ECO12 Macroeconomics Assignment: Economic Analysis and Policy

This macroeconomics assignment analyzes the impact of wage growth on the economy, exploring the relationship between wage rates, consumption, and aggregate expenditure. It examines how low wage growth can lead to economic stagnation, reduced demand, and decreased production. The assignment further discusses the interplay of wage growth, productivity, inflation, business investment, economic growth, and real interest rates, highlighting the role of government intervention in mitigating economic downturns through monetary policy, such as interest rate adjustments. Additionally, the assignment analyzes unemployment rates in Australia, the impact of part-time employment, and the implications of incorrectly assuming the NAIRU (Non-Accelerating Inflation Rate of Unemployment) on inflation and economic policy, including the use of fiscal instruments like tax cuts. The assignment uses figures and references to support the analysis.

Running head: MACROECONOMICS
Macroeconomics
Name of the Student
Name of the University
Student ID

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Table of Contents
Answer to question 1..................................................................................................................2
Answer to question 2..................................................................................................................3
Answer to question 3a................................................................................................................5
Answer to question 3b................................................................................................................7
References..................................................................................................................................8

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Answer to question 1
The amount an individual earns from doing job is known as the wage rate. As per
economic theory, the consumption of individuals increases with increase in their income and
thereby marginal propensity to consume increases (Friedman 2018). Therefore, increase in
wage rate increases marginal propensity to consume as it increases income. Therefore, weak
wage growth rate affects the economy in negative manner. Low or weak wage growth leads
to low rate of increase in income of the individuals and thus consumption of products fall in
and thereby demand of goods in the economy decreases. This fall in the market demand is
mainly due to the fall in consumption (Summers 2015). Owing to fall in demand, the price of
goods falls leading to lower revenue for the sellers and thereby they earn less profit. Hence,
to counter the effect of the low market demand and to recover from the situation of low
profitability the producers reduce their production. As a result, the wage rate of the workers
will fall and no employment will occur in the economy. Moreover, with fall in income of
individuals, there will further fall in demand and thereby aggregate expenditure declines. The
fall in aggregate expenditure will shift the AE curve from AE1 to AE2 as shown in figure 1
given below. The downward shift in AE and fall in demand reduces the production of the
economy and thus the output will decreases to YE2 from YE1. This will cause economic
crunch that will affect the business sector of the country. As a result, the government will
earn less revenue and thereby the whole economy will suffer from fall in income and the
equilibrium of the economy declines to yellow dot from red dot as shown in the figure below.
Therefore, due to this fall in income, the economy goes into stagnation (Coates 2015).

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Figure 1: Economic slowdown
Source: (Created by the Author)
Answer to question 2
Wage growth, productivity improvement, inflation, business investment, economic
growth and real interest rate are basic components of an economy (Kiley 2015). The
economy functions perfectly only when the above mentioned components perform well.
However, if any of the above component of the economy suffers then the economy will also
suffer. In the concerned question, it is given that all the components suffer from low value
and based on the economic theory it can be said that all these low values will have adverse
effect on the economy. Owning to low value of the components stagnation in economy
occurs. To counter the adverse effect of the low value of the components, intervention from
government is required because under free market conditions it is not possible for the
economy to recover by itself. Expected future income of individuals decreases if weak wage
growth rate in an economy persist for a long time (Heckman and Hanna 2015). The demand
will fall due to this decrease in expected future income as individuals will decrease their
consumption and save more. Therefore, the price of the goods decreases due to fall in

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demand for products. Hence, the price level of the economy will decrease and the inflation
rate of the economy decreases too. The producers of the products thus cut their production, as
there is no incentive to produce more, as there is no opportunity of gaining enough profit.
Therefore, investment in business decreases. This would lead to job cuts and thereby fall in
employment or the workers will have to work for less salary. The dwindling economy will
create a vicious cycle and it will go on until any fiscal or monetary instrument is used to
encounter it (Leeper and Leith 2016). The low economic growth caused due to the above
discussed phenomenon and it leads to long economic slowdown. Hence, to mitigate the
negative effect of the economic down turn the Central Bank will reduce the interest rate with
the objective of boosting the economy of the country. The reduction in interest rate will make
the loans cheaper and thus the producers will be encouraged to invest more. Therefore, there
will be more investment and production will rise. The increased rate of production requires
more worker and thus employment will rise and along with that, wages of the workers will
rise too. Increase in production will lead to increased amount of supply and due to this push
in supply the aggregate supply curve (AS) shift to the right from AS to AS1 as shown in
figure 2. Furthermore, the increased wage rate of the workers will increase their propensity to
consume and consequently the demand for good will increase and the aggregate demand of
the economy will rise. Therefore, in figure 2 the aggregate demand curve (AD) in the AD-AS
model will shift to the right from AD to AD1 (Rao 2016). Increase in both the aggregate
demand and supply will increase the overall economic output, but the rise in the price level
will depend on the magnitude of increase in the demand and supply. If increase in demand is
greater than supply then inflation rate will rise and vice versa since inflation depends on price
level of the economy. However, the equilibrium of the economy improves as the output
increases from Q1 to Q*.

