Name: ______________________________ Teacher: ______________________________

ECONOMICS UNITS 3 AND 4Practice written examination 2018

Reading time: 15 minutesWriting time: 2 hours

QUESTION AND ANSWER BOOK

Structure of book

Sections Number of questions Number of questions to be answered

Number of marks

A 15 15 15

B 4 4 65

Total 80

Students are permitted to bring into the examination room: pens, pencils, highlighters, erasers, sharpeners and rulers.

Students are NOT permitted to bring into the examination room: blank sheets of paper and/or white-out liquid/tape.

No calculator is allowed in this examination.

Materials supplied Question and answer book Answer sheet for multiple-choice questions Additional space is available at the end of the book if you need extra paper to complete an

answer. Clearly label all answers with the appropriate question number.

Instructions Write your name and your teacher’s name in the spaces provided above on this page.

All questions in both sections of this practice exam are compulsory. The multiple-choice questions in Section A are to be completed in pencil on the sheet

provided. All written-response questions are to be completed in blue or black pen in the spaces

provided. All written responses must be in English.

Students are NOT permitted to bring mobile phones and/or any other unauthorised electronic devices into the examination room.

SECTION A: MULTIPLE-CHOICE QUESTIONS

Instructions for Section A

Answer all questions in pencil on the answer sheet provided for multiple-choice questions.

Choose the response that is correct or that best answers the question.

A correct answer scores 1, an incorrect answer scores 0.

Marks will not be deducted for incorrect answers.

No marks will be given if more than one answer is completed for any question.

Question 1A move from a recession to the expansion phase in the business cycle will most likely result in which of the following?

A. decreased inflation

B. increased employment

C. increased unemployment

D. increased underemployment

Question 2In order to implement a loosening of monetary policy the Reserve Bank of Australia would:

A. decrease the cash rate by buying government bonds.

B. decrease the cash rate by selling government bonds.

C. increase the cash rate by selling government bonds.

D. increase the cash rate by buying government bonds.

Question 3The 2018–19 Budget papers forecast future wages growth of 3.25% in 2020. If the predictions are not accurate and current wages growth rates persist into the future, which of the following is the likely impact on budget revenues and expenditures?

A. company tax revenue will fall, personal income tax revenue will rise, welfare payments will fall

B. company tax revenue will rise, personal income tax revenue will fall, welfare payments will rise

C. company tax revenue will fall, personal income tax revenue will fall, welfare payments will rise

D. company tax revenue will rise, personal income tax revenue will fall, welfare payments will rise

Question 4Which of the following will result in a higher price elasticity of demand for cars?

A. an increase in the level of disposable income

B. an increase in the spare capacity in the production of cars

C. an increase in the number of jobs available in rural Australia

D. an increase in the number of competitors importing cars into Australia

Question 5There will be a contraction in demand for computers when:

A. productivity rises.

B. disposable income rises.

C. consumer confidence falls.

D. cost of production increases.

Question 6Which of the following aggregate supply policies is likely to result in an increase in structural unemployment?

A. increased spending on skills and trainingB. increased funding for roads, rail and ports C. increased tariffs in the agricultural industryD. a cut to subsidies for the footwear and textiles manufacturing industry

Question 7Which of the following situations would be more likely to impact the headline rate of inflation differently compared to the other three situations?

A. an increase in the terms of trade

B. an increase in real unit labour costs

C. an increase in the household savings ratio

D. an increase in the marginal propensity to consume

Question 8Consider the following index data for a hypothetical economy.

2016 2017 2018

Underlying inflation 100 103 104

Headline inflation (CPI) 100 102 103

Terms of trade 100 99 102

Producer price index 100 102 105

Based on the information above, which of the following statements is correct?

A. The economy experienced deflation in 2018.B. The economy experienced disinflation in 2018.C. The rate of inflation has increased in each of the two years to 2018.D. Cost price increases for business have slowed over the two-year period to 2018.

Question 9The introduction of taxation reform policy, such as a reduction in the level of company tax for small businesses, is likely to:

A. increase aggregate supply and reduce inflation.

B. increase both aggregate supply and unemployment.

C. decrease both aggregate supply and unemployment.

D. decrease aggregate supply and increase economic prosperity.

Question 10In the balance of payments, receipt of a dividend by an Australian investor from a German business would be recorded as:

A. a debit in the capital account.

B. a credit in the financial account.

C. a credit in the net primary income account.

D. a debit in the balance of merchandise trade.

Question 11Negative externalities in consumption are most likely to be increased by:

A. an increase in the production of cigarettes.

B. higher levels of pollution from a paper-manufacturing facility.

C. governments providing a licence to build a new coal-fired power station.

D. excessive recycling waste created by households no longer being accepted and processed by Chinese recycling companies.

