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Macroeconomic coordination process can be summarized into a graphical portray that shows the relationship between the level of interest and the quantities of GDP, APE and ASF. Demand and cost changes have an impact on the process. The process involves funding adjustment and output-price adjustments. There are external shocks that can affect macroeconomic coordination. This essay is a summary of chapters 8, 9, 10 and 11 of Ashby Money Mechanics.
Macroeconomic coordination: Graphical Portray
The chapter shows the process of macroeconomic coordination on graphical presentation. The graph, which is one diagram, will show the relationship between the level of interest on the vertical axis and the degrees of GDP, APE and ASF on the horizontal axis.
The graph will be making use of the following relationships. The relationship for employment and outputs is positive for DGP and APE. For APE, the impact for output is half the output. For ASF, the employment and output lacks effects. The effects of interest rates for GDP have no direct outcome, while APE has a negative effect and ASF has a positive effect. For prices, GDP and APE are not affected while there is a negative effect for ASF.
On the graph, a vertical line will be drawn because there is no direct outcome when the levels of interest change. The GDP vertical line moves horizontally depending on the interest change. When there is increase, it moves to the right. When there is a decrease, it moves to the left. Since the price does not affect GDP, the vertical line will not move.
To add APE in the graph we may form a linear equation; assuming there is a linear relationship. The equation: APE = a + b (GDY) – ci. a represents quantities of the combined influences while excluding interest rates and GDY. b quantifies the increase in domestic income which is used to purchase domestic output. -c quantifies changes in APE in relation to those in the interest rates levels.
Quantities of -c are usually negative and small, a small drop in APE reflects a rise in interest rates while a drop in interest rates show a slight increase in APE. i is the interest rates level. APE line will therefore be inclined to the left where the horizontal line will intercept at a + b (GDP0).
IS line denotes the interest rates levels combined with GDP, where APE is equivalent to GDP. The intercept for IS id a/ (1 – b). GDP, APE and IS matched movements implies that the three line will meet at a common point. The three intercept at the on GDP line with an increase and decrease in APE. When the GDP increases or decreases, the intercept lies on the IS line if the IS line is not changed.
The next step is to add the ASF (Aggregate Supply of Funding) line. It represents the upper limits of aggregate expenditures. ASF is on an equation denoted as; ASF ≡ (M x V)/p. M refers to existing money; p represents current price levels, and V the number of times in a year. On a linear equation ASF ≡ (m/p) + (e/p)i ; where m > 0 and e > 0.
To mark the ADF (Aggregate Demand for Funding), the line is tantamount to the larger of GDP and APE. On the graph, the line is bended because it is made up of GDP line above IS line and APE line above IS line. Thus APE < GDP on GDP line and APE > GDP on APE line.
Macroeconomic Coordination: Microeconomic Foundations
The chapter evaluates demand and cost implication on the behavior of businesses. It examines business behavior when demand increases and when it decreases. When the cost increases and when it decreases.
When demand increases, the business increases the outputs and the cost of products. The supply, demand and profits are high. Consequently, new firms venture into the business. Increased competition will make the business supply, demand and profits return to normal.
New firms will increase output, early demand rates increase and the profits will resume to initial profits. Limitations to entry of businesses include environmental factors, license and patent. Output may not lead to reduction of cost to the original cost. The output may not be raised to meet the demand. Increased costs in supplies may affect output and the cost. An increase in demand could lead to increased in cost and no increase in output.
The cost structure may decrease after the introduction of advanced technology, trained and productive employees, better exchange value and inexpensive raw materials. The business will have increased output and obtain profits after reducing the prices. Other firms will join the business to introduce competition which will lead to reduced profits.
The business industry output is increased as the competing firms output and cost levels are down. The growth of the firms may come to a standstill if the suppliers increase costs, reduce prices and the business industry output is reduced.
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When demand decreases, the output is decreased. The firm also reduces prices after demand decreases. The profits will be low and some of the firms will leave the business industry.
Consequently, the competition will also be reduced. As the competition decreases, the firms in the industry will have demand, output and prices return to normal after a while since the firms will have been reduced to a small number. The small number of firms will produce the customers’ demands as required. The firm should not go below the acceptable profit or the business will close down. The firms facing decreased demand may force the suppliers to reduce costs, so that it can stay afloat.
Increase in cost come as a result of increase in production. Basic raw materials, increased wages for workers and high cost of obtaining rare materials are passed on to the consumers by increasing the cost of the end product. When value of foreign currency and shortages are realized the costs are also increased.
The government maintenance cost of environment also cause increase in cost. With increased cost, the output reduces and profit maximize. After realizing low profit margins, firms leave the business industry. The industry output is low as the few remaining firms’ output increases after majority leaves.
Macroeconomic Coordination: The Process
An imbalance between ADF and ASF cause money suppliers and users to cause funding adjustment so that ADF and ASF are equal. Whenever GDP and APE are unequal, the suppliers of utilities make an output-price adjustment. Funding adjustment takes a short period to be implemented while output-price adjustment takes a long period since it involves risk taking and complexities. Output-price adjustments are made after the implementation of funding adjustments.
