ECO1001 Economics for Decision Making 2021 Session 2 EXAM

Question 1:

A) Economics addresses the production, the allocation and intake of goods and services.
Economics is the study of sectors such as people, companies, governments, and countries
and how they make decisions on the efficient allocation of resources. People have unlimited
wants however limited resources. Thus, economics deals with the problem of scarcity and
making the most out of the resources we have.

B) Answer:

i) Country A produces: Widgets = 5 million & Things = 120 million

Country B produces: Widgets: 4 million & Things = 60 million

ii) Opportunity cost of Widget in Country A: 1 widget is 48 things

Opportunity cost of Widget in Country B: 1 widget is 30 things

iii) Opportunity cost of 60 Things in Country A: 60 things is 1.25 widgets

Opportunity cost of 60 Things in Country B: 60 things is 2 widgets

iv) Country B has comparative advantage in widgets. Country A has comparative advantage
in Things.

v) Each time the wheat is allocated to mass companies there are costs of using the product
compared to a different supplier or a substitute such as grain.

vi) A Improvement in technology will shift both the country’s PPF outwards.
Question 2:

a) Corn is a substitute for wheat. Therefore, ceteris paribus demand would decrease for wheat,
shifting the demand curve left, resulting in a lower equilibrium price for wheat and a lower
quantity demanded. Additionally corn is a substitute good on the supply side as farmers can
plant corn or wheat. A decrease in the price of corn will see supply of corn decrease and supply
of wheat increase as farmers start to produce more wheat. This will shift the supply curve to the
right decreasing the equilibrium price of wheat and increasing the quantity supplied.
b) Sugar is a complimentary good. Therefore, ceteris paribus a fall in the price of sugar will see an
increase in demand for wheat, the demand curve shifts right, resulting in a higher equilibrium
price and more quantity demanded.
c) As the future expectations for wheat prices is to see a decrease, ceteris paribus, this may result
in a decrease in demand for wheat as consumers wait to purchase until the price drops. This will
result in the demand curve shifting left and a lower quantity demanded. Furthermore, suppliers
may start planting substitute goods such as corn instead of wheat due to the expected low
prices. This will reduce the supply of wheat, shifting the supply curve left, increasing the
equilibrium price, and reducing the quantity supplied.
d) Wheat specific fertiliser may increase the supply of wheat as farmers are “locked in” to growing
wheat regardless of the price. This would see the supply shift right and equilibrium price
decreases.
e) Non-price externalities such as seasonality, taxes, and technology would affect the supply and
demand. The technology advancements within irrigation would shift the supply to the right,
making the equilibrium higher. A complimentary grain would be used as a substitute that would
shift; the demand curve shifts to the left.
Question 3:

a) If the price celling is set below the market equilibrium this will have an immediate affect on
price and demand. As shown in the graph, the price of the good or service will be set at
where the price celling is set at. At this point quantity demand will be greater as more
consumers will be willing to purchase the good at this price. However, quantity supply will
be reduced as suppliers exit the market as profits are reduced. Ultimately this leads to a
shortfall where demand exceeds supply.
b) A price ceiling above equilibrium, certis paribus has no effect on the market price as the
price is already below the set celling.
c) A price Equilibrium at the current equilibrium price will “lock in” current market prices. This
will have no impact on price unless supply shifts left or demand shifts right, where the price
celling would then fall below equilibrium and then the effect would be seen.
Question 4:

a) The RBA will undertake open market operations by purchasing government bonds in the
overnight money market. This will result in increased liquidity for the banks as funds are
injected into the economy and will see the cash rate be reduced, that is the rate financial
institutions lend to each other to meet reserve requirements.
b) Reduced Interest rates lead to higher demand for funds. Financial institutions will lend more
money, injecting more funds into the economy. The increase in funds will see a increase in
consumption and investment which in turn increases aggregate demand. Increased
aggregate demand leads to improve employment and increasing rates of inflation
c) A potential impact on the economy if the velocity of money was slower than anticipated
output would increase due to a directly proportional supply level of money.
d) If the Regional Bank of Australia Misjudged the unemployment rate and it was closer to full
employment than anticipated, and changes were made it would lead to an increase in price
levels in the long run.
Question 5:

a) When the Regional Bank of Australia reduces rates, it aligns with the expansionary monetary
policy. If the Australian Government has increased the spending leading to budget deficit in
2020 at the same time this aligns with the expansionary fiscal policy. The result of both
happening at the same tome creates the aggregate demand (AD) to increase and shifts to
the right as well as an increase in real output.

b) A bigger value of marginal propensity to consume will create a bigger value of spending
multiplier within the economy. Furthermore, a bigger value of multiplier will lead to larger
impact of the policy stimulus. Thus, it is important to have a bigger marginal propensity to
consume that ensures the impact of fiscal policy is greater. Example below:

If marginal propensity to consume = 0.75

c) Within the economy if there is an increase in savings, consumers will save more and spend
less. Thus, marginal propensity to consume would decrease. It will diminish the impact of
fiscal initiatives in the economy.

d) Yes, both the policies are aligning with each other. Reduced rate of interest reduces
borrowing costs. It causes consumption and investment spending to increase. Thus, AD
increases. Due to the increase in government spending, AD also increases further. It leads to
the economic recovery and the economy expands. Furthermore, both policies are
interconnected with the other.
Question 6:

a) (Also stated on page) - Tariff’s will result in an increase of price by $2.00 and will see a large
increase by domestic suppliers meeting most of domestic demand. Quantity demand decreases
due to the higher price level. Government collects tariff revenue shown in the grey area box. Net
welfare loss is shown in the blue triangles. Producer surplus is shown in the red triangle.

b) Governments place tariffs on specific industries or products. These are controlled strategies
that balance trade between countries. An additional cost is added to the imported good or
service, the marginal cost will discourage imports, thus affecting the balance of trade.
Furthermore, it promotes production in that product domestically and will create
opportunities within that domestic market which assists in decreasing unemployment.

c) When Australia imposes a tariff on a large volume high value imported item. It will decrease
supply of AUD and AUD will appreciate. You can see that the foreign exchange market is
equilibrium at point "A" now placing tariff decrease supply. Thus, the supply curve shift to
the left from S to S1 and AUD get appreciated.
See below for the graph: