Macroeconomics Assignment: ECON1007, Study Period 2, 2019

This macroeconomics assignment, completed for ECON1007 at the University of South Australia, addresses key macroeconomic concepts. The assignment begins by analyzing the relationship between weak wage growth and short-term economic growth using the aggregate expenditure model, examining the impacts of consumption, investment, and net exports. It then explores the effects of cutting interest rates, considering factors like inflation, wage growth, business investment, and overall economic growth. The assignment also delves into the implications of an increasing part-time workforce, discussing unemployment rates and the natural rate of unemployment, including the long-run aggregate supply curve. Finally, it examines the consequences of the government misestimating the NAIRU and stimulating demand, leading to inflation. The document provides detailed explanations, diagrams, and references to support its analysis, offering a comprehensive understanding of macroeconomic principles.

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Question1 An explanation of the link between the weak wage growth and the weak short term
economic growth by the use of aggregate expenditure model
An aggregate expenditure model incorporates the spending components in explaining economic
growth. It generally involves four components namely the consumption, investment, government
expenditure and the net exports (Robinson 2013, p.1). In the short run period, holding the
prevailing price for goods and services in the economy constant, the spending level as depicted
by the aggregate expenditure model gives an indication of economic activity level in an
economy.
Consumption: weak wage growth means that consumers in an economy have less income to
spend on their daily needs. This, therefore, means that the consumer demand for goods and
services decreases due to less income. Businesses, on the other hand, reduce their production
level as the demand for their commodities decreases. As a result, the total output in the economy
decreases as the aggregate demand decreases and as a result, the economic growth deteriorates.
Investment: weak wage growth leaves consumers with little to spend and as a result, they
decrease their expenditure on goods and services. This means that the demand for business goods
and services decreases and hence they have to lower their production volume and cut their
investment which they may have intended to expand their productivity (Justiniano, Primiceri and
Tambalotti 2010, p.132). This lowers a nation’s aggregate supply. The decline in investment and
low productivity lower a nation’s total output and this makes its economic growth decline.
Net exports: this is the difference between a nation’s exports and imports. Weak wage growth
leaves consumers with little income to spend on imports. The little income also makes businesses
to lower their productivity and cut down their investment. This means that the nation’s exports

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decline due to reduced productivity and investment by businesses. As a result, the nation’s net
exports decrease and hence its economic growth declines.
The link between the weak wage growth and the government expenditure exists in that it is lower
government spending that leads to weak wage growth (Dao 2012, p.177). Lower government
spending leads to a decline in investment by making it difficult for businesses to invest in various
sectors of the economy. This leads consumers with lower wages and hence they have to lower
their consumption. The decline in consumption in the economy leads to weak economic growth.
Question2 Effects of cutting interest rates
The effects of cutting interest rates have been discussed based on various factors which include
inflation, wage growth, real interest rates, business investment, productivity improvement, and
economic growth.
A cut in interest rates avails money to borrowers cheaply in that they are charged lower interest
rates. This encourages businesses and individuals to borrow and as a result, more money
circulates in the economy. As a result, inflation occurs but also economic growth increases as the
total output produced increases (Hördahl and Tristani 2012, p.634).
A cut in interest rates increases the total consumption in the economy and hence businesses
make more profit from increased sales due to an increase in aggregate demand. An increase in
businesses’ profits translates to higher wage rates as employees demand wage increase (Keynes
2018, p.145).
A cut in interest rates maintains the real interest rates low and hence encourages businesses and
individuals to borrow more capital for investment and expenditure (Cochrane 2011, p.1047).

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This increases the aggregate supply and as a result, the nation’s total output increases fostering
economic growth.
A cut in interest rates enables businesses to acquire capital cheaply to expand their productivity
and invest in other economic sectors (Dosi, Fagiolo and Roventini 2010, p.1748). An increase in
business investment increases the aggregate supply hence increasing the nation’s total output.
A cut in interest rates enables businesses to acquire capital to fund research and development
projects and hence come up with means of improving productivity (Van Hemert and Nijkamp
2010, p.369). This enables them to minimize costs of production and improve the quality of their
goods and services.
In a nutshell, a cut in interest rates raises inflation, increases wage growth and lowers real
interest rates. All these increase the aggregate demand and hence shift the aggregate demand
curve to the right from AD0 to AD1. The equilibrium is shifted from point E0 to E1 hence
increasing output from Q0 to Q1. Also, the cut in interest rates encourages businesses and
investors to increase investment in the economy hence increasing aggregate supply. This shifts
the aggregate supply to the right from AS0 to AS1. The equilibrium is shifted from point E0 to E1
hence increasing output from Q0 to Q1. For both shifts, the price level in the nation is maintained
as shown. Hence the overall effect of a cut in interest rates is an increase in economic growth as
the nation’s total output is increased as shown below.

