AFE6020-B Nordhaus Political Business Cycle Model Assignment Sample

• Subject Code : AFE6020-B
• University : University of Bradford My Assignment Services is not sponsored or endorsed by this college or university.
• Subject Name : Economics

Advanced Economics - Assignment 1

Explain the following models with the help of diagrams and examples.

• Opportunistic model

Solution:

As per the modern literature, the political business class as highlighted in the paper published by Nordhaus (1975) highlighted that the political parties who are in power choose those set of economic policies during the incumbency period which would eventually maximize the plurality in the coming elections. During the election period, the voters are affected by the macroeconomic performance. To tempt the voters, the politicians will manipulate the policy instruments in such a manner so that the outcomes derived through the policies are favorable during the period of elections. As a consequence of this behavior, the policies which are implemented presently are biased against the needs of future generations. Under the opportunistic model, Nordhaus makes the following set of assumptions: -

• The present political systems comprise of two political parties with the complete set of convergence among policies.
• These pollical parties develop the required interest in maximizing the political profit and ideological programmes.
• The individual voters are identical and have aggregate unemployment and inflation I accordance with the preference functions and the unemployment rates.
• The policy makers have a complete set of control over the level of unemployment by affecting the aggregate demand the fiscal or monetary policies.
• The expectations about the inflation are mainly adaptive with majority of agents being backward looking.
• The policy makers hold complete control over the level of unemployment by manipulating the aggregate demand including the fiscal and monetary policies.

Following the above mentioned set if assumptions, the study of Nordhaus states that the rate of voting in favour of the incumbent government is inversely related with the rate of inflation and the unemployment within the country.

The above figure clearly contours the relationship between the aggregate voting function, unemployment and the level of inflation. The aggregate voting function indicates the percentage of votes which are acquired by the incumbents. The above diagram indicates that inflation and unemployment are bad goods. In such a scenario, V1 > V2 > V3 > V4. The voters could prefer any point on V1. The voters prefer to be on the point V1 to any other point V2. However, the voters will remain indifferent between any points which are on the same contour. In such a situation , the governments will try to win elections by developing variation in the economic policies in such a manner that leads to lowest possible inflation rate and unemployment. In this process, the economy will be manipulated towards the highest feasible vote contour in such a manner that it coincides with the election period. In the above figure, the short run curves are indicated by the SG, SW and SM. The position of each of these curves depends on the expected rate of inflation. The long-run Phillips curve is labelled LRPC. There are several possible outcomes depending on the policy makers’ choice.

This model of Nordhaus political business cycle depicts the short run behaviour. This short run behaviour depicts the decaying memory of the voters. As per this, the voters attach more weight to the recent events than to the distant events. Thus, the voters decaying memory provides an opportunity for the incumbents to fool the electorate despite the fact these incumbents are responsible for the level of inflation and unemployment.

Consider that the economy is at point G where LRPC is tangent to the aggregate voting function V2 representing the sustainable set of combination between the inflation and unemployment. The golden rule has emerged as a policy solution where inflation = (PG) and unemployment = UG. In the first half of an electoral period unemployment should be rising, GDP is falling and inflation is falling.

In the run-up to an election, the second half of the electoral period should be characterized by falling unemployment and rising GDP. Where the policy makers care only about the current generation a policy results in an outcome indicated in Figure by point M, where SM is at a tangent to V4. In other words, ‘myopic’ policies which ignore the welfare of future generations lead to higher inflation (PM) and lower unemployment (UM) than golden rule policies(Nordhaus, 1966).

In the immediate post-electoral period inflation rises and a recession sets in. Where the policy maker cares about both generations, an outcome Nordhaus refers to as the ‘general welfare optimum’ (point W) results. In this case Unemployment = UW and inflation = (PW) in Figure.

The Nordhaus model gives clear predictions about the pattern of unemployment and inflation during the electoral cycle. Because voters have a decaying memory, this strategy can be repeated at the next election: recent events are ‘more poignant’ than ‘ancient ills’. Hence the government can benefit from opportunistic behaviour which deliberately destabilizes the economy to produce a politically induced business cycle.

