Macroeconomics

Part B: Macroeconomics

Question :

Consumption of fixed capital: $AUD 285 billion

Gross private domestic investment: $AUD 725 billion

Government consumption expenditures: $AUD 720 billion

Government investment expenditures: $AUD 165 billion

Imports: $AUD -550 billion

Exports: $AUD 625 billion

Household consumption expenditure: $AUD 3010 billion

Net property income paid overseas: $AUD -35 billion

  1. a) GDP & Gross national expenditure

GDP:

Y = C + I + G + (X – M) (Wickens, 2012).

Here,

Y: GDP

C: Consumption (285+3010)

I: Investment (725)

G: government spending (720+165)

X: Exports (625)

M: Imports (-550)

= (285+3010) + 725 + (720+165) + (625-(-550))

= 3295+725+885+1175

= $AUD 6080 Billion

Gross national expenditure:

GNE= GDP-Exports

= $AUD 6080 b- $AUD 625 b

= $AUD 5455 billion

  1. b) Gross National Product

GNP= GDP+ Z

Z: (net income earned by domestic residents from overseas investments – net income earned by foreign residents from domestic investments): $AUD -35 billion

GNP= 6080-35

= $AUD 6045 Billion

  1. c) Net national product

NNP= GNP-Depreciation

=$AUD 6045 Billion -0

=$AUD 6045 Billion

  1. d) Current account balance

Current account balance= imports + net returns on investments abroad – exports (Wickens, 2012).

= -550-35-625

= $AUD -1210 Billion

  1. e) Gross national savings

GNS= I+CAB (Jermann & Quadrini, 2012).

= 725+(-1210)

= $AUD -485 Billion

Question 11: Demand-pull inflation & Cost-push inflation

  1. a) Differences between Demand-pull inflation & Cost-push inflation

Demand-pull inflation:

Cost-push inflation:

Demand-pull inflation is possible due to demand increase while cost-push inflation is possible due to supply shortage (Afonso & Sousa, 2012). At the same time, demand-pull inflation explains how the price inflation starts while the cost-push inflation explains why it is difficult to control inflation after its occurrence.Based on the above curves, it can be determined that Demand-pull inflation occurs when the value of the aggregate demand increases (from AD1 to AD2) faster as compared to the aggregate supply whereas cost-push inflation is related to the costs increase of inputs resulting in decrease in production and the supply of the outputs (AS1 to AS2).

Apart from this, the changes in monetary and fiscal policy can be effective to control the demand-pull inflation because these policies control the demand of the products and services due to the flow of money and tax rates, but it amounts to the high level of unemployment.

But at the same time, cost-push inflation can be controlled by using administrative control on price rise and income policy without increasing unemployment.

  1. b) Reasons for demand-pull inflation & Cost-push inflation

The reasons for demand-pull inflation are the increase in money supply and government spending.

Increase in the money supply: The increase in money supply in the market through low rate of interest causes availability of the capital for the citizens. The availability of the money increases the demand for more products than firms can keep up with resulting in an increase in price (Afonso & Sousa, 2012).

Increase in government spending: When the government spends more in the private sector by purchasing and contracting, it enhances the demand for products and causes issues related to supply leading to a price increase (Jermann & Quadrini, 2012).

The reasons for cost-push inflation are government regulation or taxation and natural disasters.

Government regulation or taxation: the government taxation or regulations for the production of any specific product may raise the cost of its production. It prevents the producers to produce that product leading to a decline in supply, but the demand for this product remains the same in the market that encourages the suppliers to increase the price of that product.

For instance, high taxes on cigarettes and alcohol can reduce the demand for these unhealthy products but also may raise the price and create inflation (Persson & Tabellini, 2012).

Natural disasters: Natural disasters may affect the production or supply of the product that may lead to a decline in supply and increase the price of the product (Jermann & Quadrini, 2012).

