Macroeconomics Assignment - Desklib

This article provides a detailed analysis of the effects of increase in investment expenditure on the Australian economy with the help of the AE Model and Dynamic AD-AS Model. It also explains the impacts of interest rate stagnancy on the economy. The article discusses the short and long run impacts of the increase in investment expenditure and the effects of the same on the aggregate demand and aggregate supply in the economy. It also explains the implications of the same on the equilibrium output and employment levels in the economy.

Running head: MACROECONOMICS ASSIGNMENT
Macroeconomics Assignment
Name of the Student
Name of the University
Author Note

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Table of Contents
Answer 1a...................................................................................................................................2
Answer 1b..................................................................................................................................4
Answer 2....................................................................................................................................5
Answer 3....................................................................................................................................8
References................................................................................................................................11

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Answer 1a
In the conceptual framework of economics, the Aggregate Expenditure refers to the
current value of the finished products and commodities produced in an economy, within a
period of time. Thus, the aggregate expenditure consists of the following components:
AE = C+I+G+NX
[Where, C is the consumption expenditure, G shows the expenditures on part of the
government, I denote the investment expenditures in the economy and NX refers to the net
exports (exports-imports) of the concerned country] (Johnson 2017)
In the AE Model, thus, the equilibrium occurs at the point where the aggregate supply
is equal to the aggregate demand in the economy and in the Classical AE Model:
AE = C+I, with the equilibrium being shown as follows:
Figure 1: Equilibrium in the AE Model

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(Source: As created by the author)
As can be seen from the above figure, the equilibrium occurs at the point where AE =
Y, which is drawn with the help of the 45-degree line, which equates the horizontal axis with
that of the vertical axis, thereby equating the Aggregate Expenditure with that of the
Aggregate Output in the economy (Persson and Tabellini 2012).
Keeping this into consideration, in the current scenario taken into consideration, of
that of the growing housing market of Australia, the investment in the housing sector can be
seen to be increasing, the effects of which can be seen on the overall economy, with the help
of the AE Model as follows (Afr.com 2018).
Figure 2: Effects of increase in the investment expenditure
(Source: As created by the author)

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The increase in the investment expenditure (due to the growth in the housing market)
leads to an increase in the Aggregate Expenditure in the economy, which in turn, leads to an
increase in the overall output (GDP) of the economy, with the equilibrium in the economy,
shifting from the point E0 to E1, as can be seen from the above figure (Burke 2012).
Answer 1b
In this context, the OPEC can be seen to be urging Australia to increase the rate of
interest in the economy, in order to cool down the boom and growth in the housing market.
This is suggested, because the rate of interest is inversely related to that of the investment
expenditure component of the aggregate expenditure in a country, which can be shown as
follows:
Figure 3: Relationship between Investment and Rate of Interest
(Source: As created by the author)

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Thus, an increase in the rate of interest can help the economy of Australia to decrease
the amount of money borrowed for the purpose of investing in the housing sector of the
economy, thereby decreasing the overall investment expenditure in the economy (Mankiw
2014). The effects of the same can be seen with the help of the AE Model, which is as
follows:
Figure 4: Effects of rise in rate of interest on the overall economy
(Source: As created by the author)
Thus, the increase in the rate of interest, followed by a fall in the investment
expenditure is expected to decrease the Aggregate Expenditure as well as the Aggregate
Output (Y) in the economy (Heijdra 2017).

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Answer 2
If the Reserve Bank of Australia does not succeed to increase the rate of interest, as
urged by the OECD, then the investment expenditure will go on increasing, due to the growth
in the housing market of the country, which usually results in increase in both the demand
side and the supply side activities in the concerned market of the country (Goodwin et al.
2015). The implications of the same, can be explained with the help of the Static Aggregate
Demand and Aggregate Supply Model in the theoretical framework of economics. The AD
consists of the following components in this model:
AD = C+G+I+NX (Symbols having their usual meanings as discussed above)
Thus, the interest rate remaining at the low level, the Investment will go on
increasing, thereby increasing the Aggregate Demand in the economy (Gallegati, Palestrini
and Russo 2017). The effects of the same in the short run and long run, can be seen as
follows:
Short Run Impacts
The Short Run Aggregate Supply Curve being positively sloped, the increase in the
aggregate demand will have the initial effects to be as follows:

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Figure 5: Initial Impact of Interest Rate Stagnancy
(Source: As created by the author)
Thus, in the short run, due to the presence of positively sloped SRAS curve, the
increase in the aggregate demand (due to increase in the investment expenditure), leads to
both increase in the output level (GDP level) as well as increase in the overall price level in
the housing market (Carlin and Soskice 2014).
Long Run Impacts
In the long run, however, the supply curve is vertical as due to the assumption of full
employment level. Thus, in this context, also, in the housing market, in the long run, the
supply curve is expected to be vertical. The logical interpretation behind the same being the
fact that the land resources are limited in the country and thus, after a certain point of time the
suppliers in the housing market cannot increase the supply of housing due to the constraint of
limitation of the resources for production of new housings in the country (Cohn 2015). Thus,

