vce economics units 3 and 4 - sciencepress

VCE ECONOMICS UNITS 3 AND 4

• Mohan Dhall •

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of Science Press. ABN 98 000 073 861

© Science Press 2019First published 2019

Science PressPrivate Bag 7023 Marrickville NSW 1475 AustraliaTel: +61 2 9516 1122 Fax: +61 2 9550 [email protected] www.sciencepress.com.au

Contents

Words to Watch iv

Introduction v

Dot Points

Unit 3 Australia’s Economic Prosperity vi

Unit 4 Managing the Economy ix

Questions

Unit 3 Australia’s Economic Prosperity 1

Unit 4 Managing the Economy 173

Answers

Unit 3 Australia’s Economic Prosperity 224

Unit 4 Managing the Economy 262

Appendix

Index 273

Dot Point VCE Economics Units 3 and 4 iii

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Contents

account, account for State reasons for, report on,

give an account of, narrate a series of events or

transactions.

analyse Interpret data to reach conclusions.

annotate Add brief notes to a diagram or graph.

apply Put to use in a particular situation.

assess Make a judgement about the value of

something.

calculate Find a numerical answer.

clarify Make clear or plain.

classify Arrange into classes, groups or categories.

comment Give a judgement based on a given

statement or result of a calculation.

compare Estimate, measure or note how things are

similar or different.

construct Represent or develop in graphical form.

contrast Show how things are different or opposite.

create Originate or bring into existence.

deduce Reach a conclusion from given information.

define Give the precise meaning of a word, phrase or

physical quantity.

demonstrate Show by example.

derive Manipulate a mathematical relationship(s) to

give a new equation or relationship.

describe Give a detailed account.

design Produce a plan, simulation or model.

determine Find the only possible answer.

discuss Talk or write about a topic, taking into account

different issues or ideas.

distinguish Give differences between two or more

different items.

draw Represent by means of pencil lines.

estimate Find an approximate value for an unknown

quantity.

evaluate Assess the implications and limitations.

examine Inquire into.

explain Make something clear or easy to understand.

extract Choose relevant and/or appropriate details.

extrapolate Infer from what is known.

hypothesise Suggest an explanation for a group of facts or phenomena.

identify Recognise and name.

interpret Draw meaning from.

investigate Plan, inquire into and draw conclusions about.

justify Support an argument or conclusion.

label Add labels to a diagram.

list Give a sequence of names or other brief answers.

measure Find a value for a quantity.

outline Give a brief account or summary.

plan Use strategies to develop a series of steps or processes.

predict Give an expected result.

propose Put forward a plan or suggestion for consideration or action.

recall Present remembered ideas, facts or experiences.

relate Tell or report about happenings, events or circumstances.

represent Use words, images or symbols to convey meaning.

select Choose in preference to another or others.

sequence Arrange in order.

show Give the steps in a calculation or derivation.

sketch Make a quick, rough drawing of something.

solve Work out the answer to a problem.

state Give a specific name, value or other brief answer.

suggest Put forward an idea for consideration.

summarise Give a brief statement of the main points.

synthesise Combine various elements to make a whole.

Words to Watch

Dot Point VCE Economics Units 3 and 4iv

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Words to Watch

What the book includes

This book provides questions and answers for each dot point in the Victorian Certificate of Education Study Design for each core topic in the Year 12 Economics syllabus:

Unit 3 Australia’s Economic Prosperity

• Area of Study 1 An Introduction to Microeconomics: The Market System, Resource Allocation and Government Intervention

• Area of Study 2 Domestic Macroeconomic Goals

• Area of Study 3 Australia and the World Economy

Unit 4 Managing the Economy

• Area of Study 1 Aggregate Demand Policies and Domestic Economic Stability

• Area of Study 2 Aggregate Supply Policies

Format of the book

The book has been formatted in the following way:

1.1 Subtopic from syllabus.

1.1.1 Assessment statement from syllabus.

1.1.1.1 First question for this assessment statement.

1.1.1.2 Second question for this assessment statement.

The number of lines provided for each answer gives an indication of how many marks the question might be worth in an examination. As a rough rule, every two lines of answer might be worth 1 mark.

