Question

Answer the following questions. Please show all your work/explanation:

Leading and lagging. Statistically some variables lead, some are coincident and some lag GDP. But why? Put yourself in the mindset of a firm owner and reason through the following questions.

a) You operate a trucking business. You are deciding whether to buy additional trucks. In making this investment, why might you be concerned about future GDP? How might your assessment of future GDP growth affect their investment decision? Hence, explain why investment decisions are often good leading indicators of GDP growth.

b) Suppose GDP growth has fallen and your trucking firm is deciding whether to layoff some workers. Your workers are reliable and have been with you for some time. What is the immediate benefit to a firm from laying off workers? And what is the immediate cost? What is the long term cost and, hence, why might you delay laying off workers? Hence, explain why layoff decisions are lagging indicators of economic growth. (Hint: For the immediate costs and benefits, think about our treatment of employment choices of the firm. For the longer term cost, think about the following: when orders pick up, then the firm will need to replace workers let go when times were bad. Why might this be costly? Why then might you want to be really certain that times are bad before you layoff workers?)

Answer 1

Leading indicators are those which leads (occurs before) the happening of an event or change. Lagging indicators are those which occurs after the happening of the event or change.

a) In making the investment in the trucking business for purchasing new trucks one should be concerned about the future GDP because GDP is an indicator of economic growth which includes growth of all the sectors of the economy. If the GDP is increasing it indicates that the production is increasing and hence to transport more products more trucks would be required. If it is assessed that the GDP would increase then the investment would be done in the purchase of the trucks and if the GDP is assessed to be decreasing in the future then trucks won't be purchased. From this we can say that the investment decisions are the leading indicators of the GDP growth because the investment decisions of the supply chain participants are based on the anticipated production.

b) If the firm decide to lay off its reliable and trustworthy workers because of the fall in GDP growth it might be beneficial for it in case its workers are permanent and firm requires to give remuneration to them irrespective of the work done. Immediate benefits equivalent to the remuneration of the workers layed off could be derived by the firm. But the cost according to the contract of employment and the law are to be born by the firm. If the workers are paid according to the work paid then it is not advised to lay them off because in the long term if the orders picked up then firm will be required to hire new workers that may be available at a higher cost than the present workers and also may not be as reliable as the old one's. Also the firm would be required to bear the recruitment expenses and the training expenses. So the firm should be certain about the economic growth's direction before laying off. Laying off could only take place after the slow down of the economic growth. Hence, layoff decisions are lagging indicators of economic growth.