Question 12

Source: ‘Balance of payments and external position’, Chart Pack, Reserve Bank of Australia, 2 August 2018, http://www.rba.gov.au/chart-pack/balance-payments.html l

Examine the chart above. Which of the following statements is true?

A. There has been an increase in the net credits in the net primary income account over the last three years.

B. The balance of the capital and financial accounts has been in deficit over the past two years.

C. The total value of exports has exceeded the total value of imports over the last 12 months.

D. The total value of the current account deficit has fallen over the past 12 months.

Question 13In a situation where unemployment increases, which of the following is the most likely effect on the final budget outcome for 2018-19?

A. the size of the deficit would decrease

B. the size of the deficit would increase

C. the size of the surplus would increase

D. the size of the surplus would decrease

Question 14In the current economic environment, which of the following is not a weakness, limiting the effectiveness of monetary policy?

A. impact lag

B. political bias

C. higher levels of consumer debt

D. financial institutions not passing on the full amount of any change in the cash rate by the Reserve Bank of Australia

Question 15Which one of the following aggregate supply policies is least likely to be implemented when the economy is facing high levels of capacity constraints?

A. decreased skilled immigration

B. higher levels of education funding

C. a reduction in the company tax rate

D. increased spending on infrastructure

SECTION B: WRITTEN RESPONSES

Instructions for Section BAnswer all questions in pen in the spaces provided.

Question 1 (12 marks)

Read the following extract from an article and answer the questions that follow.

‘Solar power is continuing to surge ahead as the world's emerging energy technology, according to a United Nations report that found global spending on solar was higher than any other energy source in 2017 … Australia's own spending on solar skyrocketed with a significant boost in investment from South Australia. According to Iain MacGill from UNSW, Australia has the “highest [per capita] rooftop residential solar market in the world, and by quite a big margin”.’

Source: ‘New renewable energy capacity double fossil fuel growth in record-breaking 2017: UN report’, ABC News, 6 April 2018, http://www.abc.net.au/news/science/2018-04-06/solar-power-most-backed-fuel-technology/9612976

a. Explain one factor that might influence the price elasticity of demand for electricity.2 marks

b. Draw a fully labelled demand curve for electricity, which reflects the likely price elasticity of demand for electricity. 1 mark

c. Predict how a decrease in the price of electricity from renewable sources (as a substitute for coal-powered electricity) is likely to impact on the market for coal-powered electricity. Include in your answer an explanation of how the market for coal-powered electricity will return to equilibrium. 3 marks

d. Explain how the use of coal-powered electricity (or another product you have studied) creates negative externalities and how this might impact on allocative efficiency. 3 marks

e. Describe one way in which the government might intervene in the market for coal-powered electricity and explain how such an intervention might lead to government failure. 3 marks

Question 2 (15 marks)

a. Define the term ‘underemployment’ and illustrate your definition with an example. 2 marks

b. Analyse the likely impact of a decrease in the unemployment rate on the participation rate. 2 marks

c. Explain how one economic factor has influenced the rate of unemployment over the past two years. 3 marks

d. Assess the extent to which budgetary policy has influenced the goal of full employment since early 2017. 4 marks

e. Evaluate the strengths and weaknesses of using budgetary policy to reduce the level of unemployment. 4 marks

Question 3 (13 marks)

a. Distinguish between the current account and the capital and financial accounts of the balance of payments. 2 marks

b. Explain two structural factors contributing to Australia’s current account deficit. 4 marks

c. Explain how an increase in the level of the Australian dollar, relative to the United States dollar, is likely to impact on the balance of payments. 3 marks

d. Compare the effect of a decrease in tariffs on the goal of strong and sustainable economic growth in the short-term and the long-term. 4 marks

Question 4 (25 marks)

Read the following extract from an article and answer the questions that follow.

‘Tax cuts for Australia’s biggest corporations are “the most important tax cuts of them all”, according to the Finance Minister, Matthias Cormann. “It’s [tax cuts for the biggest corporations] an incredibly important measure for our future economic prosperity and for future opportunities for families to get ahead. I put my hand up to be part of a government because I want to do the right thing by Australia and by our long-term future.”’

