Question 1
Mars Limited produces and sells boxes in a perfectly competitive market at a price of $20. The
total cost (in dollars) of producing Q boxes per day is given by the following cost function:
C(Q) = 30 + 10Q + Q2
1.1. Find the profit maximising output. [2 marks]
1.2. Find the total cost (TC) and total variable cost (TVC) of the firm at this output calculated in
sub-question (1). [2 marks]
1.3. Find average variable cost (AVC) and average total cost (ATC) of the firm at this output
calculated in sub-question (1). [2 marks]
1.4. Find the profit of the firm at this output calculated in sub-question (1). [2 marks]
1.5. Will this firm shut down in the short run? Will this firm exit in the long run? [2 marks]
Clearly label each of your answers in the text box below.
Question 2
Use the information in the following table, which summarizes the payoffs (i.e., profit) of two
firms that must decide between an average-quality and a high quality product, to answer the
questions that follow:
Firm 2
Average quality High quality
Firm 1 Average quality 700,700 500,1200
High quality 1200,500 1000,1000
2.1. What is each player’s dominant strategy? Explain your reasoning.. [2 marks]
2.2. Is there a Nash equilibrium? If so, what is it? [2 marks]
2.3. Is this an example of a prisoner’s dilemma game? [2 marks]
2.4. Differentiate between cooperative and non-cooperative oligopoly. [2 marks]
2.5. Discuss the major characteristics of oligopoly. [2 marks]
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Question 3
Sigma Limited produces and sells organic apples in a perfectly competitive market at a price of
$5 per kilo. Sigma Limited hires its labour in a perfectly competitive labour market at an hourly
wage of $20. The production function of the firm is given by:
Q(L) = 100L – 4L2
3.1. Compute the marginal product of labour (Hint: The answer must be a function of L). [2
marks]
3.2. Does the marginal product increase or decrease when we hire more labour? Explain the
economic reason for such behaviour of the marginal product of labour. [2 marks]
3.3. Compute the value of the marginal product of labour. [2 marks]
3.4. What quantity of labour will this firm choose to hire and why? [2 marks]
3.5. Without calculation, if the price of apples increases, what will happen to the labour
demand curve? [2 marks]
Clearly label each of your answers in the text box below.
Question 4
Assume an economy is in a recession where real GDP is below the potential output.
4.1. Discuss how the government could use fiscal policy to deal with the recession. [2 marks]
4.2. Discuss how the Reserve Bank of Australia (RBA) could use monetary policy to deal with
the recession. [2 marks]
4.3. Explain the effect on aggregate expenditure (AE) curve when we use fiscal policy and
monetary policy in sub-question (1) and (2). [2 marks]
4.4. The consumption function is C = 8,000 + 0.8Y, estimate the multiplier in this economy. [2
marks]
4.5. Explain how real GDP and the price level will adjust in the long run according to Classical
economics without government and RBA intervention. [2 marks]
Clearly label each of your answers in the text box below.
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Question 5
Suppose that a country’s production is described by the following production function
Y = A K0.2 L0.8
5.1. Calculate the country’s GDP and GDP per capita if A = 10, K=40, and L=30. What will
happen to the production level if both K and L doubles? What is the economic interpretation of
your results? [2 marks]
5.2. Calculate marginal product of labour (MPL) and marginal product of capital (MPK). State
the relationship between L and MPL. State the relationship between K and MPK. Discuss the
economic interpretation of your answer. [2 marks]
5.3. Calculate the country’s GDP, GDP per capita, MPL and MPK if A = 10, K=30, and L=80.
Discuss the economic interpretation of your answer. [2 marks]
5.4. What can government do to raise productivity and living standards? [2 marks]
5.5. If China has a growth rate of 7% per annum, how long does it take to double its GDP? [2
marks]
Clearly label each of your answers in the text box below.
Question 6
Illustrate the effects of the following three scenarios on both the short-run and long-run Phillips
curves (either shift and its direction or movement).
6.1. A reduction in the natural rate of unemployment. [2 marks]
6.2. An increase in the price of imported oil. [2 marks]
6.3. A reduction in government spending. [2 marks]
6.4. Suppose the government reduces taxes by $100 million, that there is no crowding-out
effect, and that the marginal propensity to consume is 0.8. What is the total effect of the tax
cut on aggregate demand? [2 marks]
6.5. Suppose the government increases government spending by $100 million, that there is no
crowding-out effect, and that the marginal propensity to consume is 0.8. What is the total
effect of the increase in government purchases on aggregate demand? [2 marks]
Clearly label each of your answers in the text box below.
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PART B
Question 7 (20 marks)
Read the article titled – Cyclone Debbie leaves a sour taste for sugar cane growers- and
answer the following questions
Cyclone Debbie leaves a sour taste for sugar cane growers.
