ECOM4000 Economics Assignment: Micro and Macroeconomic Analysis

This economics assignment delves into both microeconomic and macroeconomic principles, using the Australian economy as a case study. Part A focuses on microeconomics, analyzing the structure of the Australian banking industry as an oligopoly, the effects of collusion among major banks, and go...Read More

Running head: ECONOMICS
Economics
Name of the Student
Name of the University
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Table of Contents
Part A: Microeconomics..................................................................................................................2
Question 1....................................................................................................................................2
Question 2....................................................................................................................................2
Question 3....................................................................................................................................3
Question 4....................................................................................................................................4
Part B: Macroeconomics..................................................................................................................5
Question 1....................................................................................................................................5
Question 2....................................................................................................................................6
Question 3....................................................................................................................................7
Question 4....................................................................................................................................7
Question 5....................................................................................................................................8
References......................................................................................................................................10

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Part A: Microeconomics
Question 1
The structure of banking industry in Australia follows the structure of an oligopoly
market. Like an oligopoly market, banking industry in oligopoly is dominated by four major
banks – Westpac, Commonwealth Bank, NAB and ANZ. The four banks control more than 80
percent of domestic lending market (Duran 2018). The other oligopoly characteristics of banking
industry of Australia include presence of entry barriers and constraint faced by consumers to
switch between banks.
During Global Financial Crisis, banks in many other countries faced severe credit crisis.
In a sharp contrast to most other nations, Australian banks performed comparatively better. The
better performance of Australian banks was due to policy taken by Australian Prudential
Regulatory Authority (APRA) and Reserve Bank of Australia. In particular, the policy that
worked effectively was the ‘four pillar’ policy preventing mergers among the major banks. The
prevention of merger reduced risk-taking behavior of banks by limiting competition in the
industry. This in turn lowered vulnerability of banks to the adverse market condition. The
guarantee on deposit of small banks prevented banks to become bankrupt.
Question 2
The collusion of four big banks in Australia will reduce competition in the banking
industry, which in turn increase market power of the banks. The collusion will allow the banks to
charge a higher price for the product or services. This will make the major banks as price maker
and other small bank will follow the price set by the major banks. After collusion, the major
banks will behave like a monopolist. This will allow banks to set a high price for a relatively

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smaller quantity and earn a supernormal profit (Cowell 2018). This is shown in the following
figure. Because of collusion, banks can restrict the market quantity at QM and charge a high price
at PM. This allows firm to enjoy more than normal profit in the long run.
Figure 1: Effect of collusion in Australian banking
Question 3
The government seeks to increase competition in the banking industry in order to prevent
excessive market power of the dominating banks. The excessive market power allows banks to
exploit the market and pass on the cost burden to customers to increase profit without having fear
of losing market share. As discussed in figure 1, collusion among major banks can lead to a
monopoly power where banks charge a relatively high price and supply a relatively smaller
product. This in turn reduces competitive efficiency of the industry, exploits customers and
lowers social welfare as a whole (Hutchens 2018). In order to prevent unintended consequences
of excessive market power of dominating banks government is seeking to increase competition.

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For this, government has attempted to lower entry barriers in the industry. APRA has designed a
new licensing framework allowing successful applicants to carry out banking activities
(Kocianski 2018).
Question 4
In a competitive market presence of supernormal profit in the market triggers entry of
new firms. In the short run, if existing firms enjoy profit, which is above the normal profit, then
new firms enter the industry to earn extra profit. As new firm enter, market supply increases. The
excessive supply lowers market price and reduces profit. The process will continue unless profit
reduces to the level where each firm earns only a normal profit (Baumol and Blinder 2015). The
process is explained in figure 2.
Figure 2: Process of entry in the competitive market
As shown in the above figure, if price in the competitive market is at P1, firms earn
supernormal profit. Consequently, new firms enter the market shifting the supply curve

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rightward. The excess supply in the market lowers price P* where firms can earn only normal
profit and entry stops.
Part B: Macroeconomics
Question 1
Discretionary fiscal policy refers to the fiscal policy that government takes beyond the
existing policy framework. The main tool for fiscal policy discretion is changes tax or
government spending. This kind of policy by expanding or contracting economic activity helps
to counter business cycle shocks. The effect of discretionary fiscal policy is shown in the
following figure. Suppose the economy is experiencing a recession. In order to stimulate
economic activity government can take expansionary fiscal policy by lowering the tax rate or
increasing government expenditure (Heijdra 2017). Both will expand aggregate demand resulting
in an increase in GDP and price level.
Figure 3: Countercyclical effect of discretionary fiscal policy