Source: ‘Cormann says corporate tax cuts the most important of all ahead of budget’, The Guardian, 4 May 2018, https://www.theguardian.com/australia-news/2018/may/04/cormann-says-corporate-tax-cuts-the-most-important-of-all-ahead-of-budget

a. Outline the roles of automatic and discretionary budgetary stabilisers. 2 marks

b. Outline the short-term impact on the federal Budget outcome of a decrease in the company (corporate) tax rate from 30% to 25%. 2 marks

c. The federal government is planning to reduce the company (corporate) tax rate to 25% over a seven-year period.

Explain how this proposed change to the tax rate could improve productivity and economic growth. 3 marks

d. Outline one strength and one weakness of using company (corporate) tax cuts to influence aggregate supply and economic growth. 4 marks

e. Explain two aggregate supply policies, other than company (corporate) tax cuts, which could be implemented to help achieve any two of the Australian Government’s domestic macroeconomic goals. 6 marks

f. Describe how two transmission mechanisms of monetary policy could operate to support the goal of strong and sustainable economic growth. 4 marks

g. Evaluate the extent to which the current monetary policy stance has been able to support the achievement of the Australian Government’s goal of low inflation since 2017. 4 marks

END OF QUESTION AND ANSWER BOOK

Extra space for responsesClearly number all responses in this space.

Economics Units 3 and 4 practice exam 2018ANSWER SHEET FOR SECTION A

Student name: ____________________________________

Use a pencil for ALL entries. For each question, shade the box that indicates your answer. All answers must be completed like the example below.

1 A B C D

Marks will NOT be deducted for incorrect answers.

NO MARK will be given if more than ONE answer is completed for any question.

If you make a mistake, ERASE the incorrect answer—DO NOT cross it out.

ONE ANSWER PER LINE

1. A B C D

2. A B C D

3. A B C D

4. A B C D

5. A B C D

6. A B C D

7. A B C D

8. A B C D

9. A B C D

10. A B C D

11. A B C D

12. A B C D

13. A B C D

14. A B C D

15. A B C D

Suggested answers

SECTION A: MULTIPLE-CHOICE QUESTIONS

Question Answer Question Answer1 B 9 A2 A 10 C3 C 11 D4 D 12 C5 D 13 B6 D 14 B7 C 15 A8 B

SECTION B: WRITTEN RESPONSESQuestion 1 (12 marks)

a. Explain one factor that might influence the price elasticity of demand for electricity.2 marks

Note: The following answer is one of a number of possible answers to this question.

The price elasticity of demand (PED) measures the responsiveness of changes in the quantity demanded to changes in price. If a small percentage change in price results in a proportionally larger change in the quantity demanded, the good or service will have a higher PED. One factor that influences the PED is the degree of necessity of a good or service. A good or service that has a high degree of necessity will tend to have a low PED. This is because when prices rise, consumers will tend to continue to purchase that good or service as it is a need. Any change in price will result in a proportionally smaller change in quantity demanded and the demand for that good or service will be price inelastic.

Marking guide:

1 mark for identifying one factor that influences the price elasticity of demand for electricity

1 mark for showing the link between the factor and the price elasticity of demand

b. Draw a fully labelled demand curve for electricity, which reflects the likely price elasticity of demand for electricity. 1 mark

Marking guide:

1 mark for drawing a fully labelled demand curve that is required to be relatively steep

c. Predict how a decrease in the price of electricity from renewable sources (as a substitute for coal-powered electricity) is likely to impact on the market for coal-powered electricity. Include in your answer an explanation of how the market for coal-powered electricity will return to equilibrium. 3 marks

Because renewably-sourced electricity and coal-powered electricity are substitute products, changes in one market will impact on the other. A decrease in the price for electricity from renewable sources will lead to an increase in demand for such electricity and result in a decrease in demand for coal-powered electricity, as consumers substitute out of coal power (relatively more expensive) and into renewable power (relatively cheaper). This will result in a shift of the demand curve to the left in the market for coal-powered electricity. At the original price, there will be a surplus of coal-powered electricity and as a result the price for coal-powered electricity will fall. This will lead to an expansion along the demand curve and contraction along the supply curve until a new equilibrium is found at a lower price and lower quantity for coal-powered electricity.

