Economic Profile
The paper discusses the economic of profile of the country that has the world’s largest economy, the United States of America. The key sector of the economy is ‘services sector’ which contributes more than half of its GDP. The U.S economy is also known as ‘consumer economy’ since it is driven by the consumers. “Around two-thirds of the total production of the country is driven by personal consumption. What to produce and how much to produce depends on the forces of supply and demand which drive the price levels of goods and services” (Economy Watch, 2009). The government and the Federal Reserve play an active role in regulating the economy by making crucial decisions regarding the monetary and fiscal policies; they fluctuate the level of money supply, tax rates, interest rates, and credit control to adjust the rate of economic growth.
The debt figure of the U.S economy is the largest in the world since the credit or debt system is very common over there; the funding of debt comes from central banks and sovereign wealth funds from other continents, such as Asia, Europe, and the Middle East (Economy Watch, 2009). The backbone of the economic growth is consumer spending; it can be in the form of house purchasing, car purchasing, or any other commodity purchasing. It is to note that when the consumer spending falls, the economic growth falls the same way, as in from 2008 till now, the consumer spending is not sound enough and keeps fluctuating up and down at a lower level, hence making it difficult for the economy to get out of the recession.
In this paper we will highlight the major economic elements that affect the U.S economy, such as price elasticity of demand and supply, negative externalities, wage inequalities, labor market condition, and monetary policies. Moreover, certain aspects that might affect negatively the nation and its economy would the part of our discussion.
Price Elasticity of Supply and Demand
The purpose of the price elasticity of demand is to measure the sensitivity of the quantity demand when prices are changed. When the demand of a certain item/thing does not change/vary much to changes in price of those items, we can call that the demand is inelastic; whereas, if the demand of those items change a lot, then we can call that demand is elastic. Luxury items usually have high elastic demand; for instance, if the prices of bread and butter are fluctuated, you would not stop eating it because it is your basic need. But when the prices of an airline ticket or a car decreases, you would buy it. Similarly, the change it the quantity supplied when the prices are changed is known as price elasticity of supply. But in the long-run, firms can make such changes so the quantity supplied would be more responsive.
Elasticity is better than inelasticity (Lepre, 2004) because it permits a means to stimulate the production, GDP, jobs, taxes, when the economy is suffering. Since, the U.S economy is mainly consumer driven economy and the larger chunk of the GDP comes from consumer spending, so the elastic demand would positively affect economy. It is basically a chain reaction; changed prices entice consumers, consumers spend, hence the overall spending boosts up the GDP level which positively affects the U.S economy as a whole. Not only this, taxes are paid simultaneously by the consumers which also increases the total number of taxes paid by the consumers.
According to the findings of Hughes, Knittel & Sperling, the short-run price elasticity was used as a measure of the change in driving behavior as result of a change in the price of gasoline. The response of a driver to higher gasoline prices resulted in the reduction in the amount of driving.
Wage Inequality and Labor Market Equilibrium
According to Michelacci & Pijoan-Mas (2008) individuals work longer hours when wage inequality is higher. This is consistent with the findings by Bell and Freeman (2001) which shows that, both in the US and in Germany, occupations with larger wage inequality are also occupations in which individuals work longer hours. The idea that labor market conditions play a role in explaining working time differences is novel. Prescott (2004) characterizes the relative decline in hours worked in Europe to the sharp increase in taxes experienced by several European countries. This tends to reduce the net return to hours worked and discourages working time.
The main reason that led to the rise in the (Bound & Johnson, 1995) income inequality during the 1980s was the return to observed skill (education and experience) rose while the labor force was becoming more educated and older. In the U.S, two forms of labor supply change have been occurring since 1970s. The first is the large increase in the average degree of labor market attachment of women has resulted an increase in the ratio of their average actual to potential labor market experience. The second element that affected the U.S income inequality is the increase in the number of immigrants from other countries, which also resulted in an increased supply of low-skilled labor. Another reason for the income inequality is the discrimination; women who are employed earn less than men, that may be due to the skill level of women or their choices to take specific courses and study further or not.
However, recent studies have challenged the above mentioned reasons. Card & DiNardo (2002) pointed out that rise in the U.S. income inequality during the 1980s was primarily a one-time ‘episodic’ event, did not recur. Since the services based economy operates on the selling and purchasing of goods and services, so the labor is traded in markets that reflect both supply and demand (Encarta Msn, 2009). As far as other factors of income inequality are concerned, they include a worker’s higher skills, experience, education, training. With the innovation of new technologies, newer products are being produced that are better in nature and hence newer ways of producing are developed. This would require training and possibly the need for more jobs hence new opportunities are being created. So, the increase in the wage inequality forces people to work longer hours hence resulting in more production of goods and services.