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Figure 2: Increase in AD and
AS and improvement in economic equilibrium
Source: (Created by the Author)
Answer to question 3a
In Australia, the unemployment rate was 10 per cent in 1992. Currently, the
unemployment rate in Australia is 5 per cent. The decrease in unemployment rate was due to
the increase in part time workforce. In the recent years, the inflation rate of Australia has
decreased significantly and one of the main reason for such fall is increment in the part time
workforce (Ball 2014). Hence, increase in part time workforce has contributed to the
economy in a positive way. Part time worker are neither considered as full time employed nor
as unemployed, however, they are included in the employed labour force and thus increment
in part time workers has decreased the unemployment rate. However, the consumption
demand has not increased significantly since wage or part time workers are less than a worker
who is full time employed. Owing to this reason, the inflation rate has not risen significantly
and it stayed at the level of NAIRU.
The level of unemployment rate at which an economy stays at the steady state
equilibrium is known as natural rate of unemployment. At this unemployment rate the output

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level of the economy is equivalent to the full employment level of output. On the other hand,
the full employment in this case means that there is only structural and frictional
unemployment rate and any addition of employee in the workforce will hamper the
optimality of the economy. The full employment level of equilibrium is only achieved at long
run and it is given as long run aggregate supply curve (LRAS) (Beveridge 2014). The full
employment level can be calculated by subtracting natural rate of unemployment from the
total work force. Therefore, it can be said that any alteration in the value of natural rate of
unemployment will alter the aggregate supply and shift the LRAS curve. The relation is
however inversely proportional that means increase in natural rate of unemployment will shift
the LRAS to the left and vice versa. In the diagram given below an increase in natural rate of
unemployment has shifted the LRAS* curve to left to LRAS1 and on the other hand the
decrease in natural rate of unemployment shifted the LRAS curve from LRAS* to LRAS2.
Figure 3: Shift in LRAS
due to change in natural rate of unemployment
Source: (Created by the Author)

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Answer to question 3b
After assuming the NAIRU at 5 per cent (actually it is at 4 per cent) mistakenly, the
government of Australia decided to decrease the unemployment rate and enhance the
economy by increasing the demand of the goods in the economy (Watson 2014). Thus, in
response to this, the government reduces the tax and as a result, the disposable income of the
people rises. The people will start to consume more for the income effect. The demand of the
economy thus increases. The AD curve will shift to the right from AD to AD1 as shown in
figure 4 and the price of the products will rise. On the other hand, the producers will reduce
the supply with the intention of making more profit. Thus the AS curve shifts to the left from
AS to AS1, and at the full employment level of output Q*, the price increases from P* to P1
and thereby inflation rate increases. Thus, an incorrect assumption of NAIRU by the
government increases the price level and thereby inflation rate of the economy.
Figure 4: Increase in
inflation
Source: (Created by the Author)

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References
Ball, L.M., 2014. The case for a long-run inflation target of four percent (No. 14-92).
International Monetary Fund.
Beveridge, W.H., 2014. Full Employment in a Free Society (Works of William H.
Beveridge): A Report. Routledge.
Coates, D., 2014. Models of capitalism: Growth and stagnation in the modern era. John
Wiley & Sons.
Friedman, M., 2018. Theory of the consumption function. princeton university press.
Heckman, S. and Hanna, S.D., 2015. Individual and institutional factors related to low-
income household saving behavior. Journal of Financial Counseling and Planning, 26(2).
Kiley, M.T., 2015. What can the data tell us about the equilibrium real interest
rate?. Available at SSRN 2665710.
Leeper, E.M. and Leith, C., 2016. Understanding inflation as a joint monetary–fiscal
phenomenon. In Handbook of Macroeconomics (Vol. 2, pp. 2305-2415). Elsevier.
Rao, B.B. ed., 2016. Aggregate demand and supply: a critique of orthodox macroeconomic
modelling. Springer.
Summers, L.H., 2015. Demand side secular stagnation. American Economic Review, 105(5),
pp.60-65.
Watson, M.W., 2014. Inflation persistence, the NAIRU, and the Great Recession. American
Economic Review, 104(5), pp.31-36.