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Question3
a. Implications of increasing part-time workforce
From the year 1992, part-time jobs have increased hence lowering unemployment rates. From
the year 1992 up to date, the part-time workforce has increased increasing the nation’s
productivity level. The increase in business productivity implies that many more workers either
on a part-time or full-time basis have been employed to take part in the increased business
productivity. This has enabled the nation to reduce the unemployment rates from a high level of
10 percent during the year 1992 up to 5 percent or below currently.
The natural rate of unemployment is the lowest unemployment rate reached by an economy. It’s
natural in the sense that its causes are not problems arising from poor economic performance.
Surplus, structural and frictional unemployment are considered to be natural types of
unemployment. A healthy economy also experiences the natural rate of unemployment as

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workers persistently come and go seeking for new jobs. The jobless status until one finds a job is
actually the natural rate of unemployment. The long-run aggregate supply curve indicates the
relationship between the real gross domestic product and the level of price whereby the output
level at this period is actually attains the full employment. The natural rate of unemployment is
attained at the vertical point of the long run aggregate supply curve as shown in the diagram
below.
The natural rate of unemployment is attained at the intersection point between the long run
aggregate supply curve and the real gross domestic product. This is referred to as the output level
full employment attainment point. At this point, the wages fully adjust to and the cost changes
from wage adjustment are passed to final consumers.
b.
If the government estimates NAIRU incorrectly to 5 percent instead of 4 percent and stimulates
demand to reduce unemployment, then inflation occurs as explained. When the government

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stimulates demand, it means that the consumption in the economy increases. It means that
consumers have more income available for expenditure and hence increase their spending on the
nation’s goods and services (Kaplan and Violante 2014, p.1199). The result is more money after
only a few goods and services which are unable to meet consumers’ demand. This shifts the
aggregate demand curve to the right from AD0 to AD1. As a result, equilibrium is raised and
shifts to the right from point E0 to E1. This raises the overall price for goods and services from P0
to P1. The quantity supplied in the market increases and shifts from Q0 to Q1. The general rise in
the price of goods and services results in inflation. An illustration is shown in the diagram below.

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References
Cochrane, J.H., 2011. Presidential address: Discount rates. The Journal of finance, 66(4),
pp.1047-1108.
Dao, M.Q., 2012. Government expenditure and growth in developing countries. Progress in
Development Studies, 12(1), pp.77-82.
Dosi, G., Fagiolo, G. and Roventini, A., 2010. Schumpeter meeting Keynes: A policy-friendly
model of endogenous growth and business cycles. Journal of Economic Dynamics and
Control, 34(9), pp.1748-1767.
Hördahl, P. and Tristani, O., 2012. Inflation risk premia in the term structure of interest
rates. Journal of the European Economic Association, 10(3), pp.634-657.
Justiniano, A., Primiceri, G.E. and Tambalotti, A., 2010. Investment shocks and business
cycles. Journal of Monetary Economics, 57(2), pp.132-145.
Kaplan, G. and Violante, G.L., 2014. A model of the consumption response to fiscal stimulus
payments. Econometrica, 82(4), pp.1199-1239.
Keynes, J.M., 2018. The General Theory of the Rate of Interest. In The General Theory of
Employment, Interest, and Money (pp. 145-153). Palgrave Macmillan, Cham.
Robinson, M., 2013. Aggregate expenditure ceilings and allocative flexibility. OECD Journal on
Budgeting, 12(3), pp.1-19.

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Van Hemert, P. and Nijkamp, P., 2010. Knowledge investments, business R&D and
innovativeness of countries: A qualitative meta-analytic comparison. Technological Forecasting
and Social Change, 77(3), pp.369-384.