Macroeconomics: Inflation and its Effects

This macroeconomics assignment examines the effects of higher-than-anticipated inflation on different stakeholders, including the federal government, homeowners with fixed-rate mortgages, a private school investing in government bonds, and a pensioner whose pension is indexed to inflation. Students are asked to explain how inflation affects each case and justify their reasoning. Additionally, they must interpret Milton Friedman's famous quote, 'Inflation is always and everywhere a monetary phenomenon,' by elaborating on the relationship between money supply and demand with inflation. Finally, students need to demonstrate their understanding of macroeconomic concepts by providing a real-world example illustrating the interconnectedness of macroeconomic indicators like GDP, inflation, and unemployment.

Macro1 (ECON1010), Sem. 2 2017 Question Set
MACRO1 (ECON1010) Assignment 2
(Chapter 29, 30&33 Principles of Economics or Chapters 10,11 & 14 Principles of Macroeconomics )
Submit online at the ‘Assessment Task’ in Blackboard
Due: 11:59PM on 1 0ctober (Sunday) 2018
Tutorial Time and Day:
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Student Name:
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Student ID:
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This assignment covers the following topics:
 The Monetary System (Chapter 29 or Chapter 10)
 Inflation: Its causes and costs (Chapter 30 or Chapter 11)
 Aggregate Demand and Aggregate Supply (Chapter 33 or Chapter 14)
READ THE FOLLOWING FIRST (Very Important)
1. This assignment contributes to 20% of the overall marks for the course.
2. Only a single submission permitted (hence, please ensure to attach the file version of the
assignment)
3. Use and Submit this template only for your submission (i.e., write down your answers in
the space provided in each question and submit) – any other form of the file is NOT accepted
(Failing to do so will automatically mean zero mark for this task).
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in “APPS” you can use a Microsoft word processor;
http://www1.rmit.edu.au/students/mydesktop
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have suggested that Safari might not work well).
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7. Explain your answers, but be succinct.
8. Label each axis and explain the diagram that you use carefully (if any).
9. Show all of your working in order to get partial credits.
10. After the due date any late submission will be marked as ‘late’. A penalty of 10% of the allocated
marks (i.e., 2 marks) per day will apply for late submissions.
11. A failure of your home computer (or any kind of the IT problem) cannot be a reason for
the late submission (all requests for an extension of this nature will be rejected
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12. Make sure you have included your student ID and name in the front page of the assignment
13. Working with other fellow students is strongly encouraged. However, you cannot just copy your
friend’s answers. If we find out this, you will be harshly punished for the academic plagiarism.
See ‘students responsibilities’ at RMIT’s policy on this:
14. http://www1.rmit.edu.au/browse;ID=sg4yfqzod48g1
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Macro1 (ECON1010), Sem. 2 2017 Question Set
Short Answer Questions:
1. Consider an economy in which initially there are no banks. Suppose that one consumer initially holds
the entire money supply in the form of $1,000 in currency. Then assume a new bank is opened, The
First National Bank, and the consumer deposits the entire $1,000 into the bank. Based on this
scenario answer the following questions (5 marks):
a. Assuming that the First National Bank has a 100% reserve ratio, use a T account to show what effect
this deposit will have. (0.5 mark)
First National Bank
Debit Credit
Reserves 1000
Deposits 1000
b. Still assuming a 100% reserve ratio, explain what effect this deposit will have on the economy’s total
money supply. (1 mark)
The deposit will negatively impact the money supply. This is because the consumer holds the entire
money supply which is now deposited in a bank. On the other hand, the bank will have sufficient
reserves.
c. Show how the First National Banks T account will look, if instead it has a 10% reserve ratio and
holds no excess reserves. (0.5 mark)
Minimum reserves = 1000 *10% = $100
Excess Reserves = 1000 -100 =$900
First National Bank
Debit Credit
Reserves 100
Deposits 1000
Loan 900
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Macro1 (ECON1010), Sem. 2 2017 Question Set
d. Following form c. if other banks now open up and face a 10% reserve ratio, and assuming that every
consumer holds her or his money as deposits instead of currency, explain what effect the initial
deposit will eventually have on the money supply. (1 mark)
In case other banks are able to open up and they get a 10% reserve ratio, they are therefore able to
give out loans from the excess reserves to the public. This money will be brought into the cycle
through lending and the banks will continue to have excess reserves. The result will be increase in
the money supply since the amount deposited is multiplied by a money multiplier.
= 1000 * 10 = 10000
= 10000 - 1000 = 9000
Money supply increases by 9000.
e. Are consumers as a group wealthier when the banking system chooses a 10% reserve ratio. Explain
the reasons for your answer. (2 marks)
In a sense the consumers become wealthier with a 10% reserve ratio, this is because a large amount of
the money is loaned out and is able to gain interest also, the borrowers are able to invest in businesses
that are able to gain a return which increases the wealth of the entire economy.
2. Using the AD-AS framework consider the following scenario. The economy is operating at full
employment when an unanticipated crisis hits the banking sector that results in a credit squeeze. (4
marks)
a. Explain in detail how this event in the financial system is likely to impact the real economy and what
will be the implications for unemployment and inflation in the short term. In your answer be sure to
also address which components of the AD-AS model may be impacted by this scenario. Your answer
should be around ½ page. (3 marks)
In case of a credit squeeze, the money supply is limited by the banks. This may mean that there is an
increase in the interest rates that make loanable funds less accessible to the borrowers who might require the
money not only to spend but also invest. In the short term therefore the aggregate demand may decrease
since there is reduced capacity to purchase. Due to the decrease in aggregate demand, the economy real
output decreases while the prices also decrease. The level of inflation decreases and the unemployment
levels increase due to reduced investment levels.
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Macro1 (ECON1010), Sem. 2 2017 Question Set
b. Using the diagram below, illustrate how this scenario will:
i) Influence equilibrium in the short run (SR) labelling the new SR equilibrium A. (0.5 mark)
ii) Influence equilibrium in the long run (LR) assuming no government or policy intervention
labelling the new LR equilibrium B. (0.5 mark)
Illustrate here (Tips: to create new lines, simply copy the existing curves and move to the new
locations)
3. Suppose that inflation in Australia was expected to be 3% in 2016, but that prices rose by 5%
instead. Would the unexpectedly high inflation help, hurt or have no effect on the following. After
identifying the effect that the higher than anticpated inflation has in each case, briefly explain the
reason why in one of two sentences for each case. (4 marks)
a. The federal government (1 mark)
Inflation reduces the real value of government debt especially since the taxable revenues also rise with
inflation. It therefore makes it easier for the government to pay its debts.
b. A homeowner with a fixed rate mortgage (1 mark)
The homeowner gains from inflation because since it is a fixed mortgage rate, the real money value is lower
than the cost of paying the debt.
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SRAS
Quantity of output
Inflation
rate LRAS
AD
A
B