How to use the book

Completing all questions will provide you with a summary of all the work you need to know from the syllabus. You may have done work in addition to this with your teacher as extension work. Obviously this is not covered, but you may need to know this additional work for your school exams.

When working through the questions, write the answers you have to look up in a different colour to those you know without having to research the work. This will provide you with a quick reference for work needing further revision.

Introduction

Dot Point VCE Economics Units 3 and 4 v

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Introduction

Area of Study 1 An Introduction to Microeconomics: The Market System, Resource Allocation and Government Intervention

1.1 Key knowledge 5

1.1.1 Relative scarcity: needs, wants, 5 resources and opportunity cost.

1.1.2 The nature of, and conditions for, 8 a perfectly competitive market.

1.1.3 The law of demand and the demand 10 curve including movements along, and shifts of, the demand curve.

1.1.4 Factors likely to affect demand 16 and the position of the demand curve: changes in disposable income, the prices of substitutes and complements, preferences and tastes, interest rates, changes in population and consumer confidence.

1.1.5 The law of supply and the supply 21 curve including movements along, and shifts of, the supply curve.

1.1.6 Factors likely to affect supply 28 and the position of the supply curve: changes in the cost of production, technological change, productivity growth and climatic conditions.

1.1.7 The effects of changes in supply 31 and demand on equilibrium prices and quantity traded.

1.1.8 The role of relative prices in 35 markets on the allocation of resources and the effect on living standards.

1.1.9 The meaning and significance 38 of price elasticity of demand and supply.

1.1.10 Factors affecting price elasticity 52 of demand: degree of necessity, availability of substitutes, proportion of income and time.

1.1.11 Factors affecting price elasticity of 54 supply: spare capacity, production period and durability of goods.

1.1.12 The meaning and significance of 56 economic efficiency: allocative efficiency, productive efficiency, dynamic efficiency and intertemporal efficiency.

1.1.13 The effect of competitive markets 59 on the efficiency of resource allocation.

1.1.14 Reasons for market failure: public 61 goods, externalities, asymmetric information and common access resources.

1.1.15 The role and effect of indirect 64 taxation, subsidies, government regulations and government advertising as forms of government intervention in the market to address market failure.

1.1.16 One contemporary example of 69 government intervention in markets that unintentionally leads to a decrease in the efficiency of resource allocation.


Dot Point Page Dot Point Page

Dot Point VCE Economics Units 3 and 4viDot Points

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Area of Study 2 Domestic Macroeconomic Goals

2.1 The nature and purpose of 73 economic activity

2.1.1 The difference between material 73 and non-material living standards.

2.1.2 Factors that may influence living 74 standards including access to goods and services, environmental quality, physical and mental health, life expectancy, crime rates and literacy rates.

2.1.3 The circular flow model of income 78 including the role of households, businesses, government, financial institutions and the external sector in an open contemporary macroeconomy.

2.1.4 The nature and causes of the 83 business cycle.

2.1.5 The meaning and importance of 85 aggregate demand and the factors that may influence the level of aggregate demand in the economy: changes in the general level of prices, disposable income, interest rates, consumer confidence, business confidence, the exchange rate and rates of economic growth overseas.

2.1.6 The aggregate demand curve. 90

2.1.7 The meaning and importance of 93 aggregate supply and the factors that may influence the level of aggregate supply in the economy: changes in the general level of prices, quantity and quality of the factors of production, cost of production, technological change, productivity growth, exchange rates and climatic conditions.

2.1.8 The aggregate supply curve. 98

2.1.9 The effects of changes in aggregate 101 demand and aggregate supply on the level of economic growth, employment and price levels.

2.2 The Australian government’s 103 domestic macroeconomic goals

2.2.1 The meaning of the goal of low 103 inflation (price stability).

2.2.2 Measurement of the inflation rate using 105 the consumer price index (CPI) including the difference between the headline and underlying (core) rate of inflation.

2.2.3 Causes of inflation including 108 demand and cost inflation.

2.2.4 Consequences of a high inflation 111 rate: erosion of purchasing power, redistributive effects, resource misallocation, savings and investment and international competitiveness.

