Unit 4 IA3 Rev

Question 1

How does demand-pull inflation differ from cost-push inflation in the AD/AS model?

Answer 1

Demand-pull is caused by a rightward shift in AD; cost-push results from a leftward shift in AS due to rising input costs.

Question 2

What is stagflation and how would it appear on the AD/AS model?

Answer 2

Stagflation is simultaneous high inflation and unemployment, represented by a leftward shift of SRAS reducing output but raising prices.

Question 3

What is a wage-price spiral and under what conditions might it emerge?

Answer 3

It occurs when rising wages push up costs, leading to higher prices, triggering further wage demands — likely in tight labour markets.

Question 4

Why might expansionary fiscal policy fail to shift AD significantly during a trough?

Answer 4

Because of low consumer confidence, high household debt, and a low marginal propensity to consume.

Question 5

Why would AS-focused policies be preferable to AD stimulus in an inflationary environment?

Answer 5

Because they increase output without adding to inflationary pressure — e.g. productivity, tax reform, deregulation. (More injections, than leakages)

Question 6

What are the risks of using demand-side policies to solve supply-side problems?

Answer 6

They can exacerbate inflation without fixing bottlenecks, particularly when structural unemployment or input shortages are the cause.

Question 7

How can supply-side improvements flatten the SRAS curve?

Answer 7

They make output more responsive to price changes, reducing inflationary pressure as AD expands.

Question 8

What is the NAIRU and how does it relate to inflation targeting?

Answer 8

The Non-Accelerating Inflation Rate of Unemployment is the lowest unemployment that doesn’t trigger rising inflation.

Question 9

Why is inflation with low wage growth especially harmful to real incomes?

Answer 9

Because purchasing power erodes, leading to a decline in living standards despite nominal wage increases.

Question 10

What role do inflation expectations play in shifting the short-run Phillips Curve?

Answer 10

If expectations rise, the curve shifts right — inflation becomes embedded even at higher unemployment levels.

Question 11

What are inside and outside lags in monetary policy?

Answer 11

Inside lag: time to recognise and decide; Outside lag: time for policy to affect spending and prices.

Question 12

Why are monetary policy lags problematic during rapid economic shocks?

Answer 12

Because decisions take effect after the shock may have passed, risking overcorrection or delayed impact.

Question 13

Why can monetary policy be considered regressive?

Answer 13

It disproportionately impacts lower-income households with high debt and little financial buffer.

Question 14

What is policy crowding out and when does it occur?

Answer 14

When government spending increases demand for credit, raising interest rates and reducing private investment.

Question 15

Why might interest rate increases fail to reduce inflation in 2024–25 conditions?

Answer 15

Because cost-driven inflation (mortgages, energy) isn’t sensitive to demand, making rate hikes ineffective.

Question 16

How can policy targeting price stability worsen equity outcomes?

Answer 16

It may reduce inflation but increase unemployment or lower disposable incomes for vulnerable groups.

Question 17

What is hysteresis in unemployment and why does it matter?

Answer 17

It refers to long-term unemployment becoming structural, as skills decay and re-employment becomes harder.

Question 18

Why does bracket creep affect real disposable income despite rising nominal wages?

Answer 18

Because as wages rise into higher tax brackets, the average tax rate increases, reducing real take-home pay.

Question 19

How do automatic stabilisers work during a downturn?

Answer 19

They increase government spending (e.g. JobSeeker, welfare) and reduce tax revenue without new legislation.

Question 20

What are the limitations of using GDP as a measure of living standards?

Answer 20

It excludes distributional impacts, household debt, environmental degradation, and non-market activity.

Question 21

How can a skills shortage impact both AS and the PPC?

Answer 21

It limits productive capacity, pushing the economy inside the PPC and constraining output growth.

Question 22

How would a decline in productivity shift the AS curve?

Answer 22

Leftward, reducing output and increasing price levels (stagflation risk).

Question 23

Why is a per capita recession more concerning than headline GDP stagnation?

Answer 23

Because it means that the average individual is becoming poorer, even if total output rises slightly.

Question 24

What is the economic rationale for skilled migration in addressing labour market gaps?

Answer 24

It expands the labour force, raises potential output, and reduces bottlenecks in high-demand sectors.

Question 25

What is the danger of relying on migration rather than training to fill labour shortages?

Answer 25

It may lead to dependency, underinvestment in local skills, and increased competition for housing.

Question 26

What are structural reforms and why are they difficult to implement?

Answer 26

They change the economy’s underlying institutions (e.g. tax, labour, education), often facing political resistance and long lags.

Question 27

How can tax reform improve both productivity and equity?

Answer 27

By removing inefficient distortions, broadening the base, and reducing bracket creep for middle incomes.

Question 28

What is the difference between fiscal sustainability and expansion?

Answer 28

Sustainability means maintaining debt levels and deficits over the long term; expansion refers to current increases in Government spending or reducing tax (growing the economic sector)

Question 29

Why might infrastructure investment have a larger multiplier than household transfers?

Answer 29

Because it leads to long-term productivity gains and less leakage through imports or saving.

Question 30

How does business confidence interact with investment and AD?

Answer 30

Confidence drives investment decisions, which shift AD and affect long-run AS.

Question 31

What are the five economic objectives of government policy in Australia?

Answer 31

Price stability, sustainable economic growth, full employment, equity in income distribution, external stability.

Question 32

Why is achieving all five objectives simultaneously difficult?

Answer 32

Because of trade-offs — e.g. reducing inflation may increase unemployment, growth may hurt sustainability.

Question 33

How does inflation targeting conflict with full employment?

Answer 33

High interest rates used to reduce inflation can reduce AD and raise unemployment.

Question 34

Why is housing affordability a supply-side, not just a demand-side issue?

Answer 34

Because insufficient housing stock and zoning laws restrict supply, regardless of monetary policy.

Question 35

How can full employment be achieved without triggering inflation?

Answer 35

Through supply-side policies that increase productive capacity and improve labour mobility.

Question 36

What are distributional consequences of inflation?

Answer 36

It disproportionately affects those on fixed incomes, low wages, and with little financial flexibility.

Question 37

What is meant by equitable income distribution in economic terms?

Answer 37

Fairness in access to income and opportunity, not equal income — often assessed by Gini coefficient.

Question 38

How can environmental sustainability be incorporated into economic policy evaluation?

Answer 38

By assessing long-run impacts of growth and integrating green investment into fiscal planning.

Question 39

How does consumer confidence act as a transmission mechanism in monetary policy?

Answer 39

Higher rates reduce confidence and expected future income, leading to lower consumption now.

Question 40

Why is low productivity growth a long-term risk to living standards?

Answer 40

Because it limits real wage growth, tax revenue, and the capacity to fund public services.