Microeconomic Theory Essay

1. Explain why society faces a trade-off between consumption goods and capital goods. Society is faced with trade off between consumption goods and capital goods in that resources are scarce, and therefore it has to make choices based on the opportunity costs of benefiting from consumption at present or having a greater level of consumption tomorrow through investment in capital goods. 2. Distinguish between absolute and comparative advantage. Absolute advantage refers to that trade, which is not reciprocally favorable as opposed to a Comparative trade, where trade is reciprocally favorable. 3. Explain the Law of Demand. The law of demand states that as the price of a service or good increases, consumer demand for the service or good will decrease and vice versa, provided all other factors remain constant. 4. Explain the Law of Supply The law of supply states that as the price of a service or good increases, the quantity of services or goods tendered by suppliers increases and vice versa, provided all the factors remain constant. 5. Explain the effects of price ceilings. It is a kind of government measure, where it fixes a limit on the price to be charged on a product. Effective price ceiling must be different from the free market price. A price ceiling positioned below the free market price will put suppliers in a state where they can no longer charge what they had been charging, for that particular product. This will force some suppliers to move out of the market, hence reduction in the quantity produced. On the other side quantity demanded will increase for the same product because consumers are able to buy at a lower price. Since quantity demanded exceeds quantity produced, a shortage will occur and it will result to non-price competition 6. Explain the effects of price floors. It is a kind of government measure where it imposes a limit on the lowest price that can be charged on a product and for it to be effective it must be set higher than the equilibrium price. When the price floor is position above the market equilibrium price, consumers observe that they now have to pay a higher price for that particular product. Suppliers, on the other part are ensured higher price than what they were charging before. This has the effect of increasing production, hence excess supply of the product in the market. Thus to maintain price floor over a longer period, the government will be forced to take action to reduce the excess supply 7. Distinguish between private goods and public goods and explain the nature of the free-rider problem. Private goods are the kind of goods whose profits, are indivisibly spread over the whole community, even if the individuals do not desire to purchase it. While private goods refers to the ones that are divisible and can be provided separately to various individuals, without external costs or benefits to others. Positive externalities that are not remunerated normally result from the production of public goods. When private organizations are not getting all the profits of a public good that they have produced, there will be no sufficient incentives to produce it voluntarily. Hence, consumers will take advantage of public goods without sufficiently contributing to their production. Distinguish between average tax rates and marginal tax rates. Average tax rate refers to the total amount of taxes paid divide by income. It shows the sum of tax paid per dollar earned while marginal tax rate refers to the income tax rate paid on the last dollar of income earned 9. Distinguish between average tax rates and marginal tax rates. Average tax rate refers to the total amount of taxes paid divide by income. It shows the sum of tax paid per dollar earned while marginal tax rate refers to the income tax rate paid on the last dollar of income earned 10. Explain the structure of the US income tax system. The structure of US tax system is very complex one that entails payment to at least four various levels of government and many ways of taxation. US taxation comprises local government possibly consisting of one or more of township, municipal, county and district governments. It may also embrace regional entities like school and utility and transit districts as well as incorporating federal government and state 11. Describe how prices indexes are calculated and define the key types of price indexes Price indexes refers to a standardized average or a weighted average of prices for a given category of services and goods in a given place, over a given intermission of time Types of price indexes include consumer price index, producer price index and GDP deflator 12. Distinguish between nominal and real interest rates. Nominal interest is the rate of interest prior to adjustment for inflation in contrast to real interest rate and it encompasses all three risk factors plus the time value of money in contrast to real interest rate, which includes only systematic and regulatory risks. Generally, real interest rate is equal to nominal interest rate minus inflation and currency adjustment. 13. Describe the circular flow of income and output. The circular flow of income and output shows joint flow of income between consumers and producers. The mutually supporting entities of consumers and producers, referred to as households and firms respectively offer each other with factors to facilitate the easy flow of income. Firms supply consumers with services and goods in exchange for consumer spending and factors of production from the household. 14. Define gross domestic product (GDP). Gross domestic product is the total market value of all the final services and goods produced within a country over a given period. 