Answers To Questions On Goods Classification, Unemployment, Inflation, And Economic Growth Essay.

Question 1
a) Classify each of the following items as a final good or service or an intermediate good or service and identify which is a component of consumption expenditure, investment or government expenditure on goods and services:
(i) Banking services bought by Coles.
(ii) Security system bought by the ANZ Bank.
(iii) Coffee beans bought by McDonald’s.
(iv) New coffee grinders bought by Starbucks.

b) Would GDP per capita comparisons accross countries accurately indicate their relative levels of living standard and economic welfare? Critically evaluate and answer this question.
Question 2
a) The unemployment rate has recently fallen in the United States to the record low. Some economists have stated that this is not a sign of good news, but rather bad news. 
                               (i) Why does this mean that the drop in unemployment is bad news?
                               (ii) What types of unemployment are included in the natural rate of unemployment?
b) There is considerable interest Australia in whether the minimum wage rate contributes to youth unemployment. Draw a supply and demand diagram for the unskilled labour market, and discuss the effects of a minimum wage. Who is helped and who is hurt by the minimum wage?
Question 3
a) Contrast the phenomenon of cost-push inflation with demand-pull inflation and likely impact of each on the price level and GDP using aggregate demand and aggregate supply analysis (including graphs).

b) The Turnbull government recently signed a contract with a French company to build new submarines and plans to spend $60b for the Australian Navy submarines. These ships will be built in South Australia. Assuming fixed prices and that all monies will be spent in Australia, explain how the Australian economy will be affected by the $60b in new government purchases using AD-AS framework. (Remember: If you do not talk about the AD and AS curves, you are not using the AD-AS model.)
Question 4
a) Based on the simple quanity theory of money, what would be the impact of increasing the money supply by 25%
b) Suppose the consumer price index (CPI) stands at 250 this year. If the inflation rate is 10 per cent, what the next year’s CPI will equal?
c) What the consumption function explains? 
d) A community's saving rate is an important determinant in the model of economic growth.  Suggest a couple of ways in which policy makers may influence a nation's saving rate. 

Question 1

Part A

(i)  Banking service would be termed as a final service since it would be consumed without any more processing at the end of consumer.  Since, Coles is availing the banking services, hence the concerned spending would be categorised as consumption expenditure (Barro, 2017).

(ii) Security system would be termed as final product as it would be deployed by ANZ Bank without engaging in more processing. Since, this is not a consumable but rather an investment on the part of the bank to extend service, hence it will be categorised as investment expenditure (Froyen, 2013).

(iii) The coffee beans that are sold to McDonalds would be processed further before being sold to customers in the form of coffee beverage. Therefore, this would be categorised as an intermediate food. Further, since coffee beans are consumed at McDonalds, hence it will be categorised as consumer expenditure (Koutsoyiannis, 2013).

(iv)The coffee grinder is a product which can be used without any more processing and thereby it is a final product.  Besides, in context of Starbucks, the coffee grinder is an equipment which is used and hence would be termed as investment expenditure (Mankiw, 2016).

Part B

A common indicator for measuring the national economic development is GDP. But since population has a significant impact on GDP, therefore it is not fair to compare the GDP of two or more nations to comment on their respective economic development. A better measure in this regards is GDP per capita. Even though it is often used for comparing the economic development across nations, there are certain issues with the usage of GDP per capita as a measure of economic welfare and living standards that are indicated below (Krugman & Wells, 2015).

• The income distribution pattern is not captured by GDP per capita since it only highlights the average value which is assumed to be true for every citizen of the corresponding nation. However, this may not be true especially in case of developing nations where there is significant disparity of wealth and hence GDP per capita may present a distorted image.
• The various measures of living standard such as access of quality healthcare, education, sanitation etc. are not represented by the GDP per capita. It is only assumed that if the GDP per capita is at a particular value, then the corresponding improvement in standard of living would be same across nations which is not necessarily true.

Question 2

Part A

(i) The significant drop in rate unemployment could be a bad news as this would result in wage level increase owing to increasing demand and limited supply of labour. With the increase in wages, the producers would have higher cost which then would be levied on the consumers which would lead to inflation.  Due to higher prices of goods and services, it is possible that the export competitiveness would be adversely impacted. Also, owing to increasing cost of labour coupled with shortage of labour, it is possible that some firms may outsource some of the jobs requiring high labour to cheaper destinations (Krugman & Wells, 2015).

(ii) The following unemployment types are included in the natural unemployment rate  (Mankiw, 2016).

• Structural Unemployment – This type of unemployment is the result of structural economic changes owing to which there is an alteration in the skill requirement. Thus, since all the labour force would not have the requisite skills, hence some of people with redundant skills would not be able to secure a job and remain unemployment.
• Frictional Unemployment- This type of unemployment is the result of people shifting jobs. Typically, when people make this shift there is a brief period of unemployment in between when the efforts for securing a better job might be continuing after leaving the previous job.
  