• Partisan model

The opportunistic model is based on certain set of assumptions. Primarily, the opportunistic model behaves in the same manner. Additionally, in a particular election , the voters are assumed to have set of identical preferences over the inflation and unemployment. The partisan model approach has emerged to be an alternative approach wherein the voters and the politicians as ideological or partisan. The partisan theory of macroeconomic policy is based on the idea that in a particular election, the political parties, assignment different weight to the nominal and real economic performance. In this regard, the left party governments are more in favor of the expansive policies which are designed for lower unemployment and higher inflation. On the other hand , the right wing governments are interested in higher unemployment and lower level of inflation. In the similar context , the study of … highlighted that the left party includes the down scale classes which considers only the human capital and yields low unemployment with tighter labour markets.

On the other hand, the right party constitutes the financial capital with low or dis-inflation. Further , the political signals in demand management, output and inflation originates within the party control of the governments. Apart from this different voters have different set of preferences regarding the level of inflation and unemployment. The voters prefer to choose the left wing or the right wing parties as oer their preferences. The policy developers have adopted the required policy instruments which are determined through the level of aggregate demand. It is also important to consider that the timings of the elections are fixed exogenously. Under these set of assumptions , the politicians consider the cat of winning elections as the means of putting the required actions under the partisan programme. In such a situation , the heterogenous voters would have different set of preferences over the rate of inflation and unemployment within a country(Sieg, 2020).

The above figure depicts the Hibbs partisan political business cycle model. This model given by Hibbs in 1971 argued that the left-wing governments prefer a lower level of unemployment and high prices in comparison to the government of the right wings. In the above figure, the left-wing governments will develop a combination of PL and UL which is indicated by the point L* in the above diagram. On the other hand, the right-wing governments will develop a combination of PR and UR. indicated by point R*. The research conducted by Hibbs used a post-war US data to allow for the uncertainty among the authorities which promote sustainable output growth rate and the extent to which the aggregate demands will be partitioned in context to extra output and extra level of inflation. Further, in the second case with the ex-post projective learning and preference under a set of uncertain circumstances.

The Hibb’s model consider the political parties as representative of various types of constituencies and these constituencies have different set of preferences. The constituencies within the right wing comprise of the upper middle class and the business community. On the other hand, the left-wing constituencies comprise of the lower middle classes. The right wing and the left wing have different consequences for both inflation as well as unemployment. The distributional effects of inflation have varied level of impact on the income and wealth of the individuals.

Revealed preference of policy makers reflects the interests of the social groups who typically provide support for different parties Empirical evidence supports the ideological vie w of macroeconomic policy making whereby the differing interests of various occupational groups are reflected in the policy preferences of left- and right-wing political parties.

• Rational opportunistic model

The rational opportunistic model is different from the traditional opportunistic model wherein the voters display rational behaviour. Rational behaviour is described as the situation whereby the voters learn and examine the previous behaviour and maximize the individual preference function. The set of assumptions under the rational opportunistic model are described as follows: -

1. The economy is operating under the Philips curve wherein there exists a trade off among the unemployment and inflation.

2. The expectations regarding the inflation arising in the future are rational which means that expectations regarding the future prices are fixed.

3. The politicians are identical indicating that the they prefer work form the office.

4. There are two candidates contesting the elections the incumbent and the challenger.

5. Voters only vote for those policy makers who maximise their utility or expected utility . In this case, all the voters have the same expected utility which is given by U.

6. The policy makers have an effective control over the inflation and unemployment in the economy.

7. The timings of the elections are previously fixed exogenously.

The rational opportunistic model is characterized by the fact that the economic agents in the world are forward looking. In such a situation, it is more difficult from the policy makers to manipulate the real economic activity. However, the rational expectations revolution models which are continue to use the adaptive expectations are criticized as the imply economic agents can make systematic errors. The rational opportunistic models are characterized by two set of goals. Primarily, the opportunistic policy cycles within the models within the rational expectations. Secondly, they rationalize the voting behaviour of the economy. There could exists information asymmetry between the voters and policy makers on the specific timing on the information acquisition. As per the rational opportunistic model, the assumption that voters will witness contemporaneous growth and would observe inflation seems to be unrealistic in the actual world. The government budget, its composition, the number of deficits within the current fiscal year seems highly complex due to which a high rate of uncertainties and information asymmetries arise within the model. Thus, the rational opportunistic model specifically target the g-rowth of the economy(HIBBS, 1994).

• Rational partisan model

In a particular rational partisan model, the victories by the left parties would lead to temporary expansions and the victories by the rightist parties would eventually generate temporary recessions. The rational partisan model assumes that the expected and actual inflation will be differed by one year. This is due to the fact that contracts for the wage contracts and even the expectations about inflation are set before the elections occur. In such a situation , if the left wing party wins, the economy will witness a boom. This boom arises due to the fact that government of the left are less averse towards the level of inflation. Additionally , these governments are more focused upon promoting the desired employment and the output growth rates. In the similar context , if the right wing party wins the election, a long term recession will follow as the expectations for the inflation will be too high. The extent of boom and recession which will be witnessed depends on the degree of electoral surprise. However , the extent of success of the rational partisan theory remains inconclusive.

The rational partisan model is based upon the extent of rationality of the price expectations and the extent of institutional sluggishness within the scope of wage adjustments. . Rational voters will take these effects into consideration in making their vote decisions. This does not necessarily imply, however, that the key idea behind the retrospective voter models that the incumbent party benefits from favourable economic outcomes is false. Apart from their preferences, political parties may differ in their abilities to achieve economic goals. Favourable economic outcomes may indicate that the incumbent party is particularly able to deal with current economic problems(Ferré & Manzano, 2014; Swank, 1995).

Advanced Economics - Assignment 2

A) Explain how Bandwagon effect influences demand. Explain and illustrate how a change in quantity demanded due to panic-buying during COVID-19 pandemic has caused the change in the price of the goods. Differentiate the functional effect and Bandwagon effect with the help of diagram(s). (1500 words) (25 marks)

Solution:

Bandwagon effect is from of behavioural science which is the result of certain set of consumer beliefs among the people which influences them to purchase a particular product. It is the tendency of the customers to follow the actions of other individual. In such a situation, the demand of a commodity is increased as the other individuals have been consuming the same commodity at that particular price. The buyer’s preference to purchase the goods purchased by other individuals could arise as a result of information derived from other individuals. The bandwagon effect first proposed by David Luder also known as the cromo effect arises because individuals tend to follow the other individuals. In such a situation, the purchase decisions of the consumers occur as some people always wish to be associated with other people or these consumers are fashionable or stylish. Further, this demand could also be influenced by trendsetters, film stars and models.

The above diagram highlights the shift in the demand curve that arises as a result of the bandwagon effect for a product. As more and more individuals follow the buying behaviour of the other individuals, the demand curve shifts to the right from DD to D’D’. As the prices fall from P to P1 , the quantity demanded changes from point a to point b as the law of demand operates. As the price falls from P to P1 , the quantity demanded increases from Q to Q1. Simultaneously, the bandwagon affect operates as individuals follows the action of their peers. Due to this, the demand curve shifts from D to D’D’ with further shift in quantity demanded from Q1 to Q2. The point of equilibrium shifts from point B to E.

The functional demand is defined as the demand of the commodity that arises due to the qualities inherited within the commodity itself. Further, the non-functional demand represents that portion of the demand which arises due to the factors other than the qualities inherent within the commodity. The functional demand is represented by the shift from point A to point B. Additionally, the bandwagon effect is represented by the shift from the point B to point E indicating the shift of quantity demanded from Q1 to Q2.

The bandwagon affect operates under certain set of assumptions. Primarily, the buyers have complete knowledge about the total quantities demanded at every price. In such a situation, the demand curve of a particular individual is the function of the total market demand at certain prices(Leibenstein, 2012; Maxwell, 2014). Additionally, it is important to note that only one point on the demand curve can be considered as the point of equilibrium. There are various factors which could lead to bandwagon effects: -

1. Fashion trends

As times change better approaches can be developed for getting things done, individuals' behavior, conduct and recognition likewise change. This prompt rise of innovators, progressively individuals' conduct is affected by design crazes and pioneers. Individuals like to be in style, purchase, do wear, act, like their colleagues, the longing to resemble the group. Showcasing way to deal with temporary fad impact is certain as an ever-increasing number of individuals might want to evaluate the item as others are doing it.

2. Impact of television and other electronic media

In the present time one can scarcely disregard the effect of media (TV, web, magazines and so forth.) in creating so lid brand picture of the item. In a profoundly serious reality where the cross flexibility of interest is certain and gets exceptionally versatile, corporates influence to develop the brand picture which prompts positive fleeting trend impact. It speaks to the longing of individuals to buy a ware so as to get into 'the swim of things.

