PACC6007 Economics

Answer:

As per definition ‘a price index is a weighted average of the prices of a selected basket of goods and services relative to their prices in some base-year’.( econport.org. Price Index). There can be many indices for prices – Wholesale Price Index Retail price Index, Consumer Price Index . The basic difference is the prices considered by each index. The construction of any index is done in steps: first a base year is chosen. Second, a basket of goods  is chosen. A weighting scheme is drawn up for all goods in the basket. Next, prices for these goods are collected. Lastly a weighted average number is calculated using these prices and the weights assigned – this number is the INDEX number. The index number for base year is taken as 100, to facilitate comparison with other years easily.

For Australia, the base year was changed to 2012.  Due to this all values in the data we present are less than 100 before 2012, while values are above 100 in post 2012 values. We are required to find data on consumer prices.

‘The Consumer Price Index (CPI) is a measure of changes, over time, in retail prices of a constant basket of goods and services representative of consumption expenditure by resident households in Australian metropolitan areas’. ( Abs.gov,au. Consumer Price Index). For the Australian CPI the basket of goods comprise of 11 broad groups, namely Food and non-alcoholic beverages, Alcohol and tobacco, Clothing and footwear, Housing Furnishings, household equipment and services, Health, Transport, Communication, Recreation and culture, Education and Insurance and financial services.

For Australia the CPI ‘is conceptually designed to provide a general measure of price inflation for all Australian households. The CPI is simply a measure of the changes in the price of this fixed basket as the prices of items in it change’ (Abs.gov.au. Quality Declaration Summary).

The process of data collection  ‘involves more than10, 000 persons and 1,00,000 price quotations from different sources’.(Main Economic Indicators)  The abs.gov.ay site hosts this data regularly on a quarterly basis, which is used for this assignment.  We use series catalogue number A2325846C. A simple average converts this data into annual data.

‘Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling’. ( Investopedia,com, Inflation). We calculate this as a % change in CPI values over the previous year values. The data is shown in the table below.

Weekly Earnings data comes in many forms in Australia out of which , ‘the Average Weekly Ordinary Time Earnings (AWOTE) for Full Time Adult Employees series is the most stable series from this publication over time, as it excludes overtime, part time and junior rates of pay’.(meteor.aihw.gov.au . Australian Institute of Health and Welfare). The series label is A85002148L

This data is biannual -every November and May in a year.  A simple average is used to transform this to annual data.

The table below provides % change in earnings as well. The Difference between inflation and change in weekly earnings is also given. The negative values imply that inflation is lower than the change  in weekly earnings.

The values in table above are shown in a chart form below:

• Inflation swings upwards and downwards many times in the 10 year period, but shows an overall falling trend. The maximum is 3.56% and the lowest is 1.51%,  a range of 2.05% only.   
• The rate of change in AWOTE in blue falls after 2009. Before 2009 it rises from 3.21% to 6.02% in 2009. The decline in recent years is unfortunate as it reflects on lower earnings of an average  Australian worker.  
• The difference between both data series is negative (except 2006) - earnings changes exceed the inflation rate, which is a good thing. It shows that if prices rise less than the rise in earnings. Overall real earnings (which are approximated by earnings/price) are increasing.

The AD-AS approach to income determination was born after the Great Depression of 1929. It was developed in line with Keynes theory o effective demand, which was the basis of the key role allotted to AD in the theory. The theory allows prices to be variable, and is based on a down sloping AD curve and an upward sloping AS curve. Equilibrium is where AD=AS. The theory allows changes in AD to affect GDP and price level.

We put GDP on X axis, with price on Y axis. AD is the total of demand for private consumption by households (C), investment demand by firms (I), spending by government agencies (G), and net exports (X-M).   AD slopes negatively (www.economicsdiscussion.net Pettinger, 2015) to show that lower prices accompany higher demand.. Thus there is a negative relation between prices on Y axis and GDP on X axis.

Any increase in AD is shown as a shift of AD curve upwards, while an increase in AS causes AS to shift right/down. . ‘A shift of the AD curve to the right means that at least one of these components increased so that a greater amount of total spending would occur at every price level’. (philschatz.com . Shifts in Aggregate Demand)

The other part of the theory is aggregate supply. It represents the total amount of goods and services produced in the economy. The AS curve is ‘a graphical representation of the relation between real production and the price level’.

The equilibrium occurs at the intersection of AD and AS, so that they are equal at this point.

In each of the events given to us we must identify what part of theory is affected- AD or AS, and the consequent direction of shift of the chosen curve. Lastly a comparison with old equilibrium tells us if price and GDP has risen or fallen.  If AD is affected we must isolate the component that is affected.

Iron is an export good , whose price has risen. According to the law of demand, its demand (or exports from Australia) will fall.  This shifts AD down, bringing down GDP and price level at E1. 

A rise in agricultural output affects aggregate supply. Consequently, AS is higher. It shifts down, with higher GDP and lower price level at E2.  

Government spends on development of Internet/broadband network. This spend in expenditure by government or G, in terms of components of AD. An increase in G causes AD to move up, and higher GDP and price level at E3

Lower prices for Australian imports-oil. This will raise demand  so that Australians demand more imports. Imports are part of ‘net exports’, defined as the difference between exports and imports. More imports means lower net exports. This is the same case as event 1. The new equilibrium at E1, comes with lower price level and GDP.