Reserve Bank of Australia GPD - Measuring Total Production, Income and Economic Growth - Case Study Example

Economics Report base on Macroeconomics Name Institutional Affiliation Date Table of Contents Introduction 3 GPD: measuring total production, income and economic growth 3 Aggregate demand and aggregate supply analysis 5 Unemployment and inflation 7 Monetary policy 9 Macroeconomics in an open economy 11 Conclusion 12 References 13 Introduction According to the article “Inflation hits top of Reserve Bank target at 3pc”, inflation which currently stands at 3% has hit the Reserve Bank of Australia (RBA) top target range. The underlying measures also rose close to RBA’s top band (Michael, 2014). The article further shows that the survey conducted by the bureau of statistics indicates that the price index was estimated at 0.6% by end of March Quarter and 0.5% during the June Quarter. The Australian dollar rose from 0.4 for every cent to 94.3 for every US cent which was slightly above the economic expectations. As discussed in this report, several factors explain the strong and stable inflation rate of the Australian dollar. One of such factors includes the non-declining demand for the mineral resource endowment of Australia especially among the Asian countries. This report seeks to address this and many more economic factors that surround the Australian economy. GPD: measuring total production, income and economic growth Among the most crucial macroeconomic aspects is the measurement of production. Gross Domestic Product (GDP) is the tool used to measure total production. It is the market value of the commodities produced within a given time period in an economy. Measuring total production of an economy translates directly to measuring the total income of the same economy. There are four major categories of GDP in terms of expenditure. These include investment, net exports, and consumption and government purchases. Total income and production can be measured using tools like Gross National Income (GNI) and Net Domestic Product (NDP). A major challenge of GDP as an economic tool is that it does not incorporate household production, thus cannot establish the true wellbeing of the people (Mankiw & Taylor, 2014). GDP usually entail two types; nominal and real GDP (Chatterjee, 2014). In nominal GDP, the market values of commodities are measured at current year prices. Similarly in real GDP, the volume of commodities is measured at constant prices. The latter can be used to measure long-run economic growth whereby standards of living of a typical citizen increase with increase in productivity. Increases in labour productivity of an economy leads to corresponding rise in real GDP per capita. Labour productivity is influenced by two major factors. These include volume of capital per hour worked and level of technology. Positive changes in the two factors translate to increase in economic growth. Figure 1 Australian Quarterly GDP Figure 1 shows Australian quarterly GDP fluctuations between the year2006 to 2008. Aggregate demand and aggregate supply analysis The trend of an economic growth is marked by alternating changes in business cycle. During economic expansion, income, production and employment increase beyond the growth trend experienced in the economy. This is followed by contraction business cycle phase, where the four economic parameters fall below the growth trend. In a scenario where the economic growth rate is negative, a recession may follow the contraction phase. During contraction, inflation rate falls while during expansion cycle, it rises. Similarly, unemployment rate rises with rise in expansion and declines with the fall in expansion. Fluctuations in price level and real GDP can be best explained by aggregate demand (AD) and short- run aggregate supply (SRAS) models (Hubbard, 2009). AD demonstrates the relationship between quantity of demanded real GDP by respective households and price level. SRAS illustrates how supplied real GDP and price level relates in the short run. The relationship between supplied real GDP and price levels in the long run is illustrated by long-run aggregate supply curve (LRAS). The difference between LRAS and SRAS curves is that the former is a vertical line (real GDP is not normally affected by changes in price level), while the latter slopes upward (firms and workers cannot accurately predict future price level). AD components are investment (I), net exports (NX) government purchases (G) and consumption (C). When the price level declines, AD curve slopes downwards since the components increase. A stationary curve is achieved when the economy moves up at constant price level. Shifts in AD curve are determined by variable such as changes in household expectations, government policy changes and foreign variable changes. Figure 2 Inflationary effects of increase in AD Figure 2 shows inflationary effects of AD and AS against real GDP. Figure 3 LRAS and SRAS Figure 3 shows the variation of short-run aggregate and long-run aggregate supply with aggregate demand. Unemployment and inflation According to Chick (2002), one of the major macroeconomic problems is unemployment. Monthly labour force of a household is applied by the Australian Bureau of Statistics (ABS) to compute labour force and unemployment rate of participation in the economy. Labour force is determined by computing the sum of the number of job owners and jobless citizens who are seeking jobs. Participation rate of labour force is determined by considering both the population aged 15 years and the working age population. There are significant social and economic costs brought about by unemployment and this implies a scenario of real GDP being lower than the potential level. The result of such a situation is retraining costs and human capital loss. In addition, payments of government benefit are increased while receipts of government tax revenue reduce. The personal costs of the jobless Australians comprise of poverty, wage loss, health loss, family and related social problems and loss of self esteem. Jobless citizens may bear retraining costs in a bid to conserve their skills away from work or in acquiring new suitable work skills needed in the economy. Unemployment comes in three types and these include structural, frictional and cyclical. Contraction of business cycle leads to cyclical form of unemployment. When workers are matched with their jobs on short-term basis, the result is frictional unemployment. Tourism fluctuation, weather