Question 2

A free market is an effective way to distribute goods and services, whereas a

monopoly is inefficient, according to general equilibrium economics. A market failure
exists when products and services are distributed inefficiently.

In a free market, businesses and consumers engage in unrestricted, open

competition to set prices for goods and services. Consumers vote with their dollars,
forcing producers to adjust to their needs and aspirations. Producers expand or
decrease output and alter their products in response to consumer demand.

In a monopoly, one supplier has complete control over the flow of an item or service.
This removes power from consumers and gives the supplier excessive control over
the good or service. If the product is a required good (such as gas, water, food,
shelter, or an internet connection), then demand for it can hold steady regardless of
how much (or how little) the price fluctuates. As a result, the provider has the ability
to intentionally limit the product's supply, resulting in scarcity and higher consumer
costs.

In the actual world, there is worry that a monopoly will use its power to raise prices
on consumers above what they would have to pay in an equilibrium market.

Underprovision or scarcity fall short in theoretical economics when compared to the

idea of perfect competition, which can be characterized as a balance of power
between buyer and supplier. Prices remain "normal" due to competitive pressure and
consumer demand for the good or service. The demand curve is elastic, changing
according on the price.

Neoclassical theory from the 20th century called general equilibrium economics
describes a particular, if admittedly utopian, idea of perfectly competitive
marketplaces.

It is of paramount importance to note that it is argued that the ideal competition

model is unrealistic and impossible.

This idea states that when power is concentrated in too few hands, market failure
occurs. A single supplier of a good or service is considered a monopoly. A
monopsony is one customer who purchases a good or service. A cartelized oligopoly
is made up of a few sizable suppliers who have agreed not to directly compete. A
natural monopoly is a cost structure that is out of the ordinary and results in effective
control by a single business.

In the actual world, the idea of monopoly broadly encompasses all of these
possibilities. It is feared that a monopoly will use its power to compel consumers to
pay prices that are higher than they would in an equilibrium market.
Due to the wildly unrealistic assumptions incorporated into perfect competition
models, many economists question the theoretical viability of general equilibrium
economics. Some of these objections also apply to dynamic stochastic general
equilibrium, which is its contemporary replacement.

The only monopolies that result in market failure, according to Milton Friedman,
Joseph Schumpeter, Mark Hendrickson, and other economists, are those that are
government-protected.

On the other hand, a political or legal monopoly is able to set monopoly rates
because the government has put up obstacles to rivalry. The mercantilist economic
system of the 16th and 17th centuries was built on this type of monopoly.

There are various examples of these monopolies in contemporary markets like

energy and education.

Monopolies do not produce enough to distribute all products and services among
consumers in an economy in a way that is allocationally efficient. This is the point
where marginal benefit and cost meet optimal output.

A monopoly can produce less and set its own prices. In a market with perfect
competition, more products are produced to satisfy more customers, which
stimulates economic growth.

A monopoly has the power to set prices, create items of poor quality, and raise
inflation.

Monopolies hinder efficiency, innovation, and healthy competition, which contributes

to market failure. All market participants control prices in an efficient market because
supply and demand are more prone to equilibrium. Instead of enhancing the health
of the market it is a part of, a monopoly can artificially increase or decrease prices to
fit its purposes by controlling the supply of an item or service.
Question 3

3.1

Purchasing goods and services costs more when inflation is rising. However, the
impact of inflation goes beyond how it affects consumers' wallets. The main trend
has a variety of effects on the economy.

The consumer price index (CPI) measures inflation, and when it is low, it supports a
strong economy. However, when the rate of inflation increases quickly, it can have a
negative impact on the economy through lowering buying power, raising interest
rates, slowing economic growth, and other factors.

Inflation is described as a "general upward price movement of goods and services in

an economy" by the U.S. Department of Labor. In other words, when the price of
goods and services grows, so does the expense of living.

Inflation is typically viewed as detrimental to an economy. Everyone's wallets feel a

little bit squeezed when the price of products and services increases. You may have
personally experienced the effects of inflation as the cost of your typical food
shopping basket increases.

However, the truth is that growing prices don't always translate into increased
wages, which means that many people across the country are forced to deal with
difficult times when inflation is on the rise, typically, people with fixed or low incomes.

Consumers are forced to take note of the changes when inflation is on the rise. Many
increase their spending and investing when prices start to rise, while some people
start to tighten their budget. Many people are aware that their money will be worth
less tomorrow than it is today.

Prices may rise even further due to the spending pattern. Additionally, markets can
take a while to adjust to shifting customer preferences. For instance, despite a
slowdown in sales, the property market continues to see high housing prices.

Everyone may suffer if inflation rises too much, as the Reserve Bank seeks to control
it by tightening monetary policy and raising interest rates.

3.2

To maintain a healthy economy, central banks manage the money supply using
instruments like interest rates.

The term "monetary policy" has been used multiple times. But regardless of how it
may appear, it usually comes down to changing the amount of money available in
the economy in order to stabilize output and control inflation.
Most economists concur that because output, as typically measured by GDP, is
stable over the long run, changes in the money supply only affect pricing. Changes
in the money supply can, however, have an immediate impact on the production of
goods and services in the near term because prices and wages typically do not
respond rapidly. Because of this, monetary policy, which is often administered by
central banks, is a useful instrument for accomplishing both inflation and growth
goals.

