National Income, Inflation, Unemployment, Fiscal and Monetary Policy

Running Head: NATIONAL INCOME, FISCAL AND MONETARY POLICY 1
National Income, Inflation, Unemployment, Fiscal and Monetary Policy
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NATIONAL INCOME, FISCAL AND MONETARY POLICY 2
National Income, Inflation, Unemployment, Fiscal and Monetary Policy
Question 6
a. Advantages and disadvantages of the CPI
The CPI is the most commonly used measure of price changes in the economy not
only in Australia but also in other parts of the world. It has the inherent advantages of
consistency and flexibility. It can be said that the index is consistent because it considers
relatively the same basket of goods for a long period. That means that it takes into account
the costs an average consumer faces during that period. Some forms of the index take into
account seasonal adjustments and consumer preferences hence its flexibility.
Nevertheless, the CPI fails to take into account the new products that, are a result of
innovation, coming into the market. Despite a possible shift in preferences in the
consumption of new goods, CPI uses a particular basket of products for an extended period
before recognizing new consumption patterns in the consumer basket(Mankiw,2015). The
CPI counts goods that are consumed by households and ignores the goods produced by
various sectors. It is with this reason that it is widely thought the GDP deflator is dethroning
it as a measure of inflation. Moreover, the CPI does not consider the substitutes of goods in
the consumer basket hence it ends up overstating inflation. Lastly, the index measures the
general rate of inflation and not the changes of inflation rates for a particular individual since
individuals may purchase a set of goods not factor in the consumer basket considered by the
CPI (Cooper &John, 2012).
b. Some people win; some lose during inflation.
The main reason why some people gain while others lose in case of inflation is that
economic transactions involve contracts that are often set over long periods. Additionally,

NATIONAL INCOME, FISCAL AND MONETARY POLICY 3
such contracts are specified in nominal but not real terms, and as such, they are not adjusted
for inflation before its occurrence (Krugman &Wells, 2013). Thus, when inflation occurs,
adjustment of the nominal terms to real terms end up reducing the real value of the
transactions. Illustratively, the debtor pays lower values in real terms in case inflation occurs
after they have borrowed hence playing to a disadvantage of the lenders.
c. Flaws of the measure of unemployment
The Australian measure of unemployment is not close to perfection as expected.
According to Krugman & Wells (2013), the unemployment measure has flaws such as
ignoring the discouraged job seekers. The measure does not include them as workers actively
seeking employment. Secondly, the official figures count the part-time employees at the same
level as full-time employees which further understates the rate of unemployment. The
implication of such flaws is an understated unemployment rate
Question 7
a) There is an increase in government purchase and an expansion in the GDP
b) There is an increase in both tax income and the national income.
c) Exports reduce and therefore a decrease in the national income
d) Both the consumption component and GDP remains unchanged.
e) Purchase of bonds implies more savings and consequently a reduction in private
investments and a reduction in the GDP.
f) Investments increase and therefore GDP increases.
g) Net exports reduce and consequently, the GDP
h) Consumption increases and the GDP declines