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Economics - Part A

  1. Gross Domestic Product (GDP) is an important indicator which tells the economic performance of a nation. It is very commonly used to measure wealth and well- being of an economy. However, there are certain limitations of using gross domestic product as a measure of well- being. These are:
  • Exclusion of non- market activities: While calculating the value of gross domestic product, it does not include the non market transactions that takes place within an economy. These non market transactions include food made by mother who is a homemaker, production of goods and services for own consumption, childcare, etc. These activities do not take place in the market and thus are not used in the calculation of GDP.
  • Exclusion of activities taking place in Underground economy: There are activities which are hidden from the government either to avoid taxes or due to illegal production of goods and services. These activities constitute for a good proportion in economic activity. But since these are hidden, they are not included in the calculation of GDP.
  • Negative Externalities are not included: While production of goods and services, there is production of negative externalities also. For example, pollution produced due to the production of goods are not included in the calculation of GDP. However, this negative externality affects the quality of life of the people in an economy and indirectly impacts the economic growth rate. Thus, gross domestic product fails to capture these negative externalities which directly have an adverse impact on the standard of living of the people and indirectly have an impact on the economic growth rate.

There are alternative indicators besides GDP which measure wealth and well- being:

  • Human Development Index
  • The Happy Planet Index
  • The Genuine Progress Indicator

These indexes take into account both income and non-income variables which GDP do not take into account such as inequality measures, life expectancy, environmental factors, literacy rates, etc.

  1. Business cycle can be defined as fluctuations in the market which affects the aggregate economic activity of a nation. It consist of periods of expansions and contractions.

Recession can be defined as the stage of business cycle when the output of the economy is falling. At this stage of business cycle, due to fall in the output, unemployment also rises. There are different causes of recession that takes place in an economy:

  • Technology Shocks: There are cases when there is change in the technology which is used in the production of goods. This can include change in the prices of inputs or raw materials used. Thus, supply shocks are an important factor that can cause recession.
  • High Interest Rates: When the interest rates are high, it is difficult for the investors to invest. This limits the liquidity in an economy, which can further lead to recession.
  • Lower Consumer Confidence: There are instances when the people lower spending their money when they believe that the economy is not working good. Although, this is psychological but have an adverse influence in an economy. This can lead to recession if the people lower their spending on goods and services.
  • Reduced Real Wages: There are cases when the real wages are falling due to increased inflation. This increased inflation leads to lower purchasing power of the people in the economy. They can purchase less amount of goods with the same money. Thus, this can lead to recession in an economy.

There are many different causes of instability in the business cycle. One of them is investment. The expansion on the business cycle leads to rise in the interest rates. This rise in the interest rate is followed by a surplus in the capital which further leads to fall in the investment. This causes a business cycle contraction. Whereas, a business cycle contraction leads to fall in the interest rates which creates a demand for capital. The level of investment rises which further lead to business cycle expansion. Thus, we can say that investments are more volatile in nature than the gross domestic product. Also, it is pro cyclical.

Economics - Part B

The relationship between the inflation rate and unemployment is defined by A.W. Phillips. He highlights the inverse relationship between the rate of inflation and the rate of unemployment. This is known as Phillips curve. The short- run Phillips curve is L- shaped. This shows a trade off between the rate of inflation and the rate of unemployment. It means, when one of it rises, the other falls.

The quote in the question shows that as the growth in the economy falls, there is less demand of goods and services in the economy. The spending of the people in the economy falls. This will lead to surplus in the inventories. The suppliers of goods and services will try to reduce the production of goods due to surplus in the inventories. This will further lead to less employment of people and a rise in the unemployment rate. In the market, due to less demand of goods and services and excess supply of goods, there will be a downward pressure on the prices. This will reduce the price level in the economy. Thus, the rate of inflation and output will fall. This shows that as the rate of unemployment rises, there is a fall in the inflation rate.

The Phillips curve is related to aggregate demand curve. When there are movements in the aggregate demand curve, it also leads changes in the Phillips curve. In the quote provided in the question, the situations is of the shock in the aggregate demand. There is fall in the aggregate demand, which lead to fall in price level. Due to fall in the demand, the production of goods and services are also reduced . This lead to fall in the employment rate and jobs layoff. There is a rise in the unemployment rate with a fall in the inflation rate.

This shows that when there is aggregate demand shock, that is, leftward shift in the aggregate demand curve, there is a downward movement along the Phillips curve. In the Phillips curve, the rate of unemployment is in the horizontal axis, and the rate of inflation is the vertical axis. Due to aggregate demand shock, the rate of inflation falls and the unemployment rises. This is shown by the downward movement along the Phillips curve. However, there are no changes in the aggregate supply curve. Therefore, we can say that aggregate demand curve has a direct impact on the changes in the movement in the Phillips curve.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Economics Assignment Help

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