2. Awareness or brand consciousness

Organizations spend the enormous sum on their publicizing financial plan for brand advancement, in this serious age so as to boost income, shoppers must be instigated to purchase and convert viable interest into deals. An item might be purchased to serve practical utility as well as the purchasing choice depends on factors like brand underwriting by a VIP so as to acclimate with the individuals they wish to be related with so as to be popular or snappy or, so as to give off an impression of resembling them. A higher inherent estimation of the item helps in building a temporary fad impact. The history of Microsoft shows how temporary fad impacts can prompt market fixation and market power.

The healthcare arises emerged in the form of Covid-19 has not only affected the supply chains and logistics globally but has also harmed the consumer sentiments. The Covid-19 crisis have set up a cognitive bias which has resulted in an irrational behavior. Particularly, in case od the supply of essential commodities like food and medicines. Though the governments across the world have adopted the best possible measures in order to maintain the supply of essential commodities. However, due to uncertainties and risks associated with the future, consumers are creating a stock of essential commodities at their home. Due to the bandwagon effect other individuals are following their actions and this has eventually developed a panic situation in the market. As the consumers are increasing piling up the stocks of the essential commodities, this has led to shortage of supply of the essential commodities despite the manufacturers are supplying more than the required quantities. The shortage of these items or excess demand can cause the price to rise but in case of such a panic situation, the consumers will be willing to sell even at such a high price. In such a situation, the bandwagon effect could be witnessed by the shift in the demand curve to the right along with the rise in price of the commodities.

B) An individual wish to maximise the following utility function:

Subject to the budget constraint

a. Derive the Marshallian demand functions for the two goods.

b. Calculate the maximum utility level

c. Show graphically your answer to parts ‘a’ and ‘b’

Solution:

The Marshallian demand function is similar to the conventional market level or consumer level demand curves. This demand function operates under certain set of assumptions. By holding the income and other price levels as constant , the extent of variation in good X which would change with change in the prices. The demand function is defined by the s dx(px, py, I). the demand curves given by Marshallian comprise of both income as well as substitution effects. The income effect is defined by the variation in the consumption when the income of the consumer falls but the prices of the commodity remains constant. On the other hand, the Substitution effect is defined by the change in consumption which is the result of the variation in the prices with the given in order to maintain the same utility level at the original prices.

Marshallian demand xi (p1 ,…,pn ,m) describes how consumption varies with prices and income. – Obtained by maximizing utility subject to the budget constraint.

The marginal rate of substitution is defined as the negative of the ratio of the two commodities.

For maximizing the utility level,

2x1 x2- 2 =0

X1^2 – 8 = 0

X1 = 2 √2 , X2 = 2 √2

One can likewise think about an interest bend that is made exclusively out of replacement impacts. This is called Hicksian request (after the financial analyst J. R. Hicks) and it answers the inquiry: Holding purchaser utility consistent, how does the amount of good X requested a change with px. We record this interest work as hx(px, py, U). The nearness of U as a parameter in the Hicksian request work shows that this capacity holds utility consistent on a similar aloofness bend as costs change. Hicksian request is likewise called repaid request. This name follows from the way that to keep the shopper on a similar impassion bend as costs differ, one would need to alter the customer's salary, i.e., repay them. For the practically equivalent to reason, the Marshallian request is called uncompensated interest.

References for Advanced Economics

Ferré, M., & Manzano, C. (2014). Rational partisan theory with fiscal policy and an independent central bank. Journal of Macroeconomics, 42, 27–37. https://doi.org/10.1016/j.jmacro.2014.06.003

HIBBS, D. A. (1994). the Partisan Model of Macroeconomic Cycles: More Theory and Evidence for the United States. Economics & Politics, 6(1), 1–23. https://doi.org/10.1111/j.1468-0343.1994.tb00081.x

Leibenstein, H. (2012). Bandwagon , Snob , and Veblen Effects in the Theory of Consumers ’ Demand Author ( s ): H . Leibenstein Reviewed work ( s ): Published by : Oxford University Press. Sociological Theory, 64(2), 183–207.

Maxwell, A. (2014). Bandwagon Effect and Network Externalities in Market Demand. Asian Journal of Management Research, 4(3), 527–532.

Nordhaus. (1966). THE_NORDHAUS_OPPORTUNISTIC_MODEL_OF_POLI.

Sieg, G. (2020). partisian political business cycle. 2(0).

Swank, O. H. (1995). Rational voters in a partisanship model. Social Choice and Welfare, 12(1), 13–27. https://doi.org/10.1007/BF00182190

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