This document discusses macroeconomic concepts including inflation, aggregate demand, aggregate supply, and monetary policy tools. It provides examples of different types of inflation and how they impact the economy. The effects of various economic events on mainland China's economy are analyzed using aggregate demand and supply diagrams. The importance of economic growth and managing uncertainty in budgeting is covered. Monetary policy tools like contractionary monetary policy are explained in the context of reducing demand-pull inflation.

1. 1
Master in Business Administration
Macro-Economics
Assignment 2
Ismail Bin Ahmed
December 2006
University of Ballarat
SCHOOL OF BUSINESS

2. 2
ASSIGNMENT TWO
Exercise Questions on Macroeconomic Environment for Business
QUESTION 1
Inflation is the continuous increase in the general price level. It can be categorised
into:
- Demand-pull inflation
- Cost-push inflation
- Imported inflation
Unexpected inflation is considered to be an economic problem because it
 creates inflationary gap
 creates deflationary gap
Runaway inflation is conducive to rapid and violent social and political change
because
 Individuals and businesses develop an inflation psychosis, causing them to
buy quickly in order to avoid paying more tomorrow.
 Huge unanticipated inflation jeopardizes debtor-lender contracts, such as
credit cards, home mortgages, life insurance policies, pensions, bonds, and
other forms of savings.
 Hyperinflation sets a wage-price spiral in motion. This is a situation when
increases in nominal wage rates are passed on in higher prices, which, in turn,
result in even higher nominal wage rates and prices.
 Because future rate of inflation is difficult or impossible to anticipate, people
turn to more speculative investments that might yield higher financial returns.
Demand-Pull Inflation
AS
Real GDP
AD2
e2
Pp
Price level
output
e1
Inflationary gap
AD1
Causation Chain: Consumers may not be the only villain in Demand-Pull Inflation.
For example: Increase in Government spending in the Mega-Projects - Increase in
the Aggregate Demand -- Demand-Pull Inflation.

3. 3
Demand-Pull Inflation is often expressed as "too much money chasing too few goods"
and occurs at or close to full employment, when the economy is operating at or near
full capacity. When Demand-Pull Inflation occurs, the monetary authorities can assure
markets, consumers and producers keep inflation low by CFP or CMP.
Cost-Push Inflation
AS1
Real GDP
AS1
AD
e2
Pp
Price level
output
e1
e1
Inflationary gap
AS2
Causation Chain: Increase in oil prices - Decrease in the Aggregate Supply--
Cost-Push Inflation.
Cost-Pull Inflation can be caused by any sharp increase in costs to businesses.
Businesses can also contribute to Cost-Pull Inflation by raising prices to increase
profits. When Cost-Pull Inflation occurs, the monetary authorities can assure markets,
consumers and producers will keep inflation low by EFP or EMP.
According to Phillips curve,
inflation ↓ → unemployment ↑
Movement along the Phillips curve (based on A.W. Phillips)
Inflation
rate %
Unemployment rate %
Thus the opportunity cost of assuring that markets, consumers and producers will
keep inflation low is the creation of unemployment

4. 4
QUESTION 2
Aggregate Expenditure (AE) is represented by the formula:
AE = C + I + G + (X – M)
Examples of each of the 4 types of aggregate expenditure are:
C = Consumption such as spending on necessities such as food, clothing, housing
and spending on consumer durables such as whitewoods, electrical equipments and
holidays.
I = Investment such as spending on capital equipment (equipment used by business
to help produce goods and services)
G = Spending on government consumption and investment expenditures.
(X-M) = Net exports.
The largest component is C (consumption) for developing nations and G for
developed nations.
The largest share of GDP in Malaysia is represented by C (consumption).
AEMalaysia = C + G + I + (X + M)
An expenditure component can be negative if:
For example, if G = Interest and if the G does not spend
OR
If, for example, the net exports,
X – M = RM70 – RM100
= - RM 30 million

5. 5
QUESTION 3
Aggregate supply (AS) curve is defined as the curve that shows the level of real
GDP produced at different possible price levels during a time period, ceteris
paribus. Simply, it shows the total dollar amount of goods and services produced in
an economy at various price levels.
The short-run Aggregate supply (SRAS) curve
Pp level
Real output, Y
SRAS
Situation I: depression range –
firms have excess capacity &
are willing to sell more at
the same prices.
Situation II: Intermediate or normal
range - increased prices are necessary to
induce firms to supply more
- China, India and developing nations
Situation III: Classical range - the
economy nears its physical
production limit - price level
changes have no effect on supply.
- US, Japan and developed nations
In the Keynesian Model, conditions underlying each of the three major segments
along a short-run aggregate supply curve are:
Situation I
Pp Level
Real Output, Y
SRAS

6. 6
Situation II
Pp Level
Real Output, Y
SRAS
Situation III
Pp Level
Real Output, Y
SRAS

7. 7
QUESTION 4
Keynes theoretical General Theory model is still relevant for the twenty-first
century market based economies as because of the relevancy of Business Cycle
Model.
Business cycle model
Level of economic
activity(real GDP)
Time (years)
BoomBoom
Recession (slump)Recession (slump)
Downswing
Downswing
Upswing
Upswing
Slow downSlow down
RecoveryRecovery
Regular cycles of about
7 - 9 years
The regular fluctuations are caused by changes in the components of aggregate
expenditure.
• i.e. AE = C+I+G+(X-M)
We can identify the general factors which are likely to cause these changes and the
next course of action in business planning to be done.
Macroeconomists devote considerable time and energy to find out where the country
is on the business cycle, and what is likely to happen in the near future.
Such knowledge helps advise business, understand trends, and help policy makers
make good policy.