Marking guide:

1 mark for predicting how a decrease in the price for electricity from renewable sources is likely to impact on the market for coal-powered electricity

1 mark for explaining how the market for coal-powered electricity changes

1 mark for explaining how the coal-powered electricity market returns to equilibrium

d. Explain how the use of coal-powered electricity (or another product you have studied) creates negative externalities and how this might impact on allocative efficiency.

3 marks

Negative externalities occur when an entity is engaged in a transaction that imposes a cost on a third party who is not involved in the transaction. The production of coal-powered electricity results in the emission of pollution due to the use of fossil fuels being burnt in order to produce the electricity. This will have a negative impact on society as it will reduce air and water quality, and contribute to global warming. Overall, it results in a decrease in non-material living standards of society, including those people who are not party to the transaction, meaning they do not produce or use the electricity. As the users and producers of coal-powered are not required to pay for the additional cost to society, it results in an over allocation of resources to coal-powered electricity. This will lead to a less efficient allocation of resources where living standards are not being maximised.

P

Q

D

Marking guide:

1 mark for stating the key characteristics of negative externalities

1 mark for explaining how the use of coal-powered electricity (or another product the student has studied) leads to negative externalities

1 mark for explaining how negative externalities result in a less efficient allocation of resources

e. Describe one way in which the government might intervene in the market for coal-powered electricity and explain how such an intervention might lead to government failure. 3 marks

Note: The following answer is one of a number of possible answers to this question.

The government might intervene in the market for coal-powered electricity in order to reduce negative externalities by providing subsidies for the installation of solar panels. These subsidies could be provided to both consumers and producers. The provision of the subsidy will reduce the total cost of installing the solar panels and increase the incentive for their installation. This will increase the generation of renewable energy and reduce the demand for coal-powered electricity, therefore reducing the level of negative externalities generated by coal-powered electricity. However, the subsidies that are being provided might in fact result in an inefficient allocation of resources if those receiving the subsidy were planning or intending on installing solar panels, regardless of the subsidy. In this way, scarce government funds are being allocated to an industry that did not require the funding, and therefore does not minimise opportunity cost and leads to government failure and a less efficient allocation of resources.

Marking guide:

1 mark for identifying an example of a government intervention

1 mark for providing a detailed description of the intervention and reasons why it was required

1 mark for stating how government intervention might lead to government failure

Question 2 (15 marks)

a. Define the term ‘underemployment’ and illustrate your definition with an example.2 marks

Note: The following answer is one of a number of possible answers to this question.

Underemployment is when an individual is classified as officially employed; however, they are partially unemployed in that they wish to work more hours than they are currently doing. This can occur, for example, if a part-time barista, working shiftwork for 25 hours per week, wishes to work an extra 10 hours per week. The person is not employed for those additional 10 hours, although this will not add to the official unemployment rate as they do not meet the required classification of being officially ‘unemployed’.

Marking guide:

1 mark for providing the meaning of underemployment

1 mark for providing a relevant example

b. Analyse the likely impact of a decrease in the unemployment rate on the participation rate. 2 marks

There is generally a negative correlation between the unemployment rate and the participation rate. When the unemployment rate decreases, it is likely to result in an increase in the participation rate. As the unemployment rate falls, those job seekers who may have previously given up looking for work (discouraged unemployed), might have a greater incentive to once again more actively seek employment. As soon as these individuals start actively seeking employment they become part of the labour force and therefore increase the participation rate, which is calculated as the size of the labour force divided by the size of the population over 15 years.

Marking guide:

1 mark for explaining the relationship between unemployment and the participation rate

1 mark for analysing how a decrease in the unemployment rate will impact on the participation rate

c. Explain how one economic factor has influenced the rate of unemployment over the past two years. 3 marks

Note: The following answer is one of a number of possible answers to this question.

Higher rates of growth in our overseas trading partners have had a positive impact on the rate of unemployment in Australia over the past two years. China has continued to grow at positive rates and the United States has seen their growth rate increase above trend. Higher growth rates in our trading partners leads to an increase in the demand for global commodities, such as coal and iron ore. These higher prices for commodities have led to an increase in Australia’s terms of trade, resulting in a higher value of exports and an increase in aggregate demand. The higher level of aggregate demand will lead to producers increasing production in order to meet the higher demand. To do this they require greater resources, including labour, resulting in an increase in the derived demand for labour and a reduction the unemployment rate. This has occurred in Australia, as the rate of unemployment has fallen to 5.4% (May 2018) over the past two years.

Marking guide:

1 mark for identifying one economic factor that has influenced the unemployment rate

2 marks for explaining how this factor has led to a decrease in the unemployment rate

d. Assess the extent to which budgetary policy has influenced the goal of full employment since early 2017. 4 marks

The government’s goal of full employment is the lowest sustainable rate of unemployment without resulting in inflationary and external pressures. It can be measured by the ‘NAIRU’—the non-accelerating inflation rate of unemployment—often known as the natural rate of unemployment and is suggested to be an unemployment rate of around 5%.

Budgetary policy has been used over the past two years to reduce the rate of unemployment through the implementation of a significant level of spending on infrastructure. In the federal Budget of 2017–18, the government set aside $75 billion for new infrastructure spending over the next 10 years. As part of this money has been spent, and the infrastructure built, it has created new jobs in the building phase.

In addition, the 2017–18 Budget also implemented the $1.5 billion Skilling Australians Fund, which was seeking to increase the skills and training for Australians, including funding for new apprenticeship positions. Providing individuals with new skills required in the workforce, will enable these people to become more employable and allow them to obtain employment in new areas required by business as the economy changes.

Both these and other measures provided for as part of budgetary policy have assisted in reducing the level of unemployment to 5.4% (May 2018), and moving closer to achieving the goal of full employment. However, the goal has not yet been achieved as the commonly accepted measure of achieving full employment is a rate of unemployment at approximately 5%. Therefore, budgetary policy has been partially successful in achieving the goal of full employment.

Marking guide:

1 mark for defining the goal of full employment

1 mark for explaining a budgetary policy that has been implemented to reduce unemployment (x two = 2 marks)

1 mark for assessing the extent to which budgetary policy has assisted in reducing the unemployment rate

e. Evaluate the strengths and weaknesses of using budgetary policy to reduce the level of unemployment. 4 marks

Budgetary policy has both strengths and weaknesses when being used to reduce unemployment. Budgetary policy can be targeted to specific areas of the economy that require assistance. If there is a prevalence of youth unemployment, the government is able to implement specific policies designed to increase skills and training for young people in order to make them more employable and reduce the incidence of this type of unemployment. However, a weakness of budgetary policy is that there is often implementation lags associated with these policies. For example, it can take a significant amount of time for policies to pass through both houses of parliament in order to be able to be implemented. For example, a policy designed to reduce unemployment in a particular state might not be passed by parliament for some time and lead to a reduction in the effectiveness of the policy, in terms of being able to reduce the level of unemployment.

A further strength of using budgetary policy to reduce unemployment is the operation of the automatic stabilisers of the budget. Automatic stabilisers will result in welfare payments increasing in times of weak economic growth and higher unemployment, while at the same time personal taxation collections will fall. These measures lead to increased injections by the government and reduced leakages, increased G1 (government consumption expenditure), smoothing out the business cycle and increasing aggregate demand, which in turn will lead to more employment (or less of a fall in employment) compared to a situation where the automatic stabilisers were not operating.

A further weakness of budgetary policy in effectively targeting unemployment is the political bias it often faces. Policies might be implemented that suit a particular political party in certain electorates in order to garner votes. This might not be the best policy to target unemployment and might lead to inefficiencies in how resources are allocated to reduce unemployment.

Marking guide:

1 mark for identifying and evaluating a strength (x two = 2 marks)

1 mark for identifying and evaluating a weakness (x two = 2 marks)

Question 3 (13 marks)

a. Distinguish between the current account and the capital and financial accounts of the balance of payments. 2 marks

The current account is a record of all international transactions of a current nature. It is made up of the balance of merchandise trade (net goods), net services, net primary income and net secondary income. The capital and financial accounts are two subaccounts that make up the other side of the balance of payments. The capital account is a record of capital transfers and the transfer of non-financial assets. The financial account records how Australia finances the current account. It records the inflows and outflows of debt and equity that relate to Australia’s net foreign liabilities. If a current account deficit occurs, it follows that there will be a capital and financial account surplus.

Marking guide:

1 mark for defining the current account

1 mark for defining the capital and financial accounts with reference to a key difference between the two sides of the balance of payments

b. Explain two structural factors contributing to Australia’s current account deficit.4 marks

Note: The following answer is one of a number of possible answers to this question.

A current account deficit (CAD) occurs when Australia pays more to foreigners (debits) than it receives from foreigners (credits) of a current nature. Structural factors contributing to Australia’s CAD refer to those factors that are persistent features of our economy and which do not fluctuate with the business cycle.

One structural reason for the CAD is Australia’s lack of international competitiveness. In many areas of our economy, Australia experiences a higher cost structure than other countries due to lower efficiency rates and relatively high wages in comparison to our trading partners. This low level of international competitiveness can lead to an increase in imports and lower relative levels of exports in both the balance of merchandise trade and net services, and therefore a persistent (structural) CAD.

A second structural reason for our CAD is that Australia experiences a savings/investment imbalance. Due to the relatively small size of our population and the continued requirement for capital investment in order to grow our economy, Australia must rely on foreign investment in order to fund these investment projects. The higher level of foreign investment will result in an increase in the net primary income component of the CAD leading to a structural CAD.

Marking guide:

1 mark for identifying a structural reason for the CAD (x two = 2 marks)

1 mark for showing how the structural reason contributes to the CAD (x two = 2 marks)

c. Explain how an increase in the level of the Australian dollar, relative to the United States dollar, is likely to impact on the balance of payments. 3 marks

An increase in the value of the Australian dollar (AUD) will lead to exports becoming more expensive for international consumers to purchase as they will require more United States dollars (USD) in order to purchase the same volume of goods and services. In addition, the higher AUD will mean that it is cheaper for Australian consumers to purchase goods and services from the United States as we will need less AUD to purchase the same volume of goods and services. This will lead to a decrease in exports and an increase in imports, and therefore a decrease in net exports. This will have an impact on the current account deficit (CAD) as lower export value will decrease credits in the balance of merchandise trade and net services, and higher imports will increase the debits in both these accounts, leading to an increase in the CAD. Higher levels of the CAD will be required to be funded by debt or equity (increased credits) in the capital and financial accounts and will result in a capital and financial account surplus. (The capital and financial accounts surplus will offset the CAD, such that the balance of payments will equal zero.)

Note: The final sentence, in brackets, is not required for full marks.

Marking guide:

1 mark for explaining the impact that a higher AUD will have on exports and imports

1 mark for explaining how the change in exports and imports will affect the CAD

1 mark for explaining how the higher CAD will impact on the balance of payments

d. Compare the effect of a decrease in tariffs on the goal of strong and sustainable economic growth in the short-term and the long-term. 4 marks

Tariffs are a form of protectionism in that they are a tax on imported goods and services, which make local goods and services more competitive. In the short-term the likely effect of a decrease in tariffs will be negative for the goal of strong and sustainable economic growth (SSEG), which is the highest level of growth consistent with full employment without causing inflationary, external or environmental pressures. Lower tariffs will decrease import taxes and make imports more competitive with locally produced goods and services. This will increase the demand for imports and also lead to imports replacing domestic goods and services. As a result, consumption will fall while imports rise and aggregate demand (AD) will decrease. Producers will respond by decreasing production to accommodate the lower AD and economic growth will fall, making it less likely that the goal of SSEG is achieved.

On the other hand, in the long-term, the effects of a decrease in tariffs should be positive for the goal of SSEG. As tariffs are reduced and domestic producers are exposed to an increase in competition, those businesses will be forced to increase technical efficiency in order to compete. This can be achieved by greater investment in infrastructure, research and development and capital. Those companies that are unable to adapt in order to compete will be forced out of business and their resources will be reallocated to areas of comparative advantage, improving allocative efficiency. Both the increased technical efficiency and the shifting of resources to areas of comparative advantage will result in higher levels of international competitiveness and in turn lead to increased domestic consumption, lower imports and increased exports, and therefore an increase in AD. Producers will respond by increasing production and this will result in higher economic growth.

Therefore, the potential long-term effects on SSEG of a decrease in tariffs will counter the negative short-term effects.

Marking guide:

2 marks for explaining the impact of a decrease in tariffs on the goal of SSEG in the short-term

2 marks for showing the difference in the impact on the goal of SSEG of a decrease in tariffs in the long-term and the short-term

Question 4 (25 marks)

a. Outline the roles of automatic and discretionary budgetary stabilisers. 2 marks

Automatic stabilisers (cyclical components of the budget) are inbuilt features to the budget that affect the level of revenue collection and expenditure automatically, in line with changes to the business cycle. As the economy expands, more individuals will find employment and pay personal income tax. The effects of these changes is that the government will be paying less welfare and receiving more tax receipts and this will result in a counter-cyclical impact on the economy and a slowing down of an unsustainable level of economic growth.

