NSW INDEPENDENT TRIAL EXAMS – 2010
ECONOMICS Yr 11 PRELIMINARY EXAMINATION
MARKING GUIDELINES
Section I
1
B
2
C
3
B
4
D
5
A
6
B
7
C
8
A
9
D
10
B
11
C
12
D
13
C
14
B
15
C
16
D
17
B
18
C
19
A
20
A
Section II
Question 21(a)
Criteria
Marks
1
 Correctly defines the meaning of market equilibrium
0
 Incorrect answer
Suggested answer: Market equilibrium is a situation where the market demand curve and the market supply
curve intersect in order to determine equilibrium price and equilibrium quantity.
Question 21(b)
Criteria
 Correctly calculates total revenue of $24,000,000 at the original point of market
equilibrium
 Incorrectly calculates total revenue at the original point of market equilibrium
Suggested answer:
Total Revenue = Price x Quantity sold
Total revenue at the point of market equilibrium = $1,200 x 20,000
Total revenue = $24,000,000
Marks
1
0
Question 21(c)
Criteria
Marks
2
 Sketches in general terms TWO factors which would cause the demand for road bikes
to change from DD to D1D1 (an increase in demand)
1
 Sketches in general terms ONE factor which would cause demand to change from DD
to D1D1 OR identifies rather than outlines TWO factors
Suggested answer: The change from DD to D1D1 is called an increase in demand which is caused by factors
affecting demand other than price. Two of the following factors that could increase demand for this product,
should be explained:
• A rise in consumer income could increase the demand for road bikes
• An increase in the population could increase the demand for road bikes
• An increase in the popularity of a particular good or service (taste patterns) such as road bikes could
increase the demand for this product
• An increase in the price of a substitute good such as new cars, motor scooters or public transport could
increase the demand for road bikes
• A decrease in the price of a complementary good such as bike helmets, bike parking facilities or spare
parts could increase the demand for road bikes
• An improvement in technology leading to better quality road bikes could increase the demand for road
bikes
Question 21(d)
Criteria
 Provides characteristics and features of TWO factors which would affect the price
elasticity of supply
 Provides characteristics and features of ONE factor which would affect the price
elasticity of supply OR identifies TWO factors
Question 21(d) continues on the next page
Marks
2
1
NSW Independent Trial Exams 2010 – Economics Yr 11 Preliminary Examination: Marking Criteria - Page 1
Question 21(d) continued
Suggested answer:
 The level of stocks which are held by the firm can affect the price elasticity of supply. If firms have
inventories they can respond to changes in price by adjusting their supply.
 If a firm has excess capacity it can expand its level of production in order to respond to a change in price
by increasing production and supply.
 The period of time it takes for a firm to change its factor inputs in response to a change in price can affect
the elasticity of supply. Students may refer to the market period (no factors of production can be changed
or varied), the short run (some factors of production can be changed or varied) and the long run (all
factors of production can be changed or varied).
Question 21(e)
Criteria
Marks
3–4
 Inquires into the reasons why the government may intervene in certain markets
1–2
 Identifies some general reasons why the government may intervene in certain markets
Suggested answer: There are certain situations where market failure occurs and the government may
intervene in the market and provide an alternative solution.
 The government may intervene in the market by setting a maximum price (price ceiling) or by setting a
minimum price (price floor).
 The government may also intervene in the market to provide public goods, for example, the armed forces
to protect a country or flood mitigation schemes to protect farmers from damaging floods.
 Merit goods are also provided by the government including libraries, public schools, art galleries and
parks and playground facilities.
 A negative externality is another example of market failure. A negative externality arises when the price
of a good doesn’t include the social costs of the good. Pollution is an example of a negative externality.
The government may intervene and impose a tax on the polluter in order to finance the social costs borne
by the community because of the pollution caused by private production of polluting goods.
Question 22(a)
Criteria
Marks
2
 Notes the differences between primary and secondary financial markets
1
 Describes either primary financial markets or secondary financial markets but does not
distinguish between them
Suggested answer: Generally financial markets can be broken up into three broad categories: primary,
secondary and derivatives markets. Primary markets are where the initial capital raisings of corporations
(either debt or equity) are made, while the secondary markets are where existing securities are traded. Hence
once securities (such as debt, shares, bonds and options) are issued in primary financial markets they become
available for further exchange in the secondary markets. Primary markets are for initial capital raisings
whilst secondary markets provide liquidity through the buying and selling of financial instruments between
market participants.
Question 22(b)
Criteria
Marks
2
 Correctly explains why and how the Reserve Bank of Australia regulates Australia’s
financial markets
1
 Describes a feature of the Reserve Bank’s regulation of Australia’s financial markets
Suggested answer: The Reserve Bank of Australia has a major role in maintaining financial system stability
and promoting the efficiency of the payments system. The Reserve Bank pursues two broad sets of policies:
those designed to prevent financial disturbances and those that counteract the effects of disturbances if they
occur. In 1998 the responsibility for the supervision of banks was transferred from the RBA to the Australian
Prudential Regulation Authority (APRA). The Reserve Bank operates the Payments System Board to ensure
the payments system functions efficiently and also conducts a Financial Stability Review to ensure financial
stability in the Australian financial system. In exceptional circumstances it can provide lender of last resort
facilities to a major financial institution.
