Download QUESTION: B.2 (10 marks) - CSUSAP

School of Marketing and Management
INTERNAL SUBJECT OUTLINE
Spring 2009
Economics 120: Macroeconomics
Subject Lecturer
Roderick Duncan
Office: C2-232 (second floor)
Telephone (02) 6338-4982
Fax
(02) 6338-4769
Email
[email protected] (preferred contact)
Tutors
Jim Browning, Stuart Evennett
Contact details provided by your tutor.
Class Contact
Lecture
Monday 11:00am-11:50am, S15-223
Tuesday 11:00am-11:50am, S15-223
Tutorials
Tuesday 4:00pm-4:50pm
Tuesday 5:00pm-5:50pm
Wednesday 4:00pm-4:50pm
Wednesday 5:00pm-5:50pm
(Tutorial sign-ups will be held in lecture during the first week.
Students will be assigned to tutorials based on their preferences
and limitations of space in tutorials.)
Consult
Monday, 10:00-11:00, 1:00-5:00, C2-232
Tuesday, 10:00-11:00, C2-232
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INTRODUCTION TO THE TEACHING STAFF
Dr. Roderick Duncan
Dr. Duncan is a lecturer in economics and finance at CSU. He studied for his undergraduate degrees
in economics and law at the Australian National University and his doctorate in economics at
Stanford University. His research interests centre on development problems in Third World countries
and especially the links between natural resources and development. He has also written on such
disparate topics as the relationship between rising female education and falling marriage rates and on
global warming policy.
SUBJECT INTRODUCTION
Welcome to a new session of study at Charles Sturt University. In this subject macroeconomic
concepts and principles are used to study the structure and performance of the Australian economy.
Topics include national income measurement and the business cycle, theories of income
determination, the financial system and monetary policy, international trade and the balance of
payments, macroeconomic policy issues and economic growth.
Macroeconomics is the study of the large-scale variables we use to measure the economy, such as
interest rates, inflation, unemployment, investment and many others. By the end of this subject you
will be able to converse about topics like “is our current account deficit too high?” and be a better
citizen, voter, and thinker because of it.
Please remember that the textbook and the modules for the subject are not the sole sources of
wisdom on these topics. You should read the financial pages of newspapers like The Sydney
Morning Herald or The Australian every day. You should definitely try to read the magazine The
Economist once a week. While reading, always try to ferret out any economic content in the
statements you read and relate what you are reading back to the material you are learning. Is the
latest Ross Gittins (from the SMH) or Paul Krugman (from the New York Times) column full of
nonsense?
SUBJECT OBJECTIVES
This subject has been prepared to enable you to:
1. be introduced to some basic concepts in macroeconomics;
2. examine the major features and performance of the Australian economy, and its relationship
to the international economy;
3. understand models relating to the level of output and prices in the Australian economy to
shocks such as changes in government policy and changes in national and international
conditions;
4. strengthen your quantitative skills in presentation- creating charts and graphs- and in using
computer spreadsheets to prepare scenarios;
5. develop communication skills relevant to tertiary-level studies, such as rational argument and
critical evaluation; and
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6. understand the big picture of the Australian business environment.
PRESCRIBED TEXTBOOK
You are advised to purchase or have continuous access to the following text:
McTaggart, D. Findlay, C. and Parkin, M.(2007) Macroeconomics, 5th ed., Pearson Education
Australia.
Earlier editions of the textbook have much the same content but be careful to compare the topics and
readings to make certain they overlap.
There will be some additional readings that will be held on reserve at the Library:
Petty, J. W. et al. (2004) Financial Management, 4th ed., Pearson Education, Chapters 4 and
10.
ALTERNATIVE RECOMMENDED TEXT(S) (optional)
There are dozens of current “introduction to macroeconomics” texts. These books all contain much
the same material but differ in style and presentation. Go to a bookstore or a library and check a few
out. Find one that suits your tastes. Your best bet would be to have access to the Jackson and
McIver text in addition to an alternative text.
RECOMMENDED TEXTS (optional)
The McTaggart text has a study guide available from Pearson Education. Some students find study
guides helpful. At the least, it is a source of extra questions with answers to practice on.
