MACRO1(ECON1010) Assignment 2

This assignment covers the following topics:
•    Monetary System (Chapter 29)
•    Inflation: Its causes and costs (Chapter 30)
•    Aggregate demand and supply (Chapter 33)
Instructions to students:READ THE FOLLOWING FIRST (Very Important)
•    This assignment contributes to 15% of the overall marks for the course.
•    Use this Word template for your submission (ie, write down your answers in the space provided in each question and submit) –the other form of the file is no longer accepted in e-submission.
•    The recommended browser is Chrome, Firefox or Explorer (some have suggested that Safari might not work).
•    The font size has to be at least 12.
•    Explain your answers, but be succinct.
•    Label and explain any diagrams, if any, that you use carefully (labelling each axis).
•    Show all of your working in order to get partial credits
•    Make sure you have included student ID and name in the front page of the assignment
•    Working with other fellow students is strongly encouraged.However, you cannot just copy your friend’s answers. If we find out this, you will be harshly punished for the academic plagiarism. See RMIT’s policy on this:
•    http://www1.rmit.edu.au/browse;ID=sg4yfqzod48g1

Short Answer Questions:
•    Provide the answers in the space provided below
•    The font size has to be at least 12.
1)    (4 marks in total).You have decided to deposit $2,000 in a savings account in the Commonwealth Bank, which does not have any excess reserves at the time when you make a deposit. (1 mark for each)

a)    How does your deposit change the Bank’s T-account?  Show the T-account changes.

b)    Now the Bank is told to maintain a reserve ratio of 0.2 (ie, 20 percent).The Bank decides to make the maximum possible loan from the deposited funds. Following from theT-account in Part a), what does the T-account look like now?

c)    Now, somebody who took out the loan in Part b) writes a cheque for the amount and then the person receiving the cheque deposits it in WestPac Bank which also maintains a reserve ratio of 0.2. Show how this changes the T-account of WestPac Bank.

d)    If the process of money creation continues what is the total money supply resulting from your initial $2,000 deposit?

2)    (3 marks in total) Suppose that the price level in Australia is expected to rise by 7% in 2016. (1 mark for each)
a)    Why do some economists claim that we should not worry too much about inflation at this level?

b)    Other economists think that there are significant costs associated with inflation above 2-3%. What are they?

c)    What are the other costs be to consider if the inflation rate unexpectedly turns out to be higher than 7%?

3)    (4 marks in total) Consider an economy that is initially in long run equilibrium in theAD-AS diagram as shown in Figure below. Use the Figure to demonstrate the following changes.
a)    Suppose people in the economy start to become a bit worry about the future of the economy and decided to save more. This translates into an increase in private saving (we assume that this happens given any real interest rate and pricelevel).
i.    How does this change the aggregate price level, real income and unemployment in the short run? Explain and illustrateit in AD-AS diagram below (1 mark)

Answer here(Tips: to create new lines (AD, SRAS), simply copy the existing curves and move to the new locations)

ii.    On the same diagram illustrate the adjustment process to long run equilibrium (assuming that real potentialoutput remains unchanged, so no change in LRAS), and explain the final impact on the pricelevel.(1 mark)

Answer here (Tips: to create new lines (AD, SRAS), simply copy the existing curves and move to the new locations)

b)    Suppose many Australian firms mistakenly expect that there willbe an increase in the relative price of their own productsas compared to others (including relative to the input costs and wages they pay). This should shift the SRAS curve. Start with the equilibrium point shown in the Figure below and use it to demonstrate the following changes.
i.    How does this change the aggregate price level, real income and unemployment in the short run? Explain and illustrate in the AD-AS diagram (1 mark)

Answer here (Tips: to create new lines (AD, SRAS), simply copy the existing curves and move to the new locations)

ii.    On the same diagram illustrate the adjustment process to long run equilibrium (assuming that real potentialoutput remains unchanged, so no change in LRAS), and explain the final impact on the pricelevel.(1 mark)
Answer here (Tips: to create new lines (AD, SRAS), simply copy the existing curves and move to the new locations)

(4 marks)Read the article from the Agewhich starts “Don’t waste any time worrying about it: Australia is heading into a recession…”
(the article can be found here: http://www.theage.com.au/comment/automotive-transformation-scheme-cancellation-may-drive-the-economy-over-the-edge-20150904-gjfdsg.html)

The author argues that the Australian economy is inevitably heading into recession. What reasons does he give for this and do you agree with them? Supposing the economy is heading for recession what in your view should (or can) the Australian government do to deal withthis? You need to write at least half a page in length.

Answer here