ECO10004: ECONOMIC PRINCIPLES

WEEK 10_TUTORIAL QUESTIONS

Key concepts: Business cycle, Recession, Expansion, Aggregate Demand, Aggregate Supply

Short-answer Questions
Question 1) What type of consumer goods is most affected by the business cycle: durable
goods or non-durable goods? Why?
Durable good (non-essential). weakness. During recession, consumer confidence is low.
They can postpone purchasing durable goods. But they cannot postpone buying non-
durable goods such as foods,
Question 2) Explain what happens to inflation and unemployment during the two different
stages of the business cycle?

In 2010, many countries began to recover from the 2007-08 Global Financial Crisis.
While their economies started growing again, the unemployment rate in many countries
continued to rise further instead of falling. Explain clearly why such a phenomenon was
happening
The unemployment rate may continue to rise during the early stages of a recovery
because employment may grow more slowly than the labour force (from population
growth and discouraged workers re-entering the labour force), and because some firms
are operating well below capacity, these firms may be slow to hire laid-off.
-Discouraged workers: they leave the labour force during recession, meaning not counted
as unemployed. They join the labour force when the recession is over; meaning counted
as unemployed.
-Firms follow a wait and see policy (reluctant to hire workers immediately after the
recession. Firms may also have excess capacity which they could use after the recession
is over (without hiring workers)

Question 3) Suppose the Australian economy is currently characterised by the following

graph:

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 a. Is the Australian economy currently facing an unemployment problem or an
inflation problem? Clearly explain why
Unemployment problem because actual GDP in the SR < Potential GDP.
b. What needs to happen so that the Australian economy can achieve full
employment? Clearly explain.
By increasing aggregate demand: AD curve will shift to the right until
reaching LR equilibrium point.
- By increasing aggregate supply: SRAS curve will shift right until reaching
LR equilibrium point.
Question 4) The recent mining boom in Australia was considered the second biggest
resource boom since the gold rush of the 19th century. The boom reached its peak between
2011 and 2013. During those years, the mining sector grew dramatically thanks to the
massive demand for iron ore and thermal coal from China.
a. Draw appropriate AD-AS graph(s) to illustrate the effects of this shock (aka the
mining boom) on the Australian economy. Explain which curve(s) would shift
and the reasons behind the shift. Assume the Australian economy was originally
at the long-run equilibrium

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 b. State clearly the effects of this shock on key macroeconomic variables (i.e. Real
GDP, Price Level and Unemployment Rate). What type of inflation would likely
occur as a result of this shock?
Due to Chinese demand of iron ore and thermal coal increases, Australia export
will increase. AD curve will shift to the right. Output increases. In the SR, real
GDP increases, unemployment falls, price level increases, unemployment falls,
price level increases. This is call demand-pull inflation.
Question 5) During the 1970s, developed economies (Australia included) were hit hard by
a severe oil crisis. Oil price was at $3 per barrel in 1973 then shot up to $12 in 1974. By
1979, oil price already rose to nearly $40 per barrel. Given how important oil and other
types of fuel were as inputs to production, this crisis had crippling effects on major
economies in the world.
a. Draw appropriate AD-AS graph(s) to illustrate the effects of this shock (aka the
oil crisis) on the Australian economy. Explain which curve(s) would shift and the
reasons behind the shift. Assume the Australian economy was originally at the
long-run equilibrium.

b. State clearly the effects of this shock on key macroeconomic variables (i.e. Real
GDP, Price Level and Unemployment Rate). What type of inflation would likely
occur as a result of this shock?
When oil price rises, cost of production increases. Firms will produce less. SRAS curve shifts
to the left. Output falls. In the SR, Real GDP falls, Unemployment rises, price level
increases.
Question 6) Please note this question was written in February, prior to the pandemic
and its economic toll being blown out of proportion.
On 25th February 2020, the Australian government announced that the economic impact
of the coronavirus would be worse than the bushfires. The virus outbreak affects the
Australian economy in multiple ways. First, the tourism and education sectors are hit hard
due to travel bans on tourists and students from China. Second, many Australian
businesses such as retail and construction are starved of supplies because their suppliers
in China have not yet returned to operation.
It is feared that a recession might occur, ending Australia’s 29-year streak of
uninterrupted economic growth.
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 a. Draw appropriate AD-AS graph(s) to illustrate the effects of this shock (aka the
coronavirus outbreak) on the Australian economy. Explain which curve(s) would
shift and the reasons behind the shift. Assume the Australian economy was
originally at the long-run equilibrium.

