Australian School of Business School of Economics

Econ1102 Macroeconomics 1 Tutorial Program Session 2, 2013

Course Website http://telt.unsw.edu.au

TUTORIAL PROGRAM Tutorials begin in week 2 (5 9 August) and end in week 13 (28 October 1 November). There are no tutorials in weeks 10 (8 11 October) and 11 (14 18 October). Students must attend the tutorial in which they are officially enrolled. Attendance at other tutorials will not be recorded. Note that 80% attendance is required by UNSW and ASB rules. The use of electronic devices during tutorials is restricted. Each weeks tutorial consists of: The required reading from the textbook (Bernanke, Olekalns and Frank) The main concepts in each lecture topic Review questions Discussion questions

In preparation for your weekly tutorial you should: Review your lecture notes Read the relevant sections of the textbook and Prepare answers to all the tutorial questions.

Review Questions These questions are designed to reinforce the macroeconomic concepts and models developed in lectures. They cover relatively basic material from the course and provide a guide to the type of short-answer questions that could be asked in an exam. Discussion Questions Discussion questions are more general and open-ended than review questions. They are designed to extend and elaborate on some of the concepts and ideas from lectures. For example they may apply macroeconomic models to current policy issues. Some of the discussion questions may involve additional readings and the analysis of macroeconomic data. Appropriate links are provided when required. Hand-in Tutorial Questions Each week students are required to submit to their tutor a written answer to one of tutorial questions for that week. The questions for which a written answer is required are indicated with an asterisk (*) in the Tutorial Program. This assessment component has a weighting of 10%. Answers must be submitted at the beginning of the tutorial. During the semester FOUR of the submitted answers (selected at random) will be graded by your tutor and given a mark out of five. Each marked paper will account for a 2.5% weighting of the final mark.

Basic Instructions for Hand-in Tutorial Questions - Your answer to the hand-in tutorial question should only be written or printed on A4 paper and you should include your name and student number. - Answers must be written in complete sentences and paragraphs. Diagrams must be explained and clearly labelled. Marks deducted for poor handwriting/presentation. (Do not write out the questions and avoid printing out data). - The hand-in tutorial question will be discussed in the following weeks tutorial. - To submit your answer to a hand-in tutorial question you need to physically attend and participate in the tutorial in which you are enrolled. Answers to hand-in tutorial questions will not be accepted in any other circumstances. - If you cannot attend a tutorial due to illness, and that hand-in tutorial question for that tutorial is selected for marking, then you need to provide appropriate documentation of the illness to the Course Administrator (Spiro Vlachos s.vlachos@unsw.edu.au). - Answers by email will not be accepted under any circumstances. Tutorial Test A short-answer test will be held during tutorials in the following week: Tutorial Test Week 8 (16 20 September)

This assessment component has a weighting of 20%. Students will have 30 minutes to complete the test. No notes, lecture or course material, or electronic devices (UNSW approved calculators allowed) will be permitted to be used during the in-tutorial test. Questions must be answered on the answer sheet provided by your tutor. A list of potential questions will be provided on the course website (one week prior to the test). Questions asked in the tutorial tests will be based on those posted on the website. However, there may be some slight differences in the actual test questions, e.g. numbers could be changed for questions that involve calculations. Students must sit the tutorial tests in the tutorial group to which they have been allocated. There will be NO supplementary tests offered for the in-tutorial test. You should make every effort to take the in-tutorial test. Students who fail to attend the test will need to apply for Special Consideration. In cases of serious illness, students will need full and convincing documentation of that illness. Students who are found to be genuinely too ill to have attended an in-tutorial test will have their mark in the final exam re-weighted to include the mark reserved for the missed test. In all other cases of non-attendance students will receive a grade of zero. Employment obligations or holiday plans of any kind are not acceptable reasons for absence from any assessment. Applications for special consideration must be lodged online through myUNSW within 3 working days of the assessment (Log into myUNSW and go to My Student Profile tab > My Student Services channel > Online Services > Special Consideration). Then submit the originals or certified copies of your completed Professional Authority form (pdf - download here) and any supporting documentation to Student Central.

