Analyzing Australia's Economy: Fiscal & Monetary Policy Impact

This economics assignment provides a comprehensive analysis of the Australian economy, focusing on the role of fiscal and monetary policies in stabilizing the economy. It examines the oligopolistic nature of the Australian banking sector, the impact of collusion among major banks, and the government's role in protecting consumers and promoting competition. The assignment also discusses discretionary fiscal policies and their countercyclical effects, analyzing the economic conditions of Australia in 2014 and the government's proactive measures to stabilize the economy through taxation and government expenditure. Furthermore, it explores the RBA's monetary policy, focusing on interest rates and their impact on currency stability, employment, and economic growth. The assignment concludes by assessing the effects of the depreciation of the Australian dollar on inflation and unemployment, recommending appropriate policy responses.

Running head: ECONOMICS 1
Economics Assignment
Name
Institution

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Economics Assignment
Part A
1. Australian Banks operate in an oligopolistic market. The market is characterized by few
large banks, many customers and considerably high barriers to entry. The Global
Financial Crisis caused a decline in competition in the Australian banking industry.
Although the four pillar’s banking policy and the government’s initiative to insure small
banks played a significant role in cushioning Australian banks against the negative
shocks of the financial crisis, competition declined since the industry witnessed greater
acquisition of smaller banks by the four major banks (Argy & Nevile, 2016). The crisis
also led to increased regulation that reduced firms from taking up highly risky
investments to win clients.
2. The collusion between the four major banks is a non-competition strategy that leads to
mutual benefit of maximizing profits. Before, the collusion, point Q is the total quantity
of output while Pc is the average price. However, after the collusion, output declines
from Q to Q2 while Price increased from point Pc to P2. This results to a super normal
profit in the industry since customers have little low price options.

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Figure 1
3. The role of government in business is to protect the customer from exploitation by
business enterprises. Additionally, its role is to promote a favorable business environment
where businesses can thrive and perpetuate an increase in national output. To protect
customers form exploitation, government seeks to increase competition in the sector to
provide customers with a more alternatives of banks to select from (Persson & Tabellini,
2016). In Figure 1 above, the Price, P2 and quantity Q2 are attained when competition is
minimal. However, when firms are operating in a competitive environment, greater
output Q is achieved leading to a decline in price to point Pc.

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4. Entrants are motivated to enter in to a competitive market when already existing firms are
making economic profits. In Figure 2 below, economic profits are made above the
breakeven point. The economic profit in the market acts as an incentive that encourages
entry. However, as more firms enter the market, greater output is recorded leading to
increased supply that pushes prices downwards which gets rid of the economic profit and
hence stopping further entry. As illustrated in the figure below, losses are witnessed
below the breakeven point but firms will wait to exit at the point where marginal cost
intersects with the average variable cost curve.
Figure 2

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Part 2
1. Discretionary fiscal policies involves the use of taxation and government spending to
influence the level of inflation. The statement “discretionary fiscal policies can be
countercyclical” means that it can operate “against the business cycle”. During inflation,
the initiation of countercyclical fiscal policies might stabilize the economy through the
action of automatic stabilizers. The Figure 3 below shows an AD/AS model when an
expansionary fiscal policy that involves increase in government spending and /or
reduction of taxes is initiated. The AD curve shifts from point AD0 to AD1 while price
level declines from P0 to P1.
Figure 3

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In 2014, the Australian economy was characterized by increased unemployment due to
insufficient job created caused by stagnation in output.
2.
Figure 4
Figure 4 above demonstrates how the economy was operating in 2014. The aggregate
demand declined and caused a recession. The price level was downwardly inflexible at P1,
causing a decline in aggregate demand from AD1 to AD2 which moved the economy leftward
from a to b along the horizontal broken-line segment and reduced real GDP from Qf to Q1.
Idle production capacity, cyclical unemployment, and a recessionary GDP gap (of Q1 minus
Qf) was witnessed. In the event that the price level was flexible downward, the decline in
aggregate demand would move the economy depicted from a to c instead of from a to b.

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3. The government was proactive in implementing fiscal policies that aimed at stabilizing
the economy. It used adjusted taxation rates and influenced government expenditure from
time to time in order to influence money supply and hence creating economic stability. In
periods of inflation, the government increased taxes leading to a reduction in aggregate
supply while in periods of deflation, it lowered taxation rates causing an increase in short
run aggregate supply (Azevedo & Leshno, 2016). Figure 5 below shows a decline in
aggregate supply as a result of reduced taxation. A leftward shift of aggregate supply
from AS1 to AS2 raises the price level from P1 to P2 and produces cost-push inflation.
Real output declines and a recessionary GDP gap (of Q1 minus Qf) occurs. The use of
taxation as a fiscal policy is appropriate for Australia’s economy since it has a strong tax
system.
Figure 5

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4. The RBA pursued interest rates as its preferred monetary policy. Prior to the crisis, it was
viewed as the most appropriate policy to stabilize the economy when there is a short-run
fluctuation in aggregate demand. The fact that it was less susceptible to political
influences made it more desirable. The RBA sets the interest rate at a level that best
contributes to stability of the currency, promotes full employment, and enhances
economic growth. Lowering interest rates also has the effect of reducing unemployment
since it would motivate business growth (Krugman, Obstfeld & Melitz, 2017). As
illustrated in Figure 6 below, increasing interest rates has the effect of shifting the
aggregate demand curve leftwards while reducing it shifts aggregate demand rightwards.
Figure 6

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5. The depreciation of the Australian dollar has the effect of increasing inflation rates. This
is because the imported good become expensive for Australians while Australia’s exports
become cheaper for foreigners (Ehrenberg & Smith, 2017). The effect of this is higher
domestic demand which raises aggregate demand causing a demand pull inflation.
Figure 7
The Figure 7 above shows a shift in aggregate demand to the right from AD to AD1 as a result of
an increased domestic demand that is caused by the lower dollar. The increased aggregate
demand causes demand pull inflation. If in 2015, inflation rose by 4% and unemployment rose
by 7%, it would be appropriate to increase government spending so as to tame unemployment.
Increasing government spending is also more appropriate because the rate of unemployment has
risen at a higher rate compared to inflation (Gregory & Smith, 2016).

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References
Argy, V. E., & Nevile, J. (2016). Inflation and Unemployment: Theory, Experience and Policy
Making. Routledge.
Azevedo, E. M., & Leshno, J. D. (2016). A supply and demand framework for two-sided
matching markets. Journal of Political Economy, 124(5), 1235-1268.
Ehrenberg, R. G., & Smith, R. S. (2017). Modern labor economics: Theory and public policy.
Routledge.
Gregory, R. G., & Smith, R. E. (2016). 15 Unemployment, Inflation and Job Creation Policies in
Australia. Inflation and Unemployment: Theory, Experience and Policy Making, 325.
Krugman, P., Obstfeld, M., & Melitz, M. (2017). International Economics: Theory and Policy,
the latest edition. Addison-Wesley.
Persson, T., & Tabellini, G. (2016). Political economics. MIT press.