WEB REFERENCES
The textbook has a website with a lot of online help. You will need to create an account to complete
the chapter quizzes from the book’s website, as these will be part of your tutorial grade. You will
receive a hand-out for the online information.
There are many helpful websites maintained by Australian government divisions, such as:
Commonwealth Treasury (http://www.treasury.gov.au/)
Reserve Bank of Australia (http://www.rba.gov.au/)
Australian Bureau of Statistics (http://www.abs.gov.au/)
Notices and resources for the class will be placed on the class Interact website.
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STUDY SCHEDULE
READINGS
WEEK
LECTURES
TOPIC FOR LECTURES
1
July 27 & 28
A first look at macroeconomics: oil
prices, leisure and bling!
2
August 3 & 4
Measuring GDP, but what does it mean?
(Start of tutorials)
McTaggart Chapters
19 and 20
3
August 10 & 11
The business cycle, or why we do well
in some years and worse in others
McTaggart Chapter 21
4
August 17 & 18
The aggregate demand-aggregate supply McTaggart Chapter 22
model: The workhorse model
5
August 24 & 25
The aggregate demand-aggregate supply McTaggart Chapter 22
model
6
August 31 &
September 1
Net present value (Mid-term exam 1)
Petty et al, Chapters 4
and 10
7
September 7 & 8
How the stock market works: Using net
present value
Petty et al, Chapters 4
and 10
Semester Break
8
October 6
Why are house prices rising/falling?
Using net present value again
Petty et al, Chapters 4
and 10
9
October 12 & 13
How money and the banks work
McTaggart Chapter 26
10
October 19 & 20
Monetary policy: Or does the Reserve
Bank of Australia hate us all?
McTaggart Chapter 27
11
October 26 & 27
12
November 2 & 3
What is the price of the Australian
dollar? (Mid-term exam 2)
McTaggart Chapter 28
13
November 9 &
10
Models of inflation and review of
subject
McTaggart Chapter 29
November 16
EXAM PERIOD COMMENCES
Fiscal policy: Government spending and McTaggart Chapter 25
taxes
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ASSESSMENT
There are 4 assessment items for this subject.
Assessment Items
Value
Due Date
1. Tutorial papers
20%
Due in tutorials starting in
Week 3 until Week 13
2. Mid-term examination 1
15%
August 31 during the normal
lecture period
3. Mid-term examination 2
15%
November 2 during the normal
lecture period
4. Final examination
50%
During examination period
PASS/FAIL REQUIREMENTS
In order to achieve a passing grade in this subject, a student must attain a minimum passing standard in both
the overall total mark and the examination.
TERMS
To meet terms and be allowed to sit for the examination of this subject, you must attend at least 10 tutorials.
Failure to meet terms will result in an automatic FL grade unless permission is granted by the lecturer.
ASSESSMENT DETAILS
Assessment Item #1: Tutorial papers
Weight in your grade: 20%
Why you do this assessment
The purpose of the tutorial papers is to make certain that you are keeping up with the material as we
proceed through the subject.
What you need to do
There will be a variety of exercises due in tutorials. Tutorial papers will be distributed in lectures.
Some of the exercises will be online.
How you will be graded
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Each tutorial paper will be worth 2% of the final grade. Each paper will be marked, but only the top
10 grades on your tutorial papers will be averaged for the grade in the subject. You can only submit
a tutorial paper if you attend your registered tutorial session.
ITEMS 2 & 3: Mid-term examinations
Weight in your grade: 15% each
Why you do this assessment
The purpose of a mid-term is to ascertain whether you have understood the material up the previous
week in the subject.
What you need to do
The mid-terms will be a mixture of multiple-choice and essay questions. The mid-terms will be held
in the first hour of the class during the regular lecture time and place.
How you will be graded
You will be graded on (1) your knowledge of the concepts and models of the subject and (2) your
ability to apply those concepts and models to real-world situations.
ITEM 4: Final examination
Weight in your grade: 50%
Why you do this assessment
The purpose of the final exam is to determine that students have adequately understood the material
from the subject and are able to apply that knowledge to new situations.
What you need to do
The final exam will be of three hours duration and will cover all topics studied in the subject. The
final exam will be conducted in the final examinations week. The structure of the final exam will be
a mixture of multiple-choice and essay questions. It will be similar to the sample exam placed at the
end of this subject outline. The final exam will be closed book.