Macro1 (ECON1010), Sem. 2 2017 Question Set
c. A private school that has invested some of its endowment in government bonds (1 mark)
The private schools is protected and better off since the bonds retain its value and is not susceptible to the
fluctuating interest rates. Also it is able to gain more for the value at which it invested.
d. A pensioner whose pension has been indexed based on the forecasted anticipated rate of inflation. (1
mark)
The pensioner is a gainer of inflation since his income will match up with the levels of inflation thereby
retaining his purchasing power of his real income.
4. Milton Friedman states: ‘Inflation is always and everywhere a monetary phenomenon.’ In ¼ of a
page explain what he means by this statement. (2 marks)
According to Milton, inflation is as a result of money dynamics in the sense of money supply and demand.
For example, increase in money supply may lead to a demand pull inflation since there is increased
aggregate demand compared to the supply in the market which may in turn contribute to cost push inflation
as the suppliers increase their demand for factors of production (Mankiw, 2014).
5. Based on what you have studied so far in Macroeconomics1, discuss and describe something that
you have found interesting and insightful that helps you understand the relevance of
Macroeconomics to the real world. Answers should be between ½ a page and 1 page in length.
(Note: This is an open question in which students should provide a real world example and explain
how some part of the course has aided understanding relevant to the example provided.) (5 marks)
Macroeconomics provides insight concerning the Macroeconomic indicators and why the international
organizations take the GDP, inflation and unemployment statistics to high consideration. It is because they
are interrelated and that they have an effect on the health of the economy as a whole. For example the
developing countries are often faced with high levels of unemployment while at the same time battling
inflation mostly because their governments often incur budget deficits which they finance through incurring
of debts in currencies which are quite expensive and overall increases their debt burden (Burda ad Wyplosz
2013).
References
Burda, M. and Wyplosz, C., 2013. Macroeconomics: a European text. Oxford university press.
Mankiw, N.G., 2014. Principles of macroeconomics. Cengage Learning.
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Macro1 (ECON1010), Sem. 2 2017 Question Set
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