ECON 1012 Macroeconomic Fundamentals Discussion

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Assignment 4
ECON1012 Principles of Economics Semester 2 2021
Course Learning Outcomes: 2 & 4
Topic/s of Primary Focus: Macroeconomic Fundamentals
(May also include content from previous topics.)
For this assignment, you will refer to the latest Australian National Accounts data
available from the Australian Bureau of Statistics at the below link.
https://www.abs.gov.au/statistics/economy/national-accounts/australian-nationalaccounts-national-income-expenditure-and-product/jun-2021
Task:
For this assignment, you are asked to provide your own analysis of the GDP figures for
the June 2021 quarter. This must be in your own words.
As part of this analysis, ensure that you include and focus on the following:
• What the headline change in GDP (+0.7%) means.
• Identify from the data, recent changes in components of expenditure C, I, G and
NX. Through your explanation, ensure that you show evidence of your
understanding of each component.
Make sure to use key terminology and course concepts where appropriate.
Format:
The format of your response should be an essay-style response.
You do not need to spend as much attention on formal essay structure as you might
for a persuasive or research-based essay. Instead you should focus on communicating
your ideas in a clear and concise manner and making sure there is a logical flow of
ideas and explanation.
Word Limit:
800 words (excluding diagrams and references)
Diagrams:
For this assignment task, you are not required to draw diagrams of an economic
model. (The AS-AD model and topic is not required.) You may wish to include
diagrams or tables directly from the ABS data, in which case it is important that you
provide appropriate references.
1
Referencing:
This is not a research assignment. So you do not necessarily need to find other
references. You should answer the question based on what you have learnt in the
course and the linked ABS page.
However, it is important that if you do take content directly from other sources
including course materials, both quoting and paraphrasing, that you appropriately
reference to show what is your own original thoughts and what ideas you have
borrowed from others. Please refer to the Academic Integrity Module within the course
for further guidance and links regarding referencing, plagiarism, and academic
integrity.
Where referencing is used, it can be in any standard style, so long as it is consistent.
The Harvard referencing style is preferred, as it is the standard in Economics and is
also common in Business disciplines.
https://www.adelaide.edu.au/writingcentre/resources/referencing-guides
All submissions will be analysed with the assistance of Turnitin, checking for
plagiarism against other students in the class and external sources.
Submission and Feedback
Students must submit the assignment by the due date via the electronic submission
portal on MyUni (the same page you downloaded this pdf!).
https://community.canvaslms.com/t5/Student-Guide/How-do-I-upload-a-file-as-anassignment-submission-in-Canvas/ta-p/274
It is students’ responsibility to ensure that it is correctly submitted by the due date.
Make sure that you see and check that is says ‘Submitted’.
Late submissions will generally *not* be accepted at all. Not even one minute late.
This might seem more strict than some of your other classes, but do keep in mind that
we also have a ‘best 4 of 5’ policy on the Assignments.
If you have a medical or other circumstance that you believe may allow an extension,
please email the course coordinator as soon as practical, and generally this must be
before the due date has passed.
Assignments will be graded, with grades and feedback provided within MyUni
approximately one week after the submission due date.
2
Grading
The assignment will be graded against the Assessment Criteria in the Rubric attached
to the MyUni Assignment and detailed below.
Grades will be allocated in-line with the University’s grade descriptors.
For example, a grade between 75-84 is a Distinction, which should indicate ‘A very
high standard of work which demonstrates originality and insight’.
Your grade is not matter of where you ‘lost marks’, but rather the evaluation of what
you have presented against the standards and the criteria.