TUTORIAL 1 (5 9 AUGUST) Output, Prices Textbook Reference: Chapter 1 Main Concepts Gross Domestic Product (GDP) GDP and Economic Welfare Prices and inflation Consumer Price Index (CPI) Costs of inflation Biases in measuring inflation Review Questions Question 1 (i) What are the main indicators of macroeconomic performance? (ii) Do you think it is possible to simultaneously achieve good outcomes for all macroeconomic objectives? (iii) Are there likely to be trade-offs between various objectives? Give some examples. Question 2 The typical consumers food basket in the base year 2000 is as follows: - 30 chickens at $3.00 each - 10 hams at $6.00 each - 10 steaks at $8.00 each. An outbreak of bird flu causes a shortage of chickens and results in their price rising to $5.00 in 2001. Hams also increase in price to $7.00 in 2001, but the price of steaks remains unchanged. (i) Calculate the change in the cost of living index between 2000 and 2001. (ii) Suppose that consumers are indifferent between two chickens and one ham. Draw an indifference curve for this type of consumer. (iii) For the case in (ii) how large is the substitution bias in the cost of living index? Explain. (iv) Now suppose that consumers treat chickens and hams as perfect complements. Draw the indifference curve for this type of consumer. What do you notice about substitution bias in this case? (v) What other bias may this consumer experience?

Discussion Questions Question 3 (i) What does GDP measure? (ii) What are the three methods for calculating GDP? (iii) Is GDP per-capita the same thing as economic welfare? (iv) Identify some factors that are likely to have an impact on economic welfare but are not measured in GDP. Question 4 (i) What does the CPI index measure? (ii) How do we calculate the rate of inflation using the CPI index. (iii) Is an increase in the CPI an increase in the cost of living? (iv) Would a decrease in the CPI lead to a decrease in the cost of living? (v) What are the costs of inflation and how may they affect each economic agent. (vi) Which of these costs is likely to be the greatest burden on the economy? Why? Question 5* (All students must submit a written answer to this question at the beginning of this tutorial.) Go to the RBA Website at http://www.rba.gov.au/statistics/tables/index.html#output_labour (i) From Table G11, calculate (and record) real GDP (chain volume measure, column L), consumption (column B), and investment (excluding inventories, sum of columns C, D, E, and F) for the calendar year 2012. (Note: The calendar year 2012 corresponds to the sum of quarters March quarter 2012, June quarter 2012, September quarter 2012, and December quarter 2012). (ii) Calculate the consumption share of GDP and investment share of GDP for 2012. Which component is the largest? Which economic agents conduct consumption spending and which economic agents conduct investment spending? (iii) For each quarter, calculate the percentage changes for the consumption series and the investment series in part (i) from the quarter June 2003 to the quarter March 2013. Construct a diagram with both series on the same graph. (see Blackboard for excel tips). (iv) What are the key differences between the two series? Use the definition of consumption and investment to explain the differences.

TUTORIAL 2 (12 16 AUGUST) Savings and Investment Textbook Reference: Chapter 2 Main Concepts Interest rates and inflation Household, Private, and Public saving National saving Saving and wealth Motives for saving Investment and capital formation Model of saving, investment and the real interest rate Review Questions Question 1 Use the following data to calculate: (i) GDP (ii) National saving (iii) Public saving (iv) Labour income Consumption expenditure Exports Government expenditure Construction of new houses Sales of existing houses Imports Beginning-of-year inventory stocks End-of-year inventory stocks Business fixed investment Government transfer payments Government interest payments Indirect taxes less subsidies Direct taxes paid by the private sector Payments to owners of capital $ Billion 200 50 40 20 80 40 10 5 60 15 5 35 25 100

Question 2 (i) Explain the relationship between investment and capital, using the concept of stocks and flows. (ii) Identify three factors that can affect a firms cost of capital. (iii) At the aggregate level, what factor is likely to be the most significant cause of variation in the cost of capital? Explain your reasoning.

