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Impact on Effectiveness of Fiscal Policy

University: Mont Rose College

  • Unit No: 8
  • Level: Undergraduate/College
  • Pages 9 / Words 2250
  • Paper Type: Assignment
  • Course Code: Fin60304
  • Downloads: 16
Question :

Economics is important for consumption in goods with the demand and supply. Presently the study of it covers and discuss the market equilibrium and if this industry operates with the perfect competitive market with monopoly markets. Give all the learning outcomes mentioned below:

  • Explain autonomous consumption which helps in spending in the Keynesian model?
  • Give the reason of rise of nominal income which not reflect the changes in a standard of living?
  • What is government’s fiscal stance from its budget position?
Answer :

INTRODUCTION

Economics is related with the consumption of goods, demand and supply. Present study will discuss market equilibrium if the industry operates under perfect competition and monopoly markets. Furthermore, it will explain horizontal growth of business, its advantage and disadvantages. Reasons of markets fail in the presence of externalities will be described in this study. In addition, assignment will show geometrically the welfare loss from the externality. Report will explain the factors that might limit effectiveness of fiscal policy.

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QUESTION 1

A.

As the graph shows that demand curve is associated with the marginal revenue, average total cost and marginal cost.

In the perfect competition market, entity has to act like price taker. It will have to accept prevailing prices and company have no power to make changes in its pricing decisions individually (Starkie, 2016). Thus, demand curve of the firm is reflected through horizontal straight line at prevailing price. In such condition enterprise will have to sell its additional units at the same price. Enterprise can earn super-normal profit when average revenue which is determined by the industry is more than firm’s short run average cost. Thus, it can be said that if the entity is operating in the perfect competition then it will be able to earn super normal profit in the situation when its prices are higher from its short run average cost.

B.

If industry is operating in the monopoly market then prices will be determined by monopolist. In such condition company will have chance to earn super normal profit. Monopoly equilibrium occur when marginal cost = marginal revenue. In this condition price is usually greater than the average cost thus, entity becomes able to generate supernormal profit. By this way new firms get attracted to get entered into this market. But these organizations have to face many barriers of entry that enable monopoly to generate supernormal profit.

C.

There are different kinds of market structure such as perfect competition, monopoly, oligopoly etc (Pigou, 2017). All these market structure creates different situation for the business units. Monopoly impacts on the economic welfare of producers and consumers both. Thus, if there is consumer and producer surplus then monopoly market will be ineffective.

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Market outcome for monopoly vs competition for consumer surplus

Both these markets create different situations for the company. If there is competitive market then individual firm will have to produce more goods until prices become equal to marginal cost (Moatti and et.al, 2015). Marginal cost of production is represented by the market supply curve in the competition market. But in the monopoly market marginal cost and market supply curve are at the same point.

In the monopoly market entity has to sell its products at higher prices but smaller quantities are being consumed (Bengtsson and et.al, 2016). Thus, it is fact that monopoly is unable to create huge profit as compare to competitive market. That means monopoly market generates less profit. In this market, higher prices and lower quantities decreases consumer surplus. Hence, it can be said that it is ineffective and consumer surplus is higher in competitive market.

Monopoly vs competition for producer surplus

Producer surplus is the term that reflects the value created by producers. Producers charge higher prices in the monopoly market as compare to competitive. Thus, value which is generated in monopoly for the producers is lower than competitive market. Thus, monopoly is ineffective (McHenry, Johnson and Hightower, 2016).

Productive efficiency can be defined as the perfect situation where company’s production is at the bottom point of its average total cost .Production efficiency in perfect competition and monopoly is completely different from each other. In the perfect competitive market production efficiency automatically arises whereas in the case of monopoly firm is unable to enhance its production (Rodrik, 2015). Thus, monopoly is inefficient in term of productivity.

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QUESTION 2

Horizontal growth can be defined as expansion of business in new geographical location. In order to pursue horizontal growth entity can replicate its business model in the new market. This is the best way of sustaining in the market for longer duration, because if entity is operating in such market where it is unable to generate profit then it can replicate business model into the new market (Klein, 2016). Furthermore, leveraging existing assess is another option for the horizontal growth of organization. Horizontal growth is the expansion of business in new adjacent market. For the horizontal growth company can merge with other firm or can acquire other companies of the same industry.

Horizontal integration is the process of integrating with leading business those which are operating in the same industry. This is the best way of increasing level of production and enhance market share of business. There are several benefits and drawbacks of horizontal growth. It is essential for the companies to make sound decision and take support of appropriate strategy for the growing in horizontal manner (Fiebiger and Lavoie, 2017). If it fails to take support of correct option then it might create difficulty for the business to sustain in the market for longer duration.

Advantage

  • One of the main benefits of applying horizontal growth method is that entity can diversify its services and products (Dell’Ariccia and et.al, 2014).
  • It helps in reducing cost, because if entity produces new products then it will have to spend more amounts but by merging with other firms it can control over such cost.
  • Horizontal growth strategies are effective for the organization because this supports in reducing external competition in the market.
  • Horizontal integration is considered as most effective growth process because enterprise gets more resources and it helps in raising its competencies. By this way company can generate more revenues and can raise its production capabilities.
  • This is the effective growth options because it reduces overall development cost of the firm and supports in increasing its profitability to great extent (Autonomous consumption, 2017).
  • Economies of scale and scope are another benefit of horizontal growth of business. By this way entity can produce more goods at normal expenditures. Interaction with other big brands supports in brining innovation in the business unit and raising operational efficiency of the company (Economic efficiency in perfect competition and monopoly, 2018).