The date and time of the final exam will be set by the university.
GRADES

For subjects with a formal examination, students must pass the final examination in order to pass the
subject.

Final grades for this subject are awarded by the Business Faculty Assessment Committee in accordance
with the University's Assessment Regulations. (see current Academic Regulations via www.csu.edu.au).

Marks may be scaled to produce a distribution of grades which conforms to the expected norms
specified in the University's and Faculty's Assessment Regulations.

High marks in the continuous assessment items will not automatically guarantee a specific award. In
order to qualify for a Credit, Distinction or High Distinction a student is expected to achieve a
commensurate nark in the final examination.
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GRADING SCALE
Each assessment item will be given a grade using a numerical score. Your final grade for the subject as a
whole will be based on the grading scale outlined in the Assessment Regulations.
HD
High Distinction 85% - 100%
An outstanding level of achievement in relation to the assessment process.
DI
Distinction 75% - 84%
A high level of achievement in relation to the assessment process.
CR
Credit 65% - 74%
A better than satisfactory level of achievement in relation to the assessment
process.
PS
Pass 50% - 64%
A satisfactory level of achievement in relation to the assessment process.
FL
Fail 0 - 49%
An unsatisfactory level of achievement in relation to the assessment process on
completion of the subject providing a student has completed and has been
assessed on at least one assessment task.
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PLAGIARISM
It is unfair to honest students that other students cheat or plagiarise. Charles Sturt University takes a serious
view of plagiarism and cheating in any form of assessment, and will take appropriate steps to detect
plagiarism including using electronic plagiarism detectors.
Plagiarism consists of a person using the words or ideas of another as if they were his or her own. That is,
using, or attempting to use, another person’s work without acknowledgement. The important message here is
that if you use the work of another person then it must be acknowledged. The phrase “using another person’s
work” includes, but is not limited to:
-
Using study guide material without acknowledgement;
paraphrasing the work of another person;
directly copying any part of another person’s work;
summarising the work of another person;
- using or developing an idea or theme derived from another person’s work;
using experimental results obtained from another person’s work; and
- in the collaborative projects, falsely representing the individual contributions of the collaborating
students where individual contributions are to be identified.
Other forms of cheating will also be treated with the utmost seriousness.
The university reserves the right to electronically scan student assignments for the purposes of verifying
originality.
Penalties for plagiarism are listed in the Academic Regulations under the Student Academic Misconduct Rule.
The penalties include: a caution or reprimand; awarding of zero marks in the assignment, essay, project, test,
examination or other work in respect of which academic misconduct has occurred; a fail in the subject; a fine;
suspended enrolment; or exclusion from the University.
The Faculty of Business has acquired computer software which can link electronic or scanned assignments to
online data to accurately detect plagiarism. The software can also detect situations when students submit
assignments which include the work of other students. The software system used by the Faculty is called
“Turnitin”. The Faculty reserves the right to require submission of assignments in electronic forms. More
details of this software can be found at the following web sites:
http://www.turnitin.com/
http://www.turnitin.com/static/products services/plagiarism prevention.html
Please note that we would much prefer to encourage students to submit assessments which clearly
acknowledge sources rather than to detect plagiarism and to impose penalties. Recent penalties
applied to plagiarism have included automatic failure and suspension from the University.
A guide to the APA style of referencing (the style now used by the Faculty of Business) is < included
in your outline or available at> http://www.csu.edu.au/division/studserv/learning/pdfs/apa.pdf
Further details on how to reference and avoid unintentional plagiarism can be found at the Student
Services website.
http://www.csu.edu.au/division/studserv/learning/referencing
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ACADEMIC STANDARDS
As an undergraduate student in a university, you are expected to produce work to high academic standards.
Written material must be presented well, be thoroughly researched, contain appropriate references, and
demonstrate considerable thought and appreciation of the subject matter. It is expected that you will read the
text and other literature thoroughly, and think deeply and critically about what you read. You will be
expected to contribute to class discussion, with informed, intelligent insights. It is vital that you do not
confine your readings to the text only. Broad reading from various academic literature, as well as
management magazines and the business section of the quality newspapers will assist you in your studies.
