Trade Infrastructure and Economic Development

Question: Discuss about the Trade Infrastructure and Economic Development. Answer: Introduction: The demand for oil is usually inelastic. Therefore, an increase in the price of oil is good news for the exporters since their revenue will increase significantly. However, the importers will have to carry the burden associated with the hiked prices. The effects arising from an increase in the global oil prices are enormous since oil is the major world traded commodity(Ajakaiye Oyejide 2012, p. 56). The prices of oil indirectly impact costs such as manufacturing, heating, and transportation. As the prices of oil increases, the costs of producing goods in an economy also rises and hence leading to a reduction in the aggregate supply(Boyes Melvin 2012, p. 85). A decline in the aggregate supply will eventually lead to a drop in the Gross Domestic Product. An increase in the oil prices will increase the costs associated with the production of goods and services in an economy. This situation will result in a reduction in the aggregate supply. On the graph one above, a decline in the aggregate supply is shown by the shift of AS curve from SRAS1 to SRAS2. A shift of the curve towards left results in a reduction in the GDP as demonstrated by the movement from Y2 to Y1. Increase in the global oil prices will result in cost-push inflation in the importing nation. The rising cost of production is known to reduce the profit margins of the companies. In an endeavor to maintain their profit margins, the firms will pass over the burden associated with increased production costs to the consumers through higher prices. This scenario will result in cost-push inflation. On the graph one above, this trend is shown by the movement of price level from P1 to P2. A hike in international oil prices overstretches the government revenue. The government has to get more money to cater for increased oil imports. The increase in the cost of undertaking business resulting from higher oil prices can also increase unemployment levels in the economy. With higher unemployment levels, the government will be required to make more stimulus payments and additional unemployment benefits. Moreover, government revenue collected from taxes will decline due to an increase in unemployment rates(Carlin Soskice 2014, p. 65). The budget deficit will widen forcing the government to resort to borrowing to accomplish its operations. As a result, public sector borrowing will increase significantly. An increase in the global oil prices increases the import expenditure depicting that a lot of money is going outside the country. In the event the countrys export gains are declining or stagnant, then enormous trade deficits can occur(Frank Bernanke 2011, p. 64). As the import expenditure increases, the balance of payment deficit will also widen. A Cut in the Personal Rate of Income Tax When a government reduces the personal income tax, the disposable income of the citizens will increase. As a result, the individuals will consume more causing an increase in the aggregate demand(Goodwin 2014, p. 87). On the graph two below, this change is shown by the shift in the AD curve from AD1 to AD2. As the aggregate demand curve shifts, the Gross Domestic Product increases, that is, movement from Y1 to Y2. A cut in the personal rate of income tax will result in demand-pull inflation. An increase in the disposable income means that the individuals have more money to spent on consumption. The demand for products will increase while the supply remains constant and hence an increase in the prices(Hubbard O'Brien 2013, p. 74). On the graph two above, this trend is shown by the movement of prices from P1 to P2. Taxes are primary sources of income for government revenue. Usually, the government taxes its citizen to get funds for running the country and provision of public services(Nils Gottfries; Palgrave Macmillan. 2013, p. 51). Therefore, a cut in personal income tax will mean that the revenue of the government declines significantly. The government will increase the borrowing to fill the gap. Reduced personal income tax leads to higher consumer spending as the disposable income will be high. The government may relax trade barriers to allow more imports to meet the rising demand. This scenario deteriorates the current account and hence an increase in the balance of payment deficit. When the government purchases public and private bonds, there will be more money in the economy. The high amount of money in circulation will increase both investments and consumption resulting in an increase in the aggregate demand. On the graph above, this effect is shown by the shift of AD curve towards the right. The GDP will grow to Y2 nearing the potential GDP. As the aggregate demand shifts towards the right, the prices of services and goods in the economy will also increase, that is, movement from P1 to P2. Therefore, the when the government buys the bonds, there will more money in circulation causing inflation. Public Sector Borrowing The intention of government buying the private and public bonds is to increase money in the economy. Therefore, we anticipate that during this period the government will not borrow and hence a decline in the public borrowing. The purchase of bonds by the government will avail more money in the economy thus increasing consumer consumption. The levels of imports in the country will increase to cater for the rising demand. Since a lot of money will be going outside the country, the trade deficit of the country will worsen. Infrastructure development is a major factor influencing the economic progress of many countries in the world. When the government increases its expenditure on the infrastructure, there will be a favorable environment for conducting businesses. For instance, improved road, air, and railway transport, as well as sufficient supply of affordable electricity lead to drop in the costs of transacting business in the country(Sikdar 2011, p. 45). Improved transport indicates that there will be a smooth movement of goods and services and hence improvement in productivity. On the graph four below, this trend is demonstrated by the shift in the aggregate supply curve rightward from SRAS1 to SRAS2. As the AS curve shifts, there will be an increase in the Gross Domestic Product, that is, movement from Y1 and Y2. Improvement in the infrastructure of the country is known to reduce the cost of doing business. For example, faster and safer movement of raw material to the industries and finished goods to the market minimizes both resources and time used by companies. Moreover, sufficient supply of electricity makes power affordable to the firms. On the graph 4, a reduction in the overall prices of commodities is shown by the movement of price level from P2 to P1. Public Sector Borrowing Constructive infrastructural development requires a significant amount of resources. Roads, electricity, rails, bridges, and airports need massive investments. The government will resort to internal and external borrowing to secure the funds for developing the infrastructure. As a result, an increase in public infrastructure spending will lead to an increase in public sector borrowing. Most prosperous countries in the world have better infrastructure in place to facilitate business operations. Good infrastructure attracts massive foreign direct investments thus boosting employment levels and economic growth and development(Sikdar 2011, p. 57). There will be an expansion in exports and a reduction in imports as most of the goods will be manufactured locally. Therefore, the balance of trade will improve. Economic event GDP Inflation Public sector borrowing Balance of trade An increase in the global oil prices Decrease Increase Increase Deteriorate A cut in the personal rate of income tax Increase Increase Increase Deteriorate An increase in the purchase of public and private bonds by the Central Bank Increase Increase Decrease Deteriorate An increase in public infrastructure spending increase Decrease Increase improve Bibliography Ajakaiye, DOI Oyejide, TA 2012, Trade infrastructure and economic development, Routledge, London ; New York. Boyes, WJ Melvin, M 2012, Macroeconomics, South Western, Mason, OH. Carlin, W Soskice, DW 2014, Macroeconomics: Institutions, Instability, and the Financial System, Oxford University Press, Oxford. Frank, RH Bernanke, BS 2011, Principles of macroeconomics, McGraw-Hill Irwin, New York, N.Y. Goodwin, NR,NJA,HJ 2014, Macroeconomics in context. , M.E. Sharpe, Armonk, New York. Hubbard, RG O'Brien, AP 2013, Macroeconomics, Pearson, Boston ; Montreal. Nils Gottfries; Palgrave Macmillan. 2013, Macroeconomics, Palgrave Macmillan, Basingstoke ; New York. Sikdar, S 2011, Principles of macroeconomics , Oxford University Press, New Delhi.