Written Assessment ECO10004 Economic Principles
Part C
Task 5: GDP, economic growth and unemployment
  1. Give two reasons why measured GDP does not reflect total production in an economy. Explain using examples.
  2. Suppose that a very simple economy produces three goods: pizzas, haircuts and backpacks. Suppose the quantities produced and their corresponding prices for 2011 and 2015 are as shown in the following table. Calculate real GDP in 2015 assuming the base year is 2011. Explain how you calculated the real GDP in words as well as showing full working out.
2011 2015
Product Quantity Price Quantity Price
Pizzas 100 10 120 12
Haircuts 50 15 45 20
Backpackers 200 40 210 45

For each of the following, indicate if the person would be classified as employed, unemployed, or not in the labour force and why:

  1. a 45-year-old person who left his job and is now working as a volunteer for 40 hours a week and is not looking for paid work
  2. a person who is working for 10 hours a week paid but is not looking for other work.
  3. a manufacturing worker who is out of a job and is currently looking for work but cannot start for 3 months as they are currently looking after their sick parent

Read the following excerpt and answer the questions 6 and 7

Macroeconomics and Economic Development: Informal Work and Dead Capital

“Dead capital” is Hernando de Soto’s term for an asset that cannot easily be bought, sold, valued or used as an investment. Despite obvious poverty in the informal sector in Peru, de Soto’s work shows that even those who live in slums possess far more capital than anyone realizes. In fact, the informal economy is so large in Peru that almost 70 percent of the working population work in informal arrangements.  … Possessions … are not represented in such a way as to make them fungible (i.e. easily exchangeable) assets. Dead capital cannot, therefore, create value for the poor. What you’re really leaving behind is the world of legally enforceable transactions and property rights. The developed world has devised a formal property system of titles, title registries, and inclusive property law that includes real estate used for homes or businesses. De Soto shows that this is in a large part why some nations are rich while others remain in poverty. He says: 

With titles, shares and property laws, people could suddenly go beyond looking at their assets as they are — houses used for shelter — to thinking about what they could be—things like security for credit to start or expand a business.

The moment Westerners were able to focus on the title of a house and not just the house itself, they achieved a huge advantage over the rest of humanity. When purchasing a home, an open records system enables buyers and sellers not only to gauge the value of homes in nearby areas, but to set reasonable prices based on comparative values. Clear titles and title insurance give buyers the confidence they need to complete a purchase. No clear title? No sale. The system also gives banks the assurance they need to offer a mortgage. It represents a real house (house, land, a factory, a car, etc.)

Source: Excerpts from : “Informal Work and Dead Capital” . Retrieved on February 2, 2106, from http://www.thepowerofthepoor.com/concepts/c6.php

  1. Many of the owners of houses in ‘shanti towns’ in the outskirts of Peru’s capital Lima, are happy that they do not have to pay land taxes, or municipal rates, as we do in Australia. Is this an advantageous situation to be in for the poor in Peru? Explain your answer.
  2. Would the informal economy hinder or promote economic growth in Peru? Explain your answer. Hint: look at “New Growth Theory” and the case study on Botswana on p. 380-381 to answer this question. 
Task 6: Inflation, Business Cycle and Aggregate Demand & Supply
  1. Suppose an economy has only three goods, and the typical family purchases the amounts given in the following table. If 2005 is the base year, then, what is the CPI for 2015? Show all working out.
Product Quantity (2005) Price (2005) Price (2015)
Computers 2 $1700 $1200
Books 50 $25 $30
Burgers 150 $1.00 $2.00
Total      

 

  1. What is cost push inflation and how is it different to demand pull inflation? Illustrate using the AD/AS. Discuss how each affects Real GDP.

 

Explain how each of the following events in questions 3, 4 and 5 would affect the aggregate demand curve.

  1. Lower interest rates.
  2. Slower income growth in other countries.
  3. Import prices increase.
  4. Starting from long-run equilibrium, use the basic (static) aggregate demand and aggregate supply diagram to show what happens in both the short run and the long run when there is a crash in property market (property prices fall by a large amount). Explain your diagram.
  5. Consider two groups of goods, A and B. Group A consists of Toyota cars and Westinghouse refrigerators. Group B consists of Huggies nappies and McDonald’s Big Macs. Briefly explain whether the sale of the goods in group A or B will fluctuate more during the business cycle relative to real GDP.