Question 3 (i) Explain the relationship between savings and wealth, using the concept of stocks and flows. Is savings the only way by which wealth can increase? (ii) Explain three basic motivations for saving. What other factors would a psychologist cite as being important for saving. (iii) Explain the difference between saving and investment as defined by a macroeconomist. Which of the following situations represent investment? Saving? Explain. (a) Your family takes out a mortgage and buys a new house. (b) You use your $200 pay cheque to buy BHP shares. (c) Your roommate earns $100 and deposits it in her account at a bank. (d) You borrow $1,000 from a bank to buy a car to use in your pizza delivery business. Discussion Questions Question 4 Use the saving and investment diagram to predict the effects on the real interest rate, saving and investment of the following events. (i) Parliament passes a 10 percent investment tax credit. (For every dollar a firm spends on investment it receives an extra $10 in tax refunds from the government). (ii) Concerns about the level of public debt lead the government to reduce expenditure and raise taxes; moving the budget from a deficit to a surplus. (iii) A new innovation dramatically reduces the cost of producing solar power on a large scale. (iv) The price of crude oil quadruples. Question 5* (All students must submit a written answer to this question at the beginning of this tutorial.) Suppose the government borrows $20 billion more next year than this year. (Assume a closed economy.) (i) Use a supply-and-demand diagram of saving and investment to analyse the effect of this policy. Does the real interest rate rise or fall? (ii) What happens to investment? To private saving? To public saving? To national saving? (iii) How does the elasticity of demand for investment to the real interest rate affect the size of these changes? (iv) Suppose households believe that greater government borrowing today implies higher taxes to pay off the government debt in the future. What does this belief do to private saving and national saving today? Does it increase or decrease the effects discussed in parts (i) and (ii)? (v) Explain which motive(s) for saving would impel households to save more in this case.

TUTORIAL 3 (19 23 AUGUST) Unemployment, the Labour market Textbook Reference: Chapter 3 Main Concepts Demand for labour Supply of labour Model of labour demand, supply and the real wage Unemployment frictional, structural and cyclical Full employment

Review Questions Question 1 Go to statistics on the RBA Website at http://www.rba.gov.au/statistics/tables/index.html#output_labour Using Table G7, summarise (with graphs) the main labour market trends in Australia over the last 20 years for: (i) The unemployment rate (column I) (ii) The participation rate (column D) (iii) The relative proportions of part-time and full-time workers in total employment (columns E, F & G) (iv) Hours worked per worker (column J/column G)

Question 2 List three types of unemployment and their causes. Discuss the likely economic and social costs of each form of unemployment. What is the natural rate of unemployment? In each of the following cases explain which type of unemployment is the best description. (i) Ted lost his job when the steel plant in Newcastle closed. He has worked in the steel plant since leaving high-school and owns a house in Newcastle. (ii) Alice was laid-off from her job in the car industry because the recession reduced the demand for cars. (iii) Lance is an unskilled worker who does seasonal work picking fruit in Victoria. When there is no fruit to pick he is unemployed. (iv) Karen, a software engineer, lost her job when the start-up company she was working in went bankrupt. She interviewed for a position with five firms, before eventually accepting a new job in a firm in the same industry. (v) Tim worked in real estate in the US but lost his job when the Global Financial Crisis hit in 2008. He has been unemployed since that time but is still searching for employment as a real estate agent.

