What happens when wages and prices fall by 20%
In a situation where wages and prices fall by 20%, it reduces consumer demand and ultimately the aggregate demand. This means that a cut on wages will make the matters worse since the consumers will hold their moneys in anticipation of less price level. “In an argument by economist Fisher, falling prices with wages depresses the economy even further making an individual even badly off” (Sullivan, 2003). In such a period past debts are more important. More savings due to minimum spending leads to a reduction in investment. This worsens the economy and extends to reduce individual demand. For this reason, 20% reductions in wages and prices have an influence on intrinsic variables factors like investment, savings, and consumption rates.
Consumer confidence
Consumer confidence refers to readiness to buy more goods and services and is determined by the financial base of the consumer in addition to status of the economy. Confidence of the consumer varies with time. Research reveals that consumers hope for a better personal financial position as compared to the progress of an economy. To proof this point, consumers are always ready to buy attractive products (watches, mobile phones and other durables) introduced into the market. Information supplied to the consumers is vital in enhancing the purchasing power.
An increase in national debt has an adverse effect on the confidence of the consumer through factors like inflation, value of the currency and other macro economic factors. So as to offset the national debt, a government will have to increase taxes levied on consumer’s goods. The subsequent effect is an overstated cost of living consequently reducing the purchasing power of the consumer. High levels of national debt also diminish the value of national currency which in turn affects the number of goods bought. In the same vein, debt tends to condense foreign direct investment consequently slashing down on national income.
Information about unemployment rates in a country trims down consumer’s optimistic behavior. This is because of the negative multiplier effect from a reduced spending. It is also important to note the existence of an inverse relationship between savings rates and the confidence of the consumer. In this case, people will consider saving more if they are supplied with information about unemployment.
Confidence of the consumer tends to appreciate with a strengthening economy (Sullivan 2003). After the financial meltdown, economies had to inject funds into various sectors to act as a stimulus package. Companies like UPS and other corporate world subsequently reported more earnings due to an increased consumer demand. Another illustration to use is the fall in the housing sector which had the effect of decrease confidence of the consumers.
‘Hands off’ policy
‘Hands off’ policy simply means that the government has minimum influence on economic activities taking place in the nation. By keeping the interest rates too low for a long time, it has a subsequent effect of increasing money in circulation leading to more demand in the economy. This will only continue for a shot run period. It is the role of Federal Reserve Bank to supply the public with information on sub-prime mortgages and the housing finance. President George Bush aimed at reducing the taxes on low income groups in order to build on consumer demand. A taxes cut on business is an incentive to expansion thus creating more employment opportunities.
Reference
Sullivan, A., & Sheffrin, S. (2003). Economics: Principles in action. Upper Saddle River: Pearson Prentice Hall.