Assessment Criteria
A coherent and well-structured explanation is presented of the
change in GDP, and the relationship with various components
Evidence is shown of understanding of the concept of GDP and how it
is presented in data
Evidence is shown of understanding of each of the components of
expenditure (C, I, G, NX)
Accurate identification from the data is made of relevant changes in
components of expenditure
Appropriate writing style, word count and referencing (where
relevant)
Marks (100)
30
20
20
20
10
3
SCHOOL OF ECONOMICS
ECON 1012 PRINCIPLES OF ECONOMICS
TOPIC 5 – GOVERNMENT INTERVENTION: THE COST
OF INTERFERING WITH MARKET FORCES
© Playconomics, LHS
Reminders
• So far we have set up a simple model of how buyers and
sellers interact in a market
• The D curve represents how much consumers are willing
and able to buy at different prices
• The S curve represents how much producers are willing
and able to sell at different prices
• Together S and D determine how much of a good or
service will be exchanged in a market, and at what price
• We used the concept of elasticity to determine by how
much the quantity demanded (or supplied) changes as
prices (or other factors) change
• We established that the perfectly competitive market
was generally efficient b/c total surplus was maximised
2
Revision – CS and PS
Adapted from © Playconomics, LHS
CS and PS Explanation
• The consumer surplus represents the area
between the D curve and the P.
– The CS arises because the consumer reservation
price > is greater than the price.
• The producer surplus is the area between the
S curve and P.
– The S curve represents the MC of production or
the minimum the producer is willing to accept.
Adapted from © Playconomics, LHS
Super Short
• CS = area between D and P
• PS = area between S and P
Adapted from © Playconomics, LHS
Market Efficiency ??
• The market is efficient because all beneficial
?? transactions occur.
• A transaction is efficient because the MB of
consumption ? MC of production (for each
production)
Adapted from © Playconomics, LHS
Today we Study government
Interventions
• We use our perfectly competitive market model
to examine government interventions ??
• Determine the interventions effect on the P
paid by buyers, the P received by sellers and the
Q traded
• To examine the (in)efficiency of each
intervention
• Frequently government intervention causes a
DWL
7
Deadweight Loss ????????
?????
Definition:
The Deadweight Loss is the loss in economic
surplus due to the market being prevented from
reaching the equilibrium P and Q where marginal
benefit (MB) equals marginal cost (MC).
© Playconomics, LHS
8
Deadweight Loss
Adapted from © Playconomics, LHS
Explanation of Diagram
• Diagram 1: With under production, beneficial
?? transactions do not occur (the yellow
area is where MB>MC)
• Diagram 2: With over production, negative
transactions occur (the yellow area is where
MC>MB)
Adapted from © Playconomics, LHS
© Playconomics, LHS
Price Ceiling ???
Definition:
The Price Ceiling represents a maximum
allowable price imposed by the government.
•
•
•
Price ceilings are normally used when government
believes that P is unfairly high and they wish to protect
low-income consumers
Suppose the weekly students room rental is $100 but the
Student’s Association lobbies ?? for the Vice
Chancellor ?? to cap ?? rents to $80
This rent control will be good for students right?
© Playconomics, LHS
12
Price Ceiling
Say Pmarket = $100 and Pceiling = $80
If Pmarket < Pceiling ? policy has no effect !! © Playconomics, LHS 13 Analysis of a Price Ceiling • • • • • • At a price of $80 what is Qd and what is Qs? Who wins from this policy? Who loses? What are the incentives ?? of tenants ??? What are the incentives of landlords? What might be a more efficient way of making students better off? • If supply of student rooms is more elastic in the long-run, what effect will a rent control have? © Playconomics, LHS 14 More practice: Show the PS, CS, TS and DWL with and without a Price Ceiling Adapted from © Playconomics, LHS © Playconomics, LHS Price Floor ??? Definition: The Price Floor represents a minimum allowable price imposed by the government. • Price floor are normally used when government believes that P is unfairly low and they wish to protect producers in a certain sector ?? • Suppose the weekly student room rental is $100 but the University Housing Authority lobbies ??the Vice Chancellor ??to require rents be $120 • This price floor will be good for the Authority right? Adapted from © Playconomics, LHS Price Floor Extra Theory • The Price Floor represents a minimum allowable price imposed by the government. • Price floor are typically used when government believes that P is unfairly low and they wish to protect producers in a certain sector. • In the 1980’s, the government put a price floor on wool and wheat products to increase the profits from farmers. • It was counterproductive ???? Adapted from © Playconomics, LHS Price Floor Say Pmarket = $100 and Pfloor = $120 If Pmarket > Pfloor ? policy has no effect !!
© Playconomics, LHS
19
Analysis of a Price Floor
•
•
•
•
•
•
At a price of $120 what is Qd and what is Qs?