Discussion Questions

Question 3 (i) Draw the demand and supply model of the aggregate labour market. Explain why the demand curve is downward sloping and why the supply curve is upward sloping. Explain the factors that would cause each of these curves to shift? (ii) Suppose the government introduces a tax on labour. Consider a payroll tax that is levied on the employer. Use the model in (i) to show the effect of the payroll tax on employment and wages. (iii) Suppose that the payroll tax is re-interpreted as a superannuation guarantee (SG) contributions levy. Use the model to analyse who pays the levy; the employer or the employee? (iv) Suppose the government introduces a minimum wage. Use the model to analyse the effect on employment, unemployment, the labour force, and the quantity of labour demanded. Who are the winners and who are the losers?

Question 4* (All students must submit a written answer to this question at the beginning of this tutorial) (i) Draw the demand and supply model of the aggregate labour market. Explain why the demand curve is downward sloping and why the supply curve is upward sloping. Explain the factors that would cause each of these curves to shift. The following link contains Australia aggregate labour market statistics compiled by the ABS:
http://www.abs.gov.au/AUSSTATS/abs@.nsf/mf/6202.0?opendocument#from-banner=LN See also:
http://www.smh.com.au/business/the-economy/jobless-rate-rises-to-fouryear-high-20130711-2prhn.html

(ii) Re-draw the model in part (i) to show the effect of the change in employed persons and the unemployment rate that has occurred since June 2012. Assume that real wages have not changed over this period. (iii) Re-draw the model in part (i) to explain the effect of an increase in the superannuation guarantee (SG) contributions levy. Use the model to analyse who pays the levy; the employer or the employee?

TUTORIAL 4 (26 30 AUGUST) Business Cycles Textbook Reference: Chapter 4 Main Concepts Business Cycles Contractions and expansions Potential output Output gap Natural rate of unemployment Okuns law Review Questions Question 1 (i) Define a contraction and an expansion. (ii) What are the main characteristics of a recession? How are recessions identified and how are they different from contractions? (iii) What is meant by a depression and in what sense is it different to a recession. The following paper is useful for answering the above questions. http://www.imf.org/external/pubs/ft/fandd/2009/03/basics.htm (iv) Give examples of firms that are likely to be adversely affected by a recession (i.e. sales and profits decline). Are there any firms which are likely to see their sales and profits rise during a recession? (v) Briefly explain how each of the following variables is likely to be influenced by a recession: the natural rate of unemployment; the cyclical rate of unemployment and the inflation rate. (vi) Define potential output. Is it possible for an economy to produce an amount greater than potential output? Explain. Question 2 (i) Okuns law is given by the following equation; ( )

Explain in words what the above equation implies. (ii) Using Okuns law complete the missing data in the following table. Year Real GDP Potential GDP u u* 2008 7840 8000 ? 6 2009 8100 ? 5 5 2010 ? 8200 4.5 4 2011 8415 8250 5 ?

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Discussion Questions

Question 3 A common way to define a recession is that it corresponds to at least two consecutive quarters of negative real growth. The Excel file GDP_Data.xls contains a quarterly index (2000=100) of real GDP for the US and Australia from Dec. 1959 to Dec. 2010. (i) Use the data to calculate the quarterly real growth rate for each country (Dont worry that it is an index, you can calculate growth rates in the usual manner). Using the above definition of a recession identify the periods when each economy has been in a recession. Report these dates in a table. By this definition did the Global Financial Crisis produce a recession in Australia? (ii) Discuss the extent to which recessions in Australia occur at (approximately) similar times to those in the US. To what extent is it true to say that Australia catches a cold when the US sneezes?

Question 4* (All students must submit a written answer to this question at the beginning of this tutorial) Go to the RBA Website at http://www.rba.gov.au/statistics/tables/index.html#output_labour (i) From Table G11, calculate the quarterly growth rate series of real GDP (chain volume measure, column L) from the quarter of March 1980 to the quarter of March 2013. (Do not print). Display the growth rate of GDP in a graph. Identify the periods for which there is a recession, using the definition of at least two consecutive quarters of a decline in GDP. (ii) From Table G7, display the monthly unemployment rate from the month of January 1980 to the month of March 2013 in a graph. (iii) Construct a table and report the recession periods in part (i) along with the corresponding changes in the unemployment rate during these recessionary periods. (iv) According to Okuns law: ( )

If potential output and the natural rate of unemployment are unchanged during recessionary periods, does Okuns law approximately predict what you have reported in part (iii)?

