QUESTION

QUESTION ONE

Australia’s economy is currently described as a “multi-speed” economy.

Critically discuss this.

[HINT: In your discussion include what has caused this multi-speed economy; any advantages and the disadvantagesfor the economy and households].

Limit: 2 Written Pages.                                                                            [10 Marks]

QUESTION TWO

Australian households have changed their spending behaviour since the mid 2000s, illustrated by Consumption falling as a share of GDP and the Savings ratio rising.

a) Discuss two possible reasons for this.                                                  [2 Marks]

b) Go to the Australia Bureau of Statistics site and find a chart/graph that illustrates the above statement.                                                                           [3 Marks]

c) Using the simple Keynesian model of Income determination, show what happens to equilibrium GDP when (as in the statement above):

• Consumptions falls                                                                        [5 Marks]
• Saving rises                                                                                  [5 Marks]

[HINT: Use two separate diagrams to show each. Explain these diagrams in words as well. Explain the operation of the multiplier effect in each instance.]

QUESTION THREE

Collect a 2011/2012 article from an Australian newspaper showing coverage of a MACROeconomic issue relating to China or India. Include a hard copy of the article with your answer.

a)Explain what macroeconomic topic the article addresses and summarise the article briefly to show your understanding.                                            [4 Marks]

b) Discuss what implications (if any) the chosen article has on Australia.    [1 Mark]

[HINT: Be completely sure that the article shows a Macroeconomic issue. Any article that discusses a Microeconomic issue will be strictly given NO marks]

QUESTION FOUR

The Australian Dollar has been performing particularly strongly against the United States Dollar for the first quarter of 2012. This appreciation of the Australian Dollar to the US Dollar has not been seen since the early 1970s. See chart below.

a) What effect does this have on the Economy? Explain in words only.

b) Using the Aggregate Demand-Aggregate Supply Model (a diagram is required), show the impact of a high domestic exchange rate on GDP and Inflation.

SOLUTION

Contents

1. Question 1. 1

2. Question 2. 2

3. Question 3. 6

4. Question 4. 7

5. References. 9

1. Question 1

Economists and analysts in light of the current economic nature of the Australian economy have warned against the existence of a multispeed Australian economy. In a multispeed economy regions and sectors centred on commodity based growth expand while the other non-commodity regions grow slowly or even contract. A multi speed economy poses challenges for the government policy making. The macroeconomic policy decisions related to interest rate and monitory policy can have a detrimental effect on the growth of a nation representing such diverse characteristics. Many economists fear that the Australian commodity based industries would be threatened in the near future with the dependency of the economy increasing on the services sector (Turner, 2012).

The Australian bank bosses have also warned the multispeed nature of the Australian economy, where the resource sector has surged and the other sectors have struggled. Credit Suisse has also warned against the divergent performance of the various sectors. The growth of the mining industry has remained strong is a classic example depicting the nature of growth of the Australian economy. Though the growth of the mining industry has been strong this has been accompanied by the sluggish growth in other sectors like retail, tourism and housing finance. The main reason for this phenomenon is continuous appreciation of the Australian dollar. The constant appreciation of the Australian dollar has implied that the imports are cheaper than the exports, implying that demand is more skewed towards imports while supply is more skewed towards exports. Thus, interfering with the demand and supply mechanism of the economy and bringing economic distortion. The Australian economy has experienced robust growth in the mining as well as in the export of live cattle, this has been at the cost of domestic industries currently battling high unemployment rates and mounting job losses.

(Brown, 2012, www.theaustralian.com.au- accessed on 15/05/2012)

The commodity price boom has resulted in the RBA responding to the potential inflationary pressures experienced by the economy, with the high interest rate caused by the global financial crisis. This has resulted in the tightening of the monitory policy while the mining industry and the Australian dollar continue to surge upwards. This has made it difficult for the non-commodity industries like manufacturing, education as well as tourism. These sectors contribution to the national economy has been constantly sinking. The Households on the other hand have responded to the situation by increasing the savings and reducing spending. This phenomenon was caused with the rising interest’s rate and the Global financial crisis. The households are feeling the pinch of the rising prices and therefore are opting to save more to scrape through the crisis. Thus with the households preferring to save more , owning to the rising costs in the economy of energy , crude oil as well as schooling the consumption of the households has decreased. This pattern has also been noticed by Woolworths who have said that the sales have been affected in light of the rising costs in the Australian economy (www.smh.co.au, www.abc.net.auaccessed on 15/05/2012,).

Thus the Australian economy is often referred to as a miracle economy, because the economy has had a limited impact of the global financial crisis and continues to have positive growth outlook. But however the lop sided nature of the growth is affected the overall economic health of the economy as one mining and the resource sector continue to grow in a robust fashion the other sectors are lagging behind. Thus, even though the Australian incomes have grown by over 4% in the previous year the impact has not been realised because of rising consumer good prices. Thus many economists argue that Australia will continue to grow richer but the impact would not be felt on an average by the population (www.smh.co.au accessed on 15/05/2012).

