Economic Principles and Decision Making

Question: Discuss about the Economic Principles and Decision Making. Answer: Introduction The report focuses on several macroeconomic variables of a country and their effect on business. Schmeckt Gut is a company, which wants to launch a Schmeckt Besser energy bar in Atolia of California. Opening a new business or expansion of a new business depends on economic condition of a country. Several economic factors affecting the business of Schmeckt Gut are supply and demand of energy bar in Atolia, aggregate demand and supply in the economy, price level etc. Furthermore, the opening business in oversee is affected by economic environment of the country. International trade, business cycle, infrastructure of the economy affect the business performance of a company (Mankiw, 2014). Investment in the economy depends on countrys interest rate. When interest rate rises, investment in the economy is discouraged. Therefore, it hampers the progress of the economy. However, higher interest rate attracts foreign investment in domestic assets. The prices of the product increases due to increase in interest rate or labour cost, the demand for normal goods fall. As a start up company, keeping higher price of the product may not be profitable. Success of a business depends on the economic condition of the target country. Therefore, assessment of target market is important before launching the product. The report highlights the relation among different variables such as average income of people of Atolia, inflation rate, and tariff rate. Discussion of Philips curve and laffer curve are considered here. Philip curve shows relation between countrys inflation and unemployment (Evans Honkapohja, 2012). Demand for product is related to unemployment rate. As unemployment rate decreases, per capita income increases. Therefore individual demand and aggregate demand increases. Hence, if there is growing aggregate demand, then the business has a good prospect in the target market. Laffer curve shows a relation between rate of taxation in the economy and other related activities within economy. Analysis of Laffer curve can suggest possible action that Schmeckt Gut can take in new business development. Links among different variables and analysis of concepts Link between inflation rate and income of an economy There is close relation between inflation rate and growth of the economy within the given period of time. For sustainable growth, some countries prefer low interest rate (Chiarella Flaschel Semmler, 2013). According to Phillps curve, there is a trade off between the inflation and unemployment. If a country wants to keep inflation rate low, the price level needs to be low. Price of consumers good depend on the aggregate demand of the economy. When aggregate demand exceeds the aggregate supply of the economy, the consumer price index moves upward direction (Borio, 2014). Figure 1: effect of aggregate demand on price (Source: created by author) Aggregate demand in the economy can rise if there is increase in money supply in the economy. Money supply can rise if the government increases its spending in the economy. Payment of public debt also increases money supply (Burda Wyplosz, 2012). When, money supply increases in the economy in the form of income and transfer payment, peoples demand for goods increases. Marginal propensity to consume increases compared to marginal saving. At very short run total production in economy remains fixed (Malmendier Nagel, 2016). Therefore, aggregate demand for goods and services exceeds the aggregate supply. In order to manage excess demand, the supplier increases price of products. Increasing price induces suppliers to provide more goods and services. Revenue of the suppliers increases (Stock Watson, 2015). However, in the short run, marginal productivity of the factors decreases after exceeding the capacity. Due to resource constraint, supply increment is not possible. The revenue of the firms increases in the long run, when it can change all the resources according to the needs of production. If the aggregate supplies curve is vertical instead of positively sloped following Keynesian model, this affects only the price level and not the output (Case Fair Oster, 2012). Figure 2: Effect on vertical aggregate supply curve (Source: created by author) According to Gandolfo (2013), a moderate rate of inflation rate is good for an economy, as higher price encourages producers to raise production. A country expands if aggregate supply increases with increase in aggregate demand. As the production of the companies increases, factors income increases, therefore the GDP at factor prices increases. In the circular flow of income, the factors income goes to the households, which further increases per capita income. Demand for physical, financial resources and final goods increases. Backward and forward linkages among industries cause expansion of the economy. Hence, GDP of the economy rises (Iacoviello, 2014). Scarth (2014) argued that, inflation has negative externality on the economy. Inflation creates uncertainty about the profitability of the projects in future period. Hence, investors may choose conservative investment policy, which may resist growth. Moreover, rise in interest rate leads to the appreciation of the domestic currency. Appreciation of the currency makes export costlier to the foreigner. Therefore, demand for export decreases, which makes domestic export sector less competitive in the international market. As a result export sector contracts and income of people involved in export sector falls (ILO Chowdhury, 2014). Decline in net export reduces GDP of the economy. Phillips curve analysis If price level in the economy increases due to hike in aggregate demand, there is demand pull inflation in the economy. Benassy (2014) cited that, demand pull inflation is good for the economy as suppliers are encouraged to provide more goods and services in the economy. Therefore, as economy expands, different