2.2.5 The meaning of the goal of strong 113 and sustainable economic growth.

2.2.6 Measurement of the rate of economic 114 growth using real gross domestic product (GDP).

2.2.7 The reasons for pursuing strong 119 and sustainable economic growth including lowering of the unemployment rate, growth in real income and increased ability of government to provide essential services.

2.2.8 The meaning of the goal of full 122 employment and classifications within the labour force: employed, unemployed, hidden unemployment, disguised or underemployed.

2.2.9 Measurement of the labour force 127 including the participation rate, the unemployment rate and the labour force underutilisation rate.

2.2.10 Types and causes of unemployment: 131 cyclical, structural, frictional, seasonal and hard core unemployment.

2.2.11 The consequences of unemployment 134 including loss of GDP, loss of tax revenue, reductions in living standards and greater income inequality.

2.2.12 Aggregate demand and aggregate 136 supply factors that have influenced inflation, economic growth, the unemployment rate and living standards in the past two years.



Dot Point VCE Economics Units 3 and 4 vii Dot Points

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Area of Study 3 Australia and the World Economy

3.1 Key knowledge 141

3.1.1 The relationship between trade 141 and living standards including lower prices for consumers, greater choice for consumers, the ability of businesses to achieve economies of scale and access to more resources for business and government.

3.1.2 The balance of payments and 145 its components.

3.1.3 Causes of Australia’s current 148 account deficit including cyclical and structural factors.

3.1.4 The relationship between 150 the current account and the capital and financial account.

3.1.5 The composition and cause 151 of net foreign debt and net foreign equities.

3.1.6 The terms of trade: meaning and 155 measurement and the factors that may influence the terms of trade.

3.1.7 The effect of movements in the 157 terms of trade on the current account balance, the domestic macroeconomic goals and living standards.

3.1.8 Factors affecting the value of 158 the exchange rate including relative interest rates,demand for exports and imports, capital flows, the terms of trade and relative rates of inflation.

3.1.9 The effect of exchange rate 164 movements on the current account balance, the domestic macroeconomic goals and living standards.

3.1.10 Factors that may influence 167 Australia’s international competitiveness including productivity, production costs, availability of natural resources, exchange rates and relative rates of inflation, and the effect of these factors on domestic macroeconomic goals and living standards.

3.1.11 The effect of trade liberalisation 170 on Australia’s international competitiveness, domestic macroeconomic goals and living standards.

Answers to Australia’s Economic 224 Prosperity



Dot Point VCE Economics Units 3 and 4viiiDot Points

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Area of Study 1 Aggregate Demand Policies and Domestic Economic Stability


1.1.1 The need for aggregate demand 177 policies in terms of stabilising the business cycle.

1.2 Budgetary policy 178

1.2.1 Sources of government revenue 178 including direct and indirect taxation, revenue from government businesses and the sale of government assets.

1.2.2 Types of government expenses 181 including government current and capital expenditure and transfer payments.

1.2.3 The budget outcome: balanced, 182 deficit or surplus.

1.2.4 The ways government may finance 183 a deficit or utilise a surplus.

1.2.5 The relationship between the 184 budget outcome and the level of government (public) debt.

1.2.6 The role of automatic stabilisers 185 (cyclical component of the budget) in influencing aggregate demand and stabilising the business cycle.

1.2.7 The role of discretionary stabilisers 187 (structural component of the budget)in influencing aggregate demand and stabilising the business cycle.

1.2.8 The effect of automatic and 188 discretionary changes in the budget on the budget outcome and government (public) debt.

1.2.9 The stance of budgetary policy: 189 expansionary or contractionary.

1.2.10 The effect of budget initiatives 190 from the past two years on the Australian government’s domestic macroeconomic goals of strong and sustainable growth, full employment and low inflation.

1.2.11 The strengths and weaknesses of 192 using budgetary policy to achieve the Australian government’s domestic macroeconomic goals and how these goals may affect living standards.

1.3 Monetary policy 193

1.3.1 The role of the RBA with respect 193 to monetary policy as outlined in its charter.

1.3.2 The role of open market operations 195 in altering interest rates.

1.3.3 Transmission mechanisms of 197 monetary policy and their influence on the level of aggregate demand including savings and investment, cash flow, availability of credit, exchange rate movements and asset prices.

