Sample Solution Answer BOTH questions Each question carries

Sample Solution

Answer BOTH questions. Each question carries equal weighting. (1) You should read the questions and the articles before setting aside time (probably on a different day) to write your answers. (2) you should write from your own understanding without references. Safe. Assign checks submitted files for plagiarism so be careful to write in your own words and complete this assignment individually. (4) Draw appropriate links to the economic theory you have learned in the course and do not offer unsubstantiated opinion. (5) Use diagrams where appropriate. Hand-drawn ones are acceptable, being faster to draw, and may be scanned in (as pdfs, please – no other file formats!). 2

1. The effects of immigration on the United States economy http: //www. budgetmodel. wharton. upenn. edu/issues/2016/1/27/th e-effects-of-immigration-on-the-united-states-economy Access the article from the Wharton School of the University of Pennsylvania at the URL given above and read it carefully. Based on your reading, answer the questions below. (a) The article claims that, “immigrants are often imperfect substitutes for native-born workers. ” However, that does not stop many Americans from being concerned that immigrants will cause their wages to fall. Suppose that the authors of the article are wrong and that native-born and migrant workers are very similar, at least in the market for low-skilled workers. Use simple supply and demand analysis to illustrate the concerns of nativeborn workers. (Include a diagram in your answer. ) (b) In around 300 of your own words, explain why the analysis that you have presented in (a) is, according to the article, not correct. 3

(a) The article claims that, “immigrants are often imperfect substitutes for native-born workers. ” However, that does not stop many Americans from being concerned that immigrants will cause their wages to fall. Suppose that the authors of the article are wrong and that native-born and migrant workers are very similar, at least in the market for low-skilled workers. Use simple supply and demand analysis to illustrate the concerns of native-born workers. (Include a diagram in your answer. ) 4

FIRST STEP: Draw the diagram. SECOND STEP: Explain the diagram. 5

Market for unskilled workers Real wage S 1 w 1 S 2 w 2 D Number of workers 6

The diagram shows the market for unskilled workers in the USA, clearing at a real wage of w 1. If new unskilled migrants enter this market, the supply of labour increases; that is S 1 shifts rightwards to S 2. The result is a lower real wage at w 2. The fall in their real wage rate is what concerns native-born workers. 7

(b) In around 300 of your own words, explain why the analysis that you have presented in (a) is, according to the article, not correct. Consider whether you want to add diagrams to your analysis to help with the explanations. Come up with at least three points and explain each clearly. 8

EXAMPLE OF A GOOD STUDENT RESPONSE The argument in 1(a) assumes that all immigrants and native-born workers have the same skill sets and are competing in the same large labour market. There are, in fact, different labour markets for workers with different skill sets. The article indicates that, if anything, earlier immigrants face more competition from the newer arrivals than native-born workers. Even if the labour supply is increased overall, overall aggregate demand for goods and services also increases as immigrants spend their wages on items that expand domestic demand. That is, even if, due to immigrants, the labour supply curve shifted to the right, this would be offset by the demand curve (of firms requiring labour) also shifting to the right. This would keep wages from falling and increase output in the economy in general. This would offset, at least to some extent, the fall in wages argued in question 1(a). The analysis shown in Table 2 of the article of the long-run wage impacts of immigration clearly show that in only one study were any native-born workers, in the “no degree” and postgraduate degree groups, affected by lower wages and then only mildly. Also, Table 2 shows that for jobs of workers at all educational levels that the hours worked has increased due to immigration over the long run. 9

Empty feeling: Evidence is mounting that Australia’s unprecedented household debt burden is hitting consumers and households hard. Access the article through the USC library website. Once logged on to the library, search for the Australian Financial Review. The article appears in the issue of 27 May 2017. Answer the questions below, in around 100 -150 words for each part. (a) ‘Philip Lowe has pointed out - there are still voices arguing for a lower cash rate. ’ What are the factors that suggest a lower cash rate would be appropriate? (b) ‘"The RBA should hike to attract much-needed offshore capital, " says TD Securities economist Annette Beacher… “Funding the current account isn't the issue (it's less than 1 per cent of GDP at the moment) but funding our fiscal deficit folly is the problem, " she warns. ’ Explain Annette Breacher’s view that the cash rate should be higher and discuss any additional evidence in the article in favour of a higher cash rate. (c) What are the ‘disinflationary’ forces at work in the Australian economy and what effects are they having on consumers? (d) Explain what the ‘wealth effect’ is and how it could affect the economy if the housing market in Sydney and Melbourne were to crash. 10