2. Question 2

a)     The Australian economy has been continuously evolving owning to the structural changes in the domestic and the international changes. The changes in the consumption patterns in the Australian economy were driven by the changes in global business environment and the globalised nature of the Australian economy. Firstly the Low rates if interest were prevalent globally from the 1990’s onwards which were responsible for the robust growth experienced globally including the growth of developing economies like India and China which surpassed all expectations. The lower rates of interest have enabled the upward movement of the asset prices, with household’s prices reaching an all-time high during the period. This in turn has resulted in high consumption patterns of the Australian households. Secondly, the high consumption pattern trend was also due to the Falling prices of the investment goods. The availability of the investment goods and technology at relatively lower prices during the period 1990- 2007 encouraged investment in all sectors leading to robust growth, eventually having a multiplier on the consumption. The price of the investment goods fell over 40% in between 1990- 2007 leading to high investment in all sectors. This has already leaded to an increase in the returns to the skilled labour, contributing to increase in the consumption of the Australian households.

The consumption patterns have undergone a downward trend owning to multispeed nature of the Australian economy and the impact of the global financial crisis. Thus, even though the Australian incomes have grown by over 4% in the previous year the impact has not been realised because of rising consumer good prices. Thus many economists argue that Australia will continue to grow richer but the impact would not be felt on an average by the population (www.smh.co.au accessed on 15/05/2012, Downers et al, 2006).

b)     Expressed in real terms the household consumption has grown from $10600 to over $26100 in 2006, The magnitude of the increase has been over 152% .The trend in the increase in the consumption has been experienced in the period 2000-2007 owning to robust economic conditions. But however the consumption has decreased slightly owning to the Global financial crisis and the Euro zone crisis which have adversely affected the Australian consumption, with the preference of the people to save more. Pinch of the rising prices and therefore are opting to save more to scrape through the crisis. Thus with the households preferring to save more , owning to the rising costs in the economy of energy , crude oil as well as schooling the consumption of the households has decreased. This pattern has also been noticed by Woolworths who have said that the sales have been affected in light of the rising costs in the Australian economy (www.smh.co.au , www.abc.net.au ,  Australian Bureau of statistics accessed on 15/05/2012)

Figure 1: Australian Households Consumption pattern 1960-2007 (Source – abs.gov.au – accessed on 15/05/2012)

c)     Keynesian Equilibrium

Case 1: When Consumption Falls

The changes in the consumption patterns causes shifts in the aggregate demand, and eventually graphically depicted by the shifts in the aggregate demand curves. Since there is no foreign sector in the in the simple Keynesian model, the consumption function comprises of ‘C’ household consumption, ‘G’ government spending and ‘I’ investment in the economy. Therefore when the consumption falls it causes the left ward shift of the aggregate demand curve. The magnitude of the shifts depends upon the multiplier effect in the economy.

Figure 2: Shift in the Aggregate Demand Curve with the Decrease in Consumption (Source: Arnold,)

The Aggregate Demand Curve shifts to the left, with the decrease in consumption. It shifts the AD curve from AD1 to AD2. This causes the leftward shift of the equilibrium from a to b and a corresponding decrease in the price from Pa to Pb and the equilibrium quantity from Qa to Qb (Arnold ,)

The change in consumption is dependent upon the multiplier.

Thus, the multiplier is negatively affected with the decrease in the consumption spending.

Case 2: When Saving Rises

In the Simple Keynesian model the consumption function can be represented as

The increase in the saving implies a decrease in the consumption as the population prefers to save more, than consume this reduces the aggregate demand eventually shifting the aggregate demand curve leftward. The increase in the saving also implies that consumption has been postponed to a later date but in the short run would lead to a decrease in the demand.

Figure 3: Decrease in Saving and Impact on Equilibrium (Source :Ghosh and Ghsoh ,2010)

The decrease in the saving and shift of the aggregate demand curve is dependent upon the change in the multiplier, which determines the extent of the shift (Ghosh and Ghosh 2010)

3. Question 3

The Sydney Morning Herald has recently reported a sharp decline in the Indian rupee. The rupee has plunged in line with all the major currencies across the globe including the USD, Pound as well as the Euro. Despite positive growth outlook reported for the Indian economy, the currency depreciation could not be insulated from the effects of the global financial crisis as well as the rising commodity prices having an adverse effect on the currency. The Falling rupee would further deepen the problems of the Indian economy already battling a sluggish industrial output growth and high inflation. The impact of the rupee depreciation will have an impact on India’s import bills in relation to the crude oil and as well as other key commodity imports (www.smh.com.au, www.thehindu.com – accessed on 15/05/2012).

The rupee depreciation has also resulted in higher inflation in the Indian economy, as the prices of essential commodities like crude oil, coal and other industrial commodities experience an upward movement. Thus, pushing the price of consumer goods upwards and resulting inflation.

