Question

Read the article from ABC 'Why Australia's government debts and budget deficits are here to stay' and answer the following questions:

a) Using the AD-AS framework discussed in class, demonstrate the impacts of spending on infrastructure and a tax cut on output and inflation in the shortrun.

b) Also explain the likely impact of spending on infrastructure on output in the long-run and show this on your AS-AD diagram.

c) Explain (using your own words) what would happen to unemployment and output in the short run if job support payments (both Jobseeker and Jobkeeper) were switched off.

Answer 1

a. It is assumed that the economy is intially at full employment level. Increase in the level of government spending on infrastructure and tax cut in the economy will increase the level of government expenditure and also increase consumption expenditure in the economy. As the level of consumption and government expenditure increases, the level of aggregate demand in the economy will increase. In the diagram below, the equilibrium shifts from e1 to E2 where both output and inflation increases in the short run. The impact is depicted in the diagram below:

b. In the long run, this reduces unemployment rate and thus increases bargaining power of workers with respect to employers. Tis increases real wage rate in the labor market and increases cost of production in the economy which will shift the short run aggregate suppply curve leftwards to SRAS' and thus in the long run new equilibrium will occur at point E3 where prices have increased to P3 and output is back to the full employment level.

c.If Job supports payments were switched off, then this will increase labor supply in the labor market which leads to excess supply of labor in the labor market leading to unemployment in the economy.As unemployment increases in the economy, production will also decrease and this will reduce production in the economy.