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TEACHER: __________________________

NAME: ____________________________

VCE ECONOMICS SAC 2


Unit 1: Area of study 2: Economic Issues Sustainable Economic Growth
Low Inflation
Model answers

(there are other answers which are also acceptable)

16 May 2012
TEST STRUCTURE & ALLOCATION OF MARKS:
Comprises of three sections A, B & C:
Sectio
n
A
B
C

Type of
question
Multiple
Choice
Short Answer
Case Study

Number of
questions
10

Number of
marks
10

7
5

30
20
Total:

INSTRUCTIONS:
Reading time: 5 minutes
Writing time: 65 minutes
Exam conditions apply. (1 mark deduction for talking)
Complete all questions in the space provided.

60

Marks
awarded

Section A: MULTIPLE CHOICE


Circle the response you think is most correct.
1. The calculation of Australias Gross Domestic Product (GDP) is likely to be an
inaccurate measure of Australias living standards. Which of the following
combination of factors may help to explain why?
i. the value of household production may not be included
ii. the value of exports is excluded
iii.it is impossible to calculate the value of services
iv the value of some production must be estimated
v. the value of voluntary and charity work may be excluded
A.
B.
C.
D.

i, iv and v
i, iii and v
ii and iii
iii, iv and v

2. In which of the following situations has inflation occurred?


A. The Consumer Price Index fluctuated during the year, but by the end of the
year it was 105.
B. No change was recorded in the Consumer Price Index, but the total cost of
completing the survey increased by 3.2%.
C. The Australian Bureau of Statistics recorded the Consumer Price Index at 110,
after it had been 114 in the previous year.
D. The Consumer Price Index was recorded at 107 in one year, and at 109 in the
following year.
3. Deflation is bad for an economy because:
A. When deflation is occurring the government will be forced to increase interest
rates.
B. People will tend to delay larger purchases while prices are falling.
C. Deflation will often coincide with a period of severe economic shortages.
D. During a period of falling prices, consumers tend to clear stock from the shelves
too quickly.

4. Australias productive capacity may be increased by:


A. the depletion of oil reserves in Australia.
B. an increase in labour productivity.
C. the ageing of the Australian population.
D. interest rate increases.
5. The inflation rate in Australia may increase if:
A. the Australian dollar appreciates
B. the savings rate increases
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C. the unemployment rate increases


D. the level of consumer confidence increases
6. A low inflation rate is an economic priority for the Australian Government
because:
A.
B.
C.
D.

low
low
low
low

inflation
inflation
inflation
inflation

helps to maintain the purchasing power of Australian households.


encourages people to borrow money.
is associated with a high Australian dollar.
promotes savings.

7. If the inflation rate in Australia was above 3%, the most appropriate policy
response of the Australian Government would be to:
A.
B.
C.
D.

increase spending on infrastructure such as roads and rail networks


lower the tax rates on investment income
decrease the Goods and Services Tax (GST)
increase the cash rate

8. Which of the following would be least likely to increase a countrys rate of


growth?
A. Increased investment levels and the expansion of capital resources
B. Farming methods resulting in better soil management and fertility
C. Increased concern over environmental matters and Aboriginal land claims
(which have reduced access to natural resources)
D. The accelerated application of new technology in industry
9. If an economy is in the recession phase of the business cycle:
A.
B.
C.
D.

The rate of employment increases


The rate of unemployment increases
The rate of investment increases
GDP increases

10.
A.
B.
C.
D.

One way of achieving an increase in labour productivity is to


find a way for employees to use each work hour more effectively
pay your employees a higher wage rate
ask employees to work extra hours each week
encourage workers to move interstate or overseas to find work.

Section B: SHORT ANSWER QUESTIONS


1. Explain two (2) reasons why you believe it is important for an economy to
continue to experience economic growth.

When economic growth occurs this means the GDP/capita


will have increased and therefore consumers will have
higher disposable income and this will increase their
material living standards.
People are better off when an economy continues to
experience economic growth. It brings higher
employment rates and a broader choice of goods and
services. That means people have more disposable
income and are free to consume more, leading to
increased material and non-material living standards.
4 marks
2. Distinguish between material and non-material living standards.

Material living standards are income based living


standards. A persons material living standards increase
if they have more disposable income because they can
buy more goods and services. Non-material living
standards are the non-money based living standards that
are more difficult to measure but reflect how we feel. For
example stress, amount of leisure time, overall
happiness, job satisfaction.
Many peoples answers for this were too simplistic remember that
DISTINGUISH means to indicate differences and similarities.

2 marks
3. Select one (1) aggregate demand factor and one (1) aggregate supply factor from
the list below and explain how each would affect the rate of economic growth in
Australia.
i.
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Extreme weather conditions in Australia

ii.
iii.
iv.