Cyclone Debbie crossed the coast near the Whitsunday islands in March 28, 2017 and tore a
path from Bowen in QLD down to Northern New South Wales bringing 260 kph winds, torrential
rains and flooding. The storm caused a total of $3.5 billion in damage. The cost to Queensland’s
sugar industry, in destroyed cane infrastructure and equipment was $250 million. Cane growers
Queensland chairman Paul Schembri said 125,000ha of cane farms from Bowen to south of
Mackay were severely damaged. Sugar production volume loss on average was 20 to 25% from
the three regions of Burdekin, Proserpine and Mackay that produce 50% of Australia’s national
sugar cane crop. The losses would also far exceed that for many individual cane farms in the
most severely affected locations.
The cyclone disrupted production methods. Most sugar cane is mechanically harvested whilst
still green and the canes are standing upright. However, the cyclone winds caused damage to
farm structures and bent and flattened the canes. Torrential rains then flooded the fields and
farm tracks with debris.
Sprawled crops make mechanical harvesting difficult. After the damaged cane dries out and fine
weather returns, the green leaves at the top turn toward the sun to try to stand up again but
the cane stick itself often remains flattened and bent on the ground. There is a risk of damage
to mechanical harvesters from cane in that condition and excessive leaf and other unseen
debris in the fields. The smaller crop yields less tonnes to spread costs over and even where
mechanical harvesters can still be used, the excessive leaf and other debris in the fields slows
harvesting time down, increasing costs further. Many cane growers resorted to burning the
flattened cane in the fields of excess leaf and debris, to salvage some harvest, a method not
used for decades. This is a more labour intensive method of harvesting.
Cyclone Debbie’s timing was not good for sugar cane growers. The cane was nowhere near its
traditional harvest time (December) so couldn’t be harvested early. The best some farmers
hoped for was that the cane ‘would straighten itself up’. In addition, the global sugar price had
been above US $22 cents in 2016 but had fallen to between U.S. $12 cents and U.S. $13 cents
per pound by August 2017, after trader realisations that a global surplus was emerging. One
bank analyst linked sugar prices to the oil price, which had been under downward pressure for
two years. This then put pressure on the ethanol price in Brazil, forcing Brazilian sugar mills to
reduce ethanol production and increase sugar production. Good weather also prevailed in
South East Asian cane growing nations contributing to the emerging global surplus. The price
fall was further exaggerated by speculators who were selling on the market. Some cane
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growers may not have suffered the price fall as badly as others if they had secured earlier more
favourable forward pricing contracts over their crop.
Australian cane growers claimed that the price was approaching “cost of production” even
without the cleanup and damage costs caused by Cyclone Debbie. Growers were forced to
search hard for cost cuts such as reducing the nutrient or irrigation or maintenance inputs
despite knowing such cuts would impair next year’s product quality.
The Indian Government then declared subsidies for its sugar industry in September 2017,
indicating further increases in global production, causing the global price to fall below the cost
of production. The Australian sugar industry receives no government price support and 80% of
Australian sugar is exported, so the industry is trade exposed to global sugar market price
volatility.
Cane growers Proserpine manager Mike Porter said growers just had to follow the appropriate
steps;
“There is nothing else you can do. This is an export industry, so we are captured by both the
international commodity price and the exchange rate. We don’t have control over either
fundamentals.”
One Queensland cane grower estimated his loss at $400,00 – $500,000 in 2017 on the back of
the cyclone, global sugar glut and subsequent very dry conditions through 2017 and 2018,
claiming recovery would take him five years. However, for many farms total recovery may
never be possible, leaving them vulnerable to future climate events.
7.1 What market structure most appropriately describes the sugar cane growing industry?
7.2 Explain what the likely short run effect of the cyclone is on the cost curves of a sugar cane
growing firm in the cyclone affected region?
7.3 Explain using the relevant market structure model, the likely short run effect of the cyclone
on the profits and quantities produced by sugar cane growing farms in the cyclone affected
region
7.4 What is the long term response in the industry to the existence of economic losses, economic
profits or normal profit? How will the changes from Q.5.2 and Q.5.3 affect the firm’s profit
position in both the short run and long run?
Clearly label each of your answers in the text box below.
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Question 8 (20 marks)
Read the article titled – Wages, consumption and GDP growth remain sluggish despite an
increase in employment – and answer the following questions.
Wages, consumption and GDP growth remain sluggish despite an increase in employment.
In the ten years prior to the global financial crisis Australia’s real GDP grew 3.4% on average per
year, decelerating to 1.6% in 2009 after the turmoil. Australia showed resilience being one of
the few developed nations that still recorded growth in 2009. Since then Australia’s real GDP
growth has averaged below 3% but grew just 2.3% for the year ended December 2018
(seasonally adjusted). Inflation continues to be low, yet all key measures of inflation are now
currently below the Reserve Bank’s preferred 2 to 3% band. The economic indicators that signal
the start of a downturn are emerging in many advanced economies including Australia.
Australian households are carrying a high total private sector debt ratio of 121 percent of GDP
in June 2018, making us less resilient to future shocks.
Australia is also seeing the lowest growth in wages as a percentage of economic activity since
1959 when official records commenced. This is despite mostly growth year on year in labour
productivity over the same period. The clear downward trend in wages share of GDP is visible
from 1980 to current, despite short term small fluctuations, with labour compensation as a
percentage of GDP falling from 56% in 1980 to 46.5% in 2018. Nominal wage growth has now
been around 2% a year since 2015.
Record numbers of Australians are also working a second job. The number exceeded one
million persons at the end of 2018 having increased by more than 20% in the past two years.
Since 2010 the wage price index shows the real value of wages growth has fallen from 7% to
2.3% whilst secondary jobs have risen from 3.8% to 6.3% of total jobs over the same period.
Secondary job roles feature work like caring, office temping, call centre answering, uber driving
and other delivery services, and healthcare and social assistance work.
Despite a small rise in the employment statistics in the years since the GFC, underemployment
levels have risen from just 2.5% in 1980 to 9% of the labour force in 2018. Underemployment
needs to be considered in context with headline employment figures. Younger Australians are
more affected by underemployment and disproportionately so. 31% of workers aged 15-19 and
20% of workers aged 20 – 24 are underemployed. Underemployment in other age
demographics does not exceed 9%. According to the OECD, Australia has the highest proportion
of “temporary” (including casual) jobs in the OECD. With higher underemployment levels the
headline employment rate is therefore likely to include a significant number of people who
want more work and cannot get it as well as those who may be working two jobs to make ends
meet, indicating that the labour force is underutilised.
In an open letter signed by 124 Labour Market, Employment Relations and Labour Law
Researchers, Dr Stanford Jim Stanford, economist, claimed Australia was in the grip of a “wages
crisis” that “isn’t going to fix itself” citing an “unprecedented slowdown” despite the
employment growth. The economists called for various measures as a matter of urgency to
tackle the crisis, including raising the minimum wage, strengthening collective wage bargaining,
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relaxing caps on the public sector and limiting the ability of private firms to outsource.
Professor John Quiggin, one signatory to the letter commented;
“for decades, government policy has been designed to weaken unions and push wages down.
It’s time to put that process into reverse.”
Australia’s current Treasurer declined to respond to the written concerns of labour market
experts. The Prime Minister countered that increasing wages costs on businesses would
contribute to loss of jobs. The argument is that tax cuts for business owners will drive
investment and create more jobs. The Business Council of Australia supports the idea of
business tax cuts and similarly argues against ‘tinkering with wages’ lest it cause ‘higher prices
and lost jobs’.
Some businesses claim they are now suffering because of sluggish consumption. The $310
billion retail sector remains largely in recession due to both low wage growth and high debt
carried by households. Retail sales growth slowed to 2.2% in the 2018 year. One market adviser
warns that big box retail is “slowly dying” with even heavyweights like Bunnings and Dan
Murphy’s now facing “significant store closures.” The physical retail sector has already taken a
hit from the growth of online shopping. Many jobs in stores like Kmart, Woolworths, Coles and
others have been lost to automation such as electronic scan and pay systems. Other local jobs
have been lost to the complete automation of factories and outsourcing of call centre
operations.
Slow wages growth forces households to reduce their discretionary spending or look for lower
priced goods and services. Wages are for the most part spent locally and there will be flow on
effects to businesses from stagnant wages growth. Ultimately businesses will see this in lower
sales, despite having interests in also keeping cost structures low by pushing for flexible wages
and flexible work patterns from their workers. There is a government policy trade off that must
be managed well to avoid low wages growth feeding into low consumption growth, thus
dragging down economic growth. The signs are there, in the current dilemma that the RBA is
attempting to grapple with. Why with a rise in employment are Consumption and GDP growth
not meeting predicted growth rates?
Questions:
8.1 What does an economy’s potential output level represent and how is this related to the
main types of unemployment?
8.2 What do current unemployment, GDP and inflation statistics suggest about what stage of
the business cycle the Australian economy is currently in?
8.3 Using the AD/AS model, and assuming the economy starts at full employment, explain in
words the effect of reduced consumption by households.
8.4 Using the AD/AS model, and assuming the economy starts below full employment, explain
in words the effect of a decrease in the rate of consumption and the long run self-correction of
the economy.