1.3.4 The stance of monetary policy: 200 expansionary or contractionary.

1.3.5 The focus of monetary policy from 203 the past two years on the levels of aggregate demand and the Australian government’s domestic macroeconomic goals of strong and sustainable economic growth, full employment and low inflation.

1.3.6 The strengths and weaknesses 205 of using monetary policy to achieve the Australian government’s domestic macroeconomic goals and how these goals may affect living standards.



Dot Point VCE Economics Units 3 and 4 ix Dot Points

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Area of Study 2 Aggregate Supply Policies


2.1.1 The nature, operation and aims 209 of aggregate supply policies and their relationship to the domestic macroeconomic goals, international competitiveness and living standards.

2.1.2 The relationship between the 211 efficient allocation of resources and aggregate supply.

2.1.3 How the following aspects of 214 budgetary policy are designed to influence aggregate supply and the achievement of domestic macroeconomic goals: spending on training and education, research and development grants, subsidies, investment in infrastructure.

2.1.4 How welfare and tax reform 217 policies are designed to influence aggregate supply and living standards.

2.1.5 The effect of immigration 219 policies on the labour market and aggregate supply, and the way in which this influences the achievement of domestic macroeconomic goals.

2.1.6 The strengths and weaknesses 220 of using aggregate supply policies to achieve the Australian government’s domestic macroeconomic goals and how these goals may affect living standards.

Answers to Managing the Economy 262


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Dot Point VCE Economics Units 3 and 4xDot Points

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DOT POINT

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Australia’s Economic Prosperity

1 Unit 3 Australia’s Economic Prosperity

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Dot Point VCE Economics Units 3 and 4

Unit 3

2Unit 3 Australia’s Economic Prosperity

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The Australian economy is constantly evolving. The main instrument for allocating resources is the market but the Australian government also plays a significant role in this regard. In this unit you will investigate the role of the market in allocating resources and examine the factors that are likely to affect the price and quantity traded for a range of goods and services. You will develop an understanding of the key measures of efficiency and how market systems can result in efficient outcomes. You will consider contemporary issues to explain the need for government intervention in markets and why markets might fail to maximise society’s living standards. As part of a balanced examination, you will also consider unintended consequences of government intervention in the market.

In this unit you will develop an understanding of the macroeconomy. You will investigate the factors that influence the level of aggregate demand and aggregate supply in the economy and use models and theories to explain how changes in these variables might influence the achievement of the Australian government’s domestic macroeconomic goals and affect living standards.

Australia’s economic prosperity depends, in part, on strong economic relationships with its major trading partners. You will investigate the importance of international economic relationships in terms of their influence on Australia’s living standards and analyse how international transactions are recorded, predict how economic events might affect the value of the exchange rate and evaluate the effect of trade liberalisation.

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An Introduction To Microeconomics: The Market System,

Resource Allocation and Government Intervention

DOT POINT


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AREA OF STUDY 1

Area of Study 1 An Introduction To Microeconomics: The Market System, Resource Allocation and Government Intervention

In this area of study you will investigate the role of the market in answering the key economic questions of what and how much to produce, how to produce and for whom to produce. You will consider the effect of decisions made by consumers and businesses on what goods and services are produced, the quantities in which they are produced, to whom they are distributed and the way they are produced. You will investigate some of the key factors that influence the level of demand and supply in the economy and how these might lead to changing prices and the movement of land, labour and capital to those areas of production that generate the most value for society. You will use models to make predictions and to consider the role of markets in achieving economic efficiency. Using a case study from the past two years you will discuss instances where the market fails to allocate resources efficiently and whether government intervention leads to a more efficient allocation of resources in terms of maximising society’s wellbeing.

Outcome 1

On completion of this unit you should be able to explain how markets operate to allocate resources, and discuss the effect of government intervention on market outcomes.

To achieve this outcome you will draw on key knowledge and key skills outlined in Area of Study 1


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1.1 Key knowledge.

1.1.1 Relative scarcity: needs, wants, resources and opportunity cost.

1.1.1.1 Define the following terms.

Scarce

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Replenishable resources

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Non-renewables

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Opportunity cost

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1.1.1.2 Distinguish between wants and needs and provide two examples of each.

