Topic 4

Question 1

major objectives of economic management 3 + 2

Answer 1

Strong economic growth (medium to long-term) and the increase in material living standards

Internal balance: price stability and full employment, stable short term growth

External balance: keeping the CAD, foreign liabilities and exchange rate at stable and sustainable
levels.

Environmental sustainability

Distribution of income

Question 2

Economic growth and quality of life

Answer 2

Goal of 3-4%
 Economic growth involves an increase in the volume of products that an economy produces
over time
 Offers substantial benefits including
o Increased standards of living
o Improved job prospects for the labour force
o The opportunity for increased investment in infrastructure and public services
through higher government tax returns
 Achieved with monetary policy + fiscal policy (short-term)
 Microeconomic policystructural reformlong term ‘strong’ economic growth

Question 3

Full employment

Answer 3

Goal of 4.9-5% (NAIRU: the level of unemployment at which there is no cyclical
unemployment)
 Benefits include
o Maximising the economy’s capacity to produce, and therefore maximising living
standards
o Minimising the adverse economic and social problems associated with
unemployment

 Fiscal policy more effective than monetary in achieving this

Question 4

Price stability

Answer 4

refers to keeping inflation, or the sustained increase in the general price level,
at an acceptable level

Goal of 2-3% inflation on average over cycle to minimise distortion in the economy
o Lower does not have any adverse effects (unless facing deflation) though it indicates
weak growth

High inflation may
o Reduce the real value of income and wealth
o Reduce our international competitiveness, due to rising costs of production
o Cause a depreciation in the exchange rate as foreign exchange markets lose
confidence in the economy
o Create uncertainty about future costs and distort economic decision making
 Monetary more effective than fiscal

Question 5

External stability

Answer 5

Achieving external stability involves a country meeting its long term financial obligations to the rest of the
world so that its external accounts do not hinder it achieving its economic goals.

-Achieving a sustainable position on the current account
-Maintaining foreign debt at a level where an economy can afford to make interest payments
on the debt and is not exposed to the risk of financial crisis by being too reliant on foreign
financial inflows
-Net foreign liabilities can facilitate growth and create jobs, but also creases income outflows
over the long term
-High terms of trade improves external stability as Australia can buy more imports with a
given quantity of exports
-In the short term, high volatility of exchange rates reflects a lack of external stability and
international confidence. In the long term, exchange rates reveal Australia’s international
competitiveness
-High international competitiveness is important for minimising the leakage from a trade
deficit, thereby reducing the CAD and foreign debt over time

• Although Australia has relatively large external imbalances, during recent decades this has not been a major concern which can be seen with Australia’s ‘AAA’ credit rating,

Question 6

Distribution of income and wealth

Answer 6

The free market produces unfair outcomes
provide porvision for the needs of people whoa re not able to provide for themslves - aged ppl, disabilitlies, illness
reduce gap by:
Progressive tax and transfer payments

Question 7

Environmental sustainability

Answer 7

Achieving ecologically sustainable development
-reduction in greenhosue gas emissions or an improvement in energy efficiemcu

carbon tax - abbott

Question 8

Potential Conflicts among Unemployment and price stability

Answer 8

may conflict in the short run if the government pursues policies to
promote economic growth and full employment. This increases aggregate demand and in turn leads to
inflationary pressures. This is depicted by the SRPC.
o For example, in pre-GFC, unemployment was recorded to be below what economics believed was
the NAIRU (4-5%) at 3.9%. As a result, CPI was recorded to be 4.7% to due to higher incomes in the
economy.

Question 9

Potential Conflicts among Economic growth and full employment and cad

Answer 9

may conflict if the pursuit of microeconomic efficiency causes structural changes, leading to structural unemployment. This may lead to a more unequal distribution of income if displaced workers suffer a loss of income relative to employed workers. However, in the long run improvements in microeconomic efficiency will increase growth and reduce unemployment.

econonomic growth - increase productivity ( new technology, downsizing of firms) –> ^ unemployment

Question 10

Potential Conflicts among Economic growth and external stability

Answer 10

government policies to increase eco grwth and employment = ^ inflation and ^ d for imports = worsen bogs and CAD

However, economic growth may also result in greater savings and a reduction in the debt servicing ratio, which will in turn improve external stability in the long run.
o For example, pre-GFC, Australia was achieving strong rates of economic growth (4.1% in 2007) and
due to increased FDI into the mining sector of Australia’s economy, the CAD was recorded to be 6%
of GDP, outside of what the IMF deems to be a sustainable CAD (3-5%).

Question 11

Potential Conflicts among Economic growth and distribution of income

Answer 11

Economic growth often creates greater inequality (as it favoyrs higher skilled workers or resource owners)

may conflict if the benefits of economic growth are being
captured by those on higher incomes than on lower incomes. Thomas Piketty has argued that if the rate of
interest is greater than the rate of economic growth, inequality will rise as capital gains will be greater than
income gains. However, economic growth may reduce inequality if growth leads to a reduction in
unemployment, increasing the incomes of lower income individuals.
o For example, following the GFC, due to lower rates of economic growth, the Gini coefficient has
improved

Question 12

Potential Conflicts among Economic growth and environmental sustainability

Answer 12

growth = greater prpftis = ^pollution and wastage
may conflict in the long run if economic growth is
ecologically unsustainable, and leads to a depletion of natural resources and an increase in externalities such
as pollution.

Question 13

Phillips curve

Answer 13

o short run: V demand = unemployment decreases, inflation increases
o Difficult to simultaneously fix both, stagflation
long run: phillips becomes a vertical line aka nairu

Question 14

Recessionary gap

Answer 14

a situation wherein the real GDP is lower than potential GDP at the full employment level.

Question 15

Inflationary gap

Answer 15

the amount by which the actual gross domestic product (GDP) exceeds potential full-employment GDP.

Question 16

Macroeconomics

Answer 16

the study of the entire economy as a whole rather than individual markets.

Question 17

Fiscal policy

Answer 17

the way a government adjusts its spending levels and tax rates to monitor and influence a nation’s economy.

Question 18

Expansionary Fiscal Policy

Answer 18

stimulates the economy during or anticipation of a business-cycle contraction.

Question 19

Contractionary Fiscal Policy

Answer 19

enacted by a government to reduce the money supply and ultimately the spending in a country.

Question 20

Classical theories

Answer 20

assumed that the economy will fix itself in a long run, and that government intervention will, at best, lead to unintended consequences and, at worst, cause massive inflation and debt.

Question 21

Deficit spending

Answer 21

the government spends more money than it collects in tax revenue.

Question 22

Crowding out

Answer 22

where increased public sector spending replaces, or drives down, private sector spending.

Question 23

Keynesian economists

Answer 23

crowding out is only a problem if economy operates at full capacity, where all workers are employed and we’re producing as much as we can.

Question 24

Austerity

Answer 24

raising taxes and cutting government spending to reduce debt. In crisis of 2008 was main policy of EU, which led to worse results than deficit spending policy in US.

Question 25

Multiplier effect

Answer 25

the initial increase in government spending of 100$ might turn out to be 175$ worth of actual spending in the economy.
a. When the economy is booming, multiplier is close to 1x.
b. When economy is in recession, the multiplier is around 2x.
c. Spending on infrastructure, and aid to state & local governments , also seems to have fairly high multiplier, about 1.5. But general cuts to payroll and income taxes seems to have a multiplier of about 1:. If the government cuts 100$ in taxes, the economy is going to grow by about 100$.