Discretionary stabilisers (structural components of the budget) are polices that are deliberate decisions by the government to change receipts or payments in an effort to influence the level of economic activity. In times of strong economic growth, where the government is seeking to slow growth from unsustainable levels, it might implement polices such as an increase in personal tax rates or cuts to government spending.

Marking guide:

1 mark for outlining the role of automatic stabilisers

1 mark for outlining the role of discretionary stabilisers

b. Outline the short-term impact on the federal Budget outcome of a decrease in the company (corporate) tax rate from 30% to 25%. 2 marks

A decrease in company (corporate) taxes will result in a decrease in the level of taxes that businesses will be required to pay to the government and will lead to a reduction in government receipts (revenue). Lower levels of receipts will result in an increase in the federal Budget deficit (or a reduction in the budget surplus).

Marking guide:

1 mark for outlining how a decrease in company (corporate) taxes will impact on government receipts

1 mark for outlining how the lower receipts will impact on the federal Budget outcome

c. The federal government is planning to reduce the company (corporate) tax rate to 25% over a seven-year period.

Explain how this proposed change to the tax rate could improve productivity and economic growth. 3 marks

The proposed change to company (corporate) tax of reducing the rate to 25% over a period of seven years will be a positive influence on both productivity and economic growth. A reduction in the rate of company tax will increase the after-tax return of businesses. This will increase their ability to reinvest into their businesses and should result in an increase in capital investment in Australia. Higher levels of capital investment should result in an increase in productivity, as the capital is used to increase outputs for every given unit of inputs. Higher productivity will increase productive capacity and therefore aggregate supply. Higher aggregate supply will lead to businesses being more willing and able to supply, increasing production and resulting in an increase in economic growth.

Marking guide:

1 mark for explaining how lower company taxes could support increased investment

1 mark for explaining how increased investment can lead to increased efficiency

1 mark for explaining how increased efficiency can increase economic growth

d. Outline one strength and one weakness of using company (corporate) tax cuts to influence aggregate supply and economic growth. 4 marks

One strength of using tax cuts to influence aggregate supply and economic growth is that they can be used to target small businesses, therefore enabling the policy to be more focussed in stimulating domestic economic growth. By targeting small businesses for the first round of corporate tax cuts, these are likely to be those that are owned and operated in Australia and the tax-cut benefits will go to Australian businesses. Investment undertaken by these businesses will enable aggregate supply to increase, as small businesses will be more willing and able to produce, leading to higher production and an increase in economic growth

One weakness of using company tax cuts to influence aggregate supply and economic growth is that businesses might not use the tax cut to reinvest into their businesses and might use the increased after-tax profits to return funds to shareholders instead of increasing wages or creating new jobs and increasing productivity. The effectiveness of using company tax cuts might be compromised by many businesses being owned by overseas entities, with the benefit of the tax cuts going back to overseas owners instead of being reinvested back into the Australia economy. If this is the case, and there is not an increased level of investment, the tax cuts might not lead to any change in aggregate supply, and economic growth will not be affected by the company tax cut.

Marking guide:

2 marks for outlining one strength of using company tax cuts to influence aggregate supply and economic growth

2 marks for outlining one weakness of using company tax cuts to influence aggregate supply and economic growth

e. Explain two aggregate supply policies (other than company tax cuts), which could be implemented to help achieve any two of the Australian Government’s domestic macroeconomic goals. 6 marks

Note: The following answer focuses on the domestic macroeconomic goals of full employment and strong and sustainable economic growth. The other possible goal is low inflation.

The government’s immigration policy is an aggregate supply policy that can be implemented in order to help achieve the goal of strong and sustainable economic growth. Australia’s skilled immigration policy annually accepts approximately 130 000 migrants that meet the Australian Government’s list of eligible skilled occupations. An increase in skilled immigration will assist economic growth as it will allow businesses to hire trained employees and increase technical efficiency. Average business costs of production will fall as there will be lower training costs and productivity will have risen, leading to an increase in aggregate supply. Businesses will be more willing and able to supply, increasing production and economic growth. This will enable the economy to move closer to achieving the goal of strong and sustainable economic growth (the highest level of economic growth, creating employment, without having a negative impact on inflation, the environment or the external market).