Read the following excerpt and answer question 8

Australia’s economy – Good on you

“Australia has weathered the China slowdown and commodities slump well. What has it done right?”

…..    Unlike most of the rich world, it [Australia] sailed through the global financial crisis, and unlike most commodity exporters, it has weathered the raw-materials price slump. Its GDP growth rate of 3.1% dwarfs that of America and the euro zone.       ………       The story of Australia’s success starts with what its government did not do: spend beyond its means. Tight budgets in the late 1990s and early 2000s, combined with improving terms of trade, meant that when the financial crisis hit, the government was running budget surpluses (though the country as a whole has a long-running current-account deficit). It could thus afford stimulus packages in late 2008 and early 2009 worth more than A$56.6 billion (US$42.8 billion) [recall that a large proportion of the stimulus was given to consumers directly]. Only China provided greater stimulus as a share of GDP.     ……

 

The Reserve Bank of Australia (RBA) estimates that, during that period, mining raised real disposable household income by 13% and wages by 6%, boosting domestic purchasing power. Saul Eslake, an independent economist, argues that “except for the Chinese people, no country derived more benefit from the growth and industrialisation of China” than Australia. The value of the Australian dollar also rose, which dented non-mining exports. But since demand from Asia kept prices high for Australia’s agricultural commodities (such as beef and wheat), and because it exports relatively few manufactured goods, the damage was contained.

As China rebalanced and commodity prices tumbled, other exporters such as Russia, South Africa and Brazil fell into recession. In Australia, although business investment has fallen sharply, GDP growth remains near its 25-year average of 3% (and as a side benefit, the commodity-price fall quelled rising inflation). For that, thank two factors. First, the rise in mining investment during the fat years led to increased production. Commodity exports have continued to grow (albeit modestly and less profitably). Though prices of iron ore and coal are well below the past decade’s peaks, they remain above pre-boom levels. More important, Australia let the dollar depreciate, which made its exports more appealing. Today Australia benefits from a growing number of Chinese consumers, who buy Australian food products that are widely seen as safer than their home-grown equivalents.

The Economist Sep 1st 2016 | SYDNEY; https://www.economist.com/news/finance-and-economics/21706262-australiahas-weathered-china-slowdown-and-commodities-slump-well-what-has-it (accessed 4 July 2017)

  1. Given the information in the above article, explain, in economic terms and using the AD/AS framework, how Australia avoided negative economic growth during the global financial crises
Task 7: Money and Monetary Policy

Refer to the figure below and answer the questions 1 and 2

  1. Given that the economy has moved from A to B what would be the appropriate monetary policy to achieve potential GDP and why?
  2. If monetary policy is successful at moving the economy from point B to equilibrium at potential GDP, what happens to unemployment and consumer confidence?
  3. Briefly discuss the effect of a fall in the cash rate on consumption.     

Read the following excerpt and answer questions 4 and 5.

 

Interest rates: RBA pressured to flag more cuts

The Reserve Bank will come under pressure this week to flag further interest rate cuts to bolster Australia’s sluggish economy in the wake of sharp falls in global equity markets and a deteriorating outlook for world growth.

The RBA board will meet for the first time this year tomorrow against a backdrop of mounting deflationary fears as the global oil price wallows at 13-year lows, and weakening growth prospects in the US, Japan and China, Australia’s biggest three trade partners…….

The ABS last week said Australia’s underlying inflation rate was 2 per cent in 2015, a little stronger than economists had expected but still affording the RBA plenty of scope to cut further.

Author: Adam Creighton; Economics correspondent, The Australian – February 1, 2016.

  1. Based on the article what is the key concern of the RBA which may result in it decreasing interest rates? Use the AD/AS framework to describe the situation.
  2. What are the factors that determine whether such a policy will be successful?
Written Assessment ECO10004 Economic Principles Part C Task 5: GDP, economic growth and unemployment
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