NSW Independent Trial Exams 2010 – Economics Yr 11 Preliminary Examination: Marking Criteria - Page 2
Question 22(c)
Criteria
Marks
2
 Indicates TWO features of the Reserve Bank’s conduct of monetary policy
1
 Indicates only ONE feature of the Reserve Bank’s conduct of monetary policy
Suggested answer: Two of the following features of the conduct of monetary policy should be addressed:
 Monetary policy aims to control consumer price inflation and encourage strong and sustainable growth of
the economy. The Reserve Bank’s operational target is to achieve 2% to 3% CPI inflation on average
over the economic cycle.
 Monetary policy decisions are made by the RBA and involve setting the interest rate on overnight loans in
the money market which is known as the cash rate.
 The RBA uses its domestic market operations to influence the cash rate. The cash rate is determined in
the money market as a result of the interaction of demand and supply of overnight funds.
 The RBA’s ability to target the cash rate stems from its control over the supply of funds which the banks
use to settle transactions among themselves. These are called exchange settlement funds and are held with
the Reserve Bank.
 Movements in the cash rate are passed through quite quickly to the whole term structure of deposit and
lending rates which ultimately affects spending and output.
Question 22(d)
Criteria
Marks
4
 Correctly explains TWO effects of an increase in the cash rate on the Australian
economy by relating cause and effect
3
 Describes rather than explains TWO effects of an increase in the cash rate on the
Australian economy by relating cause and effect
2
 Correctly explains ONE effect of an increase in the cash rate on the Australian
economy by relating cause and effect
1
 Describes rather than explains ONE effect of an increase in the cash rate on the
Australian economy
Suggested answer: Changes in interest rates can affect Australian economic activity through a number of
mechanisms. They can affect savings and investment behaviour, the spending behaviour of households, the
supply of credit, asset prices and the exchange rate, all of which affect the level of aggregate demand.
An increase in the cash rate would be implemented by the Reserve Bank of Australia to reduce the growth in
aggregate demand in order to contain inflation and rising inflationary expectations in the Australian
economy.
Two of the following effects of an increase in interest rates on the Australian economy should be explained:
 Lower levels of spending on consumer and investment goods as cash flows are reduced for households
and firms through higher interest payments on existing levels of debt
 A disincentive to borrow funds because of higher interest costs and a greater incentive to save and reduce
existing debt on the part of consumers and firms
 An increased cost of credit borrowings and purchases on the part of individuals, firms and governments.
This will reduce spending and the growth of aggregate demand
 Higher levels of capital inflow and increased demand for Australian dollars which could lead to an
appreciation of the exchange rate. This would have a dampening effect on economic growth through
lower competitiveness and export earnings
 The reduction of inflationary expectations in the economy on the part of businesses leading to a
moderation in the level of price adjustments, helping to contain price inflation
 The reduction of inflationary expectations in the economy on the part of workers leading to a moderation
in the level of wage demands, helping to contain wage inflation
 Lower levels of overall spending in the economy leading to reduced levels of output and economic
growth. This will eventually result in lower inflation and inflationary expectations through slower and
more sustainable growth in aggregate demand
NSW Independent Trial Exams 2010 – Economics Yr 11 Preliminary Examination: Marking Criteria - Page 3
Section III
Question 23
Criteria
 Integrates economic terms, concepts, issues, relationships and theory in an appropriate
context
 Uses detailed knowledge to develop a logical and cohesive answer that highlights a
clear understanding of how market equilibrium price and output are determined
 Demonstrates factually precise and extensive knowledge of how disequilibrium market
situations are resolved in the market place
 Incorporates diagrams to illustrate market equilibrium and disequilibrium market
situations
 Provides concise definitions of economic terms and applies concepts and relationships
in an appropriate context
 Uses knowledge to develop a logical and generally cohesive answer that highlights an
understanding of how market equilibrium price and output are determined
 Demonstrates factually correct and appropriate knowledge of how disequilibrium
market situations are resolved in the market place
 Uses diagrams to illustrate market equilibrium and disequilibrium market situations
 Provides clear definitions of economic terms and sound discussion of economic
concepts and relationships
 Uses knowledge to develop an answer about how market equilibrium price and output
are determined
 Demonstrates correct and usually relevant knowledge of how disequilibrium market
situations are resolved in the market place
 Uses a diagram related to market equilibrium
 Provides basic definitions of some economic terms, concepts and relationships
 Uses generalised knowledge to develop irrelevant or inappropriate answer about how
market equilibrium price and output are determined
 Demonstrates minimal knowledge of how disequilibrium market situations are
resolved in the market place.