Who wins from this policy?
Who loses?
What are the incentives ?? of tenants?
What are the incentives of landlords?
What might be a more efficient way of making the
Housing Authority better off?
• Minimum wages are another example of a price
floor
© Playconomics, LHS
20
More practice: Show the PS, CS, TS and
DWL with and without a Price Floor
Adapted from © Playconomics, LHS
© Playconomics, LHS
Taxes
• Taxes can implemented ?? to raise revenue or
to reduce the Qtraded
• Revenues can be used to redistribute wealth ???
?? and/or opportunities across different groups
within a society (reduce other taxes, provide
public goods)
• Redistributing tax revenues may be a more
effective way to reduce poverty ?? or increase
production
• What are the impacts of taxing a particular
market?
© Playconomics, LHS
23
How do we analyse a tax
• We can analyse a tax by showing it as an upward shift of the supply curve
– why? tax raises the cost of production. This means for the supplier to
produce the same amount, they must increase the cost of the good by the
amount of the tax.
• Because we are only looking at taxes per unit, the shift of the supply curve
is parallel ?? ?taxes can also be ad volorem ????
• Issue with at tax for exam:
– Who pays the tax, buyer or seller, or both? If both, how is it shared?
– What happens to market quantity and price
– How much revenue does the government raise
– Is there a DWL
Adapted from © Playconomics, LHS
Imposing a Tax
We can analyse a
tax by showing it
as an upward
shift of the
supply curve –
why?
© Playconomics, LHS
25
Effects of a Tax
•
•
•
•
•
•
•
•
What happens to P?
What happens to Q?
What happens to CS?
What happens to PS?
What happens to TS?
What is the govt revenue?
What is the Deadweight Loss of the tax?
Who bears the burden of the tax?
© Playconomics, LHS
26
Change in Surplus from Taxation
© Playconomics, LHS
27
Show the PS, CS, TS, GS and DWL with
and without a tax (of 20)
Adapted from © Playconomics, LHS
Incidence of Tax ???
• Incidence of tax means who pays for it
• The incidence of the tax depends on the
relative ?? elasticity of demand between
the buyer and seller
• Simple rule: whoever has the more inelastic
tax, pays most of the tax (reason: they are
more inflexible ???, and thus must bear ?
? most of the tax.
Adapted from © Playconomics, LHS
Taxes in Markets with Elastic/Inelastic S&D
If Govt needs to collect tax revenue from somewhere, the most
effective way of doing it is to apply it to the least “elastic” market!
Why?
© Playconomics, LHS
30
© Playconomics, LHS
Subsidies ??
• A subsidy is the opposite of a tax
• Government pays to assist certain groups of
consumers (or producers)
• Wants to make certain goods more affordable ?
??? or encourage production
• Can show as if the Supply curve has shifted down
by the amount of the subsidy – why?
• It lowers the cost of the production so
therefore the supply curve shifts down by the
amount of the subsidy
© Playconomics, LHS
32
Effects of a Subsidy
•
•
•
•
•
•
•
•
What happens to P?
What happens to Q?
What happens to CS?
What happens to PS?
What happens to TS?
How much does it cost the government?
What is the Deadweight Loss of the subsidy?
What might be a more efficient solution?
© Playconomics, LHS
33
D. Subsidy
© Playconomics, LHS
34
Show the PS, CS, TS, GS and DWL with
and without a subsidy (of 20)
Adapted from © Playconomics, LHS
A good google diagram of a subsidy! –
notice the red is where MC>MB!
Adapted from © Playconomics, LHS
Summary of Government Intervention
converge to an
equilibrium where
? Any
that prevents a
market from reaching its P* is
?
Govt intervention
So when should the government intervene?
When the market isn’t perfectly competitive!
© Playconomics, LHS
37
SOLUTIONS TO ALL EXTRA EXAMPLES Ceiling
Adapted from © Playconomics, LHS
Floor
Adapted from © Playconomics, LHS
Tax
© Playconomics, LHS
Subsidies
Adapted from © Playconomics, LHS
SCHOOL OF ECONOMICS
ECON 1012 PRINCIPLES OF ECONOMICS
TOPIC 6 – IMPERFECTLY COMPETITIVE MARKETS:
MONOPOLY
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This Topic’s Outline
• Imperfectly Competitive Markets – Monopoly (Chapter 6)
• Playconomics
– Monopoly Island
• Practice your profit-maximisation skills when there’s a single seller
• Help Mayor Stef implement policies to increase welfare – she can help!
