Download inflation - nagleeco-2009

Multiple Choice
1. C
2. B
3. B
4. C
5. A
6. B
7. A
8. A /C
9. A
10. C
11. B
12. A
13. B
14. B
15. A
16. D
17. C
18. B
19. A
20. C
Question One
a) Define the term inflation (1 mark)
Inflation refers to a sustained increase in the general level of prices in an economy.
The best known as most widely used measure of inflation in Australia is the
percentage change in CPI.
b) Calculate the inflation rate in year 2 (1 mark)
10%
c) Outline ONE possible reason for the increase in inflation in year 3 (2 marks)
Inflation may have increased in year 3 due to a depreciation of the Australian dollar
which increased the domestic price of imports and leads to a rise in inflation.
d) Explain the impacts of rising international prices on inflation in Australia (2
marks)
Rising international prices would essentially cause an increase in the price of inflation
in Australia. Rising Due to increased prices of imported goods, Australia is exposed
to imported inflation where the price of its g/s too increase.
e) Explain the relationship between inflation and economic growth (4 marks)
Higher inflation distorts economic decision making since the producers and
consumers change their spending and investment decisions in order to minimise the
effect of inflation on them, such as through buying assets rather than investing in
income-producing activities. Sustained low inflation is likely to encourage consumers
to save a higher proportion of their disposable income. Just as high inflation erodes
the value of savings lower inflation levels should reduce distortions to saving patterns.
Question Two
a) Outline TWO recent trends in Australia’s inflation rate (2 marks)
One of the most significant macroeconomic achievements of the 1990s was that
Australia achieved a sustained reduction in inflation rates after relatively high
inflation since the 1970s. In 1992 the RBA began to target inflation are a rate
averaging 2-3% in the wake of the Goods and Services Tax where inflation peaked at
approximately 6% in June 2001. Conversely, the Global Financial Crisis of 2007-8
caused inflation to plummet at approximately 1.5% in June 2009.
b) Discuss the impact of globalisation on Australia’s inflation rate (4 marks)
Globalisation has generally caused Australia’s inflation rate to fluctuate. Australia is
highly dependent upon its import trading partners to continually supply their goods
and services, therefore the emergence of trade agreements especially with China has
resulted in Australia’s inflation rate to increase. Floating the Australian exchange rate
has significantly increased inflation volatility as changes of the $A will automatically
impact the level of inflation.
Analyse the impact of low inflation on Australia’s economic performance (4
marks)
Lower rates of inflation within the Australian economy can lead to various outcomes
on Australia’s economic performance. Sustained low inflation rate allows moderate
economic growth to be maintained without it becoming necessary to curtail growth
through higher interest rates. Sustained low inflation since the early 1990s allowed for
a long period of relatively high economic growth.
Low inflation can also have a beneficial effect on the level of economic growth
because it impacts on investment and savings. Low inflation has a very positive
impact on business investment, restoring the incentive to invest in long term
productive assets rather than just short term speculative investments, which a higher
inflation environment encourages. As a result, lower inflation is likely to encourage
consumers to save a higher proportion of their disposable income.
Low inflation should improve Australia’s international competitiveness, making it
more attractive for other countries to purchase Australian goods and services, as well
as making local goods more competitive with imports. This may lead to an expansion
of exports and the replacement of imports by domestic substitutes, thus improving the
CAD. Thus low inflation often leads to increased capital inflow and higher demand
for the $A.
Question Three
a) Outline the relationship between inflation and unemployment (2 marks)
The levels of unemployment and inflation share an extremely close relationship in the
short term. Generally, high levels of unemployment often also have low rates of
inflation and vice versa. This inverse relationship is derived from the level of
economic growth. Increasing economic growth leads to declining cyclical
unemployment as aggregate demand increases. In order to accommodate the
increasing demand of consumers, firms increase their demand for labour as an input
of production, placing upward pressure on the demand pull inflation as aggregate
demand exceeds aggregate supply.
b) Explain the relationship between productivity and inflation (3 marks)
The link between productivity and inflation is well associated with wage levels. High
productivity enables greater dynamic efficiency and hence reduces the effects of
demand-pull inflation. Productivity specifically has the impact ensuring greater
production of goods and therefore minimises inflation volatility as the cost of living
and hence consequent nominal wage demands are stabilised.
c) Discuss the policies available to the government to reduce the level of inflation in
the Australian economy (5 marks)
There are a number of macroeconomic and microeconomic policies available to the
government to help combat inflation. However, the main tool used by the government
is monetary policy, as it is able to be implemented immediately, and is most effective
in containing inflation.
Actions by the RBA address inflation by selling government securities to increase the
cash rate. This results in a rise in the overnight interest rate where investment
spending and consumer spending declines, encouraging consumers to borrow. Higher
interest rates also trigger capital inflow which causes the $A to appreciate leading to a
decline in the demand for exports and consequently a fall in aggregate demand from
the export sector. Simultaneously, imports will also experience a decline in domestic
demand as the price of imports will relatively be cheaper. As a result, demand-pull
inflation and imported inflation both decrease whilst the private sector becomes more
alert of the RBA’s actions in increasing the interest rate, causing a decline in inflation
and a reduction in inflationary expectations.
Macroeconomic policies also cater for inflation in the long term by minimising costpush inflation. Such policies can be in the form of tariff reform, labour market
policies and the deregulation of financial markets. Labour market reforms include the
introduction of enterprise bargaining and workplace agreements. This means that
wage rises are increasingly linked to productivity and minimises excessive wage
growth that is not linked to productivity increases, resulting in lower cost-push
inflation.