Introductory Macroeconomics, ECON10003
Assignment 1
Answer 1):
The Free Trade agreement that has been established between Australia and Indonesia consists of
removing tariffs on goods traded between the two countries. This agreement brings changes that
directly affect aggregate demand, a concept that represents the total amount of expenditure
within an economy. Aggregate demand is made of 4 components: consumption, investment,
government spending and net exports i.e. exports-imports.
The equation/Keynesian model is:
𝐴𝐷 = 𝐶 + 𝐼 + 𝐺 + (𝑋 − 𝑀)
The free trade agreement impacts three of the components: consumption by households, business
investments and net exports. Due to the removal of tariffs on imports, the overall import prices
decrease. This in turn, increases the purchasing power for the consumers based in Australia
which means, households purchase more goods with the same amount of income. This results in
increase of overall consumption. Moreover, exports of Australian goods to Indonesia increase as
well, since businesses do not have to pay tariffs. Due to this, the trade opportunities effectively
increase, and firms invest in production as they expect larger demand for their goods.
Changes in Equilibrium
-
Before the free trade agreement, the market was at an initial equilibrium where the total
spendings = total output. Businesses produced just enough to meet the consumer demand.
After the free trade agreement, demand increased and hence, total spendings on
production and net exports increased as well. Businesses recruited more people causing a
decrease in the unemployment rate and growth in the overall economic performance.
Answer 2):
The finance minister’s argument that increasing the minimum wage will cause a lot
of job losses can be explained through the competitive labor market model:
- As seen at equilibrium wage, the number of jobs supplied by businesses is
the same as number of jobs demanded by the workers.
- However, if the minimum wage is above the equilibrium wage, then the
labor demand would fall as businesses would hire less workers. On the other
hand, labor supply would increase as more people would be willing to work
at an increased wage rate. This will result in a significant increase in
unemployment rate and job losses. Hence, the finance mister is correct in
assuming an increase in minimum wage rate would trigger more job losses.
However, some parts remain uncertain to the flexibility of the labor market.
Answer 3):
a): The reason why RBA targets an inflation rate range between 2% to 3% to
ensure stable economic performance. If the inflation is lower than this range, then
it can lead to slower economic performance, increase unemployment rate and
decrease overall spending. Consumers tend to spend less due to expecting further
decrease which reduces overall demand. This leads to businesses earing lesser
revenue and job losses.
b): To increase the inflation rate, the RBA can decrease interest rates and
encourage household/businesses borrowing, consumer spending and business
investments. As aggregate demand would increase, businesses would increase
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production, lower unemployment and more output (increased GDP) would be
produced.
- As AD curve shifts towards right, the price levels and real output (GDP) will
increase. This means the output increases and the overall unemployment rate
decreases in the short run. However, this also means that there is an increase
in inflation rate due to more demand.
c): At the initial long/short-run equilibrium, inflation and economy is
constant/stable. However, after AD shifts, there is change in the short-run
equilibrium. This leads to higher output production and economic growth, but the
costs are not adjusted. Furthermore, output is produced beyond full employment
output.
Eventually in the long-run, short run aggregated supply readjusts itself and shifts to
the left due to factors like shortage of labor supply, shortage of output. This means
that inflation rises further but the output goes back to producing at full
employment. The economy returns to long-run equilibrium but at a high
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Answer 4):
The Solow-Swan model discusses total output growth in relation factors such as
capital stock, labor force and technology advancement. As there is an increase in
the capital stock, advancing technology, infrastructure development and strong
governance, the economy of the country has grown. Moreover, due to the emphasis
on the service sector, productivity levels have increased, leading to greater output
and improved working conditions.
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