GM announced that it will close its Oshawa truck plant in 2009 and a Windsor tra
ID: 2495511 • Letter: G
Question
GM announced that it will close its Oshawa truck plant in 2009 and a Windsor transmission plant in 2010. Ford also plans a 10 percent cut in white-collar, salaried positions. In total, over 4000 direct jobs will be lost. This is chilling news for Ontario because for every job in an assembly plant, there are 7.5 jobs with auto-parts suppliers and other companies. Using appropriate diagrams, answer the following questions.
1) If the unemployment rate and inflation are both rising, can this be explained by a movement along a given Phillips curve? What must be happening to aggregate demand and aggregate supply? What must be happening to the Phillips curve?
2) If the Bank of Canada continues to take expansionary monetary policy, how are the unemployment rate and inflation affected? (Use both Phillips curve and AS-AD graphs in your explanation.)
Explanation / Answer
In this problem, GM announced a 10% cut in salaried persons. In consequence, 4000 laborers will loss job directly. Also there will be indirect effect on automobile parts industry. There aout 7.5 times job will be lost. It is about 30,000 job loss. So this declaration by GM will increase uemployment. In consequence price is expected to fall.It is explained by Philips curve.
Philips curve is a diagram which explains the relation between inflation and unemployment. As production of an economy increases, more employment opportunities are created. It reduces unemployment. But with the rise in production, law of diminishing return is observed particularly in the labor sector. Due to low productivity factor cost rises. Result is a rise in price/inflatio. Also increase in the demand of labor due to increased demand, causes wage rate to rise. Result is a rise in price.
Diagrammatically it vwill happen due to upward shift in aggreagate demand of the product. As demad curve shifts right side, intersection of demand and supply curve will move upward. Thus price will rise. Due to rise in real GNP, employment will grow and uemployment will decrease. Hence philips curve is observed. It is shown below:
So by cotrolling aggreagate demand it is possible to cotrol inflation.
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However in 1970 s a reverse situation was set in. It was observed that both price and uemployment are going up. As a result price and uemployment relation becomes positve. This situation is known as stagflation. It happens due to supply side shock in the economy. In USA during 1970s OPEC countries curtailed the supply of Oil. It raised abnormally the price of crude oil. High cost of fuel increased the cost of production. So price started going up. At the same time production decreased due to high cost of production and low profit. Result is decrease in employment opportunity and increase in uemployment.
It is shown with the help of understated diagram.
The diagram shows thatr as supply curve shifts from As1 to As2, real GNP will decrease from Y1 to Y2, due to shift in equilibrium point from E1 to E2. As a result price will also rise from P1 to P2. Due to decrease in GNP employment will fall and unemployment will rise. So Philips curve will rise instead of falling downward.
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EXpansionary monetary policy will continuos increase in money supply. It will increase availability of money for investment. Thus interest rate will drop. More busiess loan will be offered. Production will rise. Adverse supply shock will be chaecked. Thus real GDP will move up. More employment opportunity will be created. Unemployment will come in check. Thus it will provide a check in stagflation situation.
In the previous diagram, due to stagflation, eqilibrium point has shifted from E1 to E2. Now due to this expansionary effect , E2 will again shift to E1. So supply shock will be removed. Iflation will come under check. Thus instead of controlling demand, economy will manipulate supply to control stagflation.
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