MACRO1 _________________________ Assignment: Monetary System

Briefly discuss (2 marks) Inflation above 2-3 percent may be harmful for the economy as it reduces the value of money. (3 marks) Start from Point A, demonstrate how the quantity of aggregate output supplied responds to the fall in prices of final goods and services using the figure below? LRAS0 P SRAS0 A P0 AD0 P1 Y Y0 In the short-run, the supply curve of the firm will remain unchanged.

MACRO1
________________________
This assignment covers the following topics:
· Monetary system (Chapter 10)
· Inflation: its causes and costs (Chapter 11)
· Aggregated demand and supply (Chapter 14)
READ THE FOLLOWING FIRST (Very Important)
1. The font size has to be at least 12.
2. Explain your answers, but be succinct.
3. Label each axis and explain the diagram that you use carefully (if any).
4. Show all of your working in order to get partial credits.
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Short Answer Questions (answer in the space provided below):
1. Review the chapter on inflation and answer the following questions.
a)Why do some economists claim that we should not worry too much about inflation?
(2 marks)
Some economists argue that we should not worry much about inflation because a
little inflation is good for the economy. As such, it helps in stimulating economic
activities; bring growth in the economy by adjusting wages and relative pries.
b)Other economists think that there are significant costs associated with inflation
above 2-3%. What are they? Briefly discuss (2 marks)
Inflation above 2-3 percent may be harmful for the economy as it reduces the value of
money. As a result, the price of goods and services increases, the purchasing power
decreases (Woodhill). Therefore causes an increase in the level of spending unlike before
the inflation arose (Dorfman).
2. According to new legislation, all workers can earn the same wage specified
in the annual contract which they sign on 1st January no matter what
happens to prices of final goods and services during that year. This year,
the prices of final goods and services fall unexpectedly after the contract has
been written on 1 January. In this exercise you must illustrate what
happens in the economy in the following AD-AS figure in the short-run. We
assume that the economy starts at potential output, depicted in point A
below.
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a)(3 marks) Start from Point A, demonstrate how the quantity of aggregate
output supplied responds to the fall in prices of final goods and services
using the figure below? Explain your answer.
b)(3 marks) Start from Point A, demonstrate what happens when firms and
workers are permitted to renegotiate their wage contracts? Explain
your answer.
a.
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SRAS0
P
Y
Y0
P0
LRAS0
AD0
A

P1
In the short-run, the supply curve of the firm will remain unchanged. Mainly, this is due
to the fact that firms used fixed amounts of capital in the short run. As a result, the
short-run supply curve will remain in the same position despite the fall in price level.
b.
AD1
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SRAS0
P
Y
Y0
P0
LRAS0
AD0
A
SRAS0
P
YY0
P0
LRAS0
AD0
A

