1303AFE Economics for Decision Making 1 - Free Samples to Students
• The current unemployment rate is 6.6% and the number of people in the labour force is 175,585. Use this information to find the following.
• How many people are unemployed?
• If the working age population is 196,555, what is the labour force participation rate?
• Suppose that the size of the labour force increases by 20,000 people. What would happen to the unemployment rate? Assume that the number of people unemployed does not change. Explain your answer by referring to the relevant equation.
• Jim has been looking for a job after graduating from his post-graduate study. Jim has been searching for over 3 months since graduating. Is Jim frictionally unemployed, structurally unemployed or cyclically unemployed? Explain your answer.
• Describe the various key roles of the Reserve Bank of Australia (RBA) as specified on their website.
• i) Assume that the reserve ratio in a country is 16%. Calculate the simple money multiplier.
• Suppose that customers deposit $1,800 into their banks. Based on the simple money multiplier calculated in part i), calculate the total amount which the money supply in the banking system will eventually increase to.
• If the reserve ratio decreases to 12.5%, calculate the total amount which the money supply in the banking system will eventually increase to. Assume the amount of fund initially deposited by customers is also $1,800. Explain in detail how money multipliers work.
• The Central Bank of Sri Lanka would like to decrease the interest rates in the economy. What open market operation (OMO) action should the central bank take? Explain in detail the OMO process and its implications for the cash rate, interest rates, inflation and GDP. Draw by hand the effect of the OMO process using the MD-MS diagram.
Answer:
Introduction:
The term underemployment refers to a situation where a person is employed but the skills, level of education of the person or the hours of work that the person can perform are not utilized to the optimum level.
On the other hand, marginal attachment to the labour market refers to the situation where individuals who are not included in the labour force are actively searching for a job but are unable to work in the coming weeks or may be not searching for the job actively (Pigou, 2013).
Unemployment (U) = Total labour force (L) – Number of person Employed (l)
Here, u= 6.6 %, L= 175,585
=> 0.066 * 175585 = 175585 – l
=> l = 163,996
=> U = 11,589
In the economy 11,589 person are unemployed
Now, working age population (W) = 196,555 (as per the question)
- w = 83.43 %
Therefore, the labour force participation rate is 83 percent.
Now, L = 195,585
- u = 16.15 %, the unemployment rate has increased due to an increase in the total workforce. the reason for this phenomenon can be explained as follows.
The 1st order derivative is always positive as l and L are always positive. Therefore, other variables remaining constant as L increases u also increases.
Jim is frictionally unemployed. When Jim graduated he already became a part of the work force, but he is unable to find a job. Therefore, Jim is frictionally unemployed (Garcia & Sorolla, 2013).
The various key roles that the Reserve Bank of Australia is expected to play are stabilising the currency of Australia, maintaining the full level of employment and to increase the welfare and prosperity of the citizens of Australia.
r= 16 %, therefore, m = => m = 6.25
Deposit in the bank = $1800
- m = 6.25 * 1800 = 11,250
Therefore, the supply of money will eventually increase to $11,250 from $1800
Now, r = 12.5 % then m = 66.5*1800 = 120,000 on the basis of the above formula
Therefore, the money supply will increase to $120,000.
Suppose a person deposits $100 in the bank and the bank’s reserve ratio is 10 percent. Therefore keeping $10 the bank can lend $90 to another person. The second person who takes a loan of $90 from the bank deposits in another bank. Again, that bank keeps $9 in the bank account and lends out $81 and this continues into an infinite GP series. Mathematically, considering r as the reserve ratio,
Which is an infinite GP series, therefore, , which is the money multiplier.
To reduce the interest of the economy, the Central Bank of Sri Lanka should try to increase the money supply. Now, in open market operation (OMO) to increase money supply the Central Bank should buy government bonds from the public. This will increase the money supply.
The open market operation is the simplest form of controlling the supply of money in absence of the banking system. An increase in the supply of money will lead to the rightwards shift of the LM curve which will reduce the rate of interest level and increase the level of output in the short run. The prices will rise due to an upwards shift of the Aggregate Demand curve in the short run. Graphically, the interest increases, output increases and the prices also increase. Lm shifts from LM1 to LM2 and Aggregate Demand from AD1 to AD2. Thus increasing prices from P1 to P2.
|
Price Level |
Real GDP demanded (in Billions) |
Real GDP supplied (in Billions) |
|
110 |
100 |
20 |
|
125 |
75 |
40 |
|
140 |
55 |
55 |
|
175 |
25 |
80 |
|
200 |
15 |
90 |
|
225 |
10 |
95 |
From the table above the following diagram can be drawn which is provided below.
- A* is the point of equilibrium, where P=Q= 55
|
Price Level |
Real GDP demanded (in Billions) |
Real GDP supplied (in Billions) |
|
110 |
100 |
20 |
|
125 |
75 |
40 |
|
140 |
55 |
55 |
|
175 |
25 |
80 |
|
200 |
15 |
90 |
|
225 |
10 |
95 |
Output is at 50 but it should have been at 40. Therefore, prices will increase and there will be an inflationary gap.
As consumption falls the aggregate demand falls from to . Therefore, price level falls from P* to and output from Q* to . This phenomenon will occur the phenomenon in the short run. In the long run workers perceive that their real wages has increased which will cause a forward movement of the aggregate supply curve from to and further the process will continue till the long run equilibrium or the potential equilibrium is reached. The aggregate supply curve will shift up to. The economy will reach to a level of low prices and long run level of output.
From the above link, it is understood that the exports of rice from Thailand has increased. China, Sri Lanka as well as the Middle East has ordered in lump sum. This rise in exports will increase the aggregate demand and lead to high prices in short run. In the long run workers perceive that there is a fall in the real wages and thus the workers will try to increase their nominal wages which will shift the AS curve to the left till it reaches the potential output. In the long run prices will be high and output will be same.
References
Garcia, J. R., & Sorolla, V. (2013). Frictional and Non Frictional Unemployment in Models with Matching Frictions.
Pigou, A. C. (2013). Theory of unemployment. Routledge
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