BUMKT5903 Business Economics

FEDERATION UNIVERSITY AUSTRALIA

NANYANG INSTITUTE OF MANAGEMENT PTE LTD

Individual Assignment—Macro economics

THONG TU VO

30120200

Due Date: 31 May 2014

Question 11

a. Describe the relevant criteria that the Australia Bureau of Statistics use to

determine whether a person is “unemployed” and what problems do you

see using this measure?

A person who is considered as an unemployment if she or he has not been paid

at least one hours for work during any particular month while looking for a job or

temporary layoff during the month.

This measure can cause two problems below:

Overstating unemployment rate: Layton, Robinson, & Tucker (2012)

stated that: Overstating occurs when respondents to the ABS falsely

report that they are seeking employment when they are not. (p. 326). This

problem is motivated to be occurred because the unemployment benefits

on actively seeking a job, or an individual maybe employed in illegal

activities.

Understating the unemployment rate: Layton, Robinson, & Tucker

(2012) also found that: Understating the unemployment rate occurs when

discouraged workers are not to be counted in the unemployment rate. (p.

326). The number of discouraged workers is likely to rise during a

recession, the degree of underestimation of the official unemployment rate

is thought to increase during a downturn. Moreover, counting all part-time

employees as equal to fully employed employees also understates the

unemployment rate. Some others would work full-time if they could find

full-time employment. Underemployed or underutilization of work potential

is greater during a recession, but not reflected in the measured

unemployment rate.

b. Do you agree or disagree with the following statement: “With proper

management of an economy, frictional unemployment need not occur”.

Explain your reasoning?

Disagree with the above statement. Layton, Robinson, & Tucker (2012) defined

of GDP gap “full employment does not mean an unemployment rate of zero. In a

dynamic economy, with changing tastes and technology, there will always be

some level of measured unemployment while people, having left their current

employment, find suitable alternative employment” (p. 294). So according to the

definition even in the full employment, frictional unemployment still occur despite

of proper management of an economy.

For example, there are always your people who leave school and search for their

job or workers in some industry such as construction, experience short periods of

unemployment between projects and temporary layoffs are common.

Frictional unemployment is inevitable because many people with marketable

skills discover a better job after taking a job. Once they have full knowledge,

some workers quit and are unemployed while changing jobs. Also, many people

seeking their first job or looking for a job after an absence from the labor force

are unemployed while seeking full information on jobs that match their skills.

c. Is structural unemployment something macroeconomic policymakers

should be concerned about? How does it differ from cyclical

unemployment?

Structural unemployment is long-term unemployment and possibly even

permanent unemployment so macroeconomic policymakers should be concerned

about structural unemployment.

Structural unemployment caused by a mismatch of the skills of workers who are

out of work and the skills required for existing jobs. On the other hand, cyclical

unemployment is caused by lack of jobs during a recession.

Question 12.

a. Illustrate and explain with diagrams the difference between demand-pull

and cost-push inflation.

Demand-pull inflation

“Demand-pull inflation is caused by pressure on prices originating from the

buyers’ side of the market” (Layton, Robinson, & Tucker, 2012, p. 335).

Demand pull inflation occurs when aggregate demand and output is

growing at an unsustainable rate leading to increased pressure on scarce

resources and a positive output gap. Hence, when the aggregate demand

and output growth lead to an excess of total spending over supply then the

price will rise. So the rise in the general price level will be “pulled up” by

the pressure from buyers’ total expenditure.

Figure 1: demand-pull inflation (source: tutor2u.net)

Cost-push inflation

“Cost-push inflation is caused by pressure on prices originating from the

sellers’ side of the market” (Layton, Robinson, & Tucker, 2012, p. xx).

More generally, the upward pressure on price lead to increasing cost in

labour, raw material…etc., and businesses respond to rising costs, by

increasing their prices to protect profit margins.

Figure 2: cost-push inflation (source: tutor2u.net)

b. Provide (describe) two (2) causes of each type of inflation.

Cause of demand-pull inflation

o The government cuts income tax rates and increases government

expenditure at a time near full employment. Initially, the cuts in

income tax rates would cause household disposable income to

increase which would cause aggregate demand to increase. The

immediate increase in government expenditure would also cause

aggregate demand to shift rightwards.

o A fall in interest rates may stimulate too much demand – for

example in raising demand for loans or in causing rise in house

price inflation.

Cause of cost-push inflation

o Higher indirect taxes imposed by the government– for example a

rise in the duty on alcohol, cigarettes and petrol/diesel or a rise in

the standard rate of Value Added Tax. Depending on the price

elasticity of demand and supply, suppliers may pass on the burden

of the tax onto consumers.

o Component costs: e.g. an increase in the prices of raw materials

and components. This might be because of a rise in global

commodity prices such as oil, gas copper and agricultural products

used in food processing– a good recent example is the surge in the

world price of wheat.