 May use a diagram to illustrate market equilibrium
 Utilises some appropriate terminology to communicate economic issues
 Develops no logical sequence in answer
 Demonstrates a lack of knowledge about market equilibrium and disequilibrium
situations
 Does not include any economic diagrams in relation to market equilibrium
Essay plan:
Marks
17–20
13–16
9–12
5–8
1–4
A market is a situation which brings together buyers and sellers of goods and services for the purpose of
exchange. The demand by consumers for goods and services is illustrated by a demand schedule which
shows the quantities of goods and services buyers are willing and able to purchase at various price levels at a
given period of time. The supply of goods and services is illustrated by a supply schedule which shows the
quantities of goods and services sellers are willing and able to offer for sale at various price levels at a given
period of time. Where the demand and supply of a good or service are equal, market equilibrium price and
quantity or output are determined.
The relationship between price and the quantity demanded of a good or service by consumers is shown
using a demand curve. The demand curve is a downward sloping curve. It shows the inverse relationship
between price and quantity. This downward slope of the demand curve is a reflection of the law of demand
which states that more goods and services are demanded at lower prices, and less goods and services are
demanded at higher prices. Demand curves used in economic analysis are usually market demand curves
which show the total of individual demands for particular goods and services at a particular point in time.
Question 23 continues on the next page
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Question 23 continued
The supply of goods and services is illustrated through a supply schedule. A supply schedule shows what
sellers are willing and able to sell at various price levels at a given period of time. The supply schedule is
usually a market supply schedule of firms willing to supply different quantities of output over a range of
prices. The law of supply states that the quantity supplied tends to vary directly or positively with price.
This means that producers will only be willing to supply more products in a market as price increases, and
be less willing to supply products in a market as price decreases. The supply curve is therefore an upward
sloping curve. Suppliers are basically driven by the motive of profit maximisation and will increase supply
if there is a prospect of making higher profits. Producers will cut back supply in markets if prices fall, to
minimise losses from the sale of their output.
The relationship between price and the quantity supplied is shown using a supply curve. The supply curve is
an upward sloping curve. It shows the direct relationship between price and quantity, with more goods and
services being offered for sale at higher prices and less goods and services being offered for sale at lower
prices.
Market equilibrium price and quantity are established at the point of intersection of the supply and demand
curves. This means that the quantity demanded is exactly equal to the quantity supplied at the market price.
Equilibrium in the market means that there is no tendency for change in the market price or the quantity of
output at that particular point in time. However, due to the dynamic operation of the market place (with
changing demand and supply conditions), equilibrium price and quantity are constantly changing. A change
in the determinants of demand and supply can shift their respective curves causing a new equilibrium price
and quantity or level of output to be established. Better students may refer to shifts in the demand and supply
curves and how these can cause changes in equilibrium prices and quantities in the market. For example, an
increase in demand will lead to a rise in price and quantity, whereas a decrease in demand will lead to lower
price and quantity in the market. On the other hand an increase in supply will lead to a lower equilibrium
price and higher equilibrium quantity, whereas a decrease in supply will lead to a higher equilibrium price
and lower equilibrium quantity in the market.
Market disequilibrium occurs when there is a disparity between demand and supply in the market place.
If the quantity supplied is greater than the quantity demanded, a surplus of a good or service will arise in the
market place. This will occur at a price above equilibrium price and quantity. In order for equilibrium to be
re-established firms will reduce their price to clear the surplus in the market. Supply will contract towards
equilibrium and demand will extend towards equilibrium. Ultimately equilibrium will be restored at a lower
price and equilibrium quantity will be established.
Disequilibrium may also occur when there is a shortage of a good or service in the market. This will occur at
a price below equilibrium price and quantity. In this situation the quantity demanded is greater than the
quantity supplied. Consumer competition will tend to force up prices. Price will rise and suppliers will
extend their supply and consumers will contract their demand. Equilibrium will be re-established at a higher
price and equilibrium quantity will be established.
(Students should use diagrams to illustrate market equilibrium and disequilibrium situations and solutions).
Equilibrium analysis helps economists to understand and predict how changes in market conditions will
affect equilibrium prices and quantities. Price changes and price signals in markets perform a number of
important functions in a market economy:
 Prices help to ration available goods and services between competing consumers and therefore act as a
rationing device.
 Prices help to allocate resources between competing uses in production and therefore assist in the process
of resource allocation.
 Prices act as signals to producers and consumers to adjust their behaviour in terms of achieving the goals
of profit maximisation (producers) and utility maximisation (consumers).