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SAMPLE EXAMINATION PAPER
FACULTY OF BUSINESS
SAMPLE EXAMINATION
ECO120 MACROECONOMICS
SUBJECT CONVENOR: Dr. Roderick Duncan
DAY & DATE:
TIME:
WRITING TIME: 3 Hours
READING TIME: 10 Minutes
MATERIALS SUPPLIED BY UNIVERSITY:
1 x 24 Page Answer Booklet
General Purpose Answer Sheer
MATERIALS PERMITTED IN EXAMINATION: 2B Pencil/Eraser
Battery/Solar Powered Calculator
(no printer, non-programmable)
NUMBER OF QUESTIONS:
Part A: 30 out of 30;
Part B: 3 out of 5;
Part C: 2 out of 4
INSTRUCTIONS TO CANDIDATES:
1.
Enter your name and student number and sign in the space provided at the bottom of this
page.
2.
This is a closed book examination; therefore no written material, reference books or notes will be
permitted into the examination room.
3.
Write your answers in the answer booklets provided except for Part A which is to be
answered on the General Purpose Answer Sheet. Number each question clearly.
Part A (multiple choice): Answer all questions (30 marks)
Part B (short answer ): Answer 3 only of the 5 questions (30 marks)
Part C (essay questions): Answer 2 only of the 4 questions (40 marks)
INSTRUCTIONS TO INVIGILATORS:
THE EXAMINATION PAPER MUST NOT BE RETAINED BY THE CANDIDATE.
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PART A
Multiple Choice Questions
(30 marks)
Answer all thirty (30) questions.
1. GDP may be defined as:
A) The monetary value of all final domestic goods and services produced within a nation in a
given year.
B) National income minus all non-income charges against output.
C) The monetary value of all economic resources used in the production of a year’s output.
D) The monetary value of all goods and services, final and intermediate, produced in a given
year.
2. If intermediate goods and services were included in the GDP:
A)
B)
C)
D)
GDP would then have to be deflated for changes in the price level.
Nominal GDP would exceed real GDP.
GDP would be overstated.
GDP would be understated.
3. James Olivier grows oranges for his family and to give away to friends. This activity is:
A)
B)
C)
D)
Excluded from GDP in order to avoid double counting.
Excluded from GDP because an intermediated good is involved.
Productive activity, but is excluded from GDP because no market transaction occurs.
Included in GDP because it reflects production.
4. Which of the following will increase the multiplier?
A)
B)
C)
D)
A fall in the marginal propensity to save.
An increase in the supply of money.
A decline in interest rates.
A decline in unemployment.
5. In the short run, firms expand their production when the price level rises because:
A) The money wage rate remains constant so the higher prices for their product makes it
profitable for firms to expand production.
B) Each firm must keep its production level up to the level of its rivals, and some firms will
expand production as the price level increases.
C) The higher prices allow the firm to hire more workers by offering higher wages, thereby
increasing productivity and profits.
D) Firms can increase their profits by increasing their maintenance.
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6. A major technological advance causes:
A) The long-run aggregate supply curve to shift rightward and the short-run aggregate supply
curve to shift leftward.
B) The long-run aggregate supply curve to shift rightward and the short-run aggregate supply
curve to remain where it is.
C) The short-run aggregate supply curve to shift rightward and the long-run aggregate supply
curve to remain where it is.
D) Both the long-run and the short-run aggregate supply curves to shift rightward.
7. Suppose we knew that the nominal level of GDP fell and that inflation was greater than zero.
What could we infer about real GDP from these facts?
A)
B)
C)
D)
Real GDP fell.
Real GDP stayed the same.
Real GDP rose.
We don’t have enough information to make a statement about real GDP.
8. Money functions as:
A)
B)
C)
D)
A store of value.
A unit of account.
A medium of exchange.
All of the above.
9. The operation of automatic stabilisers means that as the economy goes into recession:
A)
B)
C)
D)
Tax rates automatically rise.
Government expenditures increase and government revenues fall.
Government expenditures fall and government revenues rise.
The income tax scales are automatically altered without requiring the approval of Parliament.
10. The consumption function shows:
A)
B)
C)
D)
How much all households plan to consume at each level of real disposable income.