Question 13.

a. Explain why the aggregate demand curve is downward-sloping?(p.369)

Layton, Robinson, & Tucker (2012) found the reason why the aggregate demand

curve is downward-sloping:

(1) The real balances or wealth effect is the impact on demand for real GDP

cause by the inverse relationship between the purchasing power of a fixed

nominal stock of financial assets and rising prices, and which causes a

reduction in consumption.

(2) The interest-rate effect occurs as a result of rising prices increasing the

demand for borrowed funds. For a fixed nominal supply of funds available, as

the demand for borrowed funds increases, interest rate rise, thereby causing

consumption and investment spending to fall.

(3) The net export effect is the impact on real GDP demand caused by the

inverse relationship between net export and rising prices. An increase in the

domestic price level tends to reduce the demand for domestic exports and

increase the demand for imports, and vice-versa for a fall in domestic price

level. (p. 369)

b. Explain the difference between the Keynesian and monetarist views on

how an increase in the money supply cause inflation.

Monetarist economists:

Monetarist economists believe that the velocity of money (V) is stable

and predictable, aggregate demand could change if and only if there

was a change in the money supply. An increase in the money supply

directly affects the nominal aggregate demand and thereby raises the

price level. This argument is based on the equation of exchange, MV =

PQ. If V is constant (or nearly so) and M increases, then PQ must also

increase. If Q is already the full employment level of output, then the

increase in M will lead to an increase in P

Keynesian economists

Keynesian economists view the velocity of money as volatile and

unstable both in short run and the longer. In normal times, an increase

in the money supply was one means by which aggregate demand

could be changed.  But in a period of recession, the increase in the

money supply would have little effect.  The increase in the money

supply would reduce the interest rate.  But borrowers might not react to

the lower interest rates, borrow more, and increase their buying.  They

might not do so because of pessimistic expectations. This also

increases the investment level and consequently aggregate demand.

The resulting effect will be a rise in the price level (i.e. inflation) as well

as increased output, unless the economy is at full employment output.

c. Why is the shape of the aggregate supply curve important to the

Keynesian monetarist controversy

Keynesians believe that the aggregate supply curve is relatively flat. This

means that increases in the aggregate demand curve will add much to real

GDP and little to the price level. Monetarists believe the aggregate supply

curve is relatively steep. This means that increases in the aggregate demand

curve increase real GDP by a rather small amount, but the price level rises

sharply.

Question 15

a. Consider this statement: “banks do not create money because this is the

Central Bank’s (Reserve Bank of Australia) responsibility. Do you agree or

disagree? Illustrate and explain using a quantified example.

Disagree. It is true that the RBA is responsible for the creation of Base Money

(i.e. affecting the cash rate by affecting the money supply). However, banks can

still create money by extending new loans to their customers in the form of newly

created bank deposits. Because bank deposits are regarded as money, this

results in money being created. In this credit creation process, the so-called

money multiplier determines the extent to which banks can multiply an initial

increase in their reserves.

b. Suppose that you deposit your pay cheque drawn on another bank into

your own bank account. Explain the impact on the overall money supply

that this will have in the economy.

There is no change to the overall money supply. This is simply a transfer from

the employer’s bank to the employee’s bank.

c. Supposes that you remove $2000 from under your mattress and deposit it

in the Westpack bank. If the required reserve ratio is 10 percent, what is the

maximum amount the bank can lend from this deposit?

The maximum amount this bank can lend is equal to its excess reserves, i.e.

initial deposit of $2000 less the required reserve of $200 = $1800.

Question 18

a. the nation’s palm oit is sold in the United Kingdom.............................................ii

b. DVD recorder imported into the nation from Japan.............................................i

c. Interest earned by the nation’s residents on overseas assets.............................vi

d. Some of the nation’s residents take a holiday in Bali..........................................iii

e. Insurance over purchased in the nation by overseas residents..........................iv

f. The nation gives overseas aid to a developing country.......................................vii

g. US car company sets up a factory in the nation..................................................x

h. Running down the stock of foreign exchange in the Central Bank of the nation

............................................................................................................................

xiv

i. Migrants to the nation transferring property to the nation....................................vii

j. New deposits made in banks in the nation by overseas residents......................xii

References

1. Geoff Riley (2011, May 24). AS Macro Key Term: Demand Pull Inflation.

Retrieved May 30, 2014, from

http://www.tutor2u.net/blog/index.php/economics/print/as-macro-key-term-

demand-pull-inflation/

2. KOTAK Mutual Fund (n.d.). The main causes of inflation. Retrieved May 30,

2014, from

http://www.kotakyouandi.com/kotakyouandi/gyanshala/Economics/level1/

Economics-ch-2.html

3. Layton, A. P., Robinson, T. J., & Tucker, I. B. (2012). Economics for

today (4th ed.). South Melbourne, Vic: Cengage Learning.

4. Layton, A. P., Robinson, T. J., & Tucker, I. B. (2012). Inflation and

unemployment. InEconomics for today (4th ed., p. 326). South Melbourne, Vic:

Cengage Learning.