ECON545: Project 2—Macroeconomic Analysis

Each of the scenarios has a list of Macroeconomic areas you are to address, with sources, in your answer. Briefly you are to research and show how these apply to your scenario: GDP growth rate (20 points), the business cycle (30 points), fiscal policy and level of unemployment (50 points), monetary policy and interest rates (50 points), international trade (40 points), and demographics (20 points).

 

Answer – The new business idea of Cindy is very innovative but being an intelligent businessman Cindy should look for all the broad macroeconomic conditions in the U.S economy where he is planning to begin her contracting business for installing solar panels. Cindy has not only to look for the growth prospects of Solar energy equipment which will make use of solar energy to harness and convert it into other types of energy which can be used for daily chores work. Being a student of economics, I would like to give him few ideas and some broad perspectives which Cindy should be taken care of before investing such a huge amount at one instance. In a challenging economy and a highly competitive business sector, Cindy may consistently create new sources of financing that could be widely adopted throughout the solar industry. The San Mateo, California-based company already is known for its innovative rooftop leasing program, launched in 2008, which helped to stimulate the solar residential market by virtually eliminating the upfront costs of installation. Cindy’s new company may also offer institutional investors a new opportunity to purchase several bonds which has been secured by its customers and commercial power contracts. It would need to raise capital in order to finance the setting up of the company in California.

The New Year has brought optimism among U.S. solar companies, from manufacturers to project developers, with some of them touting solid 2013 financial performance and promise to do better in 2014. Some of the solar companies have generated good amount of revenues last year. Moreover, Federal, state and local governments offer incredible solar tax credits and rebates to encourage homeowners to switch to renewable energy to lower their energy usage and switch to solar power. The amount of the rebate subsidy varies by program, but some are generous enough to cover up to 30% of your solar power system cost. Therefore, it would be beneficial for Cindy to set up such solar installation company.

The federal government allows you to deduct 30% of your solar power system costs off your federal taxes through an investment tax credit (ITC). If you do not expect to owe taxes this year, you can roll over your credit to the following year. Such huge incentives and benefits from the side of government will satisfy the social soul of Cindy as she likes to work for the society.

These incentives dramatically lower the cost of a solar power system or energy efficiency project. These tax credits and rebates often make solar power less expensive than power from the utility company.

We will start from the overview of the U.S economy, the current GDP volume and the contribution by each sector. The inflation rate and the unemployment rate would also have great impact on the growth and the operations of the business in U.S. With crude oil prices over $120 per barrel, it is no wonder that gas prices are so high.  Oil prices affect not only gasoline, but everything that revolves around gasoline as well.  Groceries are more expensive, anything that is delivered by a semi-truck is higher than and even something as simple as ordering a pizza is costing a little more these days. Therefore, the price elasticity of other goods is higher than the price elasticity of demand for Gasoline. Hence, Cindy cannot keep much higher prices for his products. It would not be necessary that everybody who is going to visit the station would purchase the goods from Cindy’s store. (Bank, World Development Indicators, 2014)

Oil companies are having a hard time keeping up with the rapid growth of India and China.  If these trends continue, it is likely that oil prices could reach $200 per gallon or more.

Oil prices are also affecting the rest of the economy.  With people spending so much more money on gas and groceries, they are spending much less on other products.  As this continues inflations is becoming an ever growing threat. The limited budget of the people should be allocated as efficiently as possible. Under these conditions, it would be best to develop some alternative source of energy so that oil and gas price increase could come to a halt. Initially, Cindy could suffer from losses due to less demand of such panels at home and offices, however once it become popular among people due to its cost reduction in long run, Cindy would be able to earn good amount of profits.

The government has constructed an economic stimulus packet to help compensate for high gas prices and also to help stimulate the economy.  By sending out free money, they are hoping that people will run out and start spending, however, recent polls show that most people will be using the free money to pay bills or to invest. The aggregate demand in the economy will increase which will further push up the expenditures by the people on the Gasoline and its products. (Fed, 2010)

 

The demand of solar products would depend on the demand of the Gasoline by the consumers. Higher the demand of Gasoline, more will be the chance that people will switch over to solar panels in future because of its relatively low cost. The current demand for Gasoline in U.S is       , and the demand for Gasoline is inelastic too. It means that if there is rise in the price of Gasoline by say $5 per barrel, then there will not be fall in the demand for Gasoline. This is because Gasoline is an essential good and there are also no close substitutes available for Gasoline. Hence, Cindy would earn a reasonable amount of revenue if he sets up his business of a new alternative.

 

The supply of Gasoline would also play a significant role in the business status of Cindy, Since the supply of Gasoline would depend on many factors from where it has been imported and also the international tariffs and tax structure, therefore the market equilibrium quantity and price of Gasoline will be affected by foreign demand of Gasoline by countries such as India and China.  Supply and demand analysis of Gasoline can be seen in the graph below:-

 

As we are aware that the prices of Gasoline have been rising over the time as there is high consumption of fuel in the country, it has been creating a spiral in the country which will affect all businesses in the country. The prime reason behind this spiral is the setting up of low interest rates by the Federal Reserve and the most important is sub-prime mortgages. They are spending more money just to get to work every week, and the thought of using excess gas to go on vacation or a shopping spree is enough to make you shudder.