Consumer spending diminishes, corporate production falls, forcing companies to cut

staff and halt investing in new capacity, and overseas demand for the nation's
exports may also decline during a recession. In other words, there is a fall in
aggregate, or overall, demand, and the government can react by implementing a
policy that tilts away from the way the economy is going. The preferred
countercyclical strategy is frequently monetary policy.

Such a countercyclical strategy would result in the intended expansion of output (and
employment), but would also raise prices because it would expand the money
supply. Increased demand will put pressure on input costs, particularly labor, as an
economy draws closer to operating at maximum capacity. Workers then spend their
extra money on more products and services, which drives up prices and wages and
accelerates overall inflation, an outcome that governments often try to prevent.

Therefore, the monetary policy maker must strike a compromise between price and
output goals. In fact, even central banks that merely aim to reduce inflation would
typically acknowledge that they also focus on stabilizing output and maintaining an
economy that is close to reaching full employment.

There are other methods than monetary policy for controlling overall demand for
goods and services. Governments have employed fiscal policy—taxation and
spending—a lot recently during the global crisis. However, legislation for tax and
spending changes often takes time, and once such changes have been passed into
law, it is politically challenging to undo them. It is simple to understand why monetary
policy is typically viewed as the first line of defense in stabilizing the economy during
a downturn. Add to that worries that consumers may not respond in the expected
way to fiscal stimulus (for example, they may save rather than spend a tax cut).
(Countries with a fixed exchange rate are the exception; in these nations, monetary
policy is inextricably linked to the exchange rate aim.)

Most economists believe that monetary policy is best managed by a central bank (or
some other similar organization) that is independent of the elected government,
despite the fact that it is one of the government's most significant economic
weapons. This assumption is based on academic study that was conducted about 30
years ago and focused on the issue of temporal inconsistency. Less independent
monetary officials might find it advantageous to make low inflation promises in order
to lower consumer and business inflation expectations. They might eventually find it
difficult to avoid increasing the money supply in response to following events,
causing a "inflation surprise." Due to the relatively low cost of labor (wage changes
are gradual), this surprise would initially increase output. It would also lower the real,
or inflation-adjusted, value of government debt. However, as individuals quickly
became aware of this "inflation bias" and increased their anticipation of price
increases, it became more challenging for policymakers to ever attain low inflation.

Some economists recommended that policymakers adopt a rule that eliminates all
choice in changing monetary policy in order to solve the issue of time inconsistency.
In actuality, however, adhering credibly to a (potentially complex) guideline proved
challenging. An alternative strategy would be to hand over control of monetary policy
to an independent central bank that was insulated from much of the political process,
as was already the case in a number of economies. This would still keep the process
free of politics and increase the public's faith in the government's commitment to low
inflation. The research suggests that lower and more stable inflation are actually
linked to central bank independence.

The aggregate demand, and hence output and prices, are significantly impacted by
changes in monetary policy. The actual economy is affected by policy decisions in a
variety of ways (Ireland, 2008).

The interest rate channel is the one that most people typically pay attention to. For
instance, if the central bank tightens, borrowing costs increase, individuals are less
inclined to finance purchases of goods like homes or vehicles, and companies are
less willing to invest in new machinery, software, or structures. Lower inflation would
be consistent with this decreased level of economic activity because cheaper
demand typically translates into lower prices.

However the narrative is not over yet. A rise in interest rates also tends to lower
people's and businesses' net worth, or the so-called "balance sheet channel,"
making it more difficult for them to qualify for loans at any interest rate and lowering
demand for goods and services. A rate increase decreases overall bank profitability
as well as banks' willingness to lend, which affects the bank lending channel. High
rates typically cause the currency to appreciate because foreign investors desire the
currency more due to their increased demand for higher returns. Exports decline as
they become more expensive and imports grow as they become less expensive
through the exchange rate channel. GDP subsequently declines.

Through expectations, the self-fulfilling element of inflation, monetary policy has a

significant additional impact on inflation. Many pay and price agreements are made
in advance on the basis of inflation forecasts. Interest rate increases that are
followed by announcements of future increases may persuade the public that
policymakers are committed to limiting inflation. Therefore, more gradual salary and
price rises will be included into long-term contracts, which will keep actual inflation
rates low.
After the start of the global financial crisis in 2008, central banks all throughout the
world abruptly reduced policy rates—in some cases to zero—using up all available
room for reductions. However, they have come up with creative ways to keep
relaxing policy.

Purchasing a lot of financial products off the market has been one strategy. The
balance sheet of the central bank grows as a result of this "quantitative easing,"
which also adds fresh money to the economy. The money supply increases as banks
acquire more reserves (the deposits they keep at the central bank).

Credit easing, a closely similar alternative, may also increase the size of the central
bank's balance sheet, but the emphasis is more on the balance sheet's composition,
or the sorts of assets bought. The interest rate channel did not function as a result of
the recent crises' various specific credit markets becoming clogged. In response,
central banks specifically targeted certain troubled markets.

Credit easing, according to some, links monetary policy too closely to industrial
policy because the central bank ensures the flow of funds to specific segments of the
market. But the debate over quantitative easing is still ongoing. It entails investing in
a more "neutral" asset, such public debt, but it steers the central bank toward funding
the budget deficit, thereby jeopardizing its independence.