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Question 2
In 2014, Australian economy was operating below the full employment level. During this
time both unemployment rate and participation rate in the economy increases. The economy
however remained weak resulting in a lack of required employment growth. There was a decline
in part-time employment. Women employment though had increased but a drop in employment
among men offset the effect. The weak economic growth and higher unemployment rate
indicates the economy was operating with a recessionary gap.
Figure 4: Position of Australian economy in 2014
In the above figure, full employment output is at YF. The Australian economy in 2014
however was operating at Y*, below the full employment. This leads to a recession gap of the
economy (YF – Y*). Given weak economic growth, presence of recessionary gap and high
unemployment indicates recession phase of business cycle.

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Question 3
In order to fight recession government is pursuing an expansionary fiscal policy. The
fiscal policy expansion is done by both lowering the tax rate and increasing government
expenditure. Government lowered corporate tax by 1.5% during this time (smh.com.au 2014).
Government expenditures were increased significantly for infrastructural development, transport,
energy and education. Given the economic recession, the expansionary fiscal policy increases
aggregate demand in the economy. The expansion of economic activity leads to employment
growth. This helps to lower unemployment along with achieving a higher growth.
Figure 5: Effect of expansionary fiscal policy during recession
Question 4
The RBA is pursuing an expansionary monetary policy by lowering the cash rate by 0.25
basis rate (rba.gov.au 2019). The lower interest rate stimulates aggregate demand by increasing
investment. A low interest rate increases lending activity in different sectors boosting economic

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activity. The monetary policy expansion leads to an increase in aggregate demand increasing
both GDP and price. Given weak state of the Australian economy, this kind of policy is expected
to provide necessary stimulus to economic growth (Johnson 2017).
Figure 6: Effect of expansionary monetary policy during recession
Question 5
A lower dollar value, increase price of imported goods. When price of imported input
increases, cost of production increase leading to an increase in inflation. The lower value of
dollar by increasing price of both imported raw material and final goods increases inflation in
Australia.
Given the higher inflation (4%) and higher unemployment rate (7%) in the economy,
policy needs to be taken to expand economic activity that will create more job opportunities.
This however should be done with a lower inflation rate. Traditional demand side fiscal policy is

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unable to attain this goal as reduction in unemployment is achieved at the cost of a higher
inflation rate. Supply side policy is more appropriate to achieve the goal. One such policy is tax
credit on investment. If a tax credit is given on investment, then investors will be encouraged to
make more investment (Uribe and Schmitt-Grohe 2017). The higher investment increases help to
boost aggregate supply shifting the aggregate supply curve rightward. As a result, economic
activity expands lowering the unemployment rate. The increased supply in the economy lowers
the price level as well.
Figure 7: Effect of policy of tax credit on investment

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References
Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Nelson
Education.
Cowell, F., 2018. Microeconomics: principles and analysis. Oxford University Press.
Duran, P. 2018. Australia's competition watchdog to review banking oligopoly. [online] U.S.
Available at: https://www.reuters.com/article/australia-banks-competition/australias-competition-
watchdog-to-review-banking-oligopoly-idUSL3N1RN6E8 [Accessed 22 May 2019].
Heijdra, B.J., 2017. Foundations of modern macroeconomics. Oxford university press.
Hutchens, G. 2018. Damning report finds banking industry an 'oligopoly' that exploits its
customers. [online] the Guardian. Available at:
https://www.theguardian.com/australia-news/2018/aug/03/banking-industry-found-to-be-an-
oligopoly-that-exploits-its-customers [Accessed 22 May 2019].
Johnson, H.G., 2017. Macroeconomics and monetary theory. Routledge.
Kocianski, S. 2018. How Australia Is Banking On New Competition. [online] Forbes.com.
Available at: https://www.forbes.com/sites/sarahkocianski/2018/12/20/how-australia-is-banking-
on-new-competition/ [Accessed 22 May 2019].
rba.gov.au 2019. Cash Rate. [online] Reserve Bank of Australia. Available at:
https://www.rba.gov.au/statistics/cash-rate/ [Accessed 22 May 2019].
smh.com.au 2014. What we know so far about the Abbott government's 2014 federal budget.
[online] The Sydney Morning Herald. Available at: https://www.smh.com.au/national/what-we-

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know-so-far-about-the-abbott-governments-2014-federal-budget-20140512-zra3n.html
[Accessed 22 May 2019].
Uribe, M. and Schmitt-Grohe, S., 2017. Open economy macroeconomics. Princeton University
Press.