ECON1002 Introductory Macroeconomics
Introductory Macroeconomics
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ECON1002 Introductory Macroeconomics
Tutorial Tasks
1
Reading Guide: Review Week 8 Lecture 7 and Textbook Chapters 11 and 12 to prepare
for this tutorial.
Key Concepts: Policy Reaction Function; the Taylor Rule; Aggregate demand-
aggregate supply diagram; Sources of inflation, Disinflation, Inflation targeting.
REVIEW OF CONCEPTUAL UNDERSTANDING
1. What do you understand by the policy reaction function?
2. How has the way monetary policy is conducted in Australia evolved since
1990? Why?
3. Why did policy mistakes occur in the 1970s? What were the consequences?
4. What do you understand by the concept of disinflation? How does a policy of
disinflation affect the economy in the short run, and in the medium or long
run?
5. Can the AD-AS model be used to analyse the short-run and long-run effects
of fiscal and monetary policy?
6. What do you understand by inflation targeting? How does it help conduct of
monetary policy?
PROBLEMS
PROBLEMS WITH AN ASTERISK (1 AND 2) ARE FOR STUDENT PRESENTATIONS.
TUTORIAL 8
(Week beginning Oct 2)
ECON1002 Introductory Macroeconomics, Semester 2 2023
Tutorial Tasks
2
*2. This problem asks you to trace out the adjustment of inflation when the economy
starts with an output gap. Suppose that the economy’s aggregate demand curve
is:
where y is short-run equilibrium output and π is the inflation rate, measured as
a decimal. Potential output, y*, equals 950 and the initial inflation rate is 10
per cent (π = 0.10).
(a) Find output and inflation for this economy in short-run equilibrium and in
long-run equilibrium.
(b) Suppose that, each quarter, inflation adjusts according to the following rule:
This quarter’s inflation = last quarter’s inflation minus 0.0004 (y* – y).
Starting from the initial value of 10 per cent for inflation, find the value of
inflation for each of the next five quarters. Does inflation come close to its
long-run value?
3. For each of following, use an AD–AS diagram to show the short-run and long-
run effects on output and inflation. Assume the economy starts in long-run
equilibrium.
(a) An increase in consumer confidence that leads to higher consumption
spending
(b) A reduction in taxes
(c) An easing of monetary policy by the Reserve Bank (a downward shift in the
policy reaction function)
(d) A sharp drop in oil prices
(e) A war that raises government purchases
4. Planned aggregate expenditure in Lotusland depends on real GDP and the real
interest rate according to the following equation:
The Bank of Lotusland, the central bank, has announced that it will set the real
interest rate according to the following policy reaction function:
Rate of Inflation, π Real Interest Rate, r
0.0 0.02
0.01 0.03
0.02 0.04
0.03 0.05
0.04 0.06
ECON1002 Introductory Macroeconomics, Semester 2 2023
Tutorial Tasks
3
For the rates of inflation given, find exogenous expenditure and short-run
equilibrium output in Lotusland. Graph the AD curve.
5. Suppose that a permanent increase in oil prices creates an inflationary shock
and reduces potential output. Use an AD-AS diagram to show the effects of
the oil price increase on output and inflation in the short-run and the long-run,
assuming that there is no policy response. What happens if the Reserve Bank
responds to the oil price increase by tightening monetary policy?
6. Explain how a disinflationary macroeconomic policy (e.g. a contractionary
monetary policy) can successfully reduce the inflation rate to a permanently
lower level. Use the AD-AS model to describe the initial policy actions, a
short run equilibrium, adjustment process toward a new long run equilibrium.