Economics Analysis: Trade, GDP, Inflation, and Policy
Question 1: International Trade Analysis
(a) Opportunity Costs and Comparative Advantage
(i) Opportunity cost of producing corn:
- Nebraskia: 25 cars = 800 units of corn → Opportunity cost = 800/25 = 32 units of corn per car.
- Michigaland: 200 cars = 1000 units of corn → Opportunity cost = 1000/200 = 5 units of corn per car.
(ii) Opportunity cost of producing cars:
- Nebraskia: 25 cars = 800 units of corn → Opportunity cost = 25/800 = 1/32 cars per unit of corn.
- Michigaland: 200 cars = 1000 units of corn → Opportunity cost = 200/1000 = 0.2 cars per unit of corn.
(iii) Comparative advantage:
- Nebraskia has a lower opportunity cost for producing corn (1/32 < 0.2).
- Michigaland has a lower opportunity cost for producing cars (5 < 32).
- Trade recommendation: Nebraskia should specialize in corn production, and Michigaland should specialize in car production.
Graphical Representation:
To visualize this, you can draw a production possibilities frontier (PPF) for each country. The PPF shows the maximum output of two goods (cars and corn) that can be produced with the available resources.
(b) Free Trade Analysis
- (i) World price at $20,000 labeled on graph.
- (ii) Quantity supplied domestically at world price = Intersection of supply curve and $20,000 line.
- (iii) Quantity demanded domestically at world price = Intersection of demand curve and $20,000 line.
- (iv) Quantity imported/exported = Difference between quantity demanded and quantity supplied at $20,000.
- (v) Consumer surplus with free trade: Area above world price and below demand curve.
- (vi) Producer surplus with free trade: Area below world price and above supply curve.
Graphical Representation:
- Supply and Demand Graph: Plot supply and demand curves for the domestic market.
- World Price Line: Draw a horizontal line at $20,000.
- Consumer and Producer Surplus: Shade areas above the world price line and below the demand curve for consumer surplus, and below the world price line and above the supply curve for producer surplus.
(c) Tariff Analysis
- (i)-(vii): Graph adjustments for tariff:
- World price + tariff labeled ($210).
- New consumer surplus: Area above $210 and below demand curve.
- New producer surplus: Area below $210 and above supply curve.
- Tax revenue: Rectangle formed by tariff amount multiplied by imported quantity.
- Deadweight loss: Two triangles formed due to reduced trade volume.
Graphical Representation:
- Tariff Line: Draw a new horizontal line at $210 (world price + tariff).
- New Equilibrium: Find the new intersection of supply and demand at the tariff price.
- Tax Revenue and Deadweight Loss: Shade the rectangle for tax revenue and the two triangles for deadweight loss.
(d) Bilateral Free Trade Agreement
(i) Beneficiaries:
- Nebraskia producers benefit from increased exports to Old Yonk at higher prices.
- Old Yonk consumers benefit from lower prices compared to other imports.
(ii) Harmed groups:
- Old Yonk producers face competition from Nebraskia imports.
- Producers in other exporting countries lose market share.
(iii) Global efficiency:
Free trade agreement enhances efficiency by reducing deadweight loss caused by tariffs but may distort global trade patterns.
Graphical Representation:
- Trade Creation: Show increased trade between Nebraskia and Old Yonk.
- Trade Diversion: Illustrate reduced trade with other countries.
Question 2: Business Cycles, Inflation, Unemployment, AD-AS
(a) GDP Definition and Components
GDP Equation: GDP = C + I + G + NX
Components:
- Consumption (C): Household spending on goods/services (e.g., groceries).
- Investment (I): Spending on capital goods (e.g., machinery).
- Government spending (G): Public sector expenditure (e.g., infrastructure projects).
- Net Exports (NX): Exports minus imports.
(b) Inflation Impacts
(i) Beneficiaries:
- Debtors benefit as loan repayments lose value.
- Owners of real assets gain as asset prices rise.