The level of interest for funding adjustment when ADF is equal to ASF will remain the same. Those with insufficient will seek to borrow from those with more than sufficient. When the funding adjustment of ADF is greater than ASF, those with insufficient and more than sufficient will be unaware that the supply of funding is inadequate and cannot meet the demand.
The amount of those with more than sufficient will want to lend will be inadequate for borrowing needs. Those borrowing will have high interest rates. High interest rates will discourage borrowing. When the funding adjustment of ADF is less than ASF, those with insufficient and those with more than sufficient will not discern that the supply for money exceeds the amount required for borrowing.
The amount available for borrowing will be higher than the amount to be borrowed and no one will be interested to borrow excess at same interest rate. The interest rates for both suppliers and money borrowers will be lowered. Those supplying will be discouraged by the low interest rates while the borrowers will be encouraged by the low interest rates. After funding adjustment occurs, the output-price adjustment follows.
When the output-price adjustment of ASF, GDP and APE are equal, those with excess demand will increase prices and output, while those with insufficient demand will decrease prices and output. The interest rates do not change. The prices, employment rate and output remain the same when ASF, GDP and APE are equal. When the output-price adjustments indicate that GDP < APE = ASF, there is excess demand.
With increased GDP and temporary increase in price, the level of interest is high. The results will be high employment rates, increased output and high interest rates. When the output-price adjustment shows that APE < GDP = ASF, there is combined low demand and excess supply. The GDP is decreased and there is a temporary decline in prices. As a result, there are low employment rates and low outputs as well as low interest. When GDP contraction process is interrupted, the prices resume their initial level.
Macroeconomic coordination process occurs whenever there are inequalities in GDP, APE, and ASF. Without the intervention of the government, the process can solve the inequalities. Moreover, the prices that change during output-price adjustment are temporary.
Macroeconomic Shocks: Excess Demand Cases
There are external shocks that trigger the macroeconomic coordination process by causing an increase or decrease in GDP, APE, or ASF. The external shocks are not caused by change in GDP or interest rates. This chapter discusses demand caused expansion, money and credit caused expansion, cost induced deflation and supply caused inflation.
In the case of demand caused expansion, the increase in APA leads to increase in interest rates at the beginning of the funding adjustment. When the process approaches the output-price adjustment, further increase in interest rates enable high rates of employment, high inputs, increased prices and bigger profits in anticipation of GDP, ASF and APE equality.
In money and credit caused expansion, the level of ASF will be increased then the interest rates will fall at the beginning of funding adjustment. Thereafter, the interest rate will be raised during the output-price adjustment.
Consequently, the employment levels will be raised, profits increase, output levels increase and prices increase in anticipation of GDP, ASF and APE being equal. Employment and output will continue to increase until prices and revenues stop escalating. Towards the end of the shock, the employment and output will be at high levels, the interest levels will be decreased while prices and revenues remain constant.
In cost induced, deflation is characterized by a decline in the cost of production, high employment levels, augmented output and enlarged revenues. Thereafter, the interest rates declines and the prices are reduced. High revenue will encourage increase in employment levels and enlarged output. The interest rates will drop. Employment rates, output, prices and interest rates will remain constant until the onset of another shock is experienced.
For supply caused inflation, the GDP becomes decreased at the beginning of the macroeconomic coordination process. Next, the interest rates are dropped. After a period, the interest rate and prices increase, where APE and ASF reduce to the level of GDP. The depressed level of GDF takes a while and is only temporary. GDP can recover and resume original levels. The adjustment process will enable the business to recover and employment levels, output, prices and interest rate return to the initial status before the shock.
A prolonged inflation will require an increase in money and value to facilitate the recovery. Repeated money and credit caused expansion can lead to inflation where employment and output will be affected negatively.
Sustained monetary control will be an appropriate solution. Demand caused expansion and money, credit caused expansion and cost induced deflation causes increase in output and create employment, whereas supply caused inflation does not. Money and credit caused expansion, cost induced deflation and supply caused inflation lead to temporary boost of prices. When the shocks are extended for a long time, prices remain high for a long time.
Graphical Portray of the Macroeconomic coordination shows the relationship between level of interest on the vertical axis and the degrees of GDP, APE and ASF on the horizontal axis. The process can be on one diagram. Increase in demand leads to increase in the business industry and output and sometimes slight increase in cost.
Cost reduction will increase the business industry and outputs. Decrease in demand will decrease the size of business industry, the output and reduce the cost. Increased cost will lead to reduction of business industry and the output. Macroeconomic coordination process transpires when there are inequalities in GDP, APE, and ASF.
They are capable of solving the differences without the intervention of the government. Funding adjustment regulates ADF and ASF while output-price adjustment regulates GDP and APE. Funding adjustment is followed by output-price adjustment. ADF and ASF for funding adjustment are equal the interest rates remains the same. When ADF is greater than ASF, the interest rates are increased. When ADF is less than ASF the interest rates are lowered.
The interest rates do not change if ASF, GDP and APE are equal. If the GDP < APE = ASF, the demand is high and the interest rates are raised. When the APE < GDP = ASF, the demand is low and the interest are lowered. The change in price during output- price adjustment is temporary. External shocks affect the macroeconomic coordination process and cause an increase or decrease in GDP, APE, or ASF. The shocks are: demand caused expansion, money and credit caused expansion, cost induced deflation and supply caused inflation.