Decreased consumer confidence


Increased labour force participation rates
Lower interest rates

Extreme weather conditions refer to weather conditions


such as floods and hurricanes which may destroy large
numbers of crops. This would impact the countrys
access to resources which is an aggregate supply factor.
This would decrease the aggregate supply and shift it to
the left. This would result in a decrease in economic
growth.
Consumer confidence is how good the consumer feels
about the future of the economy. It is an aggregate
demand factor and would impact on consumer spending.
If consumer spending decreases, aggregate demand
would decrease and the curve would shift to the left. This
would result in a decrease in economic growth.
Labour force participation refers to the percentage of
people in the labour force those who are over 15 and
are willing and able to work. If this increases, it increases
the countrys access to resources which is an aggregate
supply factor. This would increase aggregate supply,
shifting the curve to the right. This would result in an
increase in economic growth.
Lower interest rates could be a demand factor or a
supply factor.
- Interest rates are the rates consumers and
businesses pay to borrow money from the
bank.
If the interest rates increase, consumers
disposable income decreases so consumer
spending will decrease. This will cause aggregate
demand to decrease and the curve will shift to the
left, resulting in a decrease in economic growth.
If the interest rates increase, businesses will experience
an increase in their costs of production which is an
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aggregate supply side factor. This will result in a


decrease in aggregate supply and the curve will shift to
the left. This will result in a decrease in economic growth.
8 marks
4. Define what is meant by sustainable economic growth and discuss one
government policy initiative that may help promote sustainable growth.

Sustainable economic growth is where the current


production of goods and services is gradually increasing,
meeting our current needs and wants without impacting
on the needs and wants of future generations. One
government policy initiative that may help promote
sustainable economic growth is subsidies offered to
businesses. The subsidies received by businesses can be
used to invest in renewable sources of energy such as
solar or wind power. This helps lower pollution levels
which protects and prolongs our environment, ensuring
that future generations are able to experience
sustainable economic growth also.
Could also mention the carbon tax/monetary policy or budgetary policy
for this question.
4 marks
5. Explain two (2) ways how an economy may experience an increase in economic
growth AND a fall in living standards?

An economy may experience an increase in economic


growth and a fall in non-material living standards as
during economic growth negative externalities are
produced through production, such as pollution. Also,
during these periods companies may force employees to
work longer hours to cope with the increased demand for
goods, reducing personal happiness.
An economy might also experience a fall in material
living standards as the benefits of the economic growth
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may not be distributed evenly. It is likely that demand


inflation may occur which will lead to some household
experiencing a decrease in their purchasing power and
material living standards.

Some people did not remember to distinguish between non-material and


material living standards in their answers.
4 marks
6. Explain two (2) important limitations of using GDP as a measure of economic
growth and general living standards.

GDP doesnt include non-marketed production. For


instance, transactions in black markets and production of
homemade goods and services are not part of GDP. But
they do contribute to the economic growth and living
standards.
Negative externalities are excluded from the GDP
calculation. As economic growth occurs and modern
technology improves, negative externalities like pollution
are emitted. Even though vthey impact greatly on nonmaterial living standards, they are not accounted for in
the GDP.
Using GDP as a measure of living standards is flawed
because it assumes that the increase GDP is distributed
evenly across society which it isnt. As the rich get richer
from economic growth, the poor may find it more difficult
to keep up with the inflation rates associated with a
growing economy and may experience decreased living
standards.
Other answers acceptable also.

4 Marks
7. Give an example of one (1) type of microeconomic reform policy and explain
how it is intended to affect the rate of economic growth in Australia.

A decrease in tariffs (a tax on imported goods) will put


pressure on the local industry. This will mean local
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businesses will need to increase their


efficiency/productivity in order to be able to compete
with the overseas competitors. Local industries will
become more efficient, increasing the aggregate supply
and shifting the aggregate supply curve to the right. This
will result in an increase in economic growth.

Policies which impact AD are NOT microeconomic reform policies.