(a) ‘Philip Lowe has pointed out - there are still voices arguing for a lower cash rate. ’ What are the factors that suggest a lower cash rate would be appropriate? 11

EXAMPLE OF A GOOD STUDENT RESPONSE The voices calling for a lower cash rate are concerned for the following reasons. Although still positive, the growth rate of GDP has sharply dropped from 2. 4% to 1. 5%. Using aggregate supply and demand theory, if the demand schedule is moved to the right the economy’s output will increase. Monetary policy can be used to shift the aggregate demand to the right by reducing interest rates. An increase in growth and output would increase the revenue the government could collect via taxes. This is due to being able to tax this higher output (volume) and also the increase in workers’ wages would increase tax revenues. The latter is fortuitous for the government as they can also take advantage of bracket creep to assist in increasing revenues and in bringing the budget back to surplus sooner. Lower interest rates will decease mortgage repayments allowing households to pay down record private debt levels. The inflation rate is still well below the RBA’s target of 2 -3%, so a rate rise can be justified. Too little inflation can lead to deflation. This could be dangerous for the economy as consumers delay purchases on large items as prices are always decreasing and this lower demand would decrease output. 12

(b) ‘"The RBA should hike to attract muchneeded offshore capital, " says TD Securities economist Annette Beacher… “Funding the current account isn't the issue (it's less than 1 per cent of GDP at the moment) but funding our fiscal deficit folly is the problem, " she warns. ’ Explain Annette Breacher’s view that the cash rate should be higher and discuss any additional evidence in the article in favour of a higher cash rate. 13

EXAMPLE OF A GOOD STUDENT RESPONSE Annette Breachers’ view that the cash rate should be higher is that higher interest rates will attract much needed offshore capital to fund the fiscal deficit and allow the government to build more infrastructure. She states that foreign investors will withdraw investment if the financial rewards are not there. This is because they will not get the return on capital that they expect if interest rates are low. Currently this is important because of the increase in the US rate. If we increase the cash rate in Australia it will maintain a margin above the US rate. Furthermore, a higher cash rate limits the risk of a ‘housing blow out’ as it will discourage unacceptably high leverage against property investments especially in high price markets such Sydney and Melbourne. 14

(c) What are the ‘disinflationary’ forces at work in the Australian economy and what effects are they having on consumers? 15

EXAMPLE OF A GOOD STUDENT ANSWER Disinflation is when the inflation rate decreases. The article states that annual growth slowed to 1. 5 per cent from the 2. 4 per cent recorded last year and points to a contraction in the nation’s economy in the third quarter of 2016. It is predicted that the economy may have expanded just 0. 1 per cent in the first quarter of 2017 meaning that the economy will have contracted for the second time in 9 months. The effect of Cyclone Debbie on exports, collapsing wage growth and high underemployment are other forces underlying this period of disinflation. Construction, a key employment sector and the main engine of growth sustaining the economy, has slowed as has the retail sector. Factors underlying the slowing of the retail sector are competition from abroad crunching margins and the fierce supermarket price battles caused by the entrance of new players, such as Aldi, into the Australian retail market resulting in a slowing down of the consumer price level. While consumers have been making the most of low interest rates and cheaper retail goods, they have been dipping into savings to cover the absence of wage growth and are feeling nervous about their future finances. The article also points to falls in Sydney and Melbourne Auction clearance rates and an increase the sale of second hand vehicles. 16

(d) Explain what the ‘wealth effect’ is and how it could affect the economy if the housing market in Sydney and Melbourne were to crash. 17

EXAMPLE OF A GOOD STUDENT RESPONSE The “wealth effect” is when investors feel better off when the prices of their assets rise in value. This effect can cause these investors and consumers to spend more thus increasing GDP and supporting employment growth. The large increases in Australian house prices can have a two-fold effect. First, the psychological effect on owner-occupiers can cause them to feel more comfortable and consume more. Secondly, some home owners may even use equity in their property to keep their standard of living up to a certain level even with slow wage growth. When there is a housing market crash or even major price correction in Sydney and Melbourne, this wealth effect will evaporate and what may eventuate will be the reverse with a “poverty effect”. This is where consumers feel vulnerable and stop spending as much as possible. This then spreads the effects of a housing crash to all the other industries where the homeowners were previously spending their “wealth affected” discretionary dollars. The worst affected households would be those that may end with negative equity in their properties. This loss of “wealth effect” would reduce consumption and demand. Unemployment may rise and the reduction in consumption could even bring about a recession. 18