Externalities
Since the U.S economy is dependent on debts so there is a great chance for the banks to go bankrupt, and we have seen it in the past. Negative externalities might occur if a large bank fails, and it would result in the credit losses and losses due the liquidity problems, these losses are seriously affected by how quickly (Eisenbeis, 2006) an insolvent institution is closed, how quickly depositors gain access to their funds, and how long it takes borrowers to reestablish credit relationships. Consider a recent example of Merrill Lynch, it was bankrupted last year and resulted in the loss of many shareholders, debtors, and investors. Secondly, Bernard Madoff was also jailed recently who posed a negative externality to his investors and incurred a huge loss to most of them.
Monetary and Fiscal Policies
First let’s talk about the monetary policy, which is the major instrument of the macroeconomic policy of the United States. The monetary policy is regulated by the government’s and Federal Reserve’s intervention which manages the country’s money, credit, and banking system. According to the Federal Reserve Bank of San Francisco (2004), monetary policy has two basic goals; one to promote ‘maximum’ sustainable output and employment, and the second is to promote ‘stable’ prices.
One major element that is fluctuated by the central bank is the money supply and by doing so, it can have a major effect on the macroeconomic activities. By changing the money supply, the Federal Reserve can (Samuelson & Nordhaus) influence many financial and economic variables, such as interest rates, stock prices, housing prices, and foreign exchange rates; where as by restricting the money supply, it can cause the decline in GDP and lower inflation. It is because since the U.S economy depends on consumer spending, so when money supply is reduced it will lead to higher interest rates so the people would not be willing to borrow money from the banks and hence there spending and investment would decline to a great extent. As in this recessionary period, the consumer spending has gone down, but recent steps taken by the U.S Federal Reserve such as lowering the interest rates, has affected the consumer spending in a positive way.
Between 2001 and 2003, the U.S Federal Reserve cut the (Su, 2005) interest rates 13 times from 6.5% to 1%. This measure taken was done to fight the effects of the recession that started due to the threat of more terrorist attacks on US soil. Also it would take quite a while the market to reestablish itself after this recession.
As far as the fiscal policies of the U.S are concerned, they basically denoted the use of taxes and government expenditures. The government expenditures come in two distinct forms; government purchases and government transfer payments (Samuelson & Nordhaus). Government purchases (Samuelson & Nordhaus) comprise of spending on goods and services such as purchasing tanks, construction of roads, salaries for judges, and so forth; these spending determines the overall size of the public and private sectors which tells us that how much of the spending of both sectors contributed to the level of GDP.
Another part of the fiscal policy is taxation. Taxation has also a direct impact over the economy, and it is in two ways. First, when taxes are changed, they affect people’s income. So when the disposable or spendable incomes increase or decrease, they affect the amount that people spend on goods and services as well as the amount of private savings; furthermore, the private savings and consumption then also affects the amount of investments made by the people and the outputs in the short and long run. Secondly, taxes also affect the prices of goods and services and the factors of production, so in result they have a dynamic impact over the incentives and the behavior of people. In short, the fiscal policy is primarily employed in order to affect the long-term economic growth through its impact on national saving and on incentives to work, save, and spend.
Conclusion
The U.S economy is still the world’s largest economy and has a great influence over other economies in the work. The increased number of immigrants to the U.S has incurred in the great rise in the population and increased competition in the market. The foreign investments and the consumer spending are the key aspects that drive the economy. During the recessionary period, the spending fell so the central bank decreased the interest rates that resulted in a positive impact over the consumer borrowing and spending which also improves the level of GDP. Secondly, increasing tax rates also creates new jobs and has a positive effect over employment level. Not only this, increased employment would result in more outputs and would boost up the amount of goods exported. And when exports increase, it ends up with high foreign exchange. When the employment, output, and spending level is sound, there occurs a great confidence and certainty over the country and so the foreign investors get willing to invest their money in the country which results in the further improvement of the services sector of the United States.
Considering the economic influences that can affect the nation in negative way include the use of unnecessary and non-timely measures taken by the government and central bank. Poor economic decisions can hurt the economy badly and would have a severe impact over the U.S; such as, the country’s reputation might fall which result in the increased uncertainty for the investors to invest in it, increased unemployment which could affect the people and as well as the economy as a whole, the country could lose the development of the institutions and the proper functioning of the services sector, moreover, the country could lose the number of immigrants or its own residents.
References
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- Claudio Michelacci and Josep Pijoan-Mas. 2008. The Effects of Labor Market Conditions on Working Time: the US-EU Experience.
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- Federal Reserve Bank of San Francisco. 2004. U.S Monetary Policy: An Introduction.
- John Bound and George Johnson. 1995. What Are the Causes of Rising Wage Inequality in the United States?
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- Robert A. Eisenbeis 2006. Home Country versus Cross-Border Negative Externalities in Large Banking Organization Failures and How to Avoid Them. FRB of Atlanta Working Paper No. 2006-18.