Ricky Expansion Decision Report

Introduction

Macroeconomics is the study of the aggregate economy (Kennedy, 2000). It involves the study of variables which affect the whole economy. These variables include Gross Domestic Product (GDP), growth rate, unemployment, inflation, international trade, business cycle and demographic characteristics. The study of these variables helps in understanding the structure and composition of the whole economy in order to make rational decisions which can help the economy grow during the various business stages. This is done through the use of macroeconomic models in analysing the variables data. Each of the macroeconomic variables is an indicator of the level of an economy’s performance. For example, an economy with high levels of inflation, unemployment, low output is an indication that the economy is performing poorly. Therefore, the analysis of macroeconomic variables is the backbone of the whole economy and the correct policy decisions must be made to promote a healthy economy. The next section shall analyse some of macroeconomic variables and their impact on the economy and the decision that Ricky should take in relation to each variable in deciding to expand his business.

GDP growth rate

Gross Domestic Product (GDP), is the summation of consumption, government spending, investment and net exports (Exports minus imports) (McEachem, 2012). An increase in these components indicates an increase in GDP. The goods and services are valued on market prices using the dollar. GDP is used to measure the health of an economy. GDP may be nominal GDP or real GDP. Nominal GDP uses current prices to measure the value of goods and services produced in a year while real GDP is computed using the price of a base year. Usually, the nominal and real GDP is the same. If this year’s GDP has gone up by 5%, the interpretation is that the economy has grown by 5%. GDP can be measured by use of income approach or expenditure approach. The income method adds up all the earnings of employees, net profits from companies and non-governmental organizations. The expenditure method is the one which is commonly used and it sums up all the consumption, government expenditure, investments and net exports minus imports. The two approaches should give the same results. Ricky speculates that by expanding his car manufacturing company demand will increase. Increase in demand translates to increase in consumption. Increase in consumption means increase in GDP, meaning the economic welfare of the country is improved. GDP growth rate is the increase in GDP.

Interest rates

Interest rates affect investment decisions (Baumol & Blinder, 2012). High interest rates inhibit investment and consumption. Inflation also affects interest rate which makes borrowing expensive. If Ricky intends to expand his operations, he must consider the interest rate charged in getting raw materials to manufacture cars. This is because high interest rates tend to push cost up and this affects the consumption of products by the customers. Ricky should consider the time of investment in order to benefit from low debt cost in case he intends to finance his expansion using borrowing.

Level of unemployment

Unemployment is the number of people who are looking for job and they are willing to work (Mankiw, 2012). The fact that unemployment considers only people actively looking for job and willing to work when a job opportunity arises leads to limitations on how unemployment rate is calculated. There are different types of unemployment namely frictional, structural, cyclical and seasonal unemployment. Frictional unemployment arises when job seekers are looking for specific types of jobs. People remain unemployed because they cannot get the specific jobs. Structural unemployment arises due to mismatch between workers and skills. Employers cannot get the kind of skills they require for certain jobs and the job seekers do not have the skills required by employers. Seasonal unemployment arises due to availability of jobs at specific periods of the year. Cyclical unemployment arises when there are fluctuations in businesses as a result of change in aggregate demand.
Ricky’s expansion of business will lead to creation of employment and many people who are willing to work will earn income from the employment. This means that in each household there will be few dependants. Households will have an opportunity to save and this leads to investment. Investments are possible only when people save because they can access credits from financial institutions. This will lead to an improved welfare among the households and economic growth through increased consumption and investments. Ricky can identify the type of unemployment at the time of expansion and decide which group to target when considering the people to hire.

The business cycle

Business cycle is defined as the stages that GDP undergoes when an economy encounters a downward or upward movement of economic activities. The four stages of business cycle are recession, depression, recovery and boom. During depression and recession, the GDP is lowest because economic activities are very few. These periods are characterised by excess demand because output is below equilibrium and hence high inflation rates (Kennedy, 2000). It is also characterise by high rates of unemployment. Government intervention through fiscal policy is low and the net exports are negative. Investment level is low. During recovery, the economy is gaining momentum in terms of economic activities. Production begins to show a sign of increasing hence demand for goods is not high. Since production has begun to increase, unemployment rate is low. As the cycle reaches boom, the economy has fully recovered and output is near full equilibrium. Contractions and expansions go in turns. The DGP components are affected when there are changes in economic activities. Consumption increases during expansion because households have higher earnings because they are employed. Government expenditure increase through fiscal policy and also net exports increase because there are more exports than imports. However, investments do not increase but those who invest during that time invest at a lower cost and high profits are likely to be achieved if the economy continue to blossom.
Ricky should learn the stage of business cycles both locally and internationally. If the business cycle in the local market is at recovery or boom stage, he can produce more products for auto industry since the demand is increasing. Recovery and boom stage normally indicate that the economy is in the process of healing from recession period. Therefore, these two stages could lead to increased consumption of spare parts for the auto industry. The competition is also lower at these periods because most of investors invest when an economy is booming.