Question 13: The Keynesian and Monetarist schools

a)The shape of the aggregate supply curve is important to the debate the Keynesians and Monetarists because in the conditions of the horizontal aggregate supply curve and economy below full-employment,

the rise in aggregate demand increases the real GDP and employment but the price does not change (Jermann & Quadrini, 2012).

In the views of Keynesians, the position of aggregate supply is more horizontal than vertical in the short run so stabilization policy has a significant impact on output and employment.

However, Monetarists consider that the position of aggregate supply is more vertical than horizontal as the economy is inherently stable, so discretionary stabilization policy does not have any significant impact on the economy (Persson & Tabellini, 2012).

Keynesians consider the significance of the money supply and monetary policy in the long run as they know the impact of money growth on price stability in the long run.

b)If the investment demand curve is vertical instead of downward sloping, a fall in investment; and if the investment does not increase, neither will aggregate demand or the real GDP.

If the investment demand curve was vertical, Monetarist view of monetary policy impact on investment spending, aggregate demand, and economic activity will be more correct.

If the investment demand curve is in a vertical position then the investment will fall. If the investment is not increased then the aggregate demand, as well as the real GDP, will not increase (Wickens, 2012).

c)The monetarists consider that interest rates have a more impact on expenditure than the demand for money while Keynesians hold that the interests rate have a more impact on the demand for money than expenditures in the economy.

Monetarists hold that there is a change in the money supply due to the monetary authority, and the Central Bank.

They claim that the changes in the money supply cause inflation due to the corresponding change in expenditure in the economy (Gandolfo, 2013). It is because the change in money supply also changes the availability of the capital for expenditures.

The money supply will increase the availability to purchase more goods and services that will also increase the price of the goods and services and cause inflation. So, it can be stated Monetarists consider the monetary policy as an effective method to control aggregate demand and inflation.

On the other hand, Keynesians consider that the money supply does not have an impact on the spending but affects the demand for money (Johnson, 2017). It is because people may increase their holding of idle balances with the decrease in the speed of money supply.

Question 9:

  1. A decrease in personal income tax:

The impact of a decrease in personal income tax can be presented as below AD-AS curve:The above curve shows that the decline in personal income tax will increase the disposable personal income as it will increase consumption or increase the aggregate demand in an economy. 

So, the aggregate demand curve will shift rightward as it will also raise the need for the producers to increase the production and increase the employment resulting in an increase in GDP (Wray, 2015).

  1. An increase in workforce skills through special training programs

The impact of an increase in workforce skills through special training programs can be presented as below AD-AS curve:

Q1
Q2
Real GDP

From the above curve, it can be depicted that an increase in workforce skills through special training programs can have an impact on the productivity of the workforce leading to increasing production (from AS1 to AS2).

The skill development may also reduce the cost of production that may lead to a reduction in the price of the products. Overall, it can be stated that there will be an increase in real GDP due to high production and employment (Jermann & Quadrini, 2012).

  1. A decrease in exports

The following curve shows the effect of the decrease in exports on aggregate demand and supply:

Price
Real GDP

The decrease in exports brings a decline in aggregate demand of the products outside the country. A drop in export will decline net export of aggregate demand resulting in the decline in aggregate demand as well.

It will reduce the price level of the products in the economy. The decline in aggregate demand will also decrease the real GDP level (Gandolfo, 2013). Overall, the decline in demand will also reduce employment due to low production. 

  1. An increase in an economy’s capital stock

The below curve shows the impact of an increase in an economy’s capital stock:

Real GDP

An increase in capital stock will result in an increase in aggregate supply due to more production by the producers having more machines and human resources. If the economy gains more capital, its aggregate supply curve shifts to the right resulting in an increase in GDP as well as employment (Wickens, 2012).

Question 10:

  1. Describe three problems of using fiscal policy to achieve a precise level of GDP

Time lags: If the government is intended to enhance spending under the fiscal policy, it can take more time to filter into the economy. So, it can be late as spending patterns can be changed or delayed that may affect the purpose of achieving the precise level of GDP (Tucker, 2012).