How much all households plan to consume at each possible interest rate.
How much real disposable income people will earn at each income tax bracket.
How much all households plan to consume at each level of savings.
11. The consumption function shifts upward when
A)
B)
C)
D)
Disposable income increases.
Saving increases.
The purchasing power of households’ net assets increase.
The population decreases.
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12. Which of the following statements is correct:
A)
B)
C)
D)
Interest rates and bond prices vary directly.
Interest rates and bond prices vary inversely.
Interest rates and bond prices are unrelated.
Interest rates and bond prices vary directly during inflationary periods and inversely during
recessions.
13. If there is an increase in nominal GDP, we would expect:
A)
B)
C)
D)
The demand for money to rise.
The interest rate to rise.
Bond prices to fall.
All of the above to occur.
14. Who makes decisions regarding monetary policy in Australia?
A)
B)
C)
D)
The Prime Minister.
The Cabinet.
The Treasurer.
The Board of the Reserve Bank.
15. Suppose the economy is at long-run equilibrium. Which of the following would cause the price
level to fall and real GDP to increase in the short run?
A)
B)
C)
D)
An increase in the quantity of money.
A decrease in the price of petrol that increases aggregate supply
A decrease in the stock of capital that decreases aggregate supply
A decrease in the value of real wealth.
16. Imports are deducted from Australian GDP calculations because:
A)
B)
C)
D)
They are produced by companies that are owned by non-Australians.
They are a stock, not a flow of goods.
They have to be purchased with other currencies.
They are not produced in Australia.
17. If a bond that pays off $1,000 next year is selling for $893 today, what is the interest rate (in
rounded terms) that must be applying to that bond?
A)
B)
C)
D)
6%.
8%.
10%.
12%.
18. If the Consumer Price Index rises from 300 to 333 in a particular year, the rate of inflation in that
year is:
A)
B)
C)
D)
11 percent.
33 percent.
91 percent.
10 percent.
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19. If the Reserve Bank of Australia increases the base currency by M units, then the money supply:
A)
B)
C)
D)
Does not change.
Drops by greater than M units.
Rises by less than M units.
Rises by more than M units.
20. A decrease in the required reserve ratio for banks:
A)
B)
C)
D)
Increases the amount of loans that banks can make, and so increases the money supply.
Decreases the amount of loans that banks can make, and so decreases the money supply.
Increases the amount of loans that banks can make, and so decreases the money supply.
Will have no effect on the amount of loans or the money supply.
21. If the government wishes to control inflation, then the appropriate response to a large increase in
exports is:
A)
B)
C)
D)
To cut government and to lower interest rates.
To increase government spending and to lower interest rates.
To cut government spending and to raise interest rates.
To increase government spending and to raise interest rates.
22. If the government loosens monetary policy, then
A)
B)
C)
D)
Interest rates fall, and the AD curve shifts left.
Interest rates fall, and the AD curve shifts right.
Government spending falls, and the AD curve shifts left.
Government spending rises, and the AD curve shifts right.
23. Unemployment that occurs when a worker has insufficient skills or their skills no longer are
needed in the economy is called:
A)
B)
C)
D)
Structural unemployment.
Frictional unemployment.
Seasonal unemployment.
Cyclical unemployment.
24. The Phillips curve illustrates the relationship between:
A)
B)
C)
D)
The unemployment rate and GDP growth.
Changes in the unemployment rate and GDP growth.
Changes in the inflation rate and the unemployment rate.
Changes in inflation and GDP growth.
25. If the population is 20 million, the labour force participation rate is 60% and the unemployment
rate is 5%, then the labour force is _____ million, while the unemployed are _____ million.
A)
B)
C)
D)
12 million; 1.6 million.
16 million; 0.6 million.
12 million; 1 million.
12 million; 0.6 million.
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26. A rise in the labor-force participation rate of women ____ the labor force and shifts the long-run
aggregate supply curve ____.
A) Increases; rightward
B) Increases leftward
C) Decreases; rightward
D) Decreases; leftward
27. If the interest rate is 7%, the inflation rate is 3%, and the unemployment rate is 6%, then the
Phillips Curve relationship suggests what?