NSW Independent Trial Exams 2010 – Economics Yr 11 Preliminary Examination: Marking Criteria - Page 5
Question 24
Criteria
 Integrates economic terms, concepts, issues, theory and relationships in an appropriate
context
 Defines the labour market and draws and explains a labour market diagram/s
 Explains the factors affecting the demand and supply of labour
 Synthesises own knowledge to develop a logically sequenced answer on factors
affecting the demand and supply of labour and how these have changed in recent years
in Australia
 Provides concise definitions of economic terms and applies concepts and relationships
in an appropriate context
 Defines the labour market and draws and explains a labour market diagram/s
 Outlines the factors affecting the demand and supply of labour
 Develops a logically sequenced answer on recent trends in the demand and supply of
labour in Australia and how these have changed in recent years
 Provides clear definitions of economic terms and sound discussion of the labour
market
 Develops a logical sequence in the answer
 Defines the labour market
 Attempts to explain recent trends in the demand and supply of labour in Australia
 Utilises some appropriate terminology to communicate economic ideas
 Attempts to develop a logical sequence in the answer
 Attempts to define the labour market
 Demonstrates minimal appropriate knowledge on recent trends in the demand and
supply of labour in Australia
 Utilises some appropriate terminology to communicate economic ideas on the labour
market
 Develops no logical sequence in the answer
 Demonstrates a lack of knowledge of recent trends in the demand and supply of labour
in Australia
Essay plan:
Marks
17–20
13–16
9–12
5–8
1–4
Labour is the contribution of people to the production process and is an important factor of production. In
return for its contribution to production, labour is paid wages as a source of income. For employers the
payment of wages represents the cost of using labour in production. The labour market refers to the demand
and supply of labour leading to an equilibrium wage and quantity of employment. In Australia the labour
market consists of employees (who offer their labour skills in return for the payment of wages) and
employers (who demand labour to fill job vacancies at differing wage rates). The demand for labour is a
derived demand since it is derived from the demand for final goods and services.
As at June 2010 the Australian labour force totalled 11,699,100 persons (male and female). The labour force
is made up of full time persons (7,794.700 persons), part time persons (3,306,000 persons) and the
unemployed (598,400 persons). The total labour force was 11,699,100 persons in June 2010 and this
represented a participation rate of 65.2% of the working age population of 17,955,500 persons. The 598,400
persons classified as unemployed represented 5.1% of the Australian labour force in June 2010.
The Australian labour force grew from 9,394,500 persons in 2002-03 to 11,699,100 in 2010. This reflected
general growth in the economy of 3% to 4% per annum, which required an increased volume of employment.
One of the most recent trends in the Australian economy is the emergence of labour skills shortages in
particular industries and occupations where the supply of specialist labour skills has not kept pace with the
overall demand for these skills. Examples include trades skills and professional skills.
Question 24 continues on the next page
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Question 24 continued
Both macroeconomic and microeconomic factors can affect the demand and supply of labour.
Macroeconomic factors are economy-wide factors such as the level and growth of aggregate demand which
affects the overall demand for labour resources in the economy. On the supply side, the general rate of
population growth and rate of skilled immigration will affect the overall supply of labour in the economy.
Microeconomic factors at the firm or industry level include the nature of production which will determine
labour demand and the supply of educated and skilled persons required in a particular industry or occupation.
Better students would include a diagram of the labour market for a certain industry or occupation to illustrate
the determination of the equilibrium wage rate and level of employment. In macroeconomic terms the main
factors affecting the demand for labour include the following:
 The overall level and growth in economic activity. Higher economic growth in Australia will require
increased volumes of part time and full time employment.
 The productivity of labour will influence labour demand as higher productivity will increase the demand
for labour as it is more productive in the production process.
 The general level of wages reflects the cost of employing labour by employers.
 Government industrial relations (IR) policies and the level of industrial disputation will influence labour
demand. If IR policies are positive and disputation is low there will be strong labour demand.
In macroeconomic terms the main factors affecting the supply of labour include the following:
 The size of the population and the age distribution of the population: Whilst Australia’s population has
grown by around 2% per annum in recent years, there is an ageing of the population and an increased
reliance on skilled migration to meet specific shortages of skilled labour.
 The participation rate of the working age population at over 65% has been high in Australia in recent
times. This high participation rate has helped to maintain the supply of labour in the economy.
 The average number of hours worked has remained high, meaning that productivity has been maintained,
although with up to 30% of the employed labour force working part time there is a significant level of
underemployment, where many people want to work more hours.
At the microeconomic level of activity in various firms and industries the demand for labour is influenced by
a variety of factors:
 The nature and size of industries: Increased output by mining companies has seen a large rise in the
demand for labour in the resources sector of the Australian economy concentrated in WA and Qld.
 The productivity of labour has risen in certain industries because of new technology, the use of flexible
enterprising bargaining arrangements, government training schemes and the use of outsourcing/subcontracting by many firms.
 Higher wages and improved conditions in growing industries such as mining and trades have reflected
increased demand for skilled labour.
Factors affecting the supply of labour at the microeconomic level of activity include the following:
 Differential wage rates, remuneration and improved working conditions, (especially family oriented
workplaces with child care facilities) are used by employers to attract and retain labour. The Fair Work
Act 2009 legislated improvements to the Safety Net through the National Employment Standards, Modern
Awards and annual adjustments to the National Minimum Wage.
 Education and training qualifications: There has been a recent emphasis on human capital formation
through skills, experience, education/training levels provided by government training schemes and a
proposed increased school leaving age (i.e. Learn or Earn).
 Occupational and geographic mobility of labour is encouraged by governments through trade training
centres and assistance with relocation to regions with higher prospects for employment.
 More flexible work arrangements such as job sharing, part time and shift work are used by employers in
retailing, services and manufacturing to allocate labour more efficiently and help employees to achieve a
better work/family balance. These types of arrangements also helped to minimise the level of
retrenchments and unemployment during the Global Financial Crisis in 2008-09.