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Note to teachers
• Students don’t have this section and purely for further
information that is not in the exam
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Monopoly and Other Structures (duopoly)
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Other Market Structures
• Perfect Competition isn’t the only market structure.
• Most economic courses divide market structure into 4:
– Perfect Competition (many firms sell identical ?? products)
[wheat, rice, apple fruit].
– Monopolistic Competition ????
– Oligopoly ????
• Banks, petrol stations, (4-6 firms)
• Coles and Woolworths
– Monopoly ??, ??
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Monopolistic Competition ????
Low Barriers to Entry ????
Many firms
Firms sell similar, but “differentiated goods” ?????
Firms compete by quality and prices (so prices are not all the
same)
• In general, firms do not have significant market share ???
?
• Examples: cafes, restaurants, clothes brands
•
•
•
•
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Oligopoly????
• Small number of firms (2-6)
• Sometimes sell identical goods ?? (eg petrol), sometimes
heterogeneous?? eg Samsung and Apple)
(
• High barriers???? to entry
• Difficult market to analyze – can have collusion ???? or can have
price war ???, or something in between
• Examples: banks, Coles and Woolworths, maybe mobile
phones, domestic ??flights
• Note: oligopolies with only 2 firms are also called “duooplogies”?????
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Monopolies ??
• SA Water, energy companies in small cities,
Facebook/Wechat. Australia Post
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Market Structure
This week we’ll
consider Monopoly:
the firm is a pricemaker
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11
Imperfect v. Perfect
Im-perfect = Perfect except that one or more of the
following assumptions apply:
• Consumers/suppliers are
price-takers, or
• Goods are
homogeneous??, or
• There
externalities, or
• Goods are
excludable and rival, or
(not full) information, or
free entry and exit.
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Imperfect vs. Perfect
This week we’ll consider:
• Consumers/suppliers are NOT price-takers,
• Goods are NOT homogeneous, or
• There ARE externalities, or
• Goods are NOT excludable and rival, or
• Imperfect (not full) information, or
• NO free entry and exit.
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Note to teachers – must start from
here (at latest)
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Perfect v Monopoly ?? [summary slide]
Perfect competition
•
•
•
•
•
•
Many firms
Suppliers are price takers
Goods are homogenous??
No barriers to entry ????
No LR profits
No economies of scale
Monopoly
• 1 firm
• Supplier is price maker
• Only one firm supplies the
goods
• High Barriers to entry ???
?
• Often significant economies of
scale ??????
• Can make LR profits
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Market Power
Definition:
A firm is said to be a Price-Maker (or PriceSetter) if it has the ability to set its own prices.
A firm has Market Power if it has the ability to
set its own price.
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Market Power ?????
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Barriers ?? to Entry
Barriers to entry means that the freedom of entry/exit
assumption does not apply. Comes from:
• Control Over Scarce ?? Resources (De Beers
diamonds, Alcoa aluminum?)
• Government-Created Barriers to Entry (patents??,
copyrights ??, licenses, etc) (Australia Post,
Panadol)
• Increasing Returns to Scale (SA Water, East Waste)
• Network Economies (eg facebook, Instagram,
snapchat)
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Increasing Returns to Scale??????
(IRS)
Definition:
We say that there are Increasing Returns to Scale
(Economies of Scale) when the average cost of
producing a certain good decreases with the
amount of the good produced.
The firm is producing on the downward-sloping
part of the Long-run ATC
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Increasing Returns to Scale (IRS)
Definition:
A Natural Monopoly indicates a monopoly
that occurs because of increasing returns to
scale.
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Increasing Returns to Scale??????
• In some industries, the
larger the firm the lower its
LRAC (long run average cost).
This can create a natural
monopoly.
• Think of SA water. It is
more efficient to have one
firm only because having 2
sets of water pipes to each
house is inefficient.