According to the latest GDP in U.S, the figure was $16.24 trillion in 2012. The population of U.S was313.9 million in 2012. The GNI per capita in U.S in 2012 was $52,340and it has been rising thereafter. Therefore, it shows that the country is coming out of the 2008 crisis leaving a positive impact on the growth of business units in U.S. (Bank, World Bank Data base, 2014)

Moreover, looking at the primary school enrollment ratio it shows 98% in 2012. Hence, U.S has very good literacy rate. Cindy can target residential areas where there is high literacy rate as those people quickly understand the advantages of such solar installation.

 

Looking at the other side of the U.S economy, we found that after the economic crisis of 2008, U.S dollar has weakens a lot. As people lost their confidence in banks and in the investment market, most of them withdrew their money from the banks which made the Fed to reduce the interest rate. As a result, less of the foreign investments were done in U.S from abroad. The demand for U.S dollars fell down making it worth less. At that time, the demand for gasoline also fell down but still people did not stop visiting the Gasoline stations but they just reduce their number of visits to the station. Hence, his business would be least affected by the external downturn in the economy as new products are completely different from the usage of existing energy resources. Also, the main reason for sub-prime mortgage current downturn of the dollar was too much lending to the people for housing loans. Banks offered loans at subprime mortgages and people having lower income levels were also able to afford the housing loan. But when they were not able to repay the loan, all the banks in U.S resulted into lack of funds.  In order to avoid the similar situation in future, now banks lend on the basis of some collateral security. Therefore, Cindy would have to face some problem while getting loan for his new business. He has to show some security in the bank so that he can get money from the banks at some lower interest rate.

(Wang, 2014). The good news for Cindy is that there has been rising business loans by banks in U.S. it rose at a one percent annual rate in June. The current data shows that the volume of commercial and industrial loans rose at a 9.6% annual rate which has been the largest increase in last two and a half years. The terms and conditions to be followed by the businesses have been eased out Lending to businesses is leading the credit upswing. The volume of commercial and industrial (C&I) loans in the second quarter rose at a 9.6 percent annual rate, the largest increase in 2½ years. We’re not there yet, but recent signs have been encouraging. Despite the sluggish economy, loan growth is finally beginning to pick up in key areas, reflecting both greater willingness to lend and increased desire to borrow. However, it does seem like the economy could be headed into recession, but it is not for certain yet. As with most issues dealing with money, it is a game of wait and see. (Reserve, 2013)

 

Bank lending to small businesses plays a crucial role in the economy because it gives employment to many people. They set up small businesses to earn their living just like Cindy. More the credit flow to the people would be, more they would be encouraged to set up their businesses. It will lead to rise in the employment level and the national income of the economy. Hence, it would be in benefit of both the parties – Cindy and banks. (Federal, state and local incentives, 2013)

The next factor which Cindy should consider is the business cycle in U.S.  Since the U.S economy is in its recover stage after the crisis, therefore the inflation rate is higher showing fall in the aggregate demand in U.S. Employment had been declining since the end of 2007 even though output was continuing to rise at least through the second quarter of 2008. In April 2009, the unemployment rate in U.S was 9% which has now fallen down to 6.3% as on April 2014. There was a slight 1/8 of 1 percent decline in real GDP from the second quarter of 2008 to the third quarter. The reason would be the rise in the labor productivity and therefore higher output level could be achieved through lower level of employment. The business plan of Cindy would be affected by it because he would not hire much people for his convenience store set up at Gasoline station. Initially, he should hire less number and to read their productivity level and after that, if need arises, he should hire more people for his store. (Cooper, 2011)

Source : World Bank,2014

 

The financially strapped U.S. Postal Service is considering cutting as many as 120,000 jobs. Facing a second year of losses totaling $8 billion or more, the agency also wants to pull its workers out of the retirement and health benefits plans covering federal workers and set up its own benefit systems. Congressional approval would be needed for either step, and both could be expected to face severe opposition from postal unions which have contracts that ban layoffs. The post office has cut 110,000 jobs over the last four years and is currently engaged in eliminating 7,500 administrative staff. But the loss of mail to the Internet and the decline in advertising caused by the recession have rocked the agency.

The inflation rate all over the world has been continually rising and therefore an alternative of fuel consumption is getting very essential to combat further increase in world inflation rate. Since U.S dollar is the most important currency along which many currencies revolve, therefore any major change in the economy of U.S would have major effects on the international trade position of the other countries. If the U.S dollar depreciates relative to other currencies, then the exports of U.S would rise. It implies that the imports of the other countries would also rise in this context. However, in case U.S dollar appreciates, the exports of U.S would decline and its imports will rise leading to current account deficit. Therefore, the monetary policy of the economy would have a great impact on the businesses in the country. At present, the Fed’s current policy is to maintain a target rate between 0.0% and 0.25% which was targeted since December 2008. It has been intended by Fed that it should keep this rate for at least one more year. The Fed never wants to disturb the business policies and tries its best to normalize the changes within next few months. It also wants to reduce the inflation from the economy by making changes in both fiscal and monetary policies. However, if it reduces the inflation rate, then there will be rise in the unemployment rate in the economy. Reduction in the prices of the products will lower the margin of the producers. Hence, Cindy should not keep higher margins as it would affect its sale initially. (cleane energy authority, n.d.)