When firms and workers are permitted to renegotiate their wage contracts, firms will
reduce the wages they pay to their employees in order to reduce the cost of production
to offset the costs associated with the fall in prices. In turn, this reduces the aggregate
income of households in the country. Therefore, the aggregate demand will reduce,
thereby shifting the Aggregate demand curve to the left as shown in the diagram.
3. We studied how the Reserve Bank of Australia (RBA) can influence the
money supply in the Australian financial market. Answer each question
briefly.
a) How do the open market operations increase the number of dollars in
circulation? (2 marks)
Open market operations increase the number of dollars in circulation through the buying
and selling of government securities. As such, when the federal reserve purchase
government securities in the open market, it increases the reserves of commercial banks
and allows them to increase their investments and loans. In turn, this increases the
overall supply of dollars in circulation.
b) How does the reserve ratio influence the money supply? (2 marks)
The reserve ratio influences the money supply. Mainly, this is because it is the
percentage of reserves that banks are required to hold against the deposits. Thus, then
the reserve ratio is high, commercial banks have to keep large amounts as deposit
reserves. Therefore, a high reserve ratio reduces the money supply in the economy. On
the other hand, when the reserve ratio is low, the money supply in the economy is
increased.
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c) What do you think happens to the money multiplier (M) in a financial
crisis and what is the likely impact of change in M to the economy? (2
marks)
The money multiplier represents the maximum amount the money supply could be
increased based on an increase in the banking system. Thus, in a financial crisis, the
money multiplier reduces significantly. This change in the money multiplier would
result in a decrease in the reserves in the economy as more individuals and investors
withdraw their money from the economy for the fear that it will lose value.
4. Name the movies which are based on the financial crisis (1 mark!). We had
many crises, so you must be able to name more than one movie!
https://en.wikipedia.org/wiki/List_of_banking_crises
Movies based on the financial crisis include;
-The Big-short
-Too Big to fail
- Capitalism:A love story
- Inside Job
- Wall street: Money never sleeps
- Margin Call
- The Queen of Versailles, among others. (Huddleston).
5. (3 marks) Have a look at the following article,
https://www.theguardian.com/business/grogonomics/2018/mar/08/australia-
isnt-in-recession-but-we-might-as-well-be
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Supposing the Australian economy is heading for a recession, what should
(or can) the current government now do to deal with this? Use the
economics knowledge that you have acquired in this course so far to
elaborate your discussion. You need to write at least half a page in length
(please do not use bullet points). Note that presenting a list of reference is
preferred. But not required.
According to the article, the Australian economy is on its way to a recession
(Jericho). Thus, the Australian government may set up measures that may go a
long way in reducing the possibilities of the economy entering into a period of
recession. First, the government may initiate policies that will bring about a
substantial increase in the wage growth rate in the country. An increase in wage
growth rate will raise the overall income households in the country, and hence
consumer spending will also increase. Consequently, this would bring about an
increase in the aggregate demand in the economy. In addition, the government
should initiate policies that would lead to an increase in the agricultural
production in the country. It is worth noting that the social returns to investment
in the agricultural industry are approximately 100 percent (Fernyhough).
Therefore, this would not only increase food security in the country but also
increase revenue through exports. In turn, this would raise the country’s GDP
significantly. The government may also improve the business policies in the
country to improve the level of business activity in the country (Westacott). An
increase in the business activities in the country will improve the level of GDP
in the country and further contribute to economic growth.
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Works Cited
Dorfman, Jeffrey. "Why Higher Inflation Is A Very, Very Bad Idea". Forbes, 2016,
https://www.forbes.com/sites/jeffreydorfman/2016/08/19/inflation-is-still-bad-
for-the-economy/#5daa54914340. Accessed 12 May 2018.
Fernyhough, James. "Five ways to boost the Australian economy". The New Daily,
2017, https://thenewdaily.com.au/money/finance-news/2015/08/26/five-ways-
boost-aussie-entrepreneurship/. Accessed 12 May 2018.
Huddleston, Jr Tom. "These 7 Movies Tell the Real Story Behind the Financial Crisis".
Fortune, 2015, http://fortune.com/2015/12/27/big-short-wall-street-movies/.
Accessed 12 May 2018.
Jericho, Greg. "Australia isn't in recession – but we might as well be". The Guardian,
2018,
https://www.theguardian.com/business/grogonomics/2018/mar/08/australia-isnt-
in-recession-but-we-might-as-well-be. Accessed 12 May 2018.
Westacott, Jennifer. "2018: Crunch time for Australia’s economic renewal". The
Weekend Australian, 2017,
https://www.theaustralian.com.au/news/inquirer/2018-crunch-time-for-
australias-economic-renewal/news-story/fbb08731f7c0d61e5337213f74ea6065.
Accessed 12 May 2018.
Woodhill, Louis. "Why Higher Inflation Is A Very, Very Bad Idea". Forbes, 2014,
https://www.forbes.com/sites/louiswoodhill/2014/01/23/why-higher-inflation-is-
a-very-very-bad-idea/#30f2ad22441a. Accessed 12 May 2018.
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