sectors of the economy expand. With the expansion of different sectors, demand for factors increases. According to modern economy, labour and capital are regarded as complementary factors rather than substitute (Coeurdacier Rey, 2013). Hence, demand for both the factor increases as the production increases. Due to increasing demand for factor, employment in the economy increases. Therefore, demand pull inflation is good for the economy as it has positive effect on employment. Ascari Sbordone (2014) argued that, inflation has negative effect on the economy if it is cost driven. If the cost of production rises, the production level in the economy falls. For example, if there is a wage hike in the economy due to bargaining effect of trade union or low supply of labour, the labour hire cost increases for the companies. This creates burden in their production process. Therefore, wage hike reduces demand for labour and firms tend to choose more capital intensive production process substituting labour intensive one (Petersen Amano Kryvtsov, 2014). Furthermore, if government of the economy imposes minimum wage law, firms are compelled to pay the minimum wage to every worker. Now, there are both skilled and unskilled employees in a company. In spite of low productivity, they have to be paid higher wages, which creates burden on employee by reducing profitability (Yoshikawa et al., 2015). Hence, the firms decide to turn over the low skilled workers due to wage h ike. If there is cost push inflation in the economy, unemployment rate in the economy raises. Phillips curve describes the negative relation between the unemployment and inflation rate. However, in the long run, the unemployment rate is fixed (Li Wu, 2015). Figure 3: Phillips curve (Source: created by author) Above diagram shows that in short run if policy can be taken to keep inflation low, unemployment rises. The reason is at low price, production level falls and thus demand for labour falls. If government wants to keep unemployment level low, this is done at the cost of higher inflation rate. However, in long run, both consumers and firms adjust with the price level and unemployment rate backs at the countrys natural unemployment level (Setterfield, 2016). Laffer curve analysis The traditional theory of Laffer curve shows that relation between the tax rate imposed by government and revenue generated from the tax. Storm Naastepad (2012) cited that imposition of tax rate has two effects such as arithmetic and economic effects. The first effect shows that as tax rates are lowered, the tax revenue of the government decreases. However, there is an economic effect of lowering tax rate. As income tax rate in the economy is lowered, rate of tax evasion in the country may be lowered. Furthermore, the activity of the employees, who has to pay low income, increases. Figure 4: Laffer curve (Source created by author) The above curve shows that both at 0% and 100% level of tax rate, government would not get any revenue, because, 0% level, no revenue is generated. At 100% level, nobody is willing to pay high tax rate. At the initial stages, tax revenue increases with the level of tax rate. After certain stage, when tax becomes burden of people and reduces utility of money, rate of tax evasion decreases (Cornish Forder, 2015). Therefore, Tax revenue falls. There is a relation between tax revenue and economic growth. Tax revenue is an important source of income of government. Therefore, higher tax revenue increases government spending in the economy, which further aggravates the growth of the economy. Government spends the revenue in social well fare and infrastructure development, which facilitates different sectors of the economy by helping production process (Del Negro Giannoni Schorfheide, 2015). Hence, economy and thus GDP grows. Impact of different economic variables on demand of Schmeckt Gut Schmeckt Gut wants to open business in Atolia. The business environment of Atolia has impact on start up business of Schmeckt Gut. If cost-push inflation prevails in the economy at the time of opening business in Atolia, this increases cost of production of Schmeckt Gut. This company requires hiring local labour to operate in Atolia. Therefore, wage cost would be hire for Schmeckt Gut, which may restricts the firm to keep price of newly launched energy bar low. Low price gives a firm competitive advantage in the market (Gal, 2015). The company has to competitive local firms in Atolia. From the figure 5, it is seen that there is positive correlation between income and inflation rate. As the market study depicts, inflation rate increases with increase in income. The calculated correlation between quarterly income and inflation is 0.15, which and very low however, positive. Low correlation suggests that there are other variables in the economy, which influence the inflation rate in the economy. During Q4 of 2014, the income has risen 4.50% from Q3 (calculation is referred to excel sheet). However, inflation rate has fallen during this period. During 2012, the government has increased the tariff rate as demand for products have grown. However, imposition of tariff has not much effect on demand for energy bar. As the income of people increases, the demand for product increases offsetting the effect of tariff. Generally imposition of tariff increases product prices. Therefore, imposition of tariff discourages the import demand. However, in the market of Atolia, the scen ario is different. Income effects dominate the rise in price. It indicates that demand for energy bar in Atolia is inelastic. Figure 5: Relation between inflation and income (Source: created by author) The data from market research shows that increases in demand has not affected the inflation much. The inflation rate in the economy has remained at 2.48% on an average during six years. However, it can be said the macroeconomic condition in the economy is stable. As the demand has increased, number of gyms has also increased. Tin order to boost economy, government