Question

1. GDP, UNEMPLOYMENT and FISCAL POLICY [15 marks]

1. Describe the relevant criteria that government statisticians use in Australia to determine whether a person is ‘unemployed’. Describe two ways in which the current method of calculating official ‘unemployment rate’ in Australia has been criticised for underestimating unemployment.  

                                                                                                   [3 mark]        

2. Identify whether there is likely an increase or decrease in measured Australian GDP in the following scenarios and discuss whether GDP is a ‘good’ measure of progress in each case:

1. a major increase in the extraction of coal to meet electricity demands of Chinese firms;
2. a large increase in the proportion of employed people volunteering (i.e. spending quality time, unpaid) with the poor and unemployed;
3. a sharp rise in the rate of theft (e.g. break-ins) of households and businesses.

                                                                                         [6 mark]

3. Suppose Britain’s formal departure from the European Union in 2020 results in some significant structural challenges to the British economy. The following hypothetical data show the state of the British economy from December 2020 to December 2021:

• the Consumer Price Index (CPI) falls from 110 to 100
• the underemployment rate rises from 4.7% to 10.1%
• real GDP per capita growth rate falls from 2.0% to -0.2%

Explain the phases of the business cycle the British economy is likely to be experiencing from December 2020 to December 2021. Provide specific reasons for your answer. Use a well-labelled AD/AS diagram to show the position of this economy in December 2021. Explain whether the British government should use expansionary or contractionary fiscal policy to move the economy back to the long run, full-employment GDP equilibrium. Draw the AD curve shift(s) associated with this policy on your diagram.

                                                                                                    [6 marks]

Answer 1

a) The unemployment rate is defined as the percentage of people who are that part of the labour force who are unemployed. The labour force is the sum of emloyed and unemployed people. In Australia, the Australian Bureau of Statisitics (ABS) have the responsibility of collecting labour market informantion and data. According to ABS, unemployed people are defined as all individuals over the age of 15, who were not employed during the time of reference week , had actively searched for full-time or part time work at any moment in the four week period upto the end of the reference week, were free for work in the reference week, were waiting to begin a new job within a month from the end of the ref. week and could have began in the ref week if the job had been available at that time.

However, this ABS labour force survey and criterias are no longer appropriate for the current labour market in Australia. ABS will count you as employed if you have completed at least an hour of paid work during the week prior to the survey. However, this condition does not seem right as a mere hour of paid work per week is not exactly most people's idea of employment. These people could be reffered to as being underemployed, meaning they would work for more hours, if they had the chance.

Now, if the case is that there have not been even an hour of paid work in the last week, they are asked two more questions regarding their active participation in looking for work and if they are currently available to start work. If the answers to both these questins are yes, they are considered unemployed. However, this implies that all the full-time homemakers, ill or non-working retired people who have ansered no to the above question are counted as employed which is not correct.

Also, people working two jobs, suppose 20 hours.week at a retail industry and 15 hrs/week as a cab driver, he would be classified as a full time worker as he is working a total of 35 hrs but ABS will consider only his job in the retail industry as the 'main' job and classify him as a part time worker (<35 hrs/week) . So, here the problem lies in the fact that there are two jobs being done but ABS counts only one which gives an incorrect estimate.

b) Now, as we all know GDP is measured by the formula GDP = C+ I + G + X- M , where C= consumption

I = investment, G = government spending, X = exports, M = imports.

i) Now, as Australia is the fifth largest exporter of Coal to China and mainly these steam coal exports are used for power generation. So, a major increase in extraction and subsequent export of coal to China will increase Australia's value of exports which will lead to an increase in the measured GDP. However, we cant say the same for progress. GDP being a 'good' measure of progress is not that accurate as Coal doesnot hold an economic future for Australia anymore. This is because countries all over the world is switching to cost-competitive renewable alternatives. Economic, technological and political developments accompanied by major concerns about air pollution and the environment is leading to reduction in coal usage. This in turn will curb the imports from Australia which does not spell good news for this country. So, here, the GDP is not a good measure of progress.

ii) Now, if there is a large increase in people taking up voluntary unemployment and spending their time with unemployed people, this will reflect in the GDP as increase in unemployment and therefore, reduction in income and GDP. However, this does not necessarily mean degress for the economy. As the people taking up voluntary unemployment tp spend time with the poor and employed could make them fitter for the job market and help them gain skills and knowledge to get jobs in the future. This will lead to progress of the economy in the real sense. So, the GDP doesnt give the correct measure of progress.

iii) So, though there is not much link between rise in crime rates and GDP of the economy, there is some kind of effect of the crimes against property on the GDP growth of an economy. Property crimes includes thefts and break-ins into households and businesses.This will affect the consumer spending and investment spending components of GDP adversely as people will refrain from it. So, there will be a decrease in the measured Australian GDP. Also, high theft rates could generally point towards a inequal, highly disperse, unemployed, lawless economy. So, high theft rates could indicate an economy with degress or not much progress. In this case, the GDP can still be considered a good measure of progress.

c) So, we see as per the information provided above, there is a fall in the CPI which indicates a fall in the inflation rate or general price level. The unemployment level has risen significantly, and has more than doubled. Also, the real GDP per capita growth i.e. per capita income has fallen significantly. All of this point towards a recessionary period. Also, by 2021, the British economy has reached the trough i.e. the very bottom of the recessionary period where the unemployment is at its highest and inflation is low. Take a look at fig 1 for the AD/AS diagram. During such times of recession, the British govt should use an expansionary fiscal policy like increasing government spending or reducing the taxes. This will increase the money supply, increase the quantity of loans, reduce the interest rates and increase aggregate demand, boosting the economic growth. Take a look at fig 2 to see the shifts in the AD curve and restoration of the economy.