The rupee depreciation has also resulted in increasing the fiscal burden on the government in, particular with the rise in the import bills resulting in the high balance of payments for the Indian economy (The Associated Chambers of Commerce and Industry of India, 2012)

The subsequent depreciation of the rupee would result in affecting the Australian tourism industry which would be impacted with the dollar strengthening making Australia an expensive tourist destination. Secondly India is a major trading partner and receiver of key mineral exports, the quantity of the exports can be adversely affected sighting high costs.

4. Question 4

a) The Australian economy is finally feeling the impact of the financial crisis; this is evident in the exchange rate fluctuations of the Australian dollar in comparison to the other currencies. After experiencing considerable appreciation in the currency over the past decade; owning to the robust growth of the Australian economy has been due to the growth of the Australian exports. Australia has been effectively able to capitalise on the competitive advantage that is possesses in terms of rich mineral deposits. Another reason that can be identified for the appreciation of the Australian dollar is the higher commodity exchange prices; this resulted in countries buying large amounts of Australian currency, leading to the Australian currency appreciation (RAVIMOHAN, 2010). The Australian dollar was expected to surpass its previous highs of the past in 2011 largely attributed to the rising coal and commodity prices (www.bloomberg.com – accessed on 15/5/2012).

The recent volatility in the Australian exchange rate and the Australian economy cannot be ignored this has been largely due to the dependence on the export growth. The Australian governments increased pressure on the RBA to cut rates may further introduce volatility and jeopardise the growth process. Therefore it is important that the movement of the exchange rate be tracked such that it is not able to affect or jeopardise the growth of the Australian economy.

(www.halofinancial.com- accessed on 15/5/2012).

b) With the addition of the External sector in the AD- AS framework the consumption Equation changes as follows

Where Yt is the total real domestic GDP of the country, Gt is the total government spending in the country, NXt are the Net exports of the country and Dt is the total private consumption demand of the economy. The demand for the foreign exchange is determined domestically by the monitory authority of the country. With the decline in the demand for foreign exchange because of currency appreciation affecting the real exports of the economy is likely to jeopardise the economic growth and cause a left ward shift in the Aggregate demand curve.

Figure 5 : Shift of the Aggregate Demand With Currency Appreciation (Arnold)

The leftward shift of the aggregate demand curve has resulted in the decrease in the total GDP of the domestic country as well as a corresponding decrease in the price levels. A decrease in the price levels also reduces the inflationary pressure on the economy, but is faced with a lower AD(Arnold, 2010).

5. References

• Turner , Adrian. Blue sky mining. San Franssico: Adrian Turner, 2012. Print.
• “. | The Australian.” | The Australian. N.p., n.d. Web. 15 May 2012. <http://www.theaustralian.com.au/business/australias-bank-chiefs-warn-of-multi-speed-economy/story-e6frg8zx-1226028349160>.
• Brown, David. “Prosperity, Competition, and the Exchange Rate.” davidbrown180 1.1 (2012): 1-10. Print
• “Pain and gain shifting with tectonic plates of a multi-speed economy.” Sydney Morning Herald – Business & World News Australia | smh.com.au. N.p., n.d. Web. 15 May 2012. <http://www.smh.com.au/business/pain-and-gain-shifting-with-tectonic-plates-of-a-multispeed-economy-20110418-1dls0.html>.
• “Queensland insolvencies highlight multi-speed economy – ABC News (Australian Broadcasting Corporation).” ABC.net.au. N.p., n.d. Web. 15 May 2012. <http://www.abc.net.au/news/2012-05-12/queensland-insolvencies-highlight-multi-speed-economy/4007398>.
• Downers, Peter, and Andy Stoeckel. “Drivers of structural change in the Australian Economy.” Center for International Economics 1.1 (2006): 1-180. Print.
• Ghosh, Chandana, and Chandana Ghosh. Macroeconomics. New Delhi: PHI Learning Private Limited, 2011. Print.
• “Indian Rupee | Currency .” Sydney Morning Herald – Business & World News Australia | smh.com.au. N.p., n.d. Web. 15 May 2012. <http://www.smh.com.au/business/rupees-rise-precursor-to-rapid-fall-20111130-1o70q.html>.
• The Associated Chambers of, Commerce and Industry. “Depreciation: Impact Analysis.” The Associated Chambers of Commerce and Industry of India 1.1 (2012): 1-20. Print
• Arnold, Roger A.. Economics. 5th ed. Cincinnati, Ohio: South-Western College Pub., 2001. Print.
• “4102.0 – Australian Social Trends, 2007.” Australian Bureau of Statistics. N.p., n.d. Web. 15 May 2012. <http://www.abs.gov.au/ausstats/abs@.nsf/0/0485BB5550FE5799CA25732C00207C77?opendocument>.
• “The Hindu : Business / Economy : Rupee depreciation will have impact on imports: Rangarajan.” The Hindu : Home Page News & Features. N.p., n.d. Web. 15 May 2012. <http://www.thehindu.com/business/Eco

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