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Natural Monopoly Analysis
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Monopoly
Definition:
Monopoly is a market structure where there is
only one firm operating in the market.
These notes include some (unexaminable)
supplementary ?? materials!
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Natural Monopoly Model
•
•
•
•
Demand is downward sloping
P>MR (explain later)
MC is horizontal ? (so natural monopoly)
Increasing returns to scale
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Key things to understand
• Monopoly cost curves
• Monopoly MR curve
• Same rules for profit maximisation: MR=MC and P?AVC,
Profit= Q(P-ATC)
• These 3 mathematical relationships
1.
2.
3.
Where MC constant, MC=AVC
MRMR monopolists has a tendency to restrict Q in
order to raise price, and operate on the elastic portion of the
demand curve
• By restricting output, a DWL ???? results from
underproduction.
Monopoly (In)efficiency
• In monopoly,
P>MC at profit
maximum position.
So CS decreases
and a DWL is
created
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Perfect Comp Efficiency
• In perfect competition,
P=MC so CS maximized and
no DWL
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Perfect Comp “Refresher”
• Notice in perfect comp, P=MC, and ATC is at it’s lowest
point at profit max quantity. Neither occurs in monopoly.
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Practice Questions
• Show CS, PS,
DWL at profit
maximizing
quantity
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Draw PS, CS and DWL here
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University’s Example – Discrete
Data
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Monopoly – Production Costs, Discrete
Data ????
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Monopoly – Demand
MR=P=constant
D is downward-sloping
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Monopoly: MR ? D
To sell the extra units of the good and attract new consumers,
the monopolist needs to ? P ? affects all units sold (because
the monopolist needs to charge all consumers the same price)
? there’s a tradeoff from selling more (?Q good, ?P bad) so
MR < P whenever there is market power University of Adelaide College Monopoly: MR < P MR of selling 400 rather than 200: ?TR/?Q= =(400*.65-200*.85)/(400-200) = $0.45 University of Adelaide College Monopoly: MR MR=MC University of Adelaide College DWL of Monopoly University of Adelaide College Monopolist’s Profit Max [note MC not horizontal] • Monopolist still chooses QM where MR = MC BUT MR ? P • Find QM first THEN set price by finding where QM is on the D curve University of Adelaide College Monopolist’s Profit Max • Monopolist still chooses QM where MR = MC BUT MR ? P • Find QM first THEN set price by finding where QM is on the D curve University of Adelaide College Monopolist’s Profit Max • Profit is still TR – TC = (P – ATC) x Q • But now profit can be positive in the long-run University of Adelaide College Monopoly v. Social Efficiency • How does the socially optimal ??quantity compare to the monopolist optimal quantity? • Why is there a conflict between what the monopolist wants and what consumers desire? • What is the efficiency loss of Q*monopoly? University of Adelaide College ???Competition Law University of Adelaide College Competition Law Definition: Competition Law denotes a law that is intended to foster market competition by regulating the anti-competitive conduct of firms. Goal is to ensure that consumers are charged the lowest possible prices University of Adelaide College Problems of monopoly • Many essential services are natural monopolies (water, energy, phone, telecommunications ??) • Gov often control the price of monopoly to avoid – Price being too high – Profit being too high – Q being too low (DWL too high) University of Adelaide College Monopoly and competition Policy • Because monopolists can maximize profit by restricting demand, they are often inefficient • Therefore the government often regulates them to reduce the DWL. • 2 regulation ?? policies are: – ATC pricing – MC pricing University of Adelaide College Average Cost Pricing Definition: Average Cost Pricing is a policy through which the government forces the monopolist to set the price and quantity = ATC. If P=ATC, profit = 0. Often used to regulate Natural Monopolies Eliminates positive profits monopolist could make University of Adelaide College Average Cost Pricing • The Average Cost Pricing is hard to implement ??: • • • government does not know the ATC (it can only estimate them) Once implemented, firms have no incentive??to invest in new technology to lower their costs when implemented ??, the firm’s output is allocative inefficient (allocative efficiency ???? https://en.wikipedia.org/wiki/Allocative_efficiency ) Average Cost pricing • Monopolist forced to charge P=11 where P=ATC • Notice DWL is now smaller (draw on diagram) University of Adelaide College Your practice – draw average cost pricing and DWL University of Adelaide College Problem of ATC pricing and MC pricing • There is still a DWL as P>MC
• Does not achieve allocative efficiency: A firm’s output is
said to be Allocatively Inefficient if the price asked for
the goods produced exceeds their marginal cost.