An aggregate supply policy that can be implemented in order to achieve the goal of full employment is investment by the government in infrastructure. In the 2018–19 federal Budget, the government has budgeted for $75 billion in infrastructure spending over 10 years, including $5 billion for the Melbourne Airport rail link. An increase in infrastructure spending will allow businesses to increase the speed of deliveries, reduce time on the road, reduce cost of production and increase technical efficiency. This will increase productive capacity and aggregate supply as businesses will become more willing and able to produce. In order to increase production they will require more resources, including labour, increasing the derived demand for labour and reducing the unemployment rate. This will enable the economy to move closer to the goal of full employment, which is the lowest level of unemployment without having a negative impact on inflation or the external market.

Marking guide:

1 mark for identifying and providing detail of an aggregate supply policy (x two =2 marks)

2 marks for explaining how a policy will assist in achieving a specific domestic macroeconomic goal (x two = 4 marks)

f. Describe how two transmission mechanisms of monetary policy could operate to support the goal of strong and sustainable economic growth. 4 marks

Note: The following answer focuses on the transmission mechanisms of cash flow and savings and investment. The other possible mechanisms listed in the study design include exchange rate movements, asset prices and availability of credit.

One monetary policy transmission mechanism channel that might influence strong and sustainable economic growth is the cash-flow channel. Via the cash-flow channel, a decrease in interest rates will increase the discretionary incomes of those who currently have variable rate loans; both consumers and businesses. This will increase the level of consumption and investment, stimulating aggregate demand, increasing production levels and increasing economic growth to more sustainable levels. This has occurred since 2016, when the Reserve Bank of Australia (RBA) decreased rates from 1.75% to 1.5% in order to increase growth to more sustainable levels over the longer term. Gross Domestic Product (GDP) growth is currently at 3.1% according to the most recent data—the 2018 March quarter.

The savings and investment channel is a second channel by which monetary policy can support the goal of strong and sustainable economic growth. When the RBA lowers the official cash rate, it is then passed onto retail interest rates. Lower retail rates reduce the incentive for consumers to save and increase the incentive for businesses to borrow and invest. Both these effects will increase consumption and investment, leading to higher aggregate demand. Suppliers will react to the higher aggregate demand and will allocate more resources to production, increasing economic growth and improving the ability of the economy to achieve strong and sustainable economic growth.

Marking guide:

2 marks for providing the key characteristics of a transmission mechanism and showing how it is linked to achieving the goal of strong and sustainable economic growth (x two =2 marks)

g. Evaluate the extent to which the current monetary policy stance has been able to support the achievement of the Australian Government’s goal of low inflation since 2017. 4 marks

The current stance of monetary policy is expansionary. The RBA has set the cash rate at 1.5%, which is below the neutral rate of approximately 3–3.5%, as it seeks to maintain inflation between 2–3% on average, over time. Expansionary monetary policy, via the transmission mechanism, increases the money supply and assists in increasing economic growth and stimulating inflation. Expansionary monetary policy has enabled the level of the Consumer Price Index (CPI) since 2017, to increase from the low of 1.5% up to its current rate of 1.9%. Low interest rates have provided consumers with increased discretionary income, lowered cost of production for business, and assisted in keeping the Australian dollar lower, which increases net exports via the exchange rate channel. All of these factors have helped contribute to moving the CPI closer to the low inflation goal target of 2–3% inflation.

However, due to the high level of indebtedness of Australian individuals, the current low interest rates have been less effective in stimulating inflation. As individuals already have high levels of debt, the low level of interest rates has been less effective in encouraging consumers to take out new loans in order to increase spending. As a result, inflation has not been as responsive to the lower interest rates as it had in the past, and over the last two years inflation has remained below the target goal range of 2–3% on average, over time.

Marking guide:

1 mark for identifying the current stance of monetary policy

1 mark for explaining the impact this stance has on the economy

1 mark for providing a reason why monetary policy has been able to assist in stimulating inflation

1 mark for providing a reason why monetary policy has not been able to assist in stimulating inflation

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Disclaimer: This resource has been written by the author (Chris Williams) for use with students of VCE Economics. This does not imply that it has been endorsed by the Victorian Curriculum and Assessment Authority (VCAA). The current VCE Economics Study Design (2017–2021) can be accessed directly via the VCAA website. VCE is a registered trademark of VCAA. While every care is taken, we accept no responsibility for the accuracy of information or advice contained in Compak. Teachers are advised to preview and evaluate all Compak classroom resources before using them or distributing them to students.