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in this context due to the increase in the investment and continuous increase in the aggregate
demand, the impacts are expected to be as follows:
Figure 6: Long run impacts of interest rate stagnancy
(Source: As created by the author)
Thus, in the long run, the LRAS being vertical, the output is expected to stay at a
constant level, while due to the continuous increase in the aggregate demand (due to the
increase in the investment expenditure in response to a stagnated rate of interest), the price
level in the economy will go on increasing.
Answer 3
In the Dynamic AD-AS Model, both the aggregate demand as well as aggregate
supply are variable in the short run and also in the long run. This is because, in the Dynamic
AD-AS Model, the vertical axis does not measure the price levels but takes into account the
rate of inflation and the subsequent periods of time are linked together, as the change in the
level of inflation in one period leads to a change in the expectations regarding the rates of
inflation in the future periods, thereby leading to changes in the aggregate supply in the

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coming periods, thereby differing from the Static AD-AS model (Gürkaynak and Wright
2012).
In this context, keeping into consideration the Dynamic AD-AS Model, if the Reserve
Bank of Australia succeeds to increase the rate of interest in future, then in response to the
same, the demand for borrowing of money for the purpose of investing in the housing market,
thereby decreasing the aggregate demand in the housing market. The effects can be seen as
follows:
Figure 7: Impacts of rise in rate of interest in the Dynamic AD-AS Model
(Source: As created by the author)
As is evident from the above figure, with the increase in the rate of interest and with
the subsequent decrease in the level of investment expenditures (due to fall in the borrowings
of people to invest in the housing market of the country), the aggregate demand is expected to
shift leftward (from DAD1 to DAD2). This fall in the aggregate demand in the housing

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market is expected to decreases the aggregate supply in the short run (from DAS1 to DAS2),
as lack of investment is expected to stall the growth in the housing market of the country
(Ascari and Sbordone 2014). If this trend continues for long-term, then in the long run, the
dynamic long run supply curve is also expected to move leftwards (from LRAS1 to LRAS1).
This in turn implies that the fall in aggregate demand results to short run decline in the
short run aggregate supply and this continues, resulting in the decline in the long run supply
in the economy, which in turn signifies that in the long run the equilibrium output decreases
(from E1 to E2), which in turn implies that in this scenario, the long run output as well
employment level decreases in the economy (Argy 2013). The problem becomes acute when
the expansion of the economy is below the predicted level by OECD as in such scenario the
fall in the equilibrium output and employment levels in the economy can lead to a
recessionary situation or situation of economic stagnation with lesser productive and
economic activities, thereby posing as an aggravated hurdle in the aspect of long run recovery
in the backdrop of a dampened future growth since the global recession and a situation of low
numbers of business creation in Australia.

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References
Afr.com (2018). OECD says Australian economy ready for higher RBA rates. [online]
Financial Review. Available at: https://www.afr.com/news/economy/economy-ready-for-
higher-rba-rates-tighter-budget-oecd-says-20171128-gzua5y [Accessed 23 Jul. 2018].
Argy, V., 2013. International macroeconomics: theory and policy. Routledge.
Ascari, G. and Sbordone, A.M., 2014. The macroeconomics of trend inflation. Journal of
Economic Literature, 52(3), pp.679-739.
Backhouse, R.E., 2012. Interpreting Macroeconomics: Explorations in the History of
Macroeconomic Thought. Routledge.
Burke, T., 2012. The Australian residential housing market: institutions and
actors. Australia’s unintended cities, pp.35-49.
Carlin, W. and Soskice, D.W., 2014. Macroeconomics: Institutions, instability, and the
financial system. Oxford University Press, USA.
Cohn, S.M., 2015. Reintroducing Macroeconomics: A Critical Approach: A Critical
Approach. Routledge.
Gallegati, M., Palestrini, A. and Russo, A. eds., 2017. Introduction to agent-based
economics. Academic Press.

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Goodwin, N., Harris, J.M., Nelson, J.A., Roach, B. and Torras, M., 2015. Macroeconomics in
context. Routledge.
Gürkaynak, R.S. and Wright, J.H., 2012. Macroeconomics and the term structure. Journal of
Economic Literature, 50(2), pp.331-67.
Heijdra, B.J., 2017. Foundations of modern macroeconomics. Oxford university press.
Johnson, H.G., 2017. Macroeconomics and monetary theory. Routledge.
Mankiw, N.G., 2014. Principles of macroeconomics. Cengage Learning.
Persson, T. and Tabellini, G., 2012. Macroeconomic policy, credibility and politics.
Routledge.