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TUTORIAL 5 (2 6 SEPTEMBER) The AE Model Textbook Reference: Chapter 5 Main Concepts Components of Aggregate Expenditure Exogenous and induced expenditure Consumption Function Short run equilibrium output Income-Expenditure multiplier Review Questions Question 1 (i) Define planned aggregate expenditure (AE) and list its components. Why does AE change with income? (ii) Explain the concept of a consumption function. What are the main influences on consumption? Explain the difference between the average propensity to consume and the marginal propensity to consume. (iii) Draw a diagram of the AE model and explain the process by which the economy reaches equilibrium. Question 2 Data on pre-tax income, taxes and consumption spending (on domestic goods and services) for the Simpson family are given below. Pre-tax Income ($) 25,000 27,000 28,000 30,000 Tax Paid ($) 3,000 3,500 3,700 4,000 Consumption Spending ($) 20,000 21,350 22,070 23,600

(i) Graph the consumption function for the Simpsons and find their households marginal propensity to consume. (ii) Predict the Simpsons level of consumption if their income was $32,000 and they paid taxes of $5,000. (iii) Suppose that Homer Simpson wins the lottery. As a result the Simpson family increases its consumption by $1,000 at each level of after-tax income (the lottery winnings are not treated as income). How does this change the Simpsons consumption function? What happens to their marginal propensity to consume? What happens to their average propensity to consume?

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Question 3 Consider an economy described by the following equations. (i) Derive the equation for planned aggregate expenditure (ii) Identify the exogenous expenditure and the induced expenditure components for this economy. (iii) Find the short-run equilibrium for this economy. Illustrate the equilibrium on a 45-degree diagram. (iv) What is the output gap for this economy? If the natural rate of unemployment is 4%, use Okuns law to estimate the actual unemployment rate for the economy. (v) Calculate the effect on short-run equilibrium of a decrease in planned investment spending from 900 to 800. Illustrate your answer on a diagram. Discussion Questions Question 4 (i) What is the key assumption of the basic Keynesian model? Explain why this assumption is necessary if aggregate spending is a driving force behind short-term fluctuations in output. (ii) Give an example of a good whose price changes very frequently and one whose price changes relatively infrequently.

Question 5* (All students must submit a written answer to this question at the beginning of this tutorial) The model of short-run output determination in the textbook (BOF) is based on the assumption that prices are sticky or fixed (in the short-run). Provide a review of the main arguments for why firms might fix prices in the short-run. Use the reference below to summarise the empirical evidence of price-setting behaviour by firms. What types of firms fix their prices in the short run? Which type of firms may not fix prices? Why? References Park, Anna, Vanessa Rayner and Patrick DArcy (2010), Price-setting behaviour insights from Australian firms, RBA Bulletin, June. (available on blackboard)

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TUTORIAL 6 (9 13 SEPTEMBER) Fiscal Policy Textbook Reference: Chapter 6 Main Concepts Government expenditure Taxation Endogenous taxes Automatic Stabilisers Balanced budget multiplier Public Debt Review Questions Question 1 This question illustrates the workings of automatic stabilisers. Suppose the components of planned spending in an economy are where t is the tax rate. In this economy, the tax system acts as an automatic stabiliser, because tax revenues automatically decline when national income falls. (i) Solve for an equation that determines the short-run equilibrium output for this economy. (ii) Find the expression for the multiplier, i.e. the amount that output changes when exogenous expenditure changes by one unit. (iii) Compare the formula for the multiplier in (ii) with the case when taxes are exogenous. Show that making taxes proportional to income (i.e. endogenous) reduces the size of the multiplier. (iv) Explain how reducing the size of the multiplier (or increasing the tax rate t) helps to stabilise the economy. (v) Suppose that c=0.8 and t=0.25, calculate the multiplier. Question 2 (i) The government is considering two alternative policies, one involving increased government expenditure of $50 billion and the other involving a cut in exogenous taxes of $50 billion. Which policy is likely to increase planned aggregate expenditure by more? Explain. Use the AE model to illustrate your answer. (ii) Explain the effect of a cut in the tax rate on an economys planned AE. Is the effect different from a cut in the exogenous component of taxation? (iii) Discuss the reasons why, in practice, the use of fiscal policy more complicated than what is suggested by the AE model?