Question 24 continues on the next page
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Question 24 continued
The Australian labour market has become more flexible in operation in recent years due to the reform of
workplace relations and the changing nature of work. The Fair Work Act 2009 continued previous reforms
by supporting the spread of collective workplace agreements where wages and working conditions are
negotiated at the enterprise level. In addition, the rationalisation of awards to 120 Modern Awards, which
also contain a flexibility clause, gives lower paid workers the opportunity to raise productivity in return for
higher wages. In Australian workplaces there is increasing use of new technology and the training of workers
to increase their skills. Governments have also increased incentives for older workers to remain in the
workforce for longer periods to increase their participation and add to the skills base of the labour force.
Section IV
Question 25
Criteria
 Identifies the broad functions of the government
 Demonstrates a clear and concise understanding of the role of government policy in
the stabilisation of economic activity and the redistribution of income in the Australian
economy
 Integrates an extensive and appropriate range of economic terms, with relevant
concepts, relationships and theory
 Synthesises own knowledge with the information provided to develop a sustained,
logical and well-structured response
 Identifies some of the broad functions of the government
 Demonstrates an understanding of the role of government policy in the stabilisation of
economic activity and the redistribution of income in the Australian economy
 Consistently applies appropriate economic terms, relevant concepts, relationships and
theory
 Uses own knowledge with the information provided to develop a logical and structured
response
 Identifies some of the broad functions of the government
 Demonstrates some understanding of the role of government policy in the stabilisation
of economic activity and the redistribution of income in the Australian economy
 Applies appropriate economic terms, concepts and relationships
 Uses own knowledge with the information provided to develop a coherent response
 Identifies at least ONE of the broad functions of the government
 Sketches in general terms the role of government policy in the stabilisation of
economic activity and the redistribution of income in the Australian economy.
 Uses some appropriate economic terms, concepts and relationships
 Uses information to develop a generalised response
 Refers to the role of government
 Lists some aspects of the role of government economic policy
 Uses some economic terms and/or concepts
 Presents a limited response
Essay plan:
Marks
17–20
13–16
9–12
5–8
1–4
The broad economic functions of the Australian government include the reallocation of resources and the
redistribution of income through taxation and government expenditure; the stabilisation of economic activity
through the use of monetary and fiscal policies and the provision of goods and services through public
trading enterprises. Changes to the government’s fiscal policy stance are announced and implemented
through the budget process.
Fiscal policy along with monetary policy provide the main macroeconomic policy tools that the government
can use to keep the economy growing at a sustainable pace, with low inflation and low unemployment. They
are also the policy tools the government can use to try and shorten recessions and to prevent booms in
economic activity from becoming excessive. This has traditionally been termed stabilisation policy.
Question 25 continues on the next page
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Question 25 continued
Fiscal policy is implemented through the use of a particular group of variables known as the fiscal
instruments. The instruments of fiscal policy are expenditure and revenue which are under the direct control
of the government. They are represented by rates of taxation, rates of transfer payments and levels of
government expenditure of various types.
The spending and revenue plans of the government for the fiscal period are announced through the
government budget. The budget brings the revenue and spending sides of the government’s finances together
and shows whether these finances are in surplus, deficit or balance for the year. The budget balance is
measured by the difference between total government revenue and expenditure. The three possible outcomes
for the budget are:
 Surplus: Revenue exceeds expenditure and the budget balance is positive
 Balance: Revenue equals expenditure and the budget balance is zero
 Deficit: Expenditure exceeds revenue and the budget balance is negative
Monetary policy is the instrument of macroeconomic policy that is concerned with influencing the cost and
availability of money and credit in the Australian economy. The Reserve Bank of Australia is charged with
the responsibility for the operation of monetary policy. The implementation of monetary policy combined
with fiscal policy and microeconomic reform are used to achieve the Australian government’s economic
objectives of internal balance (i.e. price stability and full employment) and economic growth.
The Reserve Bank principally implements monetary policy in the short term money market. An easing of
monetary policy (i.e. an expansionary stance) involves the Reserve Bank purchasing existing
Commonwealth Government Securities (CGS) and Repurchase Agreements (RPAs). This increases funds in
the cash market and puts downward pressure on the official cash rate. On the other hand a tightening of
monetary policy (i.e. a contractionary stance) involves the Reserve Bank selling Commonwealth
Government Securities and Repurchase Agreements to commercial banks in the cash market. This puts
upward pressure on the official cash rate. By changing the stance of monetary policy the Reserve Bank
attempts to influence domestic interest rates, the general level of economic activity, prices and the exchange
rate through the monetary transmission mechanism.
It is the presence and impact of automatic stabilisers (taxes and transfer payments in particular) which enable fiscal
policy to exert a stabilising force on economic activity. Automatic stabilisers such as income taxes and
unemployment benefits respond automatically to expenditure and output gaps in the economy. When GDP
declines, income tax collections fall due to the fall in household taxable income while unemployment and other
welfare benefits rise. These changes in government spending and tax collections are automatic i.e. they require no
explicit action by the government. They serve to increase the level of planned spending during recessions and
reduce it during expansions without the delays associated with the legislative procedures that accompany the
budget process.