• Therefore government may use marginal cost pricing but this
has 2 negatives:
– Producer may make loss;
– Government may have to give a subsidy ?? to producer
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Marginal Cost pricing
• One solution is to set P=MC
• But this creates a loss as
PM we lend to foreign countries (to pay for our
exports)
– If X expected inflation, the real value of wages (for
those not being renegotiated) will be lower and employed workers
lose
Simple rule:
–
–
unanticipated?? inflation lowers real wage
Unanticipated disinflation increases real wage
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14
Shifts in SRAS
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15
? Expected Inflation Shift SRAS
• In micro, we learned that changes in production costs shift
the supply curve
• In macro, expected ?? inflation determines the nominal
wage rate
• Conclusion: when expected inflation changes, the SRAS
shifts, but how
– If expected inflation falls, SRAS shifts
___________
– If expected inflation rises, SRAS shifts
___________
Other factors shifting SRAS – part 2
• The cost and quantity of other resources also effect
SRAS – the logic is similar to micro
• Other factors affecting supply capacity ??:

labour productivity ????? changes (output per labour )
technology changes
Energy prices
government policy changes
• Example: if energy prices increase – eg South
Australia – cost of production rises, decreasing
SRAS!
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17
Shifts of the SRAS Curve
Change in Expected Inflation
Change in Labour Productivity
© Playconomics, LHS
Quiz
• What happens to SRAS if
– Expected inflation falls;
• Technology improves
• Oil price rises
• Unions ?? successfully obtain substantial pay rises for their
workers
• $AUS depreciates massively
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19
Long Run Aggregate Supply
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20
Long-run Aggregate Supply ?????
Definition
• Long-run Aggregate Supply (LRAS): shows the natural
(normal) level of output (YN) that can be produced using the
inputs at normal capacity, when inflation equals its expected
rate, and when productivity ??? equals its trend??.
• LRAS is vertical??
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21
Why is LRAS vertical
•
•
•
LRAS is vertical: no matter what the inflation rate is,
aggregate output is constant at YN
What matters in determining long-run output is what
resources a country has, not whether prices are high or low.
The reason LRAS is vertical is the because if GDP briefly
rises above potential GDP, inflationary pressures will soon
cause GDP to return to the natural rate
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22
Extra LRAS theory if students ask
• Our model assumes the LRAS is fixed. This is partially??
true because
–
–
–
–
LRAS is determined by the level of resources (K, L, T);
At any point of time resources are fixed;
Therefore LRAS are fixed at any point of time; BUT
As resources grow over time, potential GDP grows and LRAS shifts to
right
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23
????????? ??? Trend over time
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Aggregate Demand
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25
Aggregate Demand???
• Aggregate Demand (AD): shows the combinations of
aggregate output demanded at each rate of inflation
• AD = C + I + G + NX
• AD slopes down due to forces on each component, i.e., when
inflation rises, C, I and NX ???? (G is fixed)
Factors influencing consumption
• Most models state consumption has 2 components
• Fixed consumption:
– Some consumption is independent of income, and even exists when
income is 0
• Pensioners live off retired savings;
• Others borrow to finance spending
– We assume the interest rate affects this level of consumption, i.e.,
IR??fixed consumption?
• Variable consumption:

Depends on income ( Y ), eg, the size or quality of your home or car
or nicer food or clothing.
As income rises, this part of consumption rises too.
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27
Inflation lowers consumption
•
Fixed part:
– Higher ? makes goods more expensive
– People therefore will lower their fixed consumption
– Higher ? ? central bank???? raises IR ? more
expensive to borrow ?C?
– Variable Part:

Higher ? ? lower real income ? variable C?
Higher ? ? central bank???? raises IR ? C?
