Ques. 1 Read the following comprehension and answer the given questions . (2 x 2
ID: 1204989 • Letter: Q
Question
Ques. 1 Read the following comprehension and answer the given questions . (2 x 2= 4 marks)
People often ask economists for predictions about the future of the macroeconomy. Forecasts about the economy’s future, even from experts, are not unlike a baseball writer’s prediction of who will play in the next World Series. The prediction can seem well-reasoned and logical, but it is hardly foolproof. Certain statistical series tend to move in similar ways through all business cycles. Knowledge of these series and their tendencies can provide some insight into future business cycle movements. The Conference Board, a not-for-profit organization, publishes monthly updates of what is called the “index of leading economic indicators.” The index is a weighted average of 10 statistical series that usually lead, or begin turning upward and downward, before the overall economy does. Because not all the components of the index turn before the business cycle hits a peak or a trough, movements in the index are more reliable than the movement in any one of its components. Among the most reliable of the leading indicators is an index of prices for 500 common stocks. Investors want to buy stock shares when their prices are relatively low and sell shares when prices are relatively high. During a recession, stock prices fall due to sluggish sales and profits. Interest rates are relatively low during the last months of recessions because of reduced demand for investment. In choosing between buying bonds and stocks, investors will favor stocks when: (a) stock prices have fallen to a point where there is a strong possibility of future capital gains, and (b) the opportunity cost of buying stocks—the interest rate on bonds—is low. Therefore, prices of common stocks will usually begin to rise during the late stages of a business cycle, before a business expansion begins. As the economy moves near full employment during an expansion, the situation is reversed. Strong demand for consumer goods and investment will drive prices and interest rates upward. At some point, investors sell stocks to realize capital gains and buy bonds, rather than stocks, to take advantage of high interest rates. The downward movement in stock prices will usually begin before a recession begins.
a. Scientists make accurate predictions of the movement of asteroids and comets. Why can’t economists make accurate predictions of business cycle movements?
b. Assume that the U.S. economy is in a recession. Mild weather results in lower demand for energy and a reduction in the price of oil. Investors interpret this as positive news for firms because their costs of production will be lowered. An increase in stock prices results. Will an economic expansion follow?
Explanation / Answer
a. Scientists make accurate predictions of the movements of asteroids and comets. But economists do not make accurate predictions of business cycle movements. This is because, upto certain extent, business cycle movements are depended on human sentiments which are very hard to predict and calculate. Sometimes, certain statistical series tend to move in similar ways through all business cycles. And, knowledge of these series and their tendencies can provide some insight into future business cycle movements, but not the ultimate one. Many reasons contrbute in making faulty economic forecasts, viz. structural change, inherent randomness of the economy, modelling errors and bad data which make it difficult to predict economic situations correctly.
b. Assuming that the U.S. economy is in a recession and mild weather results in lower demand for energy and a reduction in the price of oil. In this situation, investors interpret this as positive news for firms because their costs of production will be lowered. Also, the stock market is one of the most vital components of a free-market economy, as it provides companies with access to capital in exchange for giving investors certain ownership in the company. The stock market makes it possible to grow small initial sums of money into large ones, and to become wealthy without taking the risk of starting a business. When an increase in stock prices results, economic expansion should follow. This would expand the money supply to encourage economic growth and increasing money supply in the economy.