A)
B)
C)
D)
If we wish to have 5% unemployment, then we have to lower inflation.
If we wish to have 5% unemployment, then we have to raise inflation.
If we wish to have 5% unemployment, then we have to raise interest rates.
If we wish to have 5% unemployment, then we have to lower interest rates.
28. If current GDP is above the long-run AS curve (or potential GDP), then we are currently in a
____ and unemployment is _____ than the natural rate.
A)
B)
C)
D)
Boom; higher.
Boom; lower.
Recession; higher.
Recession; lower.
29. The Australian dollar appreciates relative to the Japanese yen. We would expect to see
A)
B)
C)
D)
An increase in imports from Japan and an increase in Australian exports.
A decrease in imports from Japan and a decrease in Australian exports.
An increase in imports from Japan and a decrease in Australian exports.
A decrease in imports from Japan and an increase in Australian exports.
30. US movie companies are building studios on the Gold Coast in Queensland to produce television
shows for sale back in the US. This will lead to
A)
B)
C)
D)
An increase in the supply of Australian dollars and a decrease in the demand for US dollars.
A decrease in the supply of Australian dollars and an increase in the demand for US dollars.
An increase in the demand for Australian dollars and an increase in the supply of US dollars.
A decrease in the demand for Australian dollars and a decrease in the supply of US dollars.
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PART B
(30 marks – 10 marks each)
Answer three (3) only of the five (5) questions.
Draw diagrams when applicable.
QUESTION: B.1
(5 + 5 = 10 marks)
The Federal government expands the visa program to allow the immigration to Australia of more
skilled workers.
(a) Show the impact of this expansion on the Australian labour market. Explain what is happening.
(b) Show the impact of this expansion on the Australian economy using the AD-AS diagram.
Explain what is happening.
QUESTION: B.2
(10 marks)
You intend to buy a used car from Dodgy Brothers, a used car seller. Dodgy Brothers offers you
financing for your car purchase through Dodgy Brothers Financing Inc. You are offered the
following options:


Purchase the car for $15,000 paid today; or
Pay $5,000 down-payment (today) and make three more payments starting next year and each
year after of $5,000.
Your discount rate is 12% a year.
Set out the equations to compare these two options in net present value terms. Which option is
cheaper in NPV terms?
QUESTION: B.3
(4 + 4 + 2 = 10 marks)
You estimate the consumption function for Australian households to be:
C = $50 billion + 0.75 Y
You estimate investment demand to be $100 billion and government consumption to be $100 billion.
(a) Set out the AE equation for the Australian economy. Calculate the equilibrium level of GDP.
(b) Show the AE equation and equilibrium GDP on a graph. Be sure to indicate the intercept and
slope of the AE curve and what the slope and intercept tell us.
(c) If we add a net exports component to our AE equation:
X – M = $50 billion – 0.05Y
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Show what would change on your AE equation (you don’t have to calculate the new equilibrium).
Draw a new AE diagram and show what changes because of the new NX term.
QUESTION: B.4
(5 + 5 = 10 marks)
(a) Draw the Phillips Curve and explain what the Phillips Curve shows us.
(b) The Reserve Bank of Australia has reduced average inflation in Australia from 6% in the early
1990’s to 2.5% today. How would you compare the Phillips Curve from the early 1990’s to one
today? Draw and compare the two curves.
QUESTION: B.5
(3 + 3 + 4 = 10 marks)
(a) “The value of a company share is the present value of expected future dividends from that
company.” Explain carefully what this definition means.
(b) If the statement in (a) is true, then why do share prices fall if expected interest rates rise?
Explain with an equation and in words.
(c) If the statement in (a) is true, and if investors expect the Reserve Bank of Australia to raise
interest rates by 0.25%, explain the different effects of:
 The RBA raises interest rates by 0.25%.
 The RBA raises interest rates by 0.5%.
Explain what you would expect to happen to share prices in each case.
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PART C
(40 marks – 20 marks each)
Answer two (2) only of the four (4) questions.
Draw diagrams when applicable.
QUESTION: C.1
(8 + 8 + 4 = 20 marks)
The Rudd government has promised to cut Australian Federal government spending.
(a) The Australian economy is currently in a boom. Illustrate the current boom on an AD-AS
diagram and explain what the diagram shows us.