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Why does the central bank???? raise
IR when ? higher
• Central banks around the world have inflation targets, of 23%
• When inflation rises, central banks respond by raising
interest rates to control spending
• Therefore, simple rule
– ? ?????? consumption and investment decreases ?AD?
• This is studied in more detail in later weeks
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Inflation lowers investment
• What is investment:
– Spending on new capital goods
• Why inflation influences investment:
– Higher inflation leads to higher interest rates and uncertainty;
– Higher interests rates increase cost of borrowing;
– Investment falls
• Rule:
– ?? ? IR ? ? investment falls?
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30
Government spending independent of ?
• Government spending is exogenous?????
• It is independent of inflation, and determined by political
decisions
• Changes in government spending can only shift the A? curve
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Net Exports ???
• Net Exports = X-M
• Both X and M are affected by inflation as inflation
affects international competitiveness, eg
– If France’s inflation is higher than Germany,
• France exports less to Germany (French goods are
more expensive)
• France imports more from German (German goods
comparatively ?? cheaper)
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Shifts of AD
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Economic Confidence and expectations
• Economic confidence is whether people think the economy
will be stronger or weaker in the future
• It strongly influences current spending
–
–
–
–
Low Consumer Confidence ????? ?C?
High Consumer Confidence ?C?
High business Confidence ???? ? I?
Low business confidence ? I ?
• In a recession, economic confidence is almost always low
• Investment is the most volatile ???? component of AD?
Why?
Net Export Influences
• Foreign GDP:
– When foreign GDP falls, our exports decrease because foreign
countries cannot afford as much, therefore
• China? US, Japan GDP ??X?
– Rule: foreign GDP ??X?; foreign GDP ??X?
• $AUS:
– The $AUS is the amount of foreign currency $1 AUS can buy
– When the $AUS falls, NX increase because
• Our goods are cheaper to foreigners ?X?
• Foreign goods are more expensive ?M?
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National economic policy
• Fiscal policy???? and monetary policy ???? both
affect AD and are discussed in detail later
• Brief rules are summarised below:
– T?, G?, IR ??AD ?
– T ?, G ?, IR ? ?AD ?
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Shifts of AD
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AD/AS Equilibrium
Changes to AD/AS equilibrium
• AD/AS equilibrium determines inflation, GDP, and
indirectly unemployment
• Shocks ???? to AS and AD affect economic
equilibrium
• Shocks are unanticipated??changes
• Most common shocks in real world:
•
•
•
Changes in foreign economy, eg in 2008 Global Financial Crisis;
Extreme loss of confidence – 1930 Great Depression ???
WW2 – positive shock to US economy (although not in other
countries)
Negative AS Shock
• Start in equilibrium with output at its natural level,
inflation at the equilibrium level and the economy is
proceeding ??as expected
• Let there be a temporary??and unanticipated fall
in labour productivity relative to trend …
© Playconomics, LHS
Negative AS Shock


SRAS shifts to the left as
less Y is produced (Y’, ?T)
Out of equilibrium!
Pressure on ? to rise as it
becomes more expensive
to produce
Higher ? means workers
cheaper, jobs created
New short-run
equilibrium (YSR, ?SR)
Shift of SRAS has lead to
a movement along AD
© Playconomics, LHS
Positive AD Shock
• Start in equilibrium with output at its natural level,
inflation at the equilibrium level and the economy is
proceeding as expected
• Let there be a one-time, unanticipated rise in
government expenditures …
© Playconomics, LHS
Positive AD Shock



AD shifts to the right
which means more
output needs to be
produced to satisfy
higher G (Y’, ?T)
Out of equilibrium!
Pressure on wages to
rise, raising ?
As higher costs built into
prices, move up along AS
(not AD) curve
New short-run
equilibrium (YSR, ?SR)
Shift of AD has lead to a
© Playconomics, LHS
AS-AD Summary
The Macroeconomy is complicated!
• Lots of moving parts
• AS-AD model is a way we can isolate the effect of
changing each part … and see the impact on Y and ?
• Not all changes to inflation and output are the same:
inflation might come from ‘good’ or ‘bad’ reasons
• Now we can use this model more
© Playconomics, LHS

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Explanation & Answer:
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supply and demand

monopoly

macroeconomic fundamentals

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