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Discussion Questions Question 3 The following equation is a version of the government budget constraint from page 185, Chapter 6) of BOF. The one change to the equation is that in the above case the real interest rate is not constant over time. (i) What does each variable in above equation denote? (ii) Explain in words the implications of the government budget constraint. Does it mean that a government must balance its budget on a year to year basis? Why not? The government budget constraint can be used to think about the options by which the Greek debt crisis might be resolved. (iii) We can think of the Greek situation as being one in which additional government borrowing (at least from financial markets) is no longer possible. In terms of the above equation we have . If this is the case then what are the only options available to the Greek government to solve the crisis. (iv) In terms of the government budget constraint how does a bailout of Greece by the other Eurozone countries work? (v) Although it is not included in the above equation, BOF (page 185) discuss the option of governments printing money to finance a budget deficit. Does Greece have this option? Explain.

Question 4* (All students must submit a written answer to this question at the beginning of this tutorial) Discuss how the government can use discretionary fiscal policy and automatic stabilisers to stabilise fluctuations in real GDP. What tools does the government have at its discretion to stabilise the economy? Suppose the government decides to decrease income taxes. Show in a diagram and explain how this policy will lead to an increase in real GDP. Explain how potential output may be affected.

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TUTORIAL 7 (16 20 SEPTEMBER) IN-TUTORIAL TEST WILL BE HELD DURING TUTORIALS THIS WEEK Monetary Policy Textbook Reference: Chapters 7 & 8 Main Concepts Definition and measures of money Fractional-reserve banking Reserve Bank of Australia (RBA) Exchange settlement accounts Open-market operations Overnight cash rate Demand for money Bonds Inflation target Policy instrument Policy reaction function Taylor-rule Review Questions Question 1 (i) What are the motives for holding money? Why are people willing to hold money when it typically pays a rate of return that is less than other financial assets? (ii) Discuss the main economic factors that influence the demand for money. Why does money demand depend upon the nominal rather than the real interest rate? Question 2 (i) A countrys bank reserves are 100, the public holds 200 in currency and the desired reserve-deposit ratio is 0.25. Find deposits and the money supply. (ii) A countrys money supply is 500 and currency held by the public equals bank reserves. The desired reserve-deposit ratio is 0.25. Find currency held by the public and bank reserves. (iii) A countrys money supply is 1250, of which 250 is currency held by the public. Bank reserves are 100. Find the desired reserve-deposit ratio and the money multiplier. (iv) Explain why the money multiplier is generally greater than 1. In what case would it be equal to 1?

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Discussion Questions Question 3 (i) Explain what is meant by the concept of core or underlying inflation. How does it differ from actual or headline inflation. (ii) Briefly explain two methods for estimating underlying inflation. What properties would a good measure of underlying inflation possess? (iii) Discuss the role that is played by measures of underlying inflation in the setting of monetary policy. Reference Richards, Tony and Tom Roswell (2010), Measures of underlying inflation, RBA Bulletin, March. http://www.rba.gov.au/publications/bulletin/2010/mar/2.html

Question 4* (All students must submit a written answer to this question at the beginning of this tutorial) (i) Using your textbook and the link below, explain the objectives of monetary policy. http://www.rba.gov.au/monetary-policy/about.html (ii) Explain what is meant by a monetary policy instrument. Give some examples of possible instruments for monetary policy. What instrument is currently used by the RBA in implementing monetary policy? Explain how monetary policy will affect aggregate expenditure? (iii) Suppose the primary objective of the RBA has not been met. Explain how monetary policy is implemented in order to meet this target.

