Macroeconomic Concepts and Models

This study material provides an in-depth understanding of macroeconomic concepts and models. It covers topics such as CPI, GDP, AD-AS model, and the impact of government on macroeconomic objectives. The material also discusses international trade and the global economy. Find solved assignments, essays, and dissertations on Desklib.

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Bachelor of Applied Management
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Table of Contents
Section A: Macroeconomic concepts and models.....................................................................2
Question 1: CPI......................................................................................................................2
Question 2: GDP....................................................................................................................2
Section B: AD-AS model and economic growth.......................................................................3
Question 1..............................................................................................................................3
Question 2..............................................................................................................................4
Question 3..............................................................................................................................7
Section C: Impact of government on macroeconomic objectives..............................................8
Question 1..............................................................................................................................8
Question 2: Monetary policy..................................................................................................9
Question 3: Fiscal policy......................................................................................................10
Section D: International trade and global economy.................................................................11
Question 1: International trade.............................................................................................11
Question 2: Balance of payment..........................................................................................12
Question 3: Foreign exchange..............................................................................................12
Question 4............................................................................................................................13
Reference list............................................................................................................................16

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Section A: Macroeconomic concepts and models
Question 1: CPI
Consumer Price Index (CPI) measures the movement of price level in an economy. It
actually gives measures of changes in price level of certain market basket of goods and
services that are purchased by household (Baker, 2019). The percentage change in price level
from one year to another indicate the inflation rate.
In order to calculate CPI, New Zealand statistics department first fixed a certain
basket of goods and services. The department chooses items and determines the relative
importance depending on spending patterns of household. Then prices of goods and services
in the basket are collected overtime in order to measure the change (stats.govt.nz., 2019). CPI
of the specific year is then calculated using the following formula.
CPI= Price of desired basket ∈current year
Price of desired basket ∈base year × 100
Question 2: GDP
a)
GDP=Consumtion+ Investment +Government Expenditure+Net Exports
¿ 23100+9500+1300+6200+(13300−15100)
¿ 38300
b)
The official figures for National GDP may understate level of economic activity for some
obvious reason. Firstly, there may be lack of adequate data needed for national account
estimates. Secondly, the GDP figures do not measure activities of underground economy
understating the estimate.

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c)
GDP is computed both in real and nominal terms to asses aggregate value of output in both
current year and fixed base year price. Real GDP by assessing values of output in terms of a
fixed base year price gives a more accurate measure of GDP.
d)
Real GDP per capita shows average real GDP per person. It is obtained by dividing real GDP
by population and indicates average standard of living (Cohn, 2015).
e)
As GDP does not include many aspects of well-being, some alternative measure of GDP has
been developed. One alternative measure of GDP is Genuine Progress Indicator (GPI). GPI
aims to shift the definition of economic progress from economic growth to incorporating
quality of lives. Another alternative measure is United Nations Human Development Index
(UNHDI) (Sadat, 2017). The HDI measures include income, health and education in
measuring economic progress.
Section B: AD-AS model and economic growth
Question 1
An increase in net migration in New Zealand affects both demand and supply side of
the economy. The inflow of people adds to domestic labor force increasing supply of labor.
In the labor market, the increased supply of labor lowers equilibrium wage. Larger
availability of labor at a cheaper rate increase aggregate supply of the economy. At the same
time, there is an increase in aggregate demand generated from increased migrants’ inflow.
Considering same magnitude of change in aggregate demand and aggregate supply, the

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increase in migration flow increases real GDP of the economy, keeping price at the same
level (Benhabib, Wang & Wen, 2015). This is shown in figure 1
Figure 1: Impact of increase in migration in the economy
An increase in migration shifts the aggregate demand to the right to AD1 and
aggregate supply in the economy shifts to AS1. Equilibrium GDP increases from Y1 to Y2
while price level remained same P1.
Question 2
Event: Fall in business confidence
A decline in business confidence discourages businesses to invest in business activity.
The fall in business investment affects aggregate demand adversely. This at the same lowers
aggregate supply. Considering both aggregate demand and aggregate supply, declines by the
same magnitude, real GDP declines and price level remain the same. The contraction in
business activity increases unemployment in the economy.