b. State clearly the effects of this shock on key macroeconomic variables (i.e. Real
GDP, Price Level and Unemployment Rate). What type of inflation would likely
occur as a result of this shock?
When there is a ban on Chinese student and tourist- Australia’s exports falls; AD
curve will shift to the left. When there is Chinese supplier are not operational,
Australia ‘s supply will fall; SRAS curve will shift to the left. As a result, output
falls. In the SR, Real GDP falls, unemployment rises. Price level change is
uncertain.
Question 7) Suppose that you have just landed a job in the Victoria’s Department of
Treasury and Finance, working as a graduate economist.
Suppose it is now July 2020. Many pundits believe the Australian economy has finally
scraped through the worst economic slump in recent memory caused by the coronavirus
pandemic. They hope economic activities will pick up again in the quarter ending
September 2020.
Your boss is, however, sceptical of such optimism. She has assigned you the task of
composing a report, which investigates whether the economy is heading toward a
recovery or if the recession will extend to the September quarter.
Data on economic performance for the September quarter will only be published in
December by the ABS.
What economic indicators would you include in your report to help predict the economic
situation in September? Clearly explain why the indicators you have picked would have
good predictive power.
Hints: Do a Google search for terms such as “Leading Indicators”, “Westpac –
Melbourne Institute Leading Economic Index”, “ANZ – Roy Morgan Consumer
Confidence” as well as reports by the Reserve Bank of Australia (RBA), the International
Monetary Fund (IMF) and various consultancy firms (e.g. KPMG, Deloitte, etc.)
That would help you a great deal in answering this question.
Consumer’s confidence: if improving, the economy is recovering. Business confidence: if
improving, the economy is recovering. Consumer purchase of durable goods: if
improving, the economy is recovering Commodity prices: if improving, the economy is

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recovering The stock market: if rallying, the economy is recovering. No of building
permits: if increasing, the economy is recovering.

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Multiple Choice Questions
1. A recession is often defined as
a. two consecutive quarters experiencing a decline in the economic growth rate.
b. two consecutive quarters of declining nominal GDP.
c. a significant decline in activity visible in industrial production, employment,
real income and wholesale/retail trade lasting more than a few months.
d. a significant decline in inflation and unemployment lasting more than a few
months.
2. The beginning of an economic contraction coincides with a(n) ________ while during
an economic expansion ________
a. decrease in government spending; investment increases.
b. decrease in investment; investment increases.
c. decrease in government spending; government spending increases.
d. increase in government spending; investment decreases.
3. As the economy nears the end of an expansion, interest rates usually ________ and
wages rise more ________ than prices.
a. rise; rapidly
b. rise; slowly
c. fall; rapidly
d. fall; slowly
4. Because a company such as Boeing produces expensive durable goods (aircraft), the
demand for their goods
a. is likely to increase during a recession.
b. declines when incomes in the economy are rising.
c. is consistently high, regardless of the state of the economy.
d. tends to follow the business cycle.

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5. Which of the following explains why the rate of unemployment continues to rise once
a recession is over?
a. Discouraged workers leave the labour force.
b. Wages rise faster than productivity increases so firms are reluctant to hire
workers.
c. Firms are operating below capacity for some time after the recession is
finished.
d. The unemployment rate does not continue to rise after a recession is over.
6. How do changes in income tax policies affect aggregate demand?
a. Higher taxes increase disposable income, consumption and aggregate demand.
b. Higher taxes reduce disposable income, consumption and aggregate demand.
c. Higher taxes increase corporate investment and aggregate demand.
d. Higher taxes increase aggregate supply and thus increase aggregate demand as
well.
7. How does an increase in the price level in Australia relative to the price level of other
countries affect the aggregate demand curve, ceteris paribus?
a. This will move the economy up along a stationary aggregate demand curve.
b. This will move the economy down along a stationary aggregate demand curve.
c. This will shift the aggregate demand curve to the left.
d. This will shift the aggregate demand curve to the right.
8. The distinction between the short-run and long-run aggregate supply curve is
necessary because in the long run
a. technology is fixed, but in the short run it changes.
b. changes in the price level do not affect the level of real GDP but do in the
short run.
c. the aggregate supply curve is horizontal, but in the short run it is upward
sloping.
d. the price level is constant, but in the short run it fluctuates.

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9. Along a short-run aggregate supply curve, a decrease in the price level causes
a. firms to increase their production levels, as the lower prices will increase
consumer demand.
b. no change in output to occur as, at the macroeconomic level, the price level
does not affect supply.
c. firms to reduce their production levels.
d. production levels to rise as the price of inputs become cheaper.
10. If workers expect the rate of inflation to rise from 3 per cent to 5 per cent next year,
this should
a. shift the short-run aggregate supply curve to the left.
b. shift the short-run aggregate supply curve to the right.
c. move the economy up along a stationary short-run aggregate supply curve.
d. move the economy down along a stationary short-run aggregate supply curve.

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