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TUTORIAL 8 (23 27 SEPTEMBER) A Model of Output and Inflation The AD-AS Model Textbook Reference: Chapter 9 Main Concepts Aggregate demand (AD) curve Aggregate supply (AS) curve

Review Questions Question 1 (i) What two variables are related by the AD curve? (ii) Explain how the behaviour of the central bank determines the slope of the AD curve. (iii) What other factors might affect the slope of the AD curve? (iv) What variables influence the position of the AD curve? (v) What variables would influence the positions of the SRAS and LRAS curves?

Question 2 Suppose the relationship between short-run equilibrium output and the real interest rate is given by: In addition the Reserve Banks policy reaction function is given by (i) For whole number inflation rates between 0 and 4 percent, calculate the real interest rate and short-run equilibrium output. (ii) Draw a graph to illustrate this AD curve.

Question 3 An economys AD curve is given by The initial inflation rate is 4 percent (0.04). Potential output equals 12,000. (i) Find inflation and output in short-run equilibrium. (ii) Find inflation and output in long-run equilibrium.

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Question 4 Suppose that a permanent increase in crude oil prices creates an inflationary shock and also reduces potential output. Use the AD-AS model to show the effects of the increase in the price of crude oil price on output and inflation in the short-run and the long-run, assuming no discretionary policy response by the central bank. What happens if the central bank responds to the crude oil price with a contractionary monetary policy?

Discussion Questions Question 5 Suppose that a government cuts taxes in response to a recessionary gap, but because of delays in getting the legislation through the parliament the tax cut is not put into place for 18 months. Assuming that the governments objective is to stabilise output and inflation, use the AD-AS diagram to show how this policy action might prove to be counter-productive.

Question 6* (All students must submit a written answer to this question at the beginning of this tutorial) The Reserve Bank of Australia and the Reserve Bank of New Zealand both have inflation targets. Suppose inflation in Australia is at its target, and the RBA decides that in order to meets its objectives, it should increase the target for consumer price inflation from 2-3% to 4-5%. (i) Explain and show using the AD-AS model how the RBA can implement its new inflation target. (ii) Why does a change in monetary policy shift the AD curve? (iii) Why does inflation increase when real GDP is above potential GDP? (iv) Using the AD-AS model, show how the result in part (i) affects the economy of New Zealand in the short run if there is free trade between Australia and New Zealand. How should the RBNZ respond if it is to maintain its inflation target?

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TUTORIAL 9 (21 25 OCTOBER) Open Economy Macroeconomics - Exchange Rates - Trade and Capital Flows Textbook Reference: Chapters 14 & 15 Main Concepts Exchange rates real and nominal Purchasing power parity Demand and Supply for currency Monetary policy and exchange rates Fixed and Flexible regimes Current, capital and financial accounts Saving, investment and the current account

Review Questions Question 1 Define the nominal and real exchange rates. How are the two concepts related? Which exchange rate is most important for a countrys ability to export and import goods and services?

Question 2 Over the period June to December 2008 the value of the Australian dollar fell from 96 US cents to 69 US cents. Use the demand and supply model of the exchange rate to provide a good explanation for this depreciation of the Australian dollar?

Question 3 How does each of the following transactions affect: (a) the current account balance; and (b) the capital account balance? Show that in each case the identity that the trade balance plus the net capital inflows equals zero applies. (i) An Australian exporter sells software to the UK. She uses the Pounds received to buy shares in a British firm. (ii) An East Timorese firm receives Australian dollars from selling oil to Australia. A French firm accepts the dollars as payment for drilling equipment. The French firm uses the dollars to buy Australian government bonds.