15. Define economic growth. Economic growth refers to the sturdy process by which the productive capacity of the economy is increased over time to produce growing levels of national income and output 16. Discuss the fundamental factors that contribute to a nation’s economic development. Policies of national development need to be formulate in conformity with national needs, development priorities and conditions and should focus on the lessons erudite from decades of development. International cooperation in the formulation and implementation of macroecomic policies need to be reinforcing with an analysis to enhancing greater lucidity and consistency of domestic policies and in so doing reinforcing their effectiveness. 17. Describe the effect of economic growth on the long-run aggregate supply curve. Economic growth will cause the aggregate supply curve to shift. Positive economic growth will lead to increase in productive resources that will make it possible to produce more final services and goods, thus the natural level of real GDP increases. Positive economic growth will make the LAS curve to shift to the right and vice versa 18. Discuss the meaning of the long-run equilibrium for the economy as a whole. Long run equilibrium refers to where the aggregate demand and long run aggregate supply curves intersect. Output is fixed and the price level is variable in the long- run. Thus increases in aggregate demand leads to higher prices and vice versa 19. Discuss the central assumptions of the classical model. The central assumptions of classical model are that it assumes that economic agents’ posses’ perfect information and the markets are characterized by perfectly flexible wages and prices. The result of these assumptions if functional on the short run with fixed capital stock is that output is dogged by independent supply factors 20. Describe the short-run determination of equilibrium real GDP and the price level in the classical model. The aggregate supply-aggregate demand is the fundamental macroeconomic tool for studying output variations and the resolve of the price level and inflation rate. The intersection of the aggregate demand and supply curves determines the economy’s equilibrium price level and equilibrium real domestic output 21. Distinguish between saving and savings and explain how saving and consumption are related. Saving refers to that process of constantly putting aside a sum of money while savings is that income received by a consumer not used in the output of firms through spending. Savings and consumption can be related in the equation where income is equal to the sum of savings and expenditure (consumption) 22. Identify the primary determinants of planned investment. The primary determinants of a planned investment include the expected return from investments, the taxation of returns, the cost of capital in relation to interest rate and the ease of use of savings to meet investments 23. Discuss ways in which indirect crowding out and direct expenditures offsets can reduce the effectiveness of fiscal policy actions. Inflation has an indirect outcome on international competitiveness. As prices increase, products tend to be more expensive relative to foreign products. This will result to reduced demand for exports as compared to imports. Net export being a parameter of aggregate demand will contracts GDP and partly offsets the expansionary fiscal policy. Expansionary fiscal policy makes interest rates to increase because the government must borrow to finance the increased deficit. The government raises revenues through taxes or borrowing. Hence, as the interest increases, private investment decreases. In the short run, it will decrease private investment demand, a parameter of aggregate demand and this will effectively lower GDP. Describe how certain aspects of fiscal policy function as automatic stabilizers for the economy. Automatic stabilizers are programs that automatically increase fiscal policy during recessions and contract it during booms. Unemployment insurance is an exemplar of automatic stabilizer in that the government spends more money for the period of recessions when unemployment rate is high. Equally, taxes are roughly proportional to profits and wages; hence, the size of taxes collected is higher during boom than recession. 25. Explain how federal government budget deficits occur. Federal government deficit occurs when it pays out more money than it can receive 26. Define the public debt and understand alternative measures of the public debt. Public debt refers to the credit or money owed by any echelon of government; federal government, central government and municipal government or local government. The debt is seen as an absolute number and can therefore measured as a percentage of the GDP. Alternatively, it can be measured by the amount owed in any given year. 27. Define the fundamental functions of money. Money can be described in terms of its core functions that are; it act as a medium of exchange, store of value and as a unit of account. 