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1.1.1.3 Distinguish between renewable and non-renewable resources.

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1.1.1.4 How does scarcity affect non-renewable resources?

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1.1.1.5 How does the problem of scarcity affect renewable resources?

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1.1.1.6 Define sustainability.

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1.1.1.7 Why does economic decision making need to balance the problem of scarcity with the issue of wants?

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1.1.1.8 Describe the profit maximisation goals of firms and what this means for resource use.

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1.1.1.9 Outline how firms can maximise growth and pursue profits while using resources sustainably.

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1.1.1.10 Use the information below and your own knowledge to answer the question that follows.

Capitalgoods

Consumergoods

Explain the nature of opportunity cost with reference to the diagram.

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Use the information below for a nation called Tradingo and your own knowledge to answer the next SIX questions.

Computers

20 000

Tonnesof rice

Production possibilitiesfrontier, PPF

5000

1.1.1.11 What is a production possibilities frontier?

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1.1.1.12 In the diagram how much rice can be produced in Tradingo?

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1.1.1.13 Using the diagram how many computers can be produced in Tradingo?

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1.1.1.14 Suppose that the economy in Tradingo produced 3000 computers. At this point how much rice can also be produced?

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1.1.1.15 Determine the opportunity cost in Tradingo of producing 3000 computers.

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1.1.1.16 How does the slope of the production possibilities curve relate to opportunity cost?

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1.1.2 The nature of, and conditions for, a perfectly competitive market.

Assumptions of a perfectly competitive market system

Perfect knowledge No barriers to entry to the market

Assumptions about consumers Assumptions about business

Numerous firms

Firms are price takers

Each firm produces identical products (no product

differentiation)

Inputs are identical

Make rational decisions

Short run profits may besupernormal but in the long

run are normal


Perfect competition

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1.1.2.2 Explain why perfect knowledge means that risks are reduced.

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1.1.2.3 Outline the nature of inputs and outputs in a perfectly competitive market system.

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1.1.2.4 What is the effect on competition when there are barriers to entry (or exit) in a market?

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1.1.2.5 Why do all firms have equal market power in a perfectly competitive market?

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1.1.2.6 In a perfectly competitive market are all firms price takers?

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1.1.2.7 What is the effect of a firm either raising or lowering prices in a perfectly competitive market?

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1.1.2.8 Why are new entrants to a market only likely to attract supernormal profits in the short run?

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1.1.2.9 In a perfectly competitive market what is normal profit in the long run?

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1.1.3 The law of demand and the demand curve.

The demand curve, D

Price, P

Quantity, Q

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1.1.3.2 Explain why the demand curve slopes downwards to the right on the basis of each of the following.

Income effect

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Substitution effect

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The law of diminishing marginal utility

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1.1.3.3 Describe the relationship between price and quantity on a demand curve.

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1.1.3.4 Use the demand schedule data in the table below to construct a demand curve on the axes provided.

Price of water bottle ($) Number sold

11 1

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6 4

3 15

1 90


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1.1.3.5 Use the graph in the previous question to estimate the number sold at the following prices.

$3.50 ��

$7.00 ��

Use the information below and your own knowledge to answer the next FOUR questions.

Movements along the demand curve

Price, P

Quantity, Q

D

A

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Contraction

Expansion

1.1.3.6 What happens to quantity demanded when prices vary?

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1.1.3.7 Distinguish between expansions and contractions along the demand curve.

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1.1.3.8 Identify factors that can cause a contraction in demand.

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1.1.3.9 Explain how demand can expand.

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1.1.3.10 On the demand curve, D below show an expansion and a contraction in demand.

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1.1.3.11 What happens to the quantity and price when there is an expansion in demand?

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1.1.3.12 What happens to quantity and price when there is a contraction in demand?

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1.1.3.13 What causes movements along the demand curve?

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1.1.3.14 What is an inferior good?

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1.1.3.15 Why don’t inferior goods follow the law of demand?

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1.1.3.16 Define conspicuous consumption.

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1.1.3.17 What are Veblen goods?

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1.1.3.18 Why does conspicuous consumption disobey the law of demand?

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Use the information below and your own knowledge to answer the next THREE questions.

Shifts in the demand curve, D

Price, P

Quantity, Q

DD′

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IncreaseDecrease

1.1.3.19 Distinguish between increases and decreases in demand.

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1.1.3.20 When there is an increase in demand what happens to quantity demanded at every price?

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1.1.3.21 When there is a decrease in demand what happens to quantity demanded at every price?

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DOT POINT

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223 Answers

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Answers


1.1.1.1 Scarce: Insufficient or in limited quantities.

Unlimited: Inexhaustible and infinite.

Replenishable resources: Natural resources that can be renewed in abundance through careful management.

Non-renewables: Resources that cannot be replenished once they are used as they take thousands of years to create through natural processes.

Opportunity cost: The benefit foregone from any choice in order to take up a different option or alternative.

1.1.1.2 A want is something that is desired, but not essential for living. Examples include smart phones and a new car. A need is a necessity, something that is required for a person to live – such as food, water and housing.

1.1.1.3 Renewable resources are those that can be replenished if used sustainably whereas non-renewable resources cannot be replenished however carefully they are utilised.

1.1.1.4 Scarcity affects non-renewable resources in the following way: all resources are available at any point in time in limited quantities. Non-renewable resources are scarce because they cannot be replaced. As non-renewable resources are used their scarcity increases.

1.1.1.5 The problem of scarcity affects renewable resources as follows: if they are overused they will not be able to replenish in line with demand and they will run out. If however they are used wisely, the problem of scarcity can be reduced.

1.1.1.6 Sustainability means resources are used in a way that enables the current generation to access resources without compromising the access to those resources of any future generations.

1.1.1.7 Economic decision making must balance the issue of the population’s wants with the problem of scarcity of resources. This is because if the resource use is not restricted then those resources will be depleted and this will affect the standard of living for future generations. Resources must be managed in such a way as to maximise the use of scarce resources to benefit existing and future generations.

1.1.1.8 The profit maximising goal of firms means that firms always seek to make profits as high as possible. This is generally done through increasing sales and increasing the scale of production. When scale rises, so does resource use. Accordingly, profit maximisation has a negative effect on resource availability because they are used up more quickly.

1.1.1.9 Firms can maximise growth and pursue profits while finding ways to use resources sustainably. This might require replacing non-renewable inputs with renewable inputs or designing a system that will utilise resources more efficiently and with less waste. In this way, firms can still grow and be profitable without compromising the environment.

1.1.1.10 Opportunity cost means the ‘cost of the foregone alternative’. In the graph the trade-off is between present consumption (consumer goods) and the investment in capital goods for future benefit. This trade off is an important one for economic decision makers to manage.

1.1.1.11 A production possibilities frontier (PPF) is a graph denoting how much can be made in an economy if resources are fully utilised.

1.1.1.12 Tradingo can produce 20 000 tonnes of rice if all resources are put into the production of rice.

1.1.1.13 Tradingo can produce 5000 computers if all resources are put into the production of computers.

1.1.1.14 Since Trandingo can produce either 20 000 tonnes of rice or 5000 computers, and since the PPF is linear, then each 1000 computers is worth 4000 tonnes of rice. Therefore, to produce 3000 computers, 8000 tonnes of rice can also be produced.

1.1.1.15 The opportunity cost of producing 3000 computers is the foregoing of the alternative, 12 000 tonnes of rice.

1.1.1.16 When there are two products in an economy, and when the PPF is linear, the slope of the curve will represent the rate at which one product is created at the cost of the other. Hence the gradient is the opportunity cost.

1.1.2.1 Perfect competition: A form of market structure where there are numerous firms, no barriers to entry, each firm produces identical products and consumers have perfect knowledge.

Barriers to entry: Any restraint to free entry into a market, such as licences, regulatory compliance rules and any other factor that imposes a restriction on market entry.

Perfect knowledge: A situation where all consumers have identical information about the price, inputs, all competitors, quality of product and other relevant factors within the market.

Normal profit: The minimum profit required to be able to compete within a market. In a totally competitive market, this occurs when total revenue is equal to total cost. Normal profit covers all costs (wages, rent, interest and a margin for profit that all entrepreneurs will get).

224Answers

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vce economics units 3 and 4 - sciencepress

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