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Figure 2: Impact of a fall in business investment
Event: Increase in household saving
The tendency of household to save more reduces consumption expenditure of
household. As household consumption declines, aggregate demand falls shifting aggregate
demand curve to the left. The contraction in aggregate demand moves down from E to E1.
Consequently, real GDP and inflation falls (Michaillat & Saez, 2015). Decline in aggregate
demand, causes economic activity to contract increasing the problem the unemployment.

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Figure 3: Impact of an increase in saving
Event: Increase in business confidence
Increase in business confidence affects both aggregate demand and aggregate supply
of the economy. As business confidence increases, investment in business activity increases
leading to an increase in aggregate demand. Increase in business activity expands productive
activity leading to an increase in aggregate supply. Consequently, real GDP increases, price
level remains at the same level and unemployment falls.

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Figure 4: Impact of increases business confidence
Question 3
i)
Figure 5: GDP gap

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In the above figure, equilibrium level of income is YE. The potential national income
of the economy is YP. As equilibrium income is lower than potential GDP, the economy
experiences recessionary gap.
ii)
Figure 6: Impact of rise in transfer payment
As government increases transfer payment, there is an increase in aggregate demand
shifting the aggregate demand curve to the right AD1. Equilibrium in the economy moves
from E to E1. Consequently, price level rises to P2. At the new equilibrium, GDP increases
moving closer to potential national income.
Section C: Impact of government on macroeconomic objectives
Question 1
As foreign buyers purchase property, there is an increase in housing demand. This
contributes to an increase in foreign capital inflow leading to an increase in economic growth.
The event also has some disadvantages. Firstly, excessive demand in property market may
lead to a housing bubble. Secondly, the inflow of migrant through property market and others

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areas aggravate problem of unemployment in the economy. This affects the government’s
policy objective of maintaining a steady economy growth along with stability in price level
and low unemployment rate.
Question 2: Monetary policy
The objective of monetary policy in New Zealand is to keep the inflation rate between
1 and 3 percent over medium along with supporting economic growth and maximum
employment. The official cash rate (OCR) plays an important role in achieving the inflation
target of 2 percent by adjusting the overall interest rate (rbnz.govt.nz., 2019) Given the case
above, Reserve Bank cuts the rate to 2.25 pc indicating an expansionary monetary policy.
The figure below describes potential impact of expansionary monetary policy on NZ
economy.
Figure 7: Expansionary monetary policy and impact on NZ economy

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Because of monetary policy expansion, the aggregate demand curve shifts outward
from AD1 and AD2. The policy has a potential impact of increase in real GDP and associated
price level.
Question 3: Fiscal policy
The main intention of fiscal policy is to attain a full employment, stability within the
economy along with a stable economic growth. The mentioned policy of New Zealand
government of cut tax refers to an expansionary fiscal policy. This kind of policy expands
aggregate demand of the economy increases both GDP and price level. The potential impact
of this policy on the New Zealand economy is show below.
Figure 8: Effect of an expansionary policy on New Zealand economy

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Section D: International trade and global economy
Question 1: International trade
From the following table, opportunity cost of wool and fish for New Zealand and
Australia are given below.
Opportunity cost
Wool Fish
NZ 1.5 0.67
Australia 0.6 1.67
a)
For production of wool, New Zealand has to sacrifice 1.5 units of fish and Australia
needs to sacrifice 0.6 units of fish. Because of lower opportunity cost, Australia enjoys
comparative advantage in wool.
b)
For production of fish, New Zealand has to sacrifice 0.67 units of wool and Australia
has to sacrifice 1.67 units of wool. Because of lower opportunity cost, New Zealand enjoys
comparative advantage in fish.
c)
As discussed above, New Zealand has a comparative advantage in production fish
while Australia has a comparative advantage in production of wool. Therefore, it is mutually
beneficial for both nations to specialize and exchange goods between them (Feenstra, 2015).
Specialization will increase efficiency of both nation and increases consumption choice by
allowing import from other nation.
d)