28. Identify key properties that any good that functions as money must possess. Properties of money is that it should be able to serve as (1) means of exchange (2) a enumerative (3)a source of liquidity and (4) store of value 29. Describe how the Federal Reserve assesses reserve requirements on banks and other depository institutions. The reserve requirement is a bank rule that puts the minimum reserves each bank must hold to customer notes and deposits. The reserves are meant to assure withdrawal demands. Federal Reserve approval is essential to begin any foreign banking institution in the US. Foreign banks need acquire regulatory approval from the OCC or the state banking supervisor when establishing new branches and agencies. Banks that are federally licensed must deposit cash or suitable securities at approved depository to convince the capital equivalency requirements specified by the IBA 30. Explain why the money supply changes when someone deposits in a depository institution a check drawn on the Federal Reserve System. The Federal Reserve buys and sells government securities. These, increases or decreases banks capabilities of making loans. This equally decreases or increases interest rates. If Federal Reserve sells a bond, an institution or individual buys the bond with a debit on their account and transfers the funds to the Federal Reserve. The Federal Reserve removes an equivalent amount from the bank reserve of the customer. The bank will then take away the equivalent amount from the customer’s account who bought the bond. This will decrease money supply and increase interest rates. The trend changes when the Federal Reserve decides to buy a bond 31. Identify the key factors that influence the quantity of money that people desire to hold. Motives for holding money, which can be expressed as factors that influence people to hold money, are transaction motives, precautionary motives and speculative motives 32. Describe how the Federal Reserves Tools of monetary policy influence market interest rates. The Federal Reserve buys and sells government securities. These increases or decreases banks capabilities of making loans. This equally decreases or increases interest rates. If Federal Reserve sells a bond, an institution or individual buys the bond with a debit on their account and transfers the funds to the Federal Reserve. The Federal Reserve then removes an equivalent amount from the bank reserve of the customer. The bank will then take away the equivalent amount from the customer’s account who bought the bond. This will decrease money supply and increase interest rates. The trend changes when the Federal Reserve decides to buy a bond 33. Explain why the actual unemployment might depart from the natural rate of unemployment. The departure of the natural and actual rates of unemployment is a sign of the business cycle. The stages when actual unemployment exceeds the natural unemployment are times of recession or early stages of economic recovery. The stages when actual rate is below the natural are times of a booming economy 34. Describe why there may be an inverse relationship between the inflation rate and the unemployment rate, reflected by the Phillips curve. The inverse relationship in the Philips curve can be explained well when you consider that with high unemployment laborers would accept lower wages and this would reduce firms’ cost. High wages bring about high inflation and the lower the rate of unemployment, the higher the rate of inflation and vice versa. 35. Explain why population growth can have uncertain effect on economic growth. There is no clear-cut explanation of the effect of population growth on economic growth. It can be argued that high population growth creates pressures on limited natural resources, decreases public and private capital formation and redirects counts to maintaining relative to increasing the stock of capital per worker. It can also have affirmative effects like economies of scale and specialization. Describe how government inefficiencies have contributed to the creation of relatively large quantities of dead capital in the worlds developing nations. Government poor policies make capital investment impossible. The government tends to involve in the production of consumption goods that are less important. The rate at which the economy can absorb extra human capital is low and therefore it leaves the available resource idle. The government is also not receptive to new technology whish is important in the formation of capital. Discuss the worldwide importance of international trade. International trade is very crucial for the development of a country in that it expands the choices that could otherwise been limited to what can be produced locally. Thus, countries can access goods and services cheaply from abroad. Labor can also be obtained cheaply in some countries. Cheap labor reduces production costs and this will have effect to low prices to the final product. Therefore, countries can import final product at a much lower price compared to when produced locally where labor is very expensive. Explain why nations can gain from specializing in production and engaging in international trade. A country specializing in the production of goods which it has comparative advantage will profit and it will trade for goods which it does not have comparative advantage. Therefore, free trade will make a country to use its resources efficiently. Efficient use of resources will increase the amount of goods available for production and consumption. Hence, the benefits of trade will be the outcome of specialization 39. Distinguish between the balance of trade and the balance of payments. The balance refers to discrepancy between a county’s exports and imports and it is the major part of a country’s balance of payments, which is an accounting report of the economic transactions that have taken place stuck between the inhabitants of one country and the inhabitants of other country over a particular period. 40. Identify the key accounts within the balance of payments. Key accounts within the balance of payments are current account, capital account and financial account. References Ariel, R. Lecture Notes in Microeconomic Theory: The Economic Agent. New York: Princeton University Press, 2006