Fiscal policy

Fiscal policy is a demand management policy which is aimed at maintaining output to near full employment (Baumol, & Blinder, 2012). This is because if demand is in excess, it leads to inflation and if it is insufficient, it leads to unemployment and deflation. The government uses fiscal policy through increase in expenditure and cutting taxes. This leads to increase in output through consumption and decrease in interest rates hence increase in investment. Analysis of the fiscal multiplier is crucial because it enables in making a decision of how much equilibrium of output changes with a unit increase in government expenditure. A larger amount of change in equilibrium is preferred to a small change. A fiscal policy is effective when the IS curve is vertical because it causes a larger increase in output. A horizontal IS curve will lead to a change but not as large as the vertical IS curve. Ricky would be wise if he expanded his operations a time when a fiscal policy has been passed because this will mean that his products will have high demand and his cost of investment will be lower. This will lead to increased income.

Monetary policy

A monetary policy is a demand management policy which aims at maintaining production/ output to near full employment (Lindaeuer, 2012). If monetary policies are not employed in an economy, it can lead to excess demand which lead to inflation or insufficient demand which may lead to deflation and unemployment. Monetary policy is employed through the use of increased money supply which leads to low interest rates and increased output. Through the use of monetary policy multiplier, it is possible to know how much output changes when there is a unit increase in money stock taking in to account the interaction between goods and services. The higher the monetary multiplier, the better because it means high levels of output will be achieved. A monetary policy is more effective when the LM curve is vertical because it leads to higher output. Ricky will benefit more from low investment if he expands his operation when there is a monetary policy because of the reduced interest rate.

International trade

International trade involves currying business with the rest of the world. Countries can specialize in producing the goods they have competitive advantage. This leads to increased production at low cost per unit due to economies of scale. A country can benefit in increased foreign exchange reserves. International trade leads to high level of employment, better ties with other countries and promotion of domestic industries (McEachem, 2012).
Since Ricky intends to open a car manufacturing company, he can expand his market by selling his cars in foreign countries. If the parts for auto industry meet the requirements of the foreign customers, a market will be available for Ricky and he can open new branches in the foreign markets. International trade will lead to foreign capital inflow in the country. This foreign capital inflow will increase the foreign reserves in the federal bank. A well maintained foreign reserve is an indication that the dollar has appreciated in value relative to other foreign currencies.

Demographics

These are the population characteristics in terms of age, income, race, gender and level of education among others (Kennedy, 2000). Demographic characteristics are very important because they determine which characteristics highly influence economic growth. These characterises are important for Ricky because he needs to know which type of population characteristics he shall target when expanding his business in the auto industry. Ricky needs to identify the education level and age group he wishes to employ in his business expansion. It would be wise if he employed people who are interested and qualified in the field of making parts for the auto industry.
The analysis of macroeconomic variables is important for all economies if the right decisions have to be made. This is because the performance of an economy is measured by macroeconomic variables. The discussed macroeconomic variables influence the economies output, level of consumption, investment and net exports. Well controlled macroeconomic variables leads to a healthy economy if the right policy decisions are put in place. A healthy economy is the one with high level of output, consumption, investments and net exports. Interest rate is an important factor that Ricky should consider because it influences borrowing. If Ricky intends to borrow finance from the bank he needs to consider the cost of borrowing capital. The higher the interest rate, the higher the borrowing cost and this will lead to low profit for the business. The stage of business cycle is another variable that Ricky should consider before expanding his business. If the economy is at recession or depression, Ricky should not consider expanding. This is because during this period the level of consumption is very low and most businesses are shut down. Ricky’s expansion of business will reduce the level of unemployment. This will increase income at household level which will in turn increase disposable income and savings. Demographic characteristics are another consideration that Ricky should consider. The level of income is very crucial because his business expansion concerns parts of auto industry. He must consider the location of the business in order to target the right category of people. International trade is also an important consideration because Ricky can specialize in making parts for auto industry at a low cost per unit due to economies of scale. He can also expand his market to other countries and increase his profits. Therefore, interest rate, level of unemployment, international trade, business cycle, and demographic characteristic will affect Ricky’s business directly. However, macroeconomic variables such as GDP growth rate, monetary and fiscal policy will affect Ricky’s business depending on the decisions that Federal Reserve make about the whole economy. For example, monetary and fiscal policies help stimulate the economy which help increase the output, consumption and investment. Ricky can benefit in those variables if they are implemented to increase output, consumption and investment.

References

Baumol, W. J., & Blinder, A. S. (2012). Macroeconomics: Principles & policy. Mason, OH: South Western, Cengage Learning. South-Western Pub.
Kennedy, P. E. (2000). Macroeconomic essentials: Understanding economics in the news. Cambridge, Mass. [u.a.: MIT Press.
Lindauer, J. (2012). Macroeconomics. Bloomington, Ind: iUniverse, Inc.
Mankiw, N. G. (2012). Brief principles of macroeconomics. Mason, OH: South-Western Cengage Learning.
McEachern, W. A. (2012). Macroeconomics: A contemporary introduction. Mason, OH: