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Macroeconomics

Macroeconomics

Part I. The main economic problem is the scarcity. In the economics it means that resources, or inputs, are limited while the society’s wants and needs are unlimited. In other words, scarcity implies that all of the society’s goals are unattainable at the same time; so that it should trade off one good against others. The scarcity of goods and services is explained by the limited availability of the resources together with the limited opportunities of technology, management, and human factor[1].

In macroeconomics the Production Possibility Frontier or Curve is widely used to explain the scarcity, and thus the opportunity cost concept. As shown below, the PPF demonstrates the opportunity cost of increasing one unit’s production versus another’s forgone. All points on PPF are located in such a way that they show the maximum productive efficiency, in other words, resources are used so that increase in food’s production would necessarily cause decrease in computers’ production. Any society could attain the productive efficiency, but not the allocative efficiency (whereby the use of any good brings the maximum net profit). And that is the starting point of the contradiction between command and market economies[2].

The allocative efficiency cannot be attained mostly because market and

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other institutions of social, economic, and political decision-making, such as government, can wrongly decide about the necessary combination of goods compared to what a society really needs. In the market economy the decisions are made through trading, meaning that individuals and organizations trade resources among themselves. They reallocate the goods according to their highest necessity and purchasing power. In the market economy the rate of exchange, or in other words, price of resources is determined through bringing to the equation demand and supply[3]. As the advantages of the market economy, the following ones should be mentioned:

What to produce is decided on the profitability of the particular good/service;
High prices and high profits react in the immediate increase in the production;
“Economic votes” determine how resources are allocated.
However, in the command economy the allocation of resources and price determination are under full or, at least, valuable control of the government. Only the government is to decide the three key questions of any economy: what should be produced in the economy, how should production be organized, and for whom the production should take place. The main mechanism in the command economy is the planning, whereas the government tries to establish the level of consumption of particular goods, predetermine the income level, determine the price level, and thus plan the production in order to satisfy the needs of all citizens of the country. However, as the practices showed, the command economy suffered from the huge overproduction and/or deficits, and thus did not fulfill its main goals. As the result, most of the countries with the command economy nowadays try to change it for free market one[4] (mainly about the countries of former USSR and procommunist regimes.)

Part II. The price of coffee has gone sky high because bad weather has affected crops in many South American countries; consumers have reacted as buying less coffee.

In our case S1, Q1, and P1 are the initial supply, quantity, and price respectively. S0, Q0, and P0 are situation after changes. So first of all, the reasons and origin of changes should be analyzed. In our case, the change was caused the bad weather and thus bad crops of coffee. As far as the crops were less than they were last period, it is obviously the reduction or decrease in the supply. That is why on the chart we see the shift of the supply curve (the straight lines are used for simplicity, as far as the form of the curve does not change) to the left. Correspondently, the equilibrium point will also shift together with the supply curve. And it will cause into the price increase, and decrease in the quantity supplied as P1 to Po and Q1 to Q0 respectively. As far as the change in coffee supply does not follow together with the increase in consumer’s income, it is essential that price increase have the negative impact upon the coffee consumption.[5]

Two factors have combined to lead to sky-high prices for oil. There have recently been very high rates of growth in the countries such as China and India. Supplies of oil from a number of Middle Eastern countries have been curtailed by acts of terrorism.

Price                    D1

D0                                        S1

P1                                     EP1

S0

P0                           EP0

 

 

Q0  Q1                  Quantity

This situation is more complicated as far as we have double change both in supply and demand. The high rates of growth in India and China are the indicators of the increase in demand as far as the main consumers of oil are the highly developed or dynamically developing countries. The over world consumption would increase in the case of expansion of the developed countries’ list. The increase of demand is demonstrated on the chart as the shift of demand curve to the right from D0 to D1. It immediately reacts in the increase of the quantity from Q0 to Q1. The terrorism acts in Middle East countries corresponds to the decrease of supply as far as Middle East countries are the main suppliers of oil. The decrease of supply is described as the left shift of the supply curve on the diagram from S0 to S1. After the two shifts of demand and supply curve we have obtained a completely different equilibrium point EP1. In this case as the results of such changes we can definitely talk about the considerable increase in price level from P0 to P1. However, the quantity demanded is quietly undetermined, which goes along with the decrease in quantity supplied.[6]

Part III. First, it would be helpful to define what the elasticity is before talking about its reasons and origin. The price elasticity of demand is the responsiveness of quantity demanded of a good to its price. It is measured in the percentage change in demand, which corresponds to the percentage change in price of the particular good. The general formula to compute the elasticity is: “% change in quantity demanded divided by the % change in price.” [7]

The perfectly inelastic demand is the special case of elasticity whereas the quantity demanded is completely independent from the changes in the price level. The level of elasticity is equal to 0 as far as % change in quantity demanded is also equal to 0. Graphically the perfectly inelastic demand is represented in the following way:

 
P                     D

 

E=0

 

0                                                                                      Q

The price elasticity of oil is considered to be, at least in short-run, inelastic. It does not mean that the consumption of the oil does not depend on the price at all, but at least the proportional change in the quantity demanded is less than the proportional change in the price level. It means that if the prices for oil would become sky high the demand for this product would not considerably decrease, anyway.

