Dalum Papir A/S is almost halfway through its second century as a Danish paper m
ID: 2495959 • Letter: D
Question
Dalum Papir A/S is almost halfway through its second century as a Danish paper manufacturer. Years ago, the firm was one of many paper companies, but now it constitutes one- half of Denmark's two-firm paper industry. The company utilizes highly energy-efficient techniques to manufacture glossy paper from recycles materials for magazines. Dalum Papir has had little choice but to conserve energy. Government taxation has boosted energy prices more than 45 percent above the U.S. level. In addition, like other Danish firms, Dalum Papir must meet government mandated standards for energy conservation.
Ever since the 1970s, when a worldwide spike in oil prices set off a prolonged recession, Denmark's government has sought to shield the nation's economy from future aggregate supply shocks induced by jumps in energy prices. Toward that end, it has enacted high energy taxes and tough regulatory conservation measures. A consequence is that Danish oil consumption per $1 million of real GDP has declined by more than 30 percent - to 120 tons o oil per $1 million of real GDP - over the last 30 years. Indeed, Denmark's total oil consumption has remained unchanged since the late 1970s. Thus, consistent with the government's intent, whenever oil prices suddenly shoot up, Denmark's economy tends to experience smaller aggregate supply shocks than it did in years past.
As the experience of Dalum Papir and the dwindling Danish paper industry illustrates, however, the government's quest for aggregate supply stability has come at the cost of growth in production of goods and services. Since the late 1970s, Denmark's real GDP has doubled, whereas U.S. real GDP has quadrupled. During that period, total U.S. oil consumption has increased by more than 40 percent, yet because U.S. real GDP has increased fourfold, U.S. oil consumption per $1 million of real GDP has fallen by more than 25 percent - almost as much as the percentage decline in Danish oil consumption per $1 million in real GDP. Thus, although the Danish economy is less susceptible than the U.S. economy to aggregate supply shocks, Denmark's aggregate supply is growing at about half the pace at which U.S. aggregate supply is expanding.
1. Why do unexpected variations in energy prices generate aggregate supply shocks, which sudden changes in total planned expenditures do not?
2. Other things being equal, why might we expect the Danish price level to be more stable over time than the U.S. price level?
Explanation / Answer
(1) Energy is an important and necessary input to all production processes. So, when energy price suddenly changes, cost of input rises immediately, and firms pass on this additional cost to consumers in the form of higher prices (as long as supply is more elastic than demand).
But sudden changes in planned expenditure requires time lags to affect the economy, and these changes affect aggregate demand, not aggregate supply. Demand-side shocks do not affect aggregate supply (at least in the short run).
(2) Since energy cost affects the price level as discussed in part (1), and Danish government has kept the energy expenditure within control, there is higher stability of energy price in Denmark, which dampens any possibility of a sudden and substantial change in aggregate supply. This leads to less possibility of price fluctuation, making price level relatively stable.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.