During the recent global economic crisis in 2008-09 the global economy plummeted into recession and Australia
faced its own economic downturn. Some economic commentators were suggesting that up to 500,000 Australian
jobs could be lost during 2009-10. The Australian Government took decisive action by using expansionary fiscal
policy through a number of initiatives including the $10.4 billion Economic Security Strategy, and the $42 billion
Nation Building and Job Plan. Along with the 2009 Budget (fiscal deficit of $53 billion or 4.5% of GDP) these
measures were crucial in preventing the unemployment rate from rising above 5.9% during the depths of the global
downturn.
During this period the stance of monetary policy was also eased with the cash rate lowered through six separate
adjustments between September 2008 and April 2009 from 7.25% to 3%. The countercyclical role of fiscal policy
was supported by stimulatory monetary policy. In September 2008 the Reserve Bank implemented the first of its
cash rate changes, with a decrease of 0.25%, making the cash rate 7%. This was followed by a series of reductions
in the cash rate so that by April 2009 the cash rate had been lowered to 3%. This was a significant change in the
stance of monetary policy with the Reserve Bank adopting an expansionary stance for monetary policy. This stance
involved the Reserve Bank buying back government securities, which increased the supply of funds and decreased
the cash rate in Australia.
Question 25 continues on the next page
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Question 25 continued
Fiscal policy can also be used to redistribute income, mainly through progressive income taxes and changes
to income tax thresholds and marginal tax rates. Furthermore, through social security/welfare programmes
the government has the capacity to influence income distribution. This usually involves direct payments to
low income households. In this context, the government is using the fiscal instruments to influence income
distribution after taxes and transfers. Government policies aimed at reducing income inequality are primarily
designed to redistribute income and wealth in order to reduce the social and economic disadvantage suffered
by low income members of the community. In most advanced economies a system of tax–transfers is used to
reduce inequality in the distribution of income and wealth. This usually involves the use of progressive
income taxes and transfer payments such as pensions and unemployment benefits to support low income
earners, families with children on a single income, the unemployed and other disadvantaged groups.
Transfer payments in the form of pensions, job search allowances and family benefits have been used to
provide income support for targeted groups such as single parents, large single income families, the
unemployed and the disabled. These groups generally receive the lowest incomes in any economy and this
type of income support helps to raise the household income received by the least fortunate members of
society. Wages policy can also be used by the government to redistribute income. Provisions have been made
by the Commonwealth Government through the social wage to establish a safety net of minimum wages and
working conditions to be applied across various occupations and industries. In countries like Australia this
has been achieved through the Modern Award wage system and the ten National Employment Standards
where awards set out the rates of pay, leave entitlements and other benefits a worker is to be afforded by
their employer. The award wage system has been used to provide a minimum level of income and working
conditions for workers with low skills and low bargaining power in the labour market. For example, in June
2010 Fair Work Australia (FWA) the Federal Government’s new industrial relations institution increased
minimum award rates by 4.8% ($26 a week). This increase for low paid workers was expected to benefit
around 1.4 million Australians.
Reference could be made to recent budget statements in order to demonstrate how the budget has been used
to influence the redistribution of income in the Australian economy. For example, in the 2010
Commonwealth Budget another round of tax cuts was announced to assist working families encompassing
the raising of the low income offset to $1,500 in order to provide an effective tax free threshold of $16,000
for Australians with an income of up to $30,000. The Government was also claiming to assist aspiring first
home buyers through concessionally taxed First Home Saver Accounts which would be allowed a 50%
discount on up to $1,000 of interest earned. In the 2008 Commonwealth budget steps were taken by the
government to ensure a more equitable distribution of income amongst Australian households. The 2008-09
budget included measures designed to:
 Ensure that working families are rewarded for their effort and helps ease cost of living pressures through
tax cuts.
 Help working families by cutting income tax and reducing the costs of looking after and educating
children.
 Implement a housing affordability package, making it easier for families to buy their first home and boost
the supply of affordable housing for rent and purchase.
 Ensure that grocery and petrol prices (through the National Fuel Watch Scheme) are competitive.