Losers:
- Savers lose as money in bank accounts loses purchasing power.
- Fixed-income earners struggle with rising costs.
(ii) Costs of inflation:
- Menu costs: Frequent price adjustments require resources.
- Contract renegotiation costs: Inflation disrupts agreements.
- Reduced savings/investment: Long-term growth suffers.
(c) Unemployment Calculation
(i) Employed population:
Labour Force Participation Rate = Labour Force / Population Age 15+
Given the unemployment rate of 4.3%, calculate the employed population as 96% × Labour Force.
(ii) Understated unemployment:
- Discouraged workers not seeking jobs are excluded.
- Underemployed individuals working fewer hours than desired are counted as employed.
(d) Downward Sloping AD Curve
Reasons:
- Wealth effect: Lower prices increase real wealth, boosting consumption.
- Interest rate effect: Lower prices reduce interest rates, encouraging investment.
Graphical Representation:
- AD Curve: Plot a downward-sloping aggregate demand curve.
- Wealth and Interest Rate Effects: Show how lower prices shift the AD curve to the right.
Question 3: Exchange Rates, Interest Rates, Money Supply
(a)-(b): Exchange Rate Scenarios
Scenario A:
Higher interest rates attract foreign investment → Increased demand for NZD → Appreciation.
Scenario B:
Increased travel to Australia → Higher demand for AUD → Depreciation of NZD.
Graphical Representation:
- Demand and Supply of NZD: Plot demand and supply curves for NZD.
- Interest Rate Increase: Show how higher interest rates shift the demand curve for NZD to the right.
- Increased Travel: Illustrate how increased travel shifts the demand curve for AUD to the right.
(c): Impact of NZD Appreciation
- (i) Imports increase; exports decrease due to higher relative prices.
- (ii) Consumption shifts towards cheaper foreign goods.
- (iii) GDP decreases due to reduced net exports.
Graphical Representation:
- Trade Balance: Show how an appreciating NZD affects imports and exports.
- GDP Impact: Illustrate the effect on GDP due to changes in net exports.
Part B: Macro Stabilization Policies
Question 4: Fiscal and Monetary Policy Analysis
(a)-(b): Light Rail System Policy Analysis
Graph shows AD shift rightward during recessionary gap recovery.
Policy type:
Expansionary fiscal policy aimed at increasing AD through government spending.
Recommendation in February 2021:
Support funding due to high unemployment and low inflation; infrastructure boosts long-term productivity.
Post-completion impact:
AD increases during construction; LRAS shifts right due to improved transportation efficiency.
Graphical Representation:
- AD-AS Model: Plot AD and AS curves with a recessionary gap.
- Expansionary Fiscal Policy: Show how government spending shifts the AD curve to the right.
- LRAS Shift: Illustrate the rightward shift of LRAS due to increased productivity.
(c): December 2023 Analysis
Recommendation against continuation due to high inflation and fiscal debt concerns.
Impact on private industry:
Deficit spending crowds out private investment; labor market tightens further due to government employment demands.
(d): Alternative Monetary Policy in February 2021
- (i)-(ii): Increase money supply through lower OCR or open market operations to stimulate AD recovery.
- (iii): Tool recommendation—Open Market Operations. RBNZ purchases financial assets, increasing liquidity and lowering interest rates.
Graphical Representation:
- Monetary Policy Tools: Illustrate how lowering the OCR or using open market operations increases the money supply.
- AD Curve Shift: Show how increased money supply shifts the AD curve to the right.
Cross-Checking and References
- Week 5 Lecture Slides: Focus on government intervention, market failure, and externalities. Useful for understanding how government policies can address inefficiencies in markets.
- Week 6 Lecture Slides: Cover international trade, which is relevant for questions involving comparative advantage and trade agreements.
- Mankiw, et al. (Chapter 10): Provides detailed explanations of externalities and how they affect market outcomes.
- Sloman et al. (Chapters 20 and 22): Offers insights into government intervention and public goods, which are crucial for understanding policy impacts.