Influence of Fiscal Policy on demand and supply in Malaysia

Author: Iloka Benneth Chiemelie
Published: 1/6/2014

Introduction

Macroeconomics is contextual subject that has extended in-depth in the economic settings of the business environment, and the reason is because it deals with hoe external factors influences the performance of business operations. Such external influence are usually uncontrollable as compared with internal factors, thus it is important to understand these influence in order to ensure that they don’t disturb the potential of the business to meet set goals.

Key points

Fiscal policy and aggregate demand and aggregate supply are some of the macroeconomic concepts, which have been widely adopted in the business environment. The concept of fiscal policy implies rules and regulations, which are designed by the government that relates to the flow and management of monetary value in the economy. Besides, the aggregate demand is the total demand that customers made for any given product and the aggregate supply deals with the total supply that the company is able to make for the number of goods demanded by the customers. In order to ensure efficiency in the production process, the quantity demanded must be equal to the quality supplied and the point at which aggregate demand is equal to aggregate supply is referred to as macroeconomic equilibrium (Parkin, 2012).

Justification of topics

The reason for choosing these concepts of macroeconomics is because they will help to illustrate certain policies enacted by the Malaysian government towards the management of monetary value in the country, and understand if the country’s macroeconomic environment is in equilibrium of actual being operated under instability.

Economic analysis

In the article, it was noted that the Malaysian government is still committed towards the reduction of its fiscal deficit from the previous figure of 4.5% to 4% (thestaronline.com, 2012), and such an act will serve to further strengthen the sovereign rating of its country and also boost the appreciation of ringgit as well as local equity market. It was also noted in the noted that Kenanga Research discovered that there was not widespread impact of the reduction in fiscal deficit on the entire equity market as there was not announcement on corporate tax cuts (thestaronline.com, 2012). Basically equity involves assets which are sold to the market and investors make such investment with the hope of returns. Although it might be argued that the increase in ringgit value will effectively increase equity returns, it needs to be noted that while there will be increase in the value of returns, there will be no subsequent decrease in the tax on generated revenue and the end point becomes that the expected increase in equity value might not be possible as the investors still need to make certain percentage of their earnings available as taxes.

However, such an increase in value of ringgit is good for maintaining the standard of living, as it will increase the level of disposable income. The Kenanga Research also noted this by arguing that increase the value of ringgit doesn’t increase the price of the fast moving consumer goods (FMCGs) and as such customers will be able to purchase more with the same ringgit value and in that case their standard of living is increase as they are better positioned to purchase as much commodities as they required to ensure high living standards.

Basically, if the fiscal policy is implemented by the government, aggregate demand and supply will be influenced either positively or negatively depending on the financial situation of the Malaysia during the period when such implementation is made. For instance, the Appendix 1 shows what could possibly happen with such implementation.

From the figure, it can be seen that a subsequent appreciation of ringgit (rise in domestic price in terms of currency relative to foreign goods and services or the price level in Malaysia falls) will means an increase in the demands for imported commodities as customers will be able to make more purchases with the same value. Moreover, there is a fall in Malaysia’s export because the exportation cost will be increased and exporters might start looking for other alternatives in order to maintain their business process and Malaysia will effectively be phased out in the competitive settings. All of these results in reductionin Malaysian net exports, thus lowering aggregate demand from AD₁ to AD₂(causing recession)since the domestic goods become more expensive to foreigners and the real GDP decreases to Y₂. However, this is not the case for supply as manufacturers will not be able to produce more with the same value especially in cases where their sales are based on the international market. This is because the customers outside the Malaysian market will experience increase in the price of commodity without a subsequent increase in the value of the product. Basically, this will influence the economic development of Malaysia negatively as international trade will be significantly reduced especially in cases where Malaysian brands experience high competition with brands of other nations that have lower price per value such as India and China.

A nation runs trade deficit when a nation (Malaysia) reduces its exports to other countries and increased imports from these countries (Vengedasalam, 2011).Reduction in fiscal deficit will make ringgit stronger against foreign currency leads to rise in foreign trade deficit. The notion now is that fiscal policy is directly relate to aggregate supply and demand because it involves a change in the valuation of capital of production and subsequently in the demand and supply ratio. Basically, this have high positive influence on the local market because consumers will be able to make more purchases with the same monetary value and as such standard of living as well as trade will be influenced positively in the country, but the overall economic development of such country – in this case in which the focus is on Malaysia – will be dealt a high blow because they will be a negative influence on exportation as external markets will not enjoy having to pay the same amount for a lesser value or a higher amount for the same value they use to obtain in the past. The end point is that export will decrease especially is Malaysia has other national competitors that offer higher value, and this will definitely influence the economic development of the country.

Conclusion and recommendation

Still on the contents of the newspaper, MIDF (Malaysian Industrial Development Finance Berhad)search noted that the decision to reduce the deficit in 2013 will primary depend on the performance of the global economy in the sense that if the global economy is still filled with uncertainties, then exportation of Malaysian goods will still be on the downside and such a decrease will be further troubles for the country as a result of subsequent increase in ringgit value. Basically, the fiscal policy adopted by the country depends primary on the global economic conditions.

In order to establish macroeconomic equilibrium in the Malaysian market, where the aggregate demand for made-in-Malaysia products is equal to the aggregate supply, it is recommended that the government should focus on the economic growth of the country instead of the deficit reduction and adopt necessary economic strategies such as low unemployment, providing unemployment benefits and development of public capital investment and public consumption in order to create the right environment for such growth.

Appendix 1

Influence of Ringgit appreciation on local demand

AS = Aggregate supply

AD = aggregate demand

RA = Ringgit Appreciation

The implication from the above analysis is that if the value of ringgit appreciates, the aggregate demand will increase as customers can now purchase more and also the aggregate supply will increase as manufacturers can now produce more. Basically, there is an expected equilibrium or excess supply as producers struggle to meet the changes in demand.

Appendix 2

Influence of Ringgit appreciation on international demand

AS = Aggregate supply

AD = aggregate demand

RA = Ringgit Appreciation

The implication from the above analysis is that if the value of ringgit appreciates, the aggregate demand will decrease as international customers who depend on the exchange rate will not be able to obtain the same product value as they use to in the past with the same current value and also the aggregate supply will increase as manufacturers can now produce more. Basically, there is an expected equilibrium or excess supply as producers struggle to meet the changes in demand.