Question 26
Criteria
 Identifies clearly the factors that influence the level of interest rates
 Demonstrates a clear and concise understanding of the role of the Reserve Bank in
determining the cash rate
 Integrates an extensive and appropriate range of economic terms, with relevant
concepts, relationships and theory
 Synthesises own knowledge to develop a sustained, logical and well-structured answer
Marks
17–20
Question 26 continues on the next page
NSW Independent Trial Exams 2010 – Economics Yr 11 Preliminary Examination: Marking Criteria - Page 10
Question 26 continued
 Identifies generally the factors that influence the level of interest rates
 Demonstrates an understanding of the role of the Reserve Bank in determining the cash
rate
 Consistently applies appropriate economic terms, relevant concepts, relationships and
theory
 Uses own knowledge to develop a logical and structured answer
 Identifies some of the factors that influence the level of interest rates
 Sketches in general terms the role of the Reserve Bank in determining the cash rate
 Applies appropriate economic terms, concepts and relationships
 Uses own knowledge to develop a coherent response
 Identifies some of the factors that influence the level of interest rates
 Sketches in general terms the role of the Reserve Bank in determining the cash rate
 Uses some appropriate economic terms, concepts and relationships
 Uses own knowledge to develop a generalised response
 Refers to some of the factors that influence the level of interest rates
 Lists some aspects of the role of the Reserve Bank in determining the cash rate
 Uses some economic terms and/or concepts
 Presents a limited response
Essay plan:
13–16
9–12
5–8
1–4
Interest is the return to the factor of production capital. Interest is the reward or payment for saving or
postponing consumption to a date in the future. Therefore if individuals, firms or entrepreneurs want to
borrow savings for consumption or investment purposes they must pay interest to the lender. Interest rates
are the annual percentage cost of borrowing funds in financial markets, where savings are matched with
investment by financial intermediaries. There are both short and long term interest rates depending on the
type of financial instrument that is used. Examples of short term interest rates include the official cash rate
(determined by the Reserve Bank), credit card rates, business loan rates and overdraft rates for small and
large businesses. Longer term interest rates include mortgages for residential housing, term loans for
businesses and loans to governments through the sale of government bonds.
There are a number of factors that influence the level of interest rates. Primarily the level of interest rates is
determined by the demand and supply of loanable funds in financial markets. The demand for loanable funds
is sourced from households, firms and governments that wish to borrow funds. These sectors may have a
deficit in cash and therefore need to borrow funds from lenders who have a surplus in cash. The supply of
funds in financial markets is sourced from the savings of households and firms as well as any surplus funds
that governments may have accumulated through budget surpluses or the sale of public assets through
privatisation. These surplus funds or the supply of loanable funds are deposited with financial intermediaries
in return for interest payments. Financial intermediaries in turn, on-lend these surplus funds to borrowers at a
higher rate of interest and make profits. If the overall demand for loanable funds exceeds the supply of
loanable funds the general level of interest rates will rise. This situation could arise if there is a strong rate of
economic growth, rising incomes and therefore more opportunities for consumption and investment
spending. This would lead to a rise in borrowing relative to deposits of funds.
However, if the rate of economic growth is below trend and there is rising unemployment and falling
incomes, the demand for loanable funds will tend to be less than the supply of loanable funds. In such cases
the general level of interest rates will tend to fall as financial intermediaries cut interest rates to attract
borrowers for lending. It is important to note that financial intermediaries act like profit maximising firms in
seeking to borrow funds from the public at lower rates of interest (i.e. borrowing rates) than they charge for
lending to the public (i.e. lending rates). The difference between borrowing rates and lending rates is the
interest rate spread or margin, used by financial intermediaries to pay costs and retain a margin for profit.
Question 26 continues on the next page
NSW Independent Trial Exams 2010 – Economics Yr 11 Preliminary Examination: Marking Criteria - Page 11
Question 26 continued
A second important factor which influences the level of interest rates is the risk and reward principle. The
higher the risk of a financial instrument the higher will be the interest rate charged by the lender to the
borrower. The main sources of risk include the risk of default, the risk of lower purchasing power through
higher inflation, and the loss of liquidity due to the varying terms to maturity of different financial assets.
Therefore loans that are not secured by assets such as credit card loans and overdraft loans to businesses tend
to attract a higher rate of interest than loans which are secured by assets such as mortgages.
Related to the risk and reward principle is the increase in risk aversion of lenders during times of economic
uncertainty and widespread loan defaults. This occurred during the Global Financial Crisis when banks and
other intermediaries became more risk averse in their lending. The result was that access to global credit
markets was restricted and the cost of global credit rose substantially.
A third factor which influences the level of interest rates is the rate of inflation. Inflation is the general rate of
increase in the price level over time. Higher inflation will erode the real return to lenders and to compensate
for this loss, lenders will want to increase the rate of interest. In this sense there is a distinction between
nominal and real rates of interest. If the nominal interest rate on a mortgage loan was 8% and the rate of
inflation was 3%, the real rate of interest would be 5%. However if inflation rose to 5% mortgage lenders
would seek to raise the nominal rate of interest to 10% to maintain the real interest rate or real return at 5%.
This helps to explain why countries with rising inflation tend to have rising levels of interest rates.
The level of interest rates is best referred to as the term structure of interest rates. The term structure of
interest rates refers to the relationship between short term and long term interest rates. A normal yield curve
which shows the relationship between short term and long term interest rates is upward sloping since short
term interest rates are lower than long term interest rates. This is because there is a longer time to maturity
for long term financial assets, and lenders must be compensated for their lack of liquidity since the loan may
not be paid back in full, with interest, for up to 10 years. Also inflation can be expected to be higher in the
longer term than the shorter term, so the loss of the lender’s purchasing power must be compensated for
through a higher long term interest rate.