Disadvantage

  • One of the main drawbacks of horizontal growth of the company is that entity can lose its market value. As in this method enterprise plan to expand its business by merging with other firms those which are operating in the same market but merging with other brand hamper brand image of the firm.
  • Legal repercussions are another disadvantage of these horizontal growth strategies. Entity may lose its flexibility (Negative Externality, 2018).
  • Horizontal integration is restricted because of absence of competition. Before merging with other brands entities have to fulfill all government regulations.

QUESTION 3

A.

Externalities are considered as such economic activities that lead to market failure. The main reason of this failure is that product’s price equilibrium fails to reflect true cost and benefits of the products (The Economic Inefficiency of Monopoly, 2017). In the presence of externalities equilibrium level is flawed. Negative externalities create situation of excess production thus, producers fail to bear all cost. Whereas if there is presence of positive externalities then buyers fail to get benefits of goods and services. By this way they become negative towards the brand which decreases demand. That results in decreasing production level. Externality can be defined as impact of production or consumption on third party. It is the cost or benefit that is result of an activity.

The graph represents that negative externalities reduces marginal benefit. Thus, MSB=MSC is considered as market failure. For example negative externalities are such as pollution (Why do externalities lead to market failure, 2017). Due to pollution consumption of goods gets decreased. On other than if there is more educated person then benefit of goods will not be fully internalised because they will look at the pros and cons and they will prefer to get full benefit of particular products. If they are unable to get such full benefit then they will not buy such item. Thus, it is not possible to meet with the requirement of both these cases. Hence, this may lead to market failure.

B.

A) Private and Social equilibrium point

Social cost can be defined as private cost and external benefits both. Private cost is related with the individual firm which is directly linked with economic activities. This includes such as expenditures on buying raw material etc. Social cost incurred by society and it is higher than private costs (Rodrik, 2015). Equilibrium will be at the point where private cost cut demand curve. This is the point where entity tries to raise its profit. As in the present graph A1A2 is private marginal benefit, B1B2 is social marginal benefit and C1C2 is marginal cost. It represents that if social marginal benefit gets increased then quantity will be raised. In such condition price will remain constant.

B). Equilibrium price the same under both circumstances

If there is involvement of merit goods then prices in both conditions remain same. Merit goods such as education, health care can impact on quantity but all these things do not impact on prices.

C) Show geometrically the welfare loss from the externality

Negative externality takes place in a situation when decision of firm does not involve full cost of judgement. In the presence of negative externality social cost gets higher than cost consumer is paying for the same. That result in inefficiencies by this way consumers do not take interest in the product (McHenry, Johnson and Hightower, 2016). If there are presences of negative externality then producers do not bear external cost. For example pollution is the negative externality; if steel producing firm produces goods then it will enhance level of pollution in the air. In such condition population may face health issues and poor quality of life. Thus, such type of production has negative cost for the society which is considered as welfare loss.

Above graph represents deadweight welfare loss. Red line reflects supply curve of society/ marginal cost curve whereas black shows marginal cost curve.

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QUESTION 4

A)

Autonomous consumption spending in Keynesian model

Autonomous consumption can be defined as level of consumption that has no dependency over income (Klein, 2016).

Such spending occur when income level is zero, this is done through borrowing, using up savings. Such type of consumption is depended upon assets, expected future income, level of saving, standard of living etc.

Reason for if Nominal income rises not reflect changes in the standard of living

Nominal income can be defined as income from salary that is being paid out by employer in cash. This is not being adjusted with reference to inflation. This is fixed in nature thus; it does not impact on standard of living of the person because individual has to adjust their spending within the limited amount that is received by them in term of salary. If inflation gets high or prices of goods get increased then individual will not get extra payment (Fiebiger and Lavoie, 2017). That is why it does not impact on their standards of living. As person has to manage all expenditure within fix amount of salary thus, it can be help in raising standard of living of the person.

Government’s fiscal stance from its budget position

Fiscal stance can be defined as underlying position of government in applying fiscal policy. It determines actual budgetary position of the government. Fiscal policies are made by the authorities to improve economic position of the nation. It is related with government spending and levied taxes. It shows that if spending is increasing then tax will be reduced or if expenditures are decreasing them tax will be raised (Dell’Ariccia and et.al, 2014). White paper is published by the authorities annually that describe government revenues and expenditures for the fiscal year.

B)

Factors limit effectiveness of fiscal policy

Fiscal policies are related with government spending and taxes. There are various factors that impact on effectiveness of this policy. These are explained as below:

  • Balance between taxation and spending is the major element. If tax received in lower than expenditures then it might influence government policies.
  • Changes in government spending is another major component that may affect overall fiscal policy because if authorities allocate more funds to projects then it might create difficulty in managing economic situation and generating tax (Fiebiger and Lavoie, 2017).
  • Time lag between implementation and realisation of policy is another factor that might impact on effectiveness of fiscal policy.

All these factors are required to be considered by the policy makers. This can help in preparing effective fiscal policy and improving economic value of nation.

CONCLUSION

From the above study it can be concluded that changes in nominal income doesn’t make changes in standard of living of the persons. If there are changes in social and private cost then it will defiantly impact on marginal revenues, quantity and price as well.

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