Australia's Unemployment Rate - Assignment Example

Running head: MACROECONOMICS ASSIGNMENT Answering 10 Questions on Macroeconomics Name Course Information Professor Information Date Due Question 1 a. A step taken by central bank to reduce interest rates is termed as monetary policy. One of the instruments deployed by central bank is open market purchases that often have the effect of increasing money in circulation consequently reducing interest rates. As a result, aggregate spending and investment demand rises up. Due to multiplier effect, real GDP goes up. Figure 1: model of an economy If the economy is initially at equilibrium Y1, a reduction in interest rate, say from 10% to 6%, will shift aggregate expenditure curve from AE1 to AE2. This increase in expenditure is also shown by an increase in aggregate demand from AD1 to AD2. In the short run, income will increase as interest rate increases. However, the income will stabilize in the long run, Y2. b. An increase in private domestic investment spending increases the aggregate expenditure, which in turn raises real GDP in the short run from Y1 to Y2. Income however stabilizes at Y2 in the long run as shown in figure 1. c. If international prices increase, more goods would be exported. This has the effect of increasing aggregate expenditure. The rising aggregate expenditure is also associated with rising short run income. This income will be stable in long run at Y2. d. A depreciating currency means that domestic goods are cheap hence; the economy will export more goods. Net exports will therefore increase in the short run hence raising aggregate expenditure. This has the impact of raising income, which however remains stable in the long run at Y2. e. A fall in real estate prices means that wealth of individuals has declined. Consumption will therefore decreases and shift AE downward. Eventually, GDP will fall by multiple of consumption. f. Where terms of trade in a country improve, net exports tend to increase. Since net exports determines aggregate expenditure, an improving terms of trade increases aggregate expenditure, which eventually expends real GDP from Y1 to Y2. Income will stabilize in the long run as shown in figure 1. Question 2 Scott (2013) presented an article highlighting government’s rejection of spending cuts that was intended to attain surplus in budget. The article addresses various issues facing the impending budget in Australia. Choice of this article was precipitated by the fact that various macroeconomic items have been enumerated. It is also from this article that the possibility of manipulating budgets to reach a selfish motive surfaces. In summary, the article expresses the need to avoid cutting spending because such a move would have adverse effect on employment, productivity, and output. Question 3 According to Australia Bureau of Statistics (2013), unemployment rate, seasonally adjusted figures, rose by 0.1% from 5.4% registered in December 2012. This rate was driven by a reduction in full-time employment, which was countered by an increase in part-time employment. Specifically, male part-time employment increased. By comparing the results with Roy Morgan’s, it is obvious that ABS reported low level of unemployment. The main reason is that ABS utilizes seasonally adjusted estimates, which in essence does not take into account static nature of population i.e. school leavers and graduates. Excluding these figures drives down unemployment rates. Additionally, mining industry in Australia has been experiencing massive job losses, which suggests a decline in employment growth. Some companies in Australia have also been closing business mainly because of rising costs and declining profits. Furthermore, ABS figures are lagging thus fail to address immediacy of statistic. Question 4 At equilibrium level, both savings and planned investment are equal. Briefly, savings gives rise to investment and eventual increase in income. Due to multiplier effect, a small change in spending causes large shift in GDP. In the diagram below, equilibrium is at F. An increase in Savings Function increases savings as Savings Function shift to the right. On the other hand, a sustained rise in private investment spending shifts the AE curve to the right consequently increasing income. Figure 2: Savings function (Lipsey and Chrystal, 2011) Question 5 Money multiplier is also called deposit or credit multiplier. It measures how money creation within the banking industry leads to excess money supply compared with monetary base. This multiplier therefore shows the rate of increase in money supply against monetary base. The aspects of deposits and loans in banks lead to money creation. On the other hand, income expenditure multiplier shows the amount of change in income following a change in autonomous expenditure. In brief, this multiplier examines the effect of a shift in aggregate expenditure. Borrowers normally pay a certain percentage to cover the use of borrowed assets. This is calculated as a percentage of principle. A low-risk party is charged low interest while a high-risk borrower is charged high interest rate. Conversely, exchange rate is the rate of exchanging one currency for another. This exchange rate also shows value of a country compared with another. The rate is determined in a foreign exchange market. Balance