Business Economics Apply Model Economics - MyAssignmenthelp.com

Question: Discuss about the Report for Business Economics of Apply Model Economics. Answer: 1) Economic models apply economic theory to explain and forecast parametric changes in economic variables over time under certain specific assumption. Hence simplified approximations of the real-life economic situations are represented by economic models. However, economic models are said to be unrealistic. The main reason behind this kind of statement is that an economic model is formed under a considerable number of assumptions most of which might not hold in the real world. Hence, when these assumptions are relaxed, the model loses its validity and fails to explain economic outcomes. Economic models are meant to be simplified representation of the real world. However, since the assumptions do not mostly hold in the real world, sometimes economic models fail to serve the real purpose. (Hindriks, 2008) Economic models are essentially based on certain assumptions which may be either crucial or simplifying. These assumptions are made to simplify complex real-life economic situations enabling economic theory to interpret outcomes of the real economy and also forecast the future. Once the outcome of a model is arrived at, the assumptions are relaxed one at a time to get a closer approximation of the real economic situation concerned because these assumptions generally do not hold in reality. On the flip side, since these economic models are fundamentally based on subjective assumptions, they may produce absolutely different results when any of these assumptions is relaxed or even altered. This indicates the possible failure of an economic model to predict economic outcomes for the real world. This theory validates the given statement. (Syll, 2010) Let us consider the Simple Keynesian model (SKM). It assumes that demand creates its own supply, the price level remains fixed, the economy is closed, there is excess production capacity in the economy, etc. Based on all these assumptions, it gives the outcome of equilibrium of aggregate supply and demand in the economy. However, in the real world these assumptions do not always hold. Demand does not necessarily create its own supply. Price levels are not fixed because there are instances of inflation. Moreover, almost no economy in the world is closed. Hence almost most of the assumptions on which the model is based do not hold true. If these assumptions are relaxed the model will lose its validity. Moreover, it does not consider some main economic parameters like money and interest rates that play major roles in determining the aggregate demand in the economy. So the model is not a proper approximation of the real world. (Mankiw, 2006) 2) In Australia negative gearing is an instrument of tax that entitles investors to tax deductions on incurring losses on property investments made on financial loans. Investors can secure themselves against losses from property investments by receiving a tax deduction equal to the amount of the loss. (Koulizos, 2016) 60 percent of the landlords in Australia incurred losses of around $10,000 in the year 2013-2014. However, because of the prevalence of the policy of negative gearing, these losses were recovered via income tax reductions of the respective amounts. Negative gearing, hence, encourages potential investors to invest in properties without facing losses because of the existing insurance of negative gearing. This acts as a major component of aggregate demand. In the long run, this helps expand the investment opportunities in an economy and also boosts economic growth to a large extent. A removal of negative gearing implies that the insurance policy against investment losses is withdrawn. This would evidently discourage economic agents from investing in properties any further. Even if they do invest, the scale of investment would reduce by a large extent with respect to the entire economy. (Cahill, 2016) This would lead to a distortion in prices as well as rents in the housing market in the short run because there will be a demand-supply mismatch. But, some economists suggest that in the long run, this might actually be favorable for the economy as a whole (Jericho, 2016) The above figure represents the removal of negative gearing from the economy. As negative gearing is removed, investment in properties falls which leads to a fall in the supply of houses in the medium and long run. This is represented by a leftward shift of the supply curve from SS to SS. Other things remaining constant, there is no reason why this fall in supply will be accompanied by any reduction in demand. Thus demand for houses or rental properties remains unaltered. Thus, prices go up from P* to P to equilibrate demand and the new supply as at point E. Hence, if negative gearing is removed, rents and prices get distorted, generally in the upward direction. This exerts a negative effect on investors in general, especially on individual investors like parents purchasing houses as an investment instrument for their children. Moreover, people leasing houses would also be affected because of the sudden disruption in rents. Given certain parameters and conditions, rents and prices may not after all increase on the removal of negative gearing. (Janda, 2016) On the other hand, considering the case of largescale sale of properties by landlords and other investors, the supply of houses may actually increase shifting the supply curve outward. This would in fact lead to a fall in the price of houses and also rents. 