(b) How will the Rudd government spending cuts affect the economy for your diagram in (a)?
Compare before and after the cuts.
(c) Most of the spending and employment cuts will fall on Canberra, the Federal capital. What will
happen to the economy of Canberra and to real estate values in Canberra?
QUESTION: C.2
(20 marks)
The collapse of several major investment banks in Australia causes a drop in investor confidence
across all Australian industries. Investment demand in Australia falls as a result.
Business economist, Gus Rottins, states that “Because of the investment collapse, it looks like the RBA won’t
be raising interest rates again this year.”
Assume that Gus is using an AD-AS model of the economy. Explain whether Gus is reasoning correctly with
the AD-AS model. Show whether Gus could be correct in his statement. [Be sure to include a clear
explanation of inflation targeting in your argument. It will be a necessary part of Gus’ reasoning.]
QUESTION: C.3
(8 + 8 + 4 = 20 marks)
The Australian government implements a carbon permit scheme to reduce the Australian
contribution to global warming. This tax raises the cost of generating electricity through coal (the
major form of electricity generation in Australia) by 10%.
(a) What impact would we expect this cost increase to have on the Australian economy? Show on
an AD-AS diagram.
(b) What impact would we expect this cost increase to have on Australian companies that export
primary commodities such as iron and copper? These companies are large users of coal-generated
electricity.
(c) What impact would we expect this cost increase to have on the Australian utilities that generate electricity
for Australian households and industries? Explain your reasoning carefully.
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QUESTION: C.4
(6 + 6 + 8 = 20 marks)
A recession in the US reduces international demand for Australian commodity exports such as coal,
iron and copper.
(a) Show the consequences of this recession on a market diagram for the Australian dollar.
(b) What is the effect of this recession on the Australian current account? Explain.
(c) What are the effects of this recession on the Australia economy? Show on an AD-AS diagram
and explain what is happening.
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Solutions
PART A
1. A
2. C
3. C
4. A
5. A
6. D
7. A
8. D
9. B
10. A
11. C
12. B
13. A
14. D
15. B
16. D
17. D
18. A
19. D
20. A
21. C
22. B
23. A
24. C
25. D
26. A
27. B
28. B
29. C
30. C
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PART B
Question B.1.
(a) Students should show a market diagram for labour (not necessary that they segment the market
into skilled and unskilled) with the supply of labour shifting to the right. Employment rises, and the
wage rate falls.
(b) Students should explain that a fall in wages is a shift down/right of the AS curve, as firms now
face lower labour costs. They should draw an AD-As diagram with the AS curve shifting down/right
and correctly predict that prices would fall and GDP would rise.
Question B.2.
This answer comes down to correctly laying out the NPV of the two options and then choosing the
lower of the two.
The NPV of $15,000 paid today is $15,000.
NPV 1 = $15,000
The NPV of a yearly payment of $5,000 for this year and the following three years is:
NPV 2 = $5,000 + $5,000/(1 + 0.12) + $5,000/(1 + 0.12)^2 + $5,000/(1 + 0.12)^3
Students should have some written explanation for the NPV set-up. Correctly setting up the NPV is
worth 8 out of 10. Getting the numbers right on the calculator is worth the last 2 points.
NPV 2 = $5,000 + $4,464.29 + $3,985.97 + $3,558.90 = $17,009.16
Question B.3.
(a) Students should set up the AE equation:
AE = C + I + G
AE = 50 + 0.75Y + 100 + 100
AE = 250 + 0.75Y
It does not matter how they arrive at the equilibrium GDP from here- guess, algebra, table of valuesas long as they verify that it is correct:
1000 = 250 + 0.75 (1000)
So Y = $1000 billion is the correct answer.
b) Students should correctly draw the AE diagram with axes, slope and intercept marked. The 45
degree or Y=AE line should be drawn. Equilibrium GDP should be indicated at the point where the
two lines intersect.
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(c) Students need to set up their AE equation again:
AE’ = C + I + G + NX
AE’ = 50 + 0.75Y + 100 + 100 + 50 – 0.05Y
AE’ = 300 + 0.7Y
Students should draw the new AE’ curve with a higher intercept and lower slope than the old AE
curve.