of payment deficit arises when payments made in settlement of imports and bonds bought from foreign nations exceeds sources of funds i.e. export of goods and bonds that have been sold. This implies that outflows exceed inflows. Budget deficit arises when government expenditure exceed revenue generated from various sources of government income. Trade deficit occurs when a country imports more than exports. It represents an outflow of domestic currency to other nations around the world. On the contrary, net foreign debt represents that part of debt in country owed to creditors from foreign nations. It is obtained after subtracting non-equity assets i.e. foreign reserve from gross foreign debt. Non-equity also includes lending made by residents to non-residents. Question 6 If money supply is increased, interest rate will decline. Business will move in to take advantage of the reduced opportunity cost by making investment in various projects. As investment increase, aggregate demand also increases. Eventually, real GDP rises in line with the rising aggregate demand at a given price level (Sloman and Norris, 2010). This is shown by figure 3 below. Figure 3: Money market Question 7 Demand-pull inflation takes place in an environment where demand for goods and services exceed supply of those goods and services. It arises when regulatory bodies allow supply of money to grow faster than the capacity of an economy to supply those goods and services. This type of inflation is associated with booming economy and is shown in the diagram below. Figure 4: Demand Pull Inflation In the diagram above, supply cannot meet the demand hence the rise in price from P1 to P2. There is a shift in AD curve along AS curve simply because demand is rising faster than supply. On the other hand, Cost Push inflation is initiated by rising cost of production, faced by firms. Figure 5: Cost Push Inflation In the diagram above, SRAS curve has shifted to the left due to rising cost caused by factors such as rising energy and prices of commodities. Frisch (1983) made it very clear that it was difficult to establish whether a given rate of inflation was cost-push or demand pull inflation because wages may rise because of autonomous wage push or due previous rise in prices. Similar situation applies to demand pull inflation where rising prices can be as a result of previous wage rise. Question 8 To understand economic growth in Australia since 1991, AD-AS model below is relevant. Figure 6: AS-AD Model Besides stability of exchange rate, growth in Australian economy is explained by outward looking and competitive policies instituted in the business sector (Battellino, 2010). Reforms done in labour market in 1980s further aided in cautioning unemployment swings and unsustainable wage pressures. Financial system was also made appealing to investors. All these factors explain the shift in AD curve to the right, which is followed by increase in real GDP. The danger of economic growth is inflation (Blanchard, 2000). This is reflected in the diagram above where prices are bound to rise from P1 to P2. A two-speed economy mainly covers economies that have industries going through unevenly growth. As an example, mining industry in Australia is booming but tourism and manufacturing suffer. Booms in mining helped protect the economy during the financial slump. Question 9 Implementation of expansionary policy increases money supply consequently availing more funds that are loanable. Through Keynes effect, nominal interest rate is suppressed in the short run. However, nominal interest rates will rise in the long run as inflation creeps in. In line with Fisher effect, real interest rate rises because of expansionary policy. This policy is employed to increase demand in the economy. The danger associated with the policy is inflation. Question 10 The rising AUD is caused by high interest rates that have attracted foreign demand for Australian dollar. Increase in Gold futures further contributes to rising Aussie dollar. Additionally, US stimulus package is perceived to reduce value of US dollar as a result motivating demand for gold and Aussie currency. Rising value of currency is not good for domestic producers since local goods are expensive. Consumers also experience high prices of local goods. References Australian Bureau of Statistics. (2013, Jan 17). Australia's unemployment rate increased 0.1 percentage points to 5.4 percent in December 2012. RBA. Retrieved from http://www.abs.gov.au/ausstats%5Cabs@.nsf/mediareleasesbyCatalogue/46DF E12FCDB783D9CA256B740082AA6C?Opendocument. Battellino, R. (2010, August 20). Twenty Years of Economic Growth. Reserve Bank of Australia. Retrieved from http://www.rba.gov.au/speeches/2010/sp-dg- 200810.html. Blanchard, J. O. (2000). Macroeconomics with Active Graphs CD. 2nd edn. Sydney: Pearson. Frisch, H. (1983). Theories of Inflation. Cambridge: Cambridge University Press. Lipsey, R., & Chrystal, A. (2011). Economics. Oxford: Oxford University Press. Scott, J. (2013, Jan 19). Australia Rejects Spending Cuts to Reach Surplus, Swan Says. Bloomberg L.P. Retrieved from http://www.bloomberg.com/news/2013-01- 18/australia-rules-out-spending-cuts-to-reach-surplus-swan-says.html. Sloman, J & Norris, K. (2010). Principles of Economics. Frenchs Forest: Pearson Education Australia. Read More