South-Western College Publishing - Economics  
Chinese Construction Curbed
Subject Comparative Statics
Topic Supply and Demand/Equilibrium
Key Words Deflation, Prices, Employment, Welfare Benefits, Goods, Minimum Prices, Interest Rates, Imports, Demand, Exports
News Story

The Chinese economy is experiencing deflation, that is constantly falling prices. The cause is deteriorating consumer confidence: people believe that the economy will weaken, leading to reductions in employment and lower welfare benefits including pensions.

The Chinese authorities have decided to ban the construction of new factories that would produce consumer goods, such as refrigerators and air-conditioners, as well as those that would make goods such as candy and liquor. The construction of new stores, offices, luxury hotels, and apartment buildings is also being banned. The intention is to halt the fall in prices. It is unclear whether the directive will be respected.

Previous strategies have not been very successful. Industry regulators have tried to enforce minimum prices. The financial authorities have reduced interest rates, hoping that consumers would spend more.

A further alternative might be to devalue the Chinese currency, the yuan. By increasing the price of imports, domestic and foreign demand for Chinese goods would increase. However, such a move might shake foreign confidence and Chinese exports are growing fast in any case.

(Updated October 1, 1999)

Questions
1. a)Draw a supply and demand diagram of the market for Chinese consumer goods. Show the initial equilibrium price and quantity.
  b)Show the effect of a reduction in income on the equilibrium price and quantity of consumer goods.
2. In the past, interest rates were lowered to stop the deflation.
  a)Which determinant of demand was intended to be affected? Explain.
  b)What should have happened to the equilibrium price level and why? Illustrate in a new diagram of the consumer goods market.
3. The current policy is to ban the construction of new factories that would make consumer goods.
  a)Which curve would be affected and why?
  b)How would that curve move? Illustrate in another supply and demand diagram.
  c)If the policy is successful, what will happen to the equilibrium price? Show this on your diagram.
4. A future possibility would be to devalue the currency, making imports by the Chinese more expensive.
  a)Which determinant of the demand for Chinese consumer goods would be affected? Why?
  b)How would this affect the demand for Chinese consumer goods by Chinese consumers? Show the effect graphically in another supply and demand diagram of the Chinese consumer goods market.
  d)What would happen to the equilibrium price? Illustrate your answer.
Source Seth Faison, "Fearing Deflation, Chinese Set Limits On New Factories," The New York Times, August 19, 1999.

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