Poor information: If the government collects wrong or poor data, then it will difficult for the government to achieve the desired results by using fiscal policy. For instance, the government expects the recession, it will increase aggregate demand but if the forecast goes wrong then the government action will cause inflation (Jermann & Quadrini, 2012).

Side effects on public spending: if the government reduces the government spending to decline the inflationary pressure, then it can adversely impact public services including public transport and education leading to market failure and social inefficiency (Afonso & Sousa, 2012).

  1. Why is frictional unemployment inevitable in an economy characterized by imperfect job information and non-zero job search time?

Frictional unemployment is inevitable in an economy characterized by imperfect job information and non-zero job search time due to dynamic economic conditions.

Frictional unemployment is related to the time to search for a new job while switching from one job to another. Some companies are facing contraction while some of them are facing expansion.

Some regions across the globe experience faster growth than other regions. However, the government provides the information about the job vacancies to reduce the amount of frictional unemployment for matching the jobs and workers as soon as possible (Argy, 2013).

But if the economy characterized by imperfect job information and non-zero job search time, then it delays the matches of the workers’ skills and required jobs that makes the frictional unemployment inevitable.

  1. Is structural unemployment something macroeconomic policymakers should be concerned about? How does it differ from cyclical unemployment?

Structural unemployment is the long term or possibly permanent unemployment due to no availability of the jobs for some people. It is due to mismatching of skills of people working and the skills required for doing a job.

Macroeconomic policymakers should be concerned about structural unemployment because there is need to enhance the skills of the unemployed people to match with the required skills of the existing job opportunities in the market (Daly et al., 2012).

The changes in the business environment including changes in tastes and demand and production processes may result in structural unemployment (Persson & Tabellini, 2012). Poor education level may lead to structural unemployment due to the need for the new skill sets to meet the market demand.

So, there is a need for the macroeconomic policymakers to focus on spending on skill development programs and educational programs to reduce structural unemployment. On the other hand, cyclical unemployment is related to unemployment due to the recession or business slowdown in the economy.

It is determined the phase of the business cycle that decides the level of the cyclical unemployment. In this unemployment type, the macroeconomic policymakers need to focus on the fiscal and monetary policies to reduce the impact of the recession period on employment in the country (Michaillat, 2012).

References

Afonso, A., & Sousa, R. M. (2012). The macroeconomic effects of fiscal policy. Applied Economics44(34), 4439-4454.

Argy, V. (2013). International macroeconomics: theory and policy. Routledge.

Chand, S. (2018). Retrieved from: http://www.yourarticlelibrary.com/economics/money/controversy-between-keynesian-and-monetarist-views-money-economy/26003

Daly, M. C., Hobijn, B., Şahin, A., & Valletta, R. G. (2012). A search and matching approach to labor markets: Did the natural rate of unemployment rise?. Journal of Economic Perspectives26(3), 3-26.

Gandolfo, G. (2013). International Economics II: International Monetary Theory and Open-Economy Macroeconomics. Springer Science & Business Media.

Jermann, U., & Quadrini, V. (2012). Macroeconomic effects of financial shocks. American Economic Review102(1), 238-71.

Johnson, H. G. (2017). Macroeconomics and monetary theory. Routledge.

Michaillat, P. (2012). Do matching frictions explain unemployment? Not in bad times. American Economic Review102(4), 1721-50.

Persson, T., & Tabellini, G. (2012). Macroeconomic policy, credibility and politics. Routledge.

Tucker, I., (2012). Economics for today. Nelson Education.

Wickens, M. (2012). Macroeconomic theory: a dynamic general equilibrium approach. Princeton University Press.

Wray, L. R. (2015). Modern money theory: A primer on macroeconomics for sovereign monetary systems. Springer.

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