It has been interpreted that the fall in the value of the U.S dollars with respect to other currencies is deteriorating the U.S economy. It can be interpreted in positive manner as well, that is, fall in imports will further reduce the trade deficit of the U.S economy. That is the only reason for which most of the countries keep their currencies at devalued level so that their economies stimulate. For example, China has maintained about a 400 percent undervaluation of its currency to ensure that no one in the world will be able to underprice its products. Therefore, in case Cindy would like to expand his business at international level then he must take care about the value of dollar. Looking at current scenario, Cindy should not go forward to set up another unit out of the country because he might lose the money due to depreciation of U.S dollars.

One of the biggest ways the US affects the world’s economy, though, is its buying power.  America is one of the biggest importer from the other countries. With reduction in the value of the dollars and rise in the prices of gas, Americans purchasing power has been reduced. Therefore, Cindy should not launch high priced products which might not be in demand at initial stage of the business. Domestic purchase of the goods have also reduced a lot leading to fall in the aggregate demand of the goods. Nations with less than stable economies could suffer dramatically from this downturn in spending, which would cause them to be less capable of buying American exports, furthering the downward spiral. (HRSA)

Source: Data releases of American Data Bank

The US government by making changes in its fiscal policy and in export-import policies, tries to promote the free trade and addition of new stimulus package. It includes giving money to the Americans so that they can spend freely on the goods and services rather than just investing into the stock and share market. It will add into the aggregate demand of the country. This step by the U.S government would help most of the businesses in the country. Cindy would also be able to earn good revenue if people purchase more of its product. Moreover, Cindy can introduce “launch sale” where 10% discount would be given to people who would purchase solar panels within a month.

The value of U.S dollar has also impacted by the gas prices and the value of real estate in the market. The rising bubble of housing loans before 2008 had not only burst out for the U.S economy at that time but many other countries were also deeply injured. But by implementing policy changes and gaining the confidence level of the investors, the investment level rose by almost 20-25% since 2009. Therefore, it has been suggested that people should not sacrifice their insurance policies which is indispensable during tough times. Rising level of investment will have positive impact on the Cindy’s business too.

Apart from solar panel installation, Cindy may also launch other related products which would be helpful in small daily chores like heating the bottle of baby’s milk through solar energy, etc. If used as a preventative measure, it is possible that you can survive and even thrive in a tough economy.

It must be noted that these statistics, although stated in dollar amounts, reflect the volume of consumer purchases rather than the actual expenditures on the items. There is a general concern about particular items such as gasoline. The following is a graph of the nondurable purchases shows, among other things, that purchases of energy products such as gasoline and fuel oil have been declining in recent quarters, due to higher prices, but in 2008IV and 2009I went up slightly, due to lower prices. Hence, Cindy should keep food other related items as U.S people spend more on such consumer non-durable goods as shown in the graph.

Conclusion

As an economist, I would suggest Mr. Cindy that he should set up his solar panel installation business under present conditions of the economy. It will lead to encouragement of more utilization of natural solar energy. It would also save lot of electricity and other resources. Public would need to pay less bills for their electricity. Moreover, hotels and inns would also cut their cost by making use of solar panels. However, initially he should look towards his pricing strategies in such a manner that his business get least affected by the economic cycles. He should take all the decisions keeping in mind the demand and supply conditions of his products and relate them to all the demographics and the government policies.

 

References

(n.d.). Retrieved from cleane energy authority: http://www.cleanenergyauthority.com/solar-rebates-and-incentives/

Bank, W. (2014). World Bank Data base. Retrieved from www.worldbank.org.

Bank, W. (2014). World Development Indicators. Retrieved from World Bank: http://data.worldbank.org/country/united-states

Cooper, J. C. (2011, August). Bank Lending signals a strengthening economy. Retrieved from Fiscal Times.

Fed, S. L. (2010, December). St. Louis Fed’s Bullard: The U.S. Economic Situation and Recent Monetary Policy Developments. Retrieved from http://www.stlouisfed.org/: http://www.stlouisfed.org/newsroom/displayNews.cfm?article=835

Federal, state and local incentives. (2013). Retrieved from solarcity: http://www.solarcity.com/residential/solar-energy-tax-credits-rebates

HRSA. (n.d.). U.S department of health and Services. Retrieved from npdb: http://www.npdb.hrsa.gov/resources/aboutStatData.jsp

Reserve, F. (2013). Data releases. Retrieved from Federal Reserve: http://www.federalreserve.gov/econresdata/statisticsdata.htm

Wang, U. (2014, February). Will The Solar Market Outlook Turn Rosier For 2014? Retrieved from forbes.com: http://www.forbes.com/sites/uciliawang/2014/02/19/solar-market-outlook-turns-rosier-for-2014/