment from 2000 to 2008. Discuss how the changes in these variables show the differences between the recession of 2001 and the recession in 2007 and 2008 that is discussed in the news article that opened this chapter. Ans.

2000
Real GDP Gross private Domestic Investment(I) Nonresidential fixed investment Residential fixed investment 4.1 6.8 9.8 10.5

2001
1.1 -7.0 -2.8 -3.2

2002
1.8 -1.4 -7.9 -4.2

2003
2.5 3.6 0.9 2.5

2004
3.6 10.0 6.0 7.7

2005
3.1 5.5 6.7 8.5

2006
2.7 2.7 7.9 7.4

2007
1.9 -3.1 6.7 3.7

2008
0.0 -9.5 0.3 -2.4

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ECON 5233 MBA 1004M1

Economic recessions are caused by a decline in GDP growth, which is itself caused by a slowdown in manufacturing orders, falling housing prices and sales, and a drop-off in business investment. The result of this slowdown is falling employment, and rising unemployment, which causes a slowdown in retail sales. This creates a downward spiral in manufacturing and increased layoffs. Each recession has its own specific causes, but all of them are usually preceded by a period of irrational exuberance. This is also known as a business cycle. The recession of 2001 is a great example. In 1999, there was a economic boom in computer and software sales caused by the Y2K scare. Many companies and individuals bought new computer systems to make sure their software was Y2K compliant This meant that the operating code would be able to understand the difference between 2000 and 1900, since many fields within that code only had two spaces, not the four needed to fully differentiate the two dates. As a result, the stock price of many high tech companies started to increase. This led to a lot of investors' money going to any kind of high tech company, whether they were showing profits or not. The exuberance for dot.com companies became irrational. It became apparent in January 2000 that computer orders were going to decline, since the shelf life of most computers is about two years, and companies had just bought all the equipment they would need. This led to a stock-market sell-off in March 2000. As stock prices declined, so did the value of the dot.com companies, and many go bankrupt? High interest rates are also a cause of recession. That's because it limits liquidity, or the amount of money available to invest. In spite of the stock market decline in March 2000, the Federal Reserve continued raising interest rates to a high of 6.25% in May 2000. The Feds didn't start lowering rates until January 2001, and lowered them about 1/2 points each month, resting at 1.75% in December 2001. This kept interest rates high when the economy needed low rates for cheap business loans and mortgages. One of the causes of the current recession was that the Fed was also slow to raise interest rates when the economy started to boom again in 2004. Low interest rates in 2004 and 2005 helped created the housing bubble. Irrational exuberance set in again as many investors took advantage of low rates to buy homes just to resell. Others bought homes they couldn't afford to repay. In 2006, when higher rates finally kicked in, declining housing prices caught many homeowners who had taken loans with little money down. An escalating foreclosure rate panicked many banks and hedge funds, which had bought mortgage-backed securities on the secondary market and now realized they, were facing huge losses. By August 2007, banks became afraid to lend to each other because they didn't want these toxic loans as collateral. By December 2008, employment was declining faster than in the 2001 recession. The difference between recession in 2001 and 2008 is unemployment, collapse of housing market, and stock market.

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ECON 5233 MBA 1004M1 C12-TQ3. Explain how aggregate expenditure function shifts in response to changes in each of the following variables: a) The real interest rate increases. b) Consumer confidence decreases. c) Higher taxes and imposed on business profits d) The economics of many countries in the rest of the world go into recessions.

Ans. a) Interest rates are the annual charge for borrowing funds, usually specified as a percent of the amount borrowed. Changes in interest rates affect the overall expense of borrowing and thus expenditures undertaken with the borrowed funds. Higher interest rates tend to decrease expenditures and lower interest rates lead to increase expenditures. The expense of borrowing these funds depends on interest rates. Higher interest rates add to the overall cost of these expenditures. Lower interest rates reduce the overall cost of these expenditures. This means that changes in interest rates trigger changes in consumption expenditures and investment expenditures, and thus aggregate expenditures. An increase in interest rates causes a decrease (downward shift) of the aggregate expenditure line.
b) Consumer confidence is the general perception that the household sector

has about the current and expected state of the economy. This is usually measured through a random survey of the population to discern whether consumers are relatively more or less optimistic (or pessimistic) about the state of the economy than they have been. A change in the consumer confidence, by changing consumption expenditures, induces changes in aggregate expenditures. A boost in consumer confidence increases aggregate expenditures and causes an upward shift of the aggregate expenditure line. A drop in consumer confidence then decreases aggregate expenditures and causes a downward shift of the aggregate expenditures line. A decrease in consumer confidence causes a decrease (downward shift) of the aggregate expenditures line.
c) In many countries, taxes are imposed on business, such as corporate

taxes or portions of payroll taxes. However, who ultimately pays the tax the tax burden is determined by the marketplace as taxes become embedded into production costs. Decrease Taxes imposed on a business earning, raise the effective cost of funds. If a firm has to pay some of its return on investment to the government, this return must be higher to justify making the Investment. Aggregate function shift down.

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ECON 5233 MBA 1004M1

d) The financial crisis of 200708 was made global by the U.S. current account deficit. This is because the outflow of dollars from the United States was invested in U.S. capital markets, causing inflation in asset markets and leading to a bubble and bust in the subprime mortgage sector. Second, there is global dependence on the U.S. trade deficit as a means of maintaining liquidity in financial markets. Since the U.S. dollar is the international reserve currency, international debt is mostly denominated in dollars. Because there is a high degree of global financial integration, any reduction in the U.S. balance of trade will have negative effects on many countries throughout the world. C12-AQ5. What were the key provisions of the economic stimulus bill passed by congress in February 2008? What further changes in fiscal policy have occurred since this time? Ans. The Economic Stimulus Act of 2008, enacted February 13, 2008 was an Act of Congress providing for several kinds of economic stimuli intended to boost the United States economy in 2008 and to avert a recession, or improve economic conditions. The stimulus package was passed by the U.S. House of Representatives on January 29, 2008, and in a slightly different version by the U.S. Senate on February 7, 2008. The Senate version was then approved in the House the same day. It was signed into law on February 13, 2008 by President Bush with the support of a majority of Democratic lawmakers, as well as a minority of Republicans. The law provides for tax rebates to low- and middle-income U.S. taxpayers, tax incentives to stimulate business investment, and an increase in the limits imposed on mortgages eligible for purchase by government-sponsored enterprises. The total cost of this bill was projected at $152 billion for 2008. Tax rebates created by the law were paid to individual U.S. taxpayers during 2008. Most taxpayers below the income limit received a rebate of at least $300 per person ($600 for married couples filing jointly). Eligible taxpayers received, along with their individual payment, $300 per dependent child under the age of 17. The payment was equal to the payer's net income tax liability, but could not exceed $600 (for a single person) or $1200 (married couple filing jointly). In economics, fiscal policy is the use of government expenditure and revenue collection (taxation) to influence the economy. Since 2008 the economy has continues to recover and the following changes have been made; Wall Street Bailout Economic Stimulus Effort Extending the home buyers tax credit Reformation on Contracting System Reformation on financial regulatory system.