Part B

The impact of minimum wage on the unskilled labour market can be represented using the following diagram (Barro, 2017).

It is evident that there is an inverse relation between the demand for unskilled labour and wage rate which leads to the above demand curve. Also, the supply curve for unskilled labour would be upwards sloping as at higher wage rates, the supply would be higher. The minimum wage level imposed lies above the equilibrium wage level in the free market. This leads to a mismatch between demand and supply since the supply of unskilled labour outstrips the demand (Froyen, 2013).

Question 2

The imposition of minimum wage is intended to help unskilled labour command a higher price but an opposite effect sets up. As the unskilled labour has become expensive, hence the employers make a switch towards the skilled labour which now is comparatively cheape considering the lower differential wage.  Further, the unskilled labour supply surplus might also lead to a situation where some workers might work for lower wages than the minimum wage set by the government. Thus, the beneficiaries are the skilled labour while the interest of unskilled labour is adversely impacted as explained above (Barro, 2017).

Question 3

Part A

Cost push inflation

As the name suggests, this inflation is caused by the increased production cost which are then passed on to the consumers. The applicable AD/AS curve corresponding to this type of inflation is shown as follows.

From the above graph, it is evident that a reduction in the aggregate supply has taken place on account of the increase in production costs which cause the AS curve to shift. In the short run, the aggregate demand would not change. As a result, the equilibrium price tends to increase while the real GDP decreases which is represented above (Koutsoyiannis, 2013).

Demand push inflation

As the name suggests, this inflation is caused on account of higher demand. The associated AD/AS curve in this case is shown as follows.

In demand push inflation, the aggregate demand increases which lead to demand curve shift as has been represented in the above graph (AD1 to AD2). Over the short term, the supply curve does not alter and remains constant. Further, the new equilibrium point indicates that there has been a rise in price level coupled with increased real output level (McConnell, Brue & Flynn, 2014).

Comparison

The above analysis is indicative that a common aspect to both type of inflations is that the price rise happens but in case of demand push inflation, there is an increase in the GDP or output level which is in contrast with cost push inflation where there is a decrease in the GDP or output level.

Part B

Owing to the submarine order, the government expenditure on part of Australia would witness an increase.  Also, it is known that aggregate demand is impacted by changes in government expenditure. Thus, if government expenditure would increase, it would imply an increase in aggregate demand which is represented in the following graph (Dombusch, Fischer. & Startz, 2015).

The above graph indicates the shift in the aggregate demand curve facilitated by the government spending increase. Over the short run, there would be no change in the aggregate supply which is reflected in the above diagram also. As a result, the equilibrium point changes and leads to higher GDP and hence promotes economic development. However, there could be potential cost pressure owing to higher price level which needs to be checked (Mankiw, 2016).

Question 4

Part A

In accordance with the quantity theory of money, the following equation holds true.

The information provided highlights that money supply has increased to the tune of 25%. To balance the above equation, a proportional increase in the price also ought to be observed  (McConnell, Brue & Flynn, 2014).

Part B

It is known that the CPI index value for the previous year = 250

The inflation this year has been 10%

Thus the requisite CPI index = 250 *(1+ 10%) = 275

Part C

The relationship between consumption and disposable income amount is captured by the consumption function. It is represented in the form a straight line with a y intercept. This intercept indicates the basic amount of consumption which happens when the underlying disposable income does not exist or is zero. Besides, the linear trend indicates that the disposable income increase would lead to increased consumption (Mankiw, 2016).

Part D

The means for enhancing the saving rate of the nation are highlighted as follows (Barro, 2017).

• The government needs to provide incentives related to tax for people who invest in various retirement schemes and other savings schemes so as to enable altering their behaviour through positive incentives.

• Also, the government to bring about a long term change can embark on a financial literary campaign which can focus on the need for saving and how it can potentially result in long term wealth creation.

References

Barro, R. (2017). Macroeconomics: A Modern Approach (4^th ed.). London: Cengage Learning.

Dombusch, R., Fischer, S. & Startz, R. (2015). Macroeconomics (10^th ed.). New York: McGraw Hill Publications.

Froyen, A. (2013), Macroeconomics (3^rd ed.). New Delhi: Pearson Education.

Koutsoyiannis, A. (2013). Modern Macroeconomics (4^th ed.). London: Palgrave McMillan.

Krugman, P. & Wells, R. (2015). Macroeconomics (3rd ed.). London: Worth Publishers.

Mankiw, G. (2016). Principles of Macroeconomics (6th ed.). London: Cengage Learning.

McConnell, C., Brue, S. & Flynn, S. (2014). Macroeconomics: Principles, Problems, & Policies (20^th ed.). New York:  McGraw Hill Publications.