Topic 8 - Supply-side Policies

Question 1

8.01 - What is the phillips curve?

Answer 1

It is an inverse relationship suggestive of a trade-off between inflation and the unemployment rate, which suggests higher AD equals inflation and low unemployment and lower AD equals slow growth and high unemployment

Question 2

8.02 - How is the Phillips curve relationship complicated?

Answer 2

By

• the ratchet effect - downward price/wage inflexibility when AD declines
• shifts in short run aggregate supply which affect the rate of inflation at which the apparent trade off between inflation and unemployment occurs.

Question 3

8.03 - What is stagflation?

Answer 3

It represents the simultaneous experience of both high and increasing unemployment and inflation.

Question 4

8.04 - what does the presence of stagflation suggest?

Answer 4

That the apparent trade-off between inflation and employment posited by the original Phillips curve has broken down.

Question 5

8.05 - What is the natural rate hypothesis?

Answer 5

It is a hypothesis that suggest that there is a unique level of unemployment around which observed unemployment will fluctuate, but the economy will tend towards at any point in time.

Question 6

8.06 - What is a variant of the natural rate hypothesis?

Answer 6

The adaptive expectations theory which assumes that people form their expectations of future inflation on the basis of previous and present rates of inflation and only gradually change their expectations as experience unfolds, thus that expectations are backwards looking, suggesting that continuous forecasting errors will be made.

Question 7

8.07 - An acceptance of the natural rate of employment hypothesis suggests that we face two Phillips curve? what are they?

Answer 7

• An unstable short-run Phillips curve; and

* a stable long-run Phillips curve at the natural rate of unemployment

Question 8

8.08 - What are two explanations of the natural rate hypothesis?

Answer 8

• the adaptive expectations approach, and

* the rational expectations approach

Question 9

8.09 - What is the adaptive expectations approach?

Answer 9

This approach argues that in the long run the traditional Phillips curve trade off does not exist. Expansionary demand management policies will shift the short-run Phillips curve upward, resulting in increasing inflation with no permanent decline in the unemployment rate.

Question 10

8.10 - What is the rational expectations theory (RET) approach?

Answer 10

This contends that the inflationary effects of expansionary policy will be anticipated and reflected in nominal wage demands. As a result, there will be no short-run increase in employment, and thus, no short-run Phillips curve.

Question 11

8.14 - What is demand-pull inflation?

Answer 11

Demand-pull inflation occurs when an increase in AD pulls up the price level.

Question 12

8.15 - Graphically how is demand-pull inflation drawn?

Answer 12

Aggregate demand shifts rightward along a stable AS curve. In the short run this then increases prices and real output. Because supply has increased as a result, prices will increase, decreasing output and as such in the long run the increase in aggregate demand has only moved the economy up the vertical aggregate supply curve.

Question 13

8.16 - What is cost-push inflation?

Answer 13

Cost-push inflation occurs when an increase in the cost of production at each price level shifts the aS curve leftward resulting in increased pries.

Question 14

8.17 - Graphically how is cost-push inflation drawn?

Answer 14

In the short run the AS curve moves leftward resulting in less output and higher prices. This in turn may increase demand pushing prices higher. As such in the long run the increase in aggregate supply has only moved the economy up the vertical aggregate supply curve.

Question 15

8.18 - What is the policy dilemma when faced with cost-push inflation?

Answer 15

That

• If government intervenes to increase AD an inflationary spiral will result
• If government does not intervene to increase AD a severe recession will result.

Question 16

8.19 - Given the high unemployment and high inflation of the 70’s & 80’s it is unsurprising that the market economies have looked beyond demand market policies to attempt to deal with stagflation. What are two categories of non-demand management policies that have been proposed?

Answer 16

• Market policies

* Wage-price (or incomes) policies

Question 17

8.20 - What are the two kinds of market policy?

Answer 17

• Employment and training policy; and

* Pro-competition policy

Question 18

8.21 - What is the aim of employment and training policy?

Answer 18

To better match workers to jobs, thus reducing labour-market imbalances or bottlenecks.

Question 19

8.22 - What are the three types of employment and training policy programs?

Answer 19

1) Vocational training - on the job
2) Job information - between the unemployed and potential employers
3) Anti-discrimination programs - removing non-economic obstacles to employment.

Question 20

8.23 - What is pro-competition policy?

Answer 20

It is policy that helps reduce the monopoly or market power of

• unions (affecting wages) and/or
• large companies (affecting prices)

Question 21

8.24 - How is pro-competion policy enacted by the government?

Answer 21

Through the Trade Practices Act.

Question 22

8.25 - What is the area of growth economics concerned with?

Answer 22

Concerned with analysing the patterns of long-term trends in an economy’s productive capacity and the factors that influence these trends

Question 23

8.26 - In what two related ways is Economic Growth defined and measured?

Answer 23

• the increase in real GDP that occurs over a period of time

* the increase in real GDP per capita that occurs over time.

Question 24

8.27 - How are the two definitions and measures of Economic Growth used?

Answer 24

• GDP over a period is relevant to questions of military potential, whereas per capita output is more useful for comparing the economic standard of living between nations.

Question 25

8.28 - Why is growth important?

Answer 25

• Greater ability to face economic challenges
• Increased opportunities
• Lessens the burden of scarcity
• Allows economy to realise economic goals more fully
• Places a nation in a better position to resolve domestic and international socioeconomic problems

Question 26

8.29 - Why is the ability to face economic challenges important?

Answer 26

Small changes in growth can dramatically affect a country’s economy.

Question 27

8.30 - What are the increased opportunities that economic growth brings?

Answer 27

• incomes
• education
• social welfare
• environmental

Question 28

8.31 - What are the two causes of growth?

Answer 28

• Supply factors: physical ability of economy to grow

* Aggregate demand and resource allocation factors

Question 29

8.32 - Under the Supply factors what are the underlying causes of growth?

Answer 29

• Quantity and quality of natural resources
• Quantity and quality of human resources (labour force)
• Supply or stock of capital goods
• Technology

Question 30

8.33 - Under the aggregate demand factors what are the underlying causes of growth?

Answer 30

• Demand factor

* Efficiency factor

Question 31

8.34 - Supply Growth is attributed to the availability of more and better resources, including the stock of technological knowledge. What are two ways to increase output?

Answer 31

• Increase in inputs of resources

* Increase in the quality or productivity of those inputs

Question 32

8.35 - How is labour force productivity is defined and determined?

Answer 32

Labour productivity is the real output per worker per hour. This is real output = workers hours x labour productivity.

Question 33

8.36 - What is the ‘demand factor’ of growth?

Answer 33

To realise a growing productive potential a nation must provide for the full employment of its expanding supplies of resources. This requires a growing level of aggregate demand.

Question 34

8.37 - What is the allocative (efficiency) factor of growth?

Answer 34

In order to achieve productive potential, a nation must:
* Have full-employment of resources; and
* Achieve full production from resources
Resources must be allocated to get the maximum amount of goods and services possible

Question 35

8.38 - What is the production possibilities curve? and what do points on and inside the curve represent?

Answer 35

It is the full level of production for the country assuming full employment. Points on the curve represent the maximum amounts of production possible and points inside the curve represent a failure to achieve full employment and full production.

Question 36

8.39 - What would cause the production possibility curve to move outwards?

Answer 36

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