or related events can lead to a subset of employment known as seasonal unemployment. In the case of structural employment, there is an insistent mismatch between job requirements and job attributes or skills. When the economy operates at potential real GDP, natural rate of unemployment arises. If unemployment level falls to a point where inflation rate rises, non-accelerating inflation unemployment rate arises. Structural and frictional types of unemployment can be reduced by government policies through labour retraining and job search. When there is persistent in the increase in general price levels in an economy, inflation arises. Figure 4 Australian unemployment and inflation Figure 4 shows Australian employment and inflation per capita from 2004-2012. Monetary policy There are various actions that can be taken by the central bank to realize an economy’s monetary objectives. In Australia, monetary policy entails the measures employed by RBA (Reserve Bank of Australia) to control interest rates in order to achieve macroeconomic goals. RBA controls cash availability which influences interest rates, which subsequently influences price level and real GDP. A common rate of inflation tool used to achieve monetary policy in an economy is inflation targeting. This state is achieved by sustaining stable and low inflation rates in order to achieve a sustainable long-run economic growth. Both the federal government and RBA have a consensus of achieving and maintaining on average a 2-3% inflation rate per annum within the business cycle. RBA conducts expansionary policy by reducing interest rates charges by financial institutions and RBA in order to cope with economic recession and contraction. This move results to stimulation of real GDP. Similarly, RBA undertakes contractionary policy to reduce the inflation rates which lead to increased interest and cash rates. This move results to reduced price and real GDP rates of growth. The consequences of monetary policy on price level and real GDP can be illustrated by aggregate supply and demand model dynamics. There are two major issues facing monetary policy, for instance, fairness and effectiveness (Chatterjee, 2014). It is significantly effective when used to lower economic growth rate than when used to increase it. In recent economic years in Australia , full amount of cash rate changes to other interest rates has not been passed by banks and related financial institutions. Figure 5 monetary policy Figure 5 shows change in monetary policy from January 1969 to January 2004. Macroeconomics in an open economy Balance of payment (BOP) shows a record of borrowing, trade, capital, investment flow and lending of a country (Chatterjee, 2014). It comprises of financial, capital and current accounts. The current account of a country reflects its net secondary and primary income and exports. The capital account on the other hand maintains a record of relatively micro transactions consisting of major assets citizens carry along with them when entering or leaving a country. It also consists of purchases and sales of non-produced assets, non-financial assets and debt forgiveness records. The financial account reflects the financial and physical assets purchase made by a country abroad and within the country. The difference between a country’s imports and exports with respect to commodities is known as balance of trade. It must be zero since the sum of balance of payment components must be of balance of payment components must be zero. International trade is affected by interest rate changes. One country’s currency value against another country’s is determined by nominal exchange rate. Such factors are determined by the forces of demand & supply of the currency of a given economy. When a country’s currency appreciates, its currency value with respect to another country rises. Similarly, depreciation arises when the value of a currency of a given country falls in comparison to another country. Shifts in demand and supply of Australia’s currency result to changes in exchange rates. These shifts are caused by interplay of three factors. These include changes in demand for commodities produced by Australia or foreign countries, changes in the need to invest in Australia or foreign countries and changes in prospects of currency traders especially speculators with respect to future Australian dollar or foreign currency values. Conclusion In conclusion, the Reserve Bank of Australia (RBA) should, together with the federal government consider taking effective measures to control the escalating rate of inflation in the country. This will help in setting an attractive investment environment in order to cope with issues like unemployment, unfavourable balance of trade and payment among other macroeconomic challenges, some of which are discussed in this report. A country’s performance is measured by a number of factors like inflation. Such a problem can be adjusted by price indexes. This can be done by determining the price level changes over a given period of time instead of absolute price levels. To correct the inflation effects in an economy, the nominal value should be divided by the determined price index and then obtaining a real value by multiplying 100. Sound economic and monetary policies should also be established in order to boost the country’s economic growth by increasing gross domestic product (GDP), net domestic product (NDP) and gross national income (GNI). These will in turn lead to increased production, increased income per capita and overall economic growth. In addition, comprehensive aggregate demand and supply analysis should be carried out since the trend of an economic growth is marked by alternating changes in business cycle. References Chick, V., Arestis, P., Desai, M., & Dow, S. C. (January 01, 2002). Money, macroeconomics and Keynes. Bottom of Form Top of Form Hubbard, R. G. (2009).Macro economics. Frenchs Forest, N.S.W: Pearson Prentice Hall.Bottom of Form Mankiw, N. G., & Taylor, M. P. (2014). Economics. Andover: South-Western Cengage Learning. Michael J. (23 Jul 2014).Inflation hits top of Reserve Bank target at 3pc - ABC News. Retrieved from http://www.abc.net.au/news/2014-07-23/consumer-price-index-inflation-abs-data-june-quarter/5617508 Top of Form Bottom of Form Top of Form Sir, Chatterjee. (2014). Introductory Micro and Macro Economics. Partridge Pub. Bottom of Form Top of Form Miller, R. L. R. (2014). Economics today: The macro view. Bottom of Form Top of Form Top of Form Read More