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China’s openness to New Zealand’s meat industry is disadvantageous for China’s producers,
as they now have to face a higher competition with New Zealand’s export. Consumers in
New Zealand suffers because export to China reduces availability of meat for domestic
consumers in New Zealand. Consumers thus suffers a shortage of meat in the nation.
Question 2: Balance of payment
a)
Hosting of America’s cup in 2021 increases foreign capital inflow in New Zealand. As
visitors from outside nation come to New Zealand, this adds to credit side of current account
improving current account balance.
b)
The distance of New Zealand from the world market restricts trade due to higher transport
cost and longer time to exchange (Scitovsky, 2016). This adversely affects current account of
New Zealand.
c)
Investment made by overseas companies and investors increase capital inflow in the nation.
The large-scale investment by foreign companies and investors help to improve the
infrastructure of property development. This helps to expand property market of New
Zealand.
d)
The cash flow coming from foreign ownership of NZ companies positively affects current
account through foreign earnings (Stern, 2017). On the other hand, the increased liability
worsens the financial account.

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Question 3: Foreign exchange
a)
Decline in value of New Zealand’s dollar against US, raise price of US’s goods to New
Zealand market. US exporter thus suffer a loss from a reduced import demand from New
Zealand. The US importers in contrast benefitted as a they face a relatively smaller price of
NZ’s exported good. As NZ dollar has increased compared to AUD, exporters of Australia
faces a higher demand in New Zealand (Vernon, 2017) Importers in Australia on the other
hand suffers due to increased price of imports in terms of NZ dollar.
b)
A strong NZ dollar means overseas students face a higher cost of studying in New Zealand.
This tends to lower inflow of students in New Zealand’s international education industry
adversely affecting the industry.
Question 4
a)
Occurrence of recession in USA reduces export of New Zealand to USA and other
market. This reduces the demand for New Zealand’s dollar. In the foreign exchange market
of New Zealand dollar, demand curve of NZ’s dollar shifts inward lowering both price and
quantity of New Zealand dollar.

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Figure 9: Effect of USA’s recession
b)
Increase in New Zealand’s interest rate increases demand of NZ’s dollar shifting the
demand curve to the right. This increases price and quantity of NZ’s dollar.
Figure 10: Increase in New Zealand interest rate
c)

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Development of industries that successfully compete against imported substitutes reduces
demand for foreign currency in New Zealand. As New Zealand succeeded in the export
market, demand for New Zealand dollar increases, increasing both price and quantity of NZ
dollar in the foreign exchange market (Hefeker, 2018).
Figure 11: Effect of expansion of import competing industries and success in export
market

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Reference list
Baker, D. (2016). Getting Prices Right: Debate Over the Consumer Price Index: Debate
Over the Consumer Price Index. Routledge.
Benhabib, J., Wang, P., & Wen, Y. (2015). Sentiments and aggregate demand
fluctuations. Econometrica, 83(2), 549-585.
Cohn, S. M. (2015). Reintroducing Macroeconomics: A Critical Approach: A Critical
Approach. Routledge.
Feenstra, R. C. (2015). Advanced international trade: theory and evidence. Princeton
university press.
Hefeker, C. (2018). Interest groups and monetary integration: The political economy of
exchange regime choice. Routledge.
Michaillat, P., & Saez, E. (2015). Aggregate demand, idle time, and unemployment. The
Quarterly Journal of Economics, 130(2), 507-569.
rbnz.govt.nz. (2019). Monetary policy - Reserve Bank of New Zealand. Retrieved from
https://www.rbnz.govt.nz/monetary-policy
Sadat, S. D. (2017). Rethinking Macroeconomics: An Introduction. International Journal of
Economics, Management and Accounting, 25(3), 635-639.
Scitovsky, T. (2016). Money and the Balance of Payments. Routledge.
stats.govt.nz. (2019). Consumers price index | Stats NZ. Retrieved from
https://www.stats.govt.nz/topics/consumers-price-index
Stern, R. (2017). Balance of Payments: Theory and Economic Policy. Routledge.

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Vernon, R. (2017). International investment and international trade in the product cycle.
In International Business (pp. 99-116). Routledge.