4 marks

Section C: CASE STUDY

RBA focus too much on inflation


April 18, 2012

ONE of Australia's largest superannuation funds says the Reserve Bank of Australia
(RBA) should consider more than inflation when it considers interest rate policy.
Industry Funds Management chairman Garry Weaven said today the RBA's approach
to inflation, which was adopted under previous governor Ian MacFarlane and former
federal treasurer Peter Costello, was now "totally inappropriate".
"It is very hard to get the balance right, but consistently now for many years the
Reserve has had far too much focus on inflation only and not enough on employment
and economic prosperity generally, which is their requirement under the Act," Mr
Weaven told ABC Radio today.
"It seems to be still unduly influencing the Reserve in its policies."
The central bank sets monetary policy - by managing cash interest rate levels - with
the aim of keeping inflation within a target band of two to three per cent over the
course of the economic cycle.
Inflation, as measured by the consumer price index, was 3.1 per cent in calendar
2011.
The RBA's preferred measure of underlying inflation, which removes volatile price
movements, was at 2.6 per cent.
Treasurer Wayne Swan said he disagreed with Mr Weaven.
"What I do is, I support the Reserve Bank implementing its current charter," he told
ABC Radio.
"It takes its decisions independently of the Government and that is as it should be."
Mr Weaven said Australia's cash rate was high compared to other advanced
economies, placing pressure on business.
Australia's cash rate of 4.25 per cent compares to base rates of 0.125 per cent in the
US, 0.1 per cent in Japan and 0.5 per cent in the UK.
"We do have signs of real weakness in retail and manufacturing, but more importantly
in a way we have very high interest rates by international standards," Mr Weaven
said.
"High interest rates push the currency high and that is very, very bad for
manufacturers, tourism and some other industries."
He said lower interest rates could help depreciate the Australian dollar, which is
currently above $US1.03, and reduce the pressure on exporters.
"That would be a very good thing overall for the economy," Mr Weaven said.
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1. Explain two (2) reasons why the Australian government is keen to maintain a
low inflation environment?

The Australian government aims to maintain low inflation


because low inflation wont decrease economic activity
as consumers and businesses are more confident in
spending when inflation is low as they know they will
have more purchasing power in the economy.
Low inflation leads to the stabilization of the Australian
currency if the dollar is stable, households and
individuals are able to maintain their purchasing power
as prices are not too high. If inflation were to become too
high, the value of the Australian dollar would decrease,
leading to people spending less in the economy which
leads to a decrease in the rate of economic growth.
Low inflation is good for exports as other countries are
more willing to purchase our goods due to the stable
prices. As our goods are more attractive to other
countries, they will continue to purchase them, meaning
that we will continue to experience economic growth.
4 marks
2.
a. List two (2) limitations of the CPI as a measurement of inflation.

Does not account for price changes in rural areas.


Not all goods are included.
Weightings may not be accurate as they are only
changed every 5 years.
2 marks
b. State and discuss how one (1) factor or event may cause the headlining
CPI to be overstated.
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The CPI may be overstated when the weightings of items


are not accurate to the typical household. For example, if
the cost of an item, such as an MP3 player has increased,
the CPI would increase but it may fail to account for the
declining popularity of the item.
CPI may be overstated as some of the weightings of
items can change within the 5 year period. If an item
becomes used less in households, its weighting in the CPI
calculation is inaccurate and will cause the CPI to be
overstated.
2 marks
Please refer to the article for the next three questions.
3. The article states, Mr Weaven said Australia's cash rate was high compared to
other advanced economies, placing pressure on business.
a. Define the cash rate.

This is the rate at which the RBA loans money to the


banks on the overnight money market.
1 mark
b. Discuss one (1) reason why a high cash rate puts pressure on Australian
businesses and predict what impact this pressure on businesses may
have on Australias economic growth.

A high cash rate leads to high interest rates. This means


the cost of borrowing money for businesses is increased.
Higher costs means the cost of production is higher. This
leads to increased aggregate supply, as businesses must
pay more to produce the same amount of goods and
services. The result is a decrease in the rate of economic
growth.
4 marks
4. The article says that Australian interest rates are high compared to interest
rates in other countries. Suggest a reason why Australias interest rate is
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relatively high and examine why this could be considered to be an advantage


for Australia.

Australias cash rate is relatively high because we were


not affected by the recession like other countries. The
leads to increased spending by consumers and
businesses and the cash rate remained high in order to
counter demand inflation.
An advantage of a high cash rate is that it will attract
foreign investors to spend money in Australia more than
in other countries. This will increase our aggregate
demand, leading to economic growth.
3 marks
5. The article states, High interest rates push the currency high and that is very,
very bad for manufacturers, tourism and some other industries."
a. Define exchange rate.

The exchange rate is the rate at which the Australian


dollar is changed for other currencies.
1 mark
b. Explain how a high currency can negatively impact Australias tourism
industry and subsequently economic growth

A high currency is bad for Australian tourism as the


increased dollar means foreign countries are less likely to
spend their money on Australian tourism.
Also, local residents are more likely to go overseas to
spend their money, to the further detriment of Australias
tourism industry.
High currency means that the exchange rate is high. This
means overseas people receive less for our currency
when they exchange it. This makes it more expensive for
them to spend money here. As it would cost more,
tourists will be less likely to choose Australia as a holiday
destination, having a negative effect on Australian
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tourism. Also, local tourists will choose to spend their


holiday time in other countries as it will be cheaper once
tey convert their currency.
3 marks

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