Let us bring the real example. In 1970s the prices for oil went up sharply about a ten–fold increase. According to the normal relationship price – demand – supply the price increase had to have come about by either a decrease in supply or an increase in demand.

What cost $10 at the beginning of the decade would have cost about $100 at the end of the decade, a price rise due to the supply restrictions imposed by OPEC – the oil cartel.  This was a good time to own oil, which was exactly the situation in the Middle East, the western US, and Russia – and bad to be in the oil buying business, exactly the situation in most countries of the world that imported all of their oil.  However, the demand for oil did not become less even though it costs ten much[8].

There are several reasons for the inelastic demand of oil:

First of all, oil is the energy source, which is extremely important in the new era of machines, factories, plants, cars, planes, and cosmic shuttles. Of course, scientists try to develop the alternative source of energy, which would be as acceptable and easy in usage as oil. However, on this moment humanity does not have noble and profitable solutions to this problem. Almost all countries of the world are dependent on the oil as an energy source; moreover, the more the country is developed, the more it depends on oil recovery. This is the main reason why demand for the oil is inelastic.
Secondly, there is limited quantity of countries, which have enough stocks of oil in order to export it. OPEC countries and Russia are the biggest exporting countries. Because of little amount of competitive countries on the market, the price level for oil is considerably controlled.
Thirdly, the inelastic demand for oil is also caused by the limited amount of it on the Earth. It is a common shared opinion of all scientists that the stocks of oil will be exhausted in next 10 – 15 years[9].
Summarizing, it should be stated that elasticity or inelasticity of demand reflects the dependence of the market and target audience on it. Can anyone right now imagine his/her life without gasoline or other oil products? It became the basis of most of the developed economies of the world.  Of course, it is ready to pay any price for enlargement of its existence. And for justice, it must be said that year-by-year the price is going to get higher and higher as far as those three factors mentioned above will become more valuable and important.[10]

Of course, the question of oligopoly for oil market and speculation by this situation may be arguable in the ethical sense; however, the only way out from this problem is the invention of new, competitive with oil, source of energy. Still without it humanity has the real oil wars, in which people die, regimes fall, and the strongest wins. Oil is god example of how economic issues become political one, as in the case with Iraq. Is it really worth to ignore people’s life in order to ensure limited economy’s existence?

 

 

 

 

 

 

 

 

 

Bibliography

1.      J. Sloman, M. Sutcliffe, Economics, 5th edition, Prentice Hall,
Harlow, 2003

2.      D. Begg., S. Fischer, S. Dornbusch, Economics, 7th edition,
McGraw-Hill, Berkshire, 2003

3.      M. Parkin, M. Powell, K. Mathew, Economics, 5th edition, Ddison Wesley, 2003.

4.      http://www.encyclopedia.com – was used for several visual aids and diagrams.

5.      P. Kennedy, Macroeconomic Essentials – 2nd edition: Understanding Economics in the News, The MIT Press, 2000.

6.      P. Roberts, The End of Oil: On the Edge of the Perilous New World, Houghton Mifflin, 2004.

7.      D. and S. Leeb, The Oil Factor: How Oil Controls the Economy, Warner Business Books, 2004.

 

 

[1] J. Sloman, M. Sutcliffe, Economics, 5th edition, Prentice Hall, Harlow, 2003
[2] D. Begg., S. Fischer, S. Dornbusch, Economics, 7th edition, McGraw-Hill, Berkshire, 2003
[3] P. Kennedy, Macroeconomic Essentials – 2nd edition: Understanding Economics in the News, The MIT Press, 2000
[4] J. Sloman, M. Sutcliffe, Economics, 5th edition, Prentice Hall, Harlow, 2003
[5] D. Begg., S. Fischer, S. Dornbusch, Economics, 7th edition, McGraw-Hill, Berkshire, 2003
[6] P. Kennedy, Macroeconomic Essentials – 2nd edition: Understanding Economics in the News, The MIT Press, 2000
[7] M. Parkin, M. Powell, K. Mathew, Economics, 5th edition, Ddison Wesley, 2003
[8] P. Roberts, The End of Oil: On the Edge of the Perilous New World, Houghton Mifflin, 2004
[9] D. and S. Leeb, The Oil Factor: How Oil Controls the Economy, Warner Business Books, 2004
[10] P. Roberts, The End of Oil: On the Edge of the Perilous New World, Houghton Mifflin, 2004

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