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Question 4 Use a diagram to show the effects of each of the following on the capital inflow of a country that is a net borrower from abroad. (i) Investment opportunities in the country improve due to an increase in resource prices. (ii) The government budget deficit increases (iii) The domestic private sector increases their level of saving (iv) There is an increase in the countrys risk premium

Discussion Questions Question 5 What are the costs and benefits of international capital flows? Are high levels of net capital inflows a cause of concern for policymakers? Is there an economic case for restrictions on some types of foreign investment (eg. agricultural land and minimal resources)? Discuss.

Question 6 (i) Using data on Australias real exchange rate (use the real trade weighted index) from the RBA at http://www.rba.gov.au/statistics/tables/index.html#exchange_rates graph the behaviour of the real exchange rate from June 1970 to March 2012. Briefly describe the basic trends in the real exchange rate over this period. (ii) What are the economic costs and benefits of central bank intervention to stabilize (or target) a countrys real exchange rate?

Question 7* (All students must submit a written answer to this question at the beginning of this tutorial) There is a flexible exchange rate between the Australian dollar and other currencies. Suppose that the Australian government budget has a large and persistent structural budget deficit. (i) Use the supply and demand model for savings to show the result of the large deficit relative to a balanced budget. What happens to domestic national saving, investment, and net capital inflows? (ii) Use the supply and demand model for the Australian dollar to explain what happens to the exchange rate value of the dollar from the result in part (i). (iii) Explain thoroughly who are the winners and losers from the result in part (ii).

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TUTORIAL 10 (28 OCTOBER 1 NOVEMBER) Economic Growth Textbook Reference: Chapters 10 & 11 Main Concepts Sources of economic growth Production function Cobb-Douglas production function Growth Accounting Total Factor Productivity Review Questions

Question 1 Henry, Carla and Fred are housepainters. Henry and Carla can paint 100 square metres per hour using a standard paintbrush, while Fred can paint 80 square metres per hour. Any of the three can paint 200 square metres per hour using a roller. (i) If Henry, Carla and Fred have only paintbrushes at their disposal, what is the average productivity (in terms of square metres per painter hour) for the three painters taken as a team? Assume the three painters always work the same number of hours. (ii) Repeat part (i) for the cases in which the team has one, two, three and four rollers available. Are there diminishing returns to capital? (iii) An improvement in paint quality increases the area that can be covered per hour (either by brushes or rollers) by 20 per cent. How does this technological improvement affect your answers to part (ii)? Are there diminishing returns to capital? Does the technological improvement increase or reduce the economic value of an additional roller? Question 2 (i) Explain what is mean by an aggregate production function? (ii) Write out the form of the Cobb-Douglas aggregate production function. (iii) What predictions does it make about (a) the marginal product of capital (b) the marginal product of labour and (c) returns to scale? Question 3 What would happen to the marginal product of capital in the wake of a natural disaster that wipes out three-quarters of the capital stock? What would happen to the marginal product of capital if a plague wiped out three-quarters of the population?

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Discussion Questions

Question 4 (i) What is technology and why does its growth contribute to improved living standards? (ii) Why do economists claim that technology played a large role in the economic growth of the past 200 years? (iii) Why does technology include different ways in which to organise a firm? (iv) What is wrong with a growth policy that focuses on capital formation rather than technology? (v) How do property rights affect economic growth?

Question 5* (All students must submit a written answer to this question at the beginning of this tutorial) (i) Why is growth in average labour productivity viewed as a key factor in determining long-run living standards? (ii) What policy options may the Japanese government need to pursue to maintain long run living standards? (iii) What are the main factors that might influence productivity? (vi) Using the factors discussed in part (iii) explain why Japan may have a lower level of productivity that the USA, and what policy options might the Japanese government adopt to improve Japans productivity performance? Reference: Corbett, Jenny (2012) Growth: getting Japan back on track East Asia Forum http://www.eastasiaforum.org/2012/11/28/growth-getting-japan-back-on-track/

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