PBL #4

1         How do governments influence their economies?

The government influence the economy through creating policies: fiscal policies and monetary policies (affect through free-market operation)

Price ceiling/Price Floor

Limiting the maximum/minimum price of a single commodity. It aim to provide equal chance of access for people (Price ceiling) or limit the consumption of a commodity (Price floor)

Fiscal policy: Government.  the use of government revenue collection (mainly taxes) and expenditure (spending) to influence the economy.

1. Effect of Fiscal policy

Through fiscal policy, regulators attempt to improve unemployment rates, control inflation, stabilize business cycles and influence interest rates in an effort to control the economy


2. How  can the government make the policy

 Expansion  Contractionary fiscal policy
Reduce tax

If the tax level reduce then income for households increase. This lead to increase aggregrated demand

   Raising tax

If the tax level rise then income for households reduce. This lead to reduce aggregrated demand.

 Raising Government spending

Lead to increase aggregrated demand

 Reduce Government spending

Lead to reduce aggregrated demand





Monetary policy: Central bank

  1. Effect of monetary policy

2.How can the central bank make the policy


“Inflation is taxation without legislation”

The Federal Fund Rate
The three instruments we mentioned above are used together to determine the demand and supply of the money balances that depository institutions, such as commercial banks, hold at Federal Reserve banks. The dollar amount placed with the Federal Reserve in turn changes the federal fund rate. This is the interest rate at which banks and other depository institutions lend their Federal Bank deposits to other depository institutions; banks will often borrow money from each other to cover their customers’ demands from one day to the next. So, the federal fund rate is essentially the interest rate that one bank charges another for borrowing money overnight. The money loaned out has been deposited into the Federal Reserve based on the country’s monetary policy.
The federal fund rate is what establishes other short-term and long-term interest rates and foreign currency exchange rates. It also influences other economic phenomena, such as inflation. To determine any adjustments that may be made to monetary policy and the federal fund rate, the FOMC meets eight times a year to review the nation’s economic situation in relation to economic goals and the global financial situation. (To learn about the relationship between inflation and bonds read Understanding Interest Rates, Inflation And The Bond Market.)

Open Market Operations
Open market operations are essentially the buying and selling of government-issued securities (such as U.S. T-bills) by the Federal Reserve. It is the primary method by which monetary policy is formulated. The short-term purpose of these operations is to obtain a preferred amount of reserves held by the central bank and/or to alter the price of money through the federal fund rate.

When the Federal Reserve decides to buy T-bills from the market, its aim is to increase liquidity in the market, or the supply of money, which decreases the cost of borrowing, or the interest rate.

On the other hand, a decision to sell T-bills to the market is a signal that the interest rate will be increased. This is because the action will take money out of the market (too much liquidity can result in inflation), therefore increasing the demand for money and its cost of borrowing. (To learn more read How The Federal Reserve Manages Money Supply.)

The Discount Rate
The discount rate is essentially the interest rate that banks and other depository institutions are charged to borrow from the Federal Reserve. Under the federal program, qualified depository institutions can receive credit under three different facilities: primary credit, secondary credit and seasonal credit. Each form of credit has its own interest rate, but the primary rate is generally referred to as the discount rate.

The primary rate is used for short-term loans, which are basically extended overnight to banking and depository facilities with a solid financial reputation. This rate is usually put above the short-term market-rate levels. The secondary credit rate is slightly higher than the primary rate and is extended to facilities that have liquidity problems or severe financial crises. Finally, seasonal credit is for institutions that need extra support on a seasonal basis, such as a farmer’s bank. Seasonal credit rates are established from an average of chosen market rates. (For more read Internal Rate of Return: An Inside Look.)

Reserve Requirements
The reserve requirement is the amount of money that a depository institution is obligated to keep in Federal Reserve vaults, in order to cover its liabilities against customer deposits. The Board of Governors decides the ratio of reserves that must be held against liabilities that fall under reserve regulations. Thus, the actual dollar amount of reserves held in the vault depends on the amount of the depository institution’s liabilities.

Liabilities that must have reserves against them include net transactions accounts, non-personal time deposits and euro-currency liabilities; however, as of Dec. 1990, the latter two have had reserve ratio requirements of zero (meaning no reserves have to be held for these types of accounts).
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Control exchange rate:
Currency war: China vs US

Reducing value of the currency of one country allows easier exportation (because this country will have lower prices)

“U.S. President Donald Trump criticized Beijing for harming American companies and consumers with a devaluation of its yuan.

Throughout his election campaign, Trump threatened to levy punitive tariffs against China in order to bring down the U.S. trade deficit, and any formal declaration of China as a currency manipulator could provide a mechanism for launching that effort.”



1.1         Why do governments subsidize certain commodities?

Moral standpoints (utilitarianism, protectionism/nationalism

To protect the poorest of the society. Subsidy to basic commodities makes prices of those commodities fall much below the prices  of free market. This allow poor people to have the chance to access on those commodities.

In case of foreign competition, governments can subsidize for commodities that produce in their own countries to compete with others.

Political standpoint

“Venezuela has long been the country with the cheapest gasoline in the world. Prior to February 18, prices for refined oil products, above all diesel and petrol, last changed in 1996. A previous attempt to raise them in 1989 under the second administration of Carlos Andres Perez is infamously credited with causing the Caracazo street protests and a subsequent violent crackdown.

Under the entire 14-year presidency of Hugo Chavez (1999 to 2013), prices remained frozen – a political decision rather than one grounded in sound economic argument. ”





2         How do the values of commodities change in the global market?

Change through freemarket, not much countries can have large influence on like a goverment.

It changes because it likes to changes, because the sellers and buyers on the market, however somehow effected by laws when import/export to other countries.

Same as freemarket, countries can join together to have collective bargaining, for example OPEC.


The legislation of international trade comes major from

The World Trade Organization (WTO) is an intergovernmental organization which regulates international trade. It aims to reduce tarriffs and other kind of protections from export/import.

Because heavily based on free market then the values of commodities are very easy to fluctuate. It can be affected through politics  actions or shortage comes from a crisis.

*The question is too ambiguous and difficult to understand*


Sources (not stated inside the paragraph): Economics (Special Edition) – N.Gregory Mankiw and Mark P.Taylor


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