has lowered the tariff rate on import from Industria. As the tariff rate increases, revenue of government increases. Therefore, spending in the economy raises, this further raises aggregate demand. Despite increase in aggregate demand, the economy experiences low inflation rate. This may happen due to supply side effect. Increase in aggregate supply may offset the effect of aggregate demand and keeps the economy stable. Regression analysis: There are several factors determine the variation of the demand of the product of Schmeckt Gut. There is a consideration of certain variables and impacts of their variation on the change in the demand. Here, the depended variable is demand and the independent variables are income, tariff, numbers of gyms and inflation rate. The rationale behind choosing the independent variables is that, increase in the number of gyms may a have impact on consuming more energy bars (Svensson, 2015). Because, in most the gym instructor recommend the energy bars. Increase in come can cause a increase in the demand for the energy bars, increasing the rate of inflation cause a rise to the price increase in the domestic market. Therefore, rise in the price of Schmeckt Gut may cause a lower demand and losing of some consumer. Tariff imposition by the government plays a crucial role in this aspect. As Schmeckt Gut is foreign country, it has to pay a tariff to the government. If, there lower rate of tariff prevail, then price of the product must be lower, but high tariff causes increase in price of the product. Again increase in price may cause to decling output production or retaining the high price may cause to losing some customer in the market. Taking into account all these factors, a model of regression is setting up. All the independent variables are in absolute form and dependent variables are in log form. Therefore, coefficients of the regression show the variation in the demand due to the independent variables. The number of gyms and the inflation rate of the domestic country do not have any significant effect on the variation of demand. However, income and tariff have significant effect on determining variation of the demand for the Schmeckt Gut. Interestingly, income of the people has a significantly positive impact on the demand for the product where as the tariff has a negative impact on the demand for the product. Therefore, as the income of the people increases, there is an increase in the demand for the product. Tariff has a negative impact on the demand. If the governments imposition tariffs increases, this is negatively associated with the demand for the product. Therefore, to increase its demand, Schmeckt Gut depends on the income profile of the country and existing and future rate of tariffs. Therefore, there are insignificant effect of the number of gyms and inflation rate whereas income and tariffs have a significant effect on the demand of the product. The high values of adjus ted r-square suggest the regression model is good-fit. This means the above independent variables explain the change in the demand for the product by more than 80%. Therefore, from the above discussion it is clear that explaining the variation of the demand income and tariff have a significant effect. To increase the demand of the product Schmeckt Gut, there should be a consistent rise in peoples income of that country and government tariff should be reduced or should go in favour of the Schmeckt Gut. Recommendations It is seen from the analysis that, there is stable business environment in Atolia. This indicates that the company has low risks in operating business in that country. However, there are others factors, which can affect the economy. There are other factors such as productivity of the resources, performance of working capital, capital investment in the economy, local competitiveness, nature of customers and suppliers. In order to establish business in overseas, the company has to develop good relation with the local stakeholders such as suppliers and customers. Apart from inflation, there are others factors, which affect the business such as fixed expenses, variable expenses, price of raw material etc. Every economy has to face different business cycle. The stages from 2011 to 2015 is the boom stage of business cycles, when aggregate demand is high, inflation rate is low, output and income is high. The economy therefore is prospective for business setup. However, the country may face different situation like recession if there is no control over supply and demand. Therefore, the company has to prepare itself for the unprecedented situation. Management of working capital is important for business. Working capital helps the business to finance any short term needs in business. Moreover, in order to compete in the local market, the company has to get economies of scale. Strategic decision in production such as product differentiation, bundling strategy, quality improvement may helpful in acquiring the market for energy bar in Atolia. Conclusion The report analyses business prospect of Schmeckt Gut in Atolia. Business performance depends on several macroeconomic factors of the target country. The report has tried to establish relation among different macroeconomic variables such as income, aggregate demand, and supply and inflation rate. Phillips curve depicts relation between cost push inflation and unemployment. However, the analysis says that demand pull inflation has positive effect on the economy. The analysis of Laffer curve shows relation between tax rate and tax revenue in an economy. There is a significant relation between tax revenue and growth of an economy. Tax revenue is an important source of income of government. Therefore, higher tax revenue increases government spending in the economy, which further induces the growth of the economy. As the data depicts, macroeconomic condition of the target country is stable and very prospective as the inflation rate is low. 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