3) The excise tax is $ 0.537 per cigarette. (as on 1st July 2016) The aggregate excise tax on 20 cigarettes is $ (0.537 x 20) = $10.74 $11 The new price of 20 packet cigarettes is $ (10 + 11) = $21 The tax would affect sellers in the following way: In the above figure, DD is the demand curve for cigarettes and SS is the supply curve of cigarettes. The equilibrium is established at E with price P* and quantity Q*. When an excise tax is imposed, the price goes up. This increased price is divided between buyers and sellers by increasing the price paid by buyers and reducing the price received by sellers. Thus, as the price received by sellers falls and the quantity supplied also falls. Therefore, the total revenue of the tobacco producers declines to a considerable extent. On imposition of a tax, the price goes up from P* to PB. However, the increased price does not reflect the entire amount of the tax. The buyers have to pay PB whereas the sellers receive only PS. The tax rate is (PB PS) = $0.537. On the welfare grounds, the consumer surplus reduces by the area A and the producer surplus falls by the area B. Though this seems to be a loss of welfare apparently, this actually results in the improvement of social welfare with resp ect to health parameters. The tax rate is proportionately divided between buyers and sellers and the proportions can be arbitrary. Here the respective elasticities play a major role. The respective proportions depend on the elasticity of demand for tobacco and the elasticity of the supply of tobacco. The agent who will pay the higher proportion of the tax has lesser elasticity relative to the other. The general assumption is that the demand elasticity of cigarettes is relatively much low compared to the supply elasticity of cigarettes which is relatively higher. Cigarette being an addiction good is generally demand inelastic. Hence, buyers would pay more tax than sellers as shown in the following diagram: In the above figure, DD is the demand curve which is relatively inelastic as compared with the supply curve SS. As can be seen from the figure, consequently the tax share of buyers given by the area A is more than that of the sellers represented by the area B. Thus, buyers bear a higher part of the total tax revenue. 4) The French company DCNS took up the contract of building the Australian submarines at a price of $50b. There are many economic reasons behind giving the contract of producing all twelve submarines to only one firm and not to various firms. Cost minimization is the main motive and this would benefit both the producer and the Australian economy. Suppose the contract was given out to 4 different firms where each would have to produce 3 submarines. In this case, the aggregate cost borne by 4 different firms to produce 3 submarines each would exceed the cost borne by DCNS for the production of the 12 submarines. Here, the law of diminishing costs operates. This implies that with increase in the units of the commodity, costs go on falling. The cost would be minimized with the maximum production. This would translate into reduced prices that the Australian government would have to pay. In case 4 firms were to produce 3 submarines each, the price charged from the Australian government mig ht have been $15b for each firm which would add up to a total cost of $60b which exceeds the $50b that its already paying to DCNS. Bulk orders are generally more appealing to any producer. Thus, if one producer is given to produce the entire order, the work can be done more efficiently, at the minimum cost and accurately. This is beneficial for the Australian government and economy as well as the producer or firm taking up the order; which in this case is DCNS. Thus, the Australian government has proper economic justification in providing the entire contract to DCNS because this not only reduces the cost but also ensures efficient production.. This can be shown as follows: When each firm has 3 submarines to produce, an average total cost of $5b per submarine is incurred. However when one firm has to produce 12 submarines, the average total cost is $3b per submarine. Hence if each firm produces 3 submarines, the total cost would $15b. However, in this case when only one firm is producing all the submarines, $36b is the aggregate cost. Hence, as the number of submarines produced by a firm increases, the total cost falls. If however, 4 firms were to produce 3 submarines each the total cost would be greater. Thus the deal of all the 12 submarines being produced by DCNS only is beneficial for the Australian economy as a whole. (Henderson, 2016) References Mankiw, N. (2006). Macroeconomics. USA: Wh Freeman. Pindyck, R., Rubinfeld, D. (2008). Microeconomics. USA: Pearson Education. Varian, H. (2009). Intermediate Microeconomics: A Modern Approach. USA: W.W. Norton Company. Hindriks, F. (2008). False Models as Explanatory Engines. Retrieved from https://www.rug.nl/staff/f.a.hindriks/false_models_as_explanatory_engines.pdf Syll, L. (2010). What is (wrong with) economic theory?. Retrieved from https://www.paecon.net/PAEReview/issue55/Syll55.pdf Koulizos, P. (2016). How negative gearing works. Retrieved from https://www.realestate.com.au/advice/how-negative-gearing-works/ Jericho, G. (2016). How negative gearing replaced the great Australian dream and distorted the economy. Retrieved from https://www.theguardian.com/business/grogonomics/2016/apr/28/how-negative-gearing-replaced-the-great-australian-dream-and-distorted-the-economy Cahill, D. (2016). What are the options with negative gearing?. Retrieved from https://www.realestate.com.au/news/qa-what-are-the-options-with-negative-gearing/ Janda, M. (2016). Relax, we have nothing to fear from negative gearing reform. Retrieved from https://www.abc.net.au/news/2016-02-15/janda-nothing-to-fear-from-negative-gearing-reform/7168716 Henderson, A. (2016). Australian submarines to be built in Adelaide after French company DCNS wins $50b contract. Retrieved from https://www.abc.net.au/news/2016-04-26/pm-announces-france-has-won-submarine-contract/7357462