However the term structure of interest rates can be influenced by the Reserve Bank’s determination of the
cash rate in the cash market. A normal upward sloping yield curve as previously described is usually
associated with an expansionary stance of monetary policy where the Reserve Bank has acted to reduce the
official cash rate to encourage spending and a higher rate of economic and employment growth. For
example, the global financial crisis and recession in the second half of 2008 impacted on Australian financial
markets and the Australian economy. The immediate effects were a loss of consumer confidence, lower
spending and output, and greater volatility in financial markets including the share market and credit
markets. The response of the Australian government and Reserve Bank was quick and decisive:
 The Reserve Bank cut interest rates by 3% between September and December 2008 and a further 1.25%
between February and April 2009. This lowered the cash rate from 7.25% to 3%.
 The Reserve Bank supported confidence and stability in the Australian financial system by injecting
additional liquidity into the cash market to ensure adequate funds for exchange settlement. The Australian
government also gave guarantees for bank deposits.
These actions helped to create a normal yield curve as a lower cash rate led to lower short term and long term
interest rates to encourage borrowing and spending to support economic and employment growth.
The cash rate is the interest rate on overnight loans in the cash market. The Reserve Bank sets a target level
for the cash rate each day and uses its open market operations to achieve the target. The Reserve Bank can
also ease or tighten the stance of monetary policy by operating in the cash market as a buyer or seller of
Commonwealth Government Securities (CGS) and Repurchase Agreements (RPAs) to lower or raise the
cash rate. It is through its market operations that the Reserve Bank can implement a change in the stance of
monetary policy. This would be done to achieve its operational target of monetary policy, which is to keep
CPI inflation between 2% and 3% over the economic cycle.
Question 26 continues on the next page
NSW Independent Trial Exams 2010 – Economics Yr 11 Preliminary Examination: Marking Criteria - Page 12
Question 26 continued
The cash rate is generally determined by the demand and supply of cash in the cash market. The cash market
performs the function of providing access to cash for large banks and other financial intermediaries to settle
debts between themselves on a daily basis. All institutional participants in the cash market operate Exchange
Settlement Accounts (ESAs) with the Reserve Bank of Australia. The balances in ESAs must be kept in
surplus and the Reserve Bank pays interest (at below the cash rate) on these surplus funds. The cash rate
remains fairly stable over time because the Reserve Bank ensures that the demand for cash is met by an equal
supply of cash. If the demand for cash exceeded the supply of cash the Reserve Bank would inject more cash
into the market by buying Commonwealth Government Securities and re-purchasing Repurchase
Agreements from banks and other financial intermediaries. This is called liquidity management.
On the other hand if the demand for cash was less than the supply of cash the Reserve Bank would sell CGS
and RPAs to remove excess liquidity from the cash market and hold the cash rate at its target level.
Between September 2008 and April 2009 the cash rate was cut six times, as an expansionary easing cycle
was used by the Reserve Bank to support economic activity in Australia, as the GFC led to much weaker
world growth and recessions in major advanced economies like the USA, Japan and Euro area. However, by
the end of 2009 economic conditions had improved in Australia and the Reserve Bank began a tightening
cycle by raising the cash rate by 1.5% between October 2009 and May 2010. This was done in six steps of
0.25%, resulting in the cash rate rising from 3% to 4.5%. The reason for this more contractionary stance of
monetary policy was to contain inflationary pressures and expectations which were beginning to rise as the
economic recovery strengthened in 2010. These actions led to a general rise in the level of interest rates in
financial markets and tended to dampen spending and borrowing in the Australian economy.
However the tightening cycle of rises in the cash rate were discontinued by the Reserve Bank between June
2010 and August 2010 as economic conditions deteriorated again in the global economy because of a
Sovereign Debt Crisis in Europe. This was sourced from rising budget deficits and public debt in countries
such as Greece, Spain, Portugal, Italy and the UK which led to financial market volatility and uncertainty.
NSW Independent Trial Exams 2010 – Economics Yr 11 Preliminary Examination: Marking Criteria - Page 13
NSW INDEPENDENT TRIAL EXAMS – 2010
ECONOMICS Yr 11 PRELIMINARY EXAMINATION
MAPPING GRID
Question
Section I
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Section II
21(a)
21(b)
21(c)
21(d)
21(e)
22(a)
22(b)
22(c)
22(d)
Section III
23
24
Section IV
25
26
Marks
Outcome(s) assessed
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
P1, P2
P1, P2
P1, P11
P1, P8
P1, P3, P11
P1, P8
P1, P3
P1, P10
P1, P3, P11
P1, P8, P10, P11
P1, P2, P5
P1, P9, P11
P1, P2
P1
P1, P3
P1, P2, P3, P11
P1, P3
P1, P3
P1, P2, P11
P1, P2
1
1
2
2
4
2
2
2
4
P1
P1, P11
P1, P3
P1, P3
P1, P3, P6, P8, P10
P1
P1, P2, P5
P1, P2, P5
P1, P2, P3, P5, P6
20
20
P1, P3, P8, P10
P1, P2, P3, P5, P7, P8, P10
20
20
P1, P2, P5, P6, P7, P8, P10
P1, P2, P3, P5, P6, P7, P8, P10
NSW Independent Trial Exams 2010 – Economics Yr 11 Preliminary Examination: Marking Criteria - Page 14