Question

Talona's latest economic data indicates that GDP is growing at 4% and unemployment is at the natural rate, while Genovia's economic data indicates shows continuing pressure for decreasing price levels. Diagnose the current health for each of these economies and provide your prescription of the appropriate remedy needed in each instance.

Answer 1

Economy of Talona

In this economy, the GDP is growing at a rate of 4%. So, the growth rate of national output is 4%. This growth rate will be good for the economy if it is growth resulting from productive investments. Now, the unemployment rate of the economy is at its natural rate. So, the economy is at the lowest unemployment rate possible. Here the unemployment is attributable to other causes than a bad economy. So, it can be rationally inferred that the GDP growth rate is creating sufficient employment opportunities for the people. So, the growth in national output must be coming from productive sectors. So, the health of this economy is good as reflected by the economic indicators. Here, no remedy is needed for the economy.

Economy of Genovia

Here the data shows a continuing downward pressure for decreasing the price levels. The price level tends to decrease due to several factors like an increase in money supply, a decrease in money demand, an increase in interest rates, a decrease in expenditure. Now, to analyze the health of the economy it is necessary to know the followings -

1) current price level is high for the economy

2) If the decrease in price level is due to -

a) Increase in Money Supply

b) A decrease in Money demand

c) Increase in interest rate

d) decrease in expenditure

If 1) is true, then the health of the economy is getting better. No remedial actions needed.

If 1) is false, we inspect the following situations.

If 2a) is true, then the Central Bank should decrease the money supply.

If 2b) is true, policies that influence the demand for money should be undertaken, like policies increasing income and decreasing interest rates,

If 2c) is true, then policies leading to lower interest rate should be promoted.

If 2d) is true, policies encouraging expenditure should be promoted.