Question B.4.
(a) Just a basic discussion indicating what’s marked on the axes for the Phillips and that the diagram
is showing a trade-off between inflation and unemployment is needed here. Students should show
awareness of the idea of a trade-off or an inverse relationship.
(b) Students should draw two Phillips curve with the higher curve marked “early 1990s” and the
lower curve marked “today”. For full marks, students should show that the 1990s curve and the
today’s curve both cut the level of the natural rate of unemployment at 6% and 2.5% inflation
respectively.
Question B.5.
(a) Students should explain something like- “Owning a share entitles you to the dividends of that company. If
you hold a share for a long time, the value to you is the future flow of dividends. The value to you today of
holding a share is then the present value of all those future dividends.”
(b) Students should explain that a rising interest rate means that the present value of future money is
less since:
Present Value = (Future Value) / (1 + i)^(Number of Years Away)
If i rises, then the PV falls.
(c) Students should explain that if (a) is true, and if investors expect a 0.25% rise in interest rates,
then the impact of that rise will already be incorporated into the price of shares even before the actual
announcement. If the RBA rises interest rates by 0.25% as expected, then share prices will stay the
same. However if the RBA raises interest rates by 0.5%, then investors are surprised, and share
prices will fall on the announcement.
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PART C
Question C.1.
(a) The students should draw an AD-AS diagram with the intersection of AD and AS occurring to
the right of the LR AS curve.
(b) From the initial equilibrium drawn in (a), students should show that a cut in G will shift the AD
curve left. This will result in a lower level of GDP and lower prices than without the cuts. Final
GDP may end up above or below the LR As level depending on the size of the cuts.
(c) For the Canberra “economy” the shift in the AD curve will larger than for Australia as a whole.
Students could indicate this by drawing a Canberra AD-As diagram or could simply talk about it.
GDP and prices will fall further in Canberra than in the rest of the economy relative to (a). Real
estate values in Canberra would grow slower or fall compared to the rest of the country.
Question C.2.
Students should be graded on:



the relevant economic content shown in their answers;
the ability to apply that economic content to the question asked; and
the clarity and strength of their argument.
Their argument should contain the following elements:




The RBA has a target band of 2-3% for inflation which it attempts to achieve by controlling
interest rates (“inflation targeting”).
The economy currently is in a boom, and inflation is likely to be higher than the RBA target
band.
However if investment demand falls, the AD curve will shift to the left relative to before the
investment collapse.
A lower AD means that inflation will be lower than expected and may even fall within the
target band without direct RBA intervention on interest rates.
Students should have a discussion of inflation targets and the RBA. Students should link the
investment collapse to lower inflation by using an AD-AS diagram.
And yes, Gus may be correct, but the end result is not as important as students being able to show
why it might be so.
Question C.3.
(a) An increase in the cost of electricity will lead to an increase in the costs faced by Australian
businesses, so we would expect the AS curve to shift up/left. This will lead to higher prices and
lower GDP. Students should draw an AD-As diagram to illustrate this.
(b) We would expect that this would hurt exporters of primary commodities who will see lower
exports and profits. For full marks students should talk about overseas competitors for our exporters
and whether the overseas competitors also face carbon taxes. If the overseas competitors do not face
carbon taxes, our exporters will be hurt even more, as their competitive position is reduced.
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(c) Australian utilities will be hurt by higher prices as this would be expected to reduce demand.
Utilities may be able to pass the full cost of the tax on to consumers, in which case utilities may be
hurt less than if the utilities bore some of the tax themselves.
Question C.4.
(a) Students should use the market model for the A$ to predict the change in the price of the A$. If
there is a slump in the resource market, then demand for Australian exports will fall. Fewer exports
means less demand for Australian dollars by overseas firms and individuals. This will shift the
demand curve for the A$ to the left and lead to a drop in the price of the A$ (or a depreciation of the
A$). Ideally students should include a diagram of the A$ market.
(b) a fall in net exports means that the Australian current account will turn more towards the
negative/fall.
(c) A fall in net exports will lead to a shift in the AD curve left. This will lead to a fall in GDP, a rise
in unemployment and a fall in prices in Australia. Students should have an AD-AS model with some
accompanying explanatory text.
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