Rishad Kabar Economics HL Commentary 1 (draft)

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HL ECONOMICS COMMENTARY NUMBER:
TITLE OF EXTRACT:
SOURCE OF EXTRACT: INVESTOR'S BUSINESS DAILY
DATE OF EXTRACT: March 30, 2010
WORD COUNT: 749 words
DATE COMMENTARY WAS WRITTEN: March 30, 2010
SECTION(S) OF SYLLABUS WHICH COMMENTARY RELATES: 3
CANDIDATE NAME: Rishad Kabar
CANDIDATE NUMBER:







2
Home Prices, Consumer Mood Improve

Rishad Kabar Economics HL Commentary 1 (draft)
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The article written by Scott Stoddard reports how the American economy is showing
increasing signs of an upturn after the recent recession as the Prices of homes appeared to
stabilize after they posted their smallest decline in three years, and consumer confidence, as
per the consumer confidence index, or measure of how people feel about the future of the
economy and their own current financial situation, obtained through polling
1
, rose to higher
than anticipated levels in March.
Both these factors, i.e. property prices and consumer confidence, are determinants of
(aspects that could lead to a change in) consumption (C), which is defined as the total
spending by consumers on domestic goods and services
2
, which together with Investment
and Net Exports happen to be the components of Aggregate Demand, or the total
spending on goods and services in a period of time at a given price level
3

As the article writes, home prices were placed at -0.7% in January, a 0.3% increase from
December, as illustrated below.







This increase in house pricing is largely due to the government stimulus or offering of
incentives to homebuyers by giving tax credits (lower tax rates). The decrease in tax rates
would leave the consumers with more disposable income, or:
Income that remains available for spending after deductions for taxes
4

1
(Microsoft Encarta Encyclopedia, 2009), consumer confidence index
2
(Blink.J. & Dorton.I., 2008), consumption
3
(Blink.J. & Dorton.I., 2008), Aggregate Demand
4
(Microsoft Encarta Encyclopedia, 2009), Disposable Income

Scott Stoddard, 30
th
March 2010, Home Prices, Consumer Mood Improve, INVESTOR'S BUSINESS DAILY
Diagram 1 - Graph of Case-Shiller 20-city home price index
Rishad Kabar Economics HL Commentary 1 (draft)
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Demand for these homes would rise as more people would be able to afford them than
before.

In terms of Aggregate demand, the increase in prices of homes will result in property owners
feeling more wealthy as the value of their property increases.
This increase in wealth could likely result in increased borrowing and spending by the
consumers, thus increasing consumption in the economy and resulting in a shift of the
aggregate demand curve, as illustrated in diagram 1 below.











The diagram above illustrates how an increase in consumption, a component of aggregate
demand, will result in a shift in the aggregate demand curve (AD) to the right (AD
1
), a new
level of output demanded (Y to Y
1
), and an increase in general price levels from (P to P
1
)

Another determinant is the general increase in consumer confidence.
When people are confident of their economic future, they are likely to increase their
consumption.

Increase in consumption and consumer confidence are indicators that the USA is heading
towards economic recovery, or

Return of an economy to normal levels of production and employment after recession
5


5
"Recovery (economics)." Microsoft Encarta 2009 [DVD]. Redmond, WA: Microsoft Corporation, 2008
SRAS
Diagram 2: Increase in aggregate Demand due to increase in consumption in the economy
AD AD
1

0
Average Price level ($)
Real Output (Y)
Y
Y
1

P
1

Rishad Kabar Economics HL Commentary 1 (draft)
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Here, business firms will exhibit optimism about the economic outlook by investing in facilities,
hiring more laborers and producing more goods and services. More so, consumers will reflect
this optimism by increasing their purchases, typically by resorting to additional borrowing to
finance these acquisitions.
Currently, the consumer confidence index level is still below the pre-recession level;
however, the Government could further boost consumer confidence by:
Firstly, adopting an Expansionary Monetary Policy, or a monetary policy that
seeks to increase the money supply
6
.
This would be done mainly by decreasing of interest rates, as it would discourage saving as
there would be less returns, and encourage borrowing to spend from consumers and
investment from firms.

This coupled with an expansionary monetary policy, i.e. lowering tax rates would also
provide incentives for consumers to spend more as their real/disposable incomes will
increase.
The disadvantage of adopting these policies is that firstly it takes a while for the effects of
the fiscal policy to be felt, and that the government will earn a considerably lesser amount of
fiscal revenue by lowering tax rates, meaning that it has a smaller budget to spend on
important public services such as educational and infrastructure development that will
increase the economys potential output.

However the government can operate on a budget deficit by borrowing money from the
private industry thus enabling it to sustain its expenses in these services, which will
increase demand for output from businesses related to these services, aiding economic
growth.

In the short run, consumers will see an increase in their disposable income whereas
governments will see an increase in consumption & investment.
In the long run, the economy will benefit from an increase in aggregate demand and
potential output.





6
(Wikipedia,2010), Expansionary monetary policy
Rishad Kabar Economics HL Commentary 1 (draft)
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References
"Consumer Confidence." Microsoft Encarta 2009 [DVD]. Redmond, WA: Microsoft
Corporation, 2008.
Disposable income: Microsoft Encarta 2009. 1993-2008 Microsoft Corporation.
All rights reserved.
Expansionary Monetary Policy:
http://en.wikipedia.org/wiki/Expansionary_monetary_policy
Aggregate Demand: Blink, J. & Dorton, I. (2007). Aggregate Demand
Economics Course Companion. Great Clarendon Street, Oxford OX2 6DP: Oxford
University Press 2007

Consumption : Blink, J. & Dorton, I. (2007). Aggregate Demand Economics
Course Companion. Great Clarendon Street, Oxford OX2 6DP: Oxford University Press
2007