8. 8
QUESTION 5
Commentators tell us that we should put tariffs on or prohibit the import of goods
that are produced under sweat shop conditions or establishments with overworked,
underpaid employees in very hard and poor conditions.
Tariffs are the most popular and visible measures used to discourage trade. Tariffs are
imposed to reduce imports by raising import prices and to generate revenue for the
importing nation.
When tariffs are imposed, products become more expensive and economy becomes
worse off.
I see faults with this approach because in the difficult environment of developing
economies, the sweat shop environments produce
revenue
indirect protection for suppliers
QUESTION 6
Mining in Malaysia was active until the mid-80’s. The difference between then and
now in terms of mining to the performance Malaysian economy is that the
Malaysian economy now is rural-based and importance is emphasised in the
production of agricultural products.
Further more, based on the 2006 Budget, the manufacturing sector will continue to
grow at 6.8 %, the services sector, including ICT, tourism and education is projected
to increase by 6 %, the agriculture sector is anticipated to grow by 4.7 % while the
construction sector will further expand by 3.7% in 2007. Nothing about growth in the
mining sector was mentioned by the Finance Minister.

9. 9
QUESTION 7
Considering an economy that is initially at equilibrium level of real GDP, and using
aggregate demand and aggregate supply diagrams, the short-run and long-run
effects of the following events upon mainland China's economy are:
a) The Reserve Bank of Australia lifts interest rates.
When this happens,
Interest rate ↑ → causing high rate of returns in investment in Australia.
This causes investors to flock to Australia.
Therefore, Demand in China ↓
Thus, the Aggregate Demand (AD) curve in China shifts to the left.
Therefore, in China, recession takes place.
SRAS
Y
AD0
e0
Pp
Price level
e1
China Real GDP
AD1
LRAS
Po
P1
Y1
Effect: Recession takes
place in China

10. 10
b) There is an increase in private domestic investment spending.
Taking the domestic situation in China, increase in private domestic investment will
cause the Aggregate Demand (AD) curve in China shift to the right.
This situation creates an over unemployment in China.
SRAS
Y
AD1
e0
Pp
Price level
e1
China Real GDP
AD0
LRAS
P1
Po
Y1
Effect: Over
employment takes
place in China
c) An increase in international oil prices.
Increase in international oil prices will;
(From the supply perspective); P↑ → causing Demand ↓
Supply ↓  SRAS shifts to the left
SRAS1
Y
AD0
e1
Pp
Price level
eo
China Real GDP
AD1
LRAS
P1
Po
Y1
Effect: SRAS curve
moves to the left –
Long-run equilibrium
restored
SRAS2
e2P2

11. 11
d) An appreciation in the $Aust.
An appreciation in the $Aust will:
discourage investors to Australia
therefore, encouraging investors to China
→ Aggregate demand (AD) curve moves to the right.
SRASo
Y
AD1
e0
Pp
Price level
e1
China Real GDP
AD0
LRAS
P1
Po
Y1
Effect: SRAS curve
moves to the left –
Long-run equilibrium
restored
SRAS1
e) A fall in real estate prices in the capital cities
A fall in real estate prices in the capital cities will cause investors to:
Buy less in China
→ Aggregate demand (AD) shifts to the left.
At the same time, investors:
Buy more in Australia
→ Aggregate demand (AD) shifts to the right.
The supply curve doesn’t change.
SRAS
Y
AD0
e0
Pp
Price level
e1
China Real GDP
AD1
LRAS
Po
P1
Y1
Effect: SRAS curve
does not change

12. 12
QUESTION 8
The article "Pak Lah's Way of Managing the Economy" relates to the
macroeconomic issue covered in the course.
The key macroeconomic objective in the long run is economic growth. Sceptism about
Pak Lah's ability to manage the nation's economy is understandable because a good
grasp of the economic fundamentals is necessary to ensure economic growth which
will ensure higher levels of material welfare over time.
A country’s material welfare (standard of living) depends on its ability to produce
goods and services. Small differences in growth rates can lead to large differences in
living standard.
The PM needs to know:
• what economic growth is, why it is important, and how it is calculated
• whether the rate of growth can be changed by government policy
• that growth can be a ‘driving force’
The focus of economic policy in most developed countries during the 1950s - early
1980s was demand management - using fiscal and monetary policy to ‘fine tune’ the
economy and minimise fluctuations about the growth path.
The emphasis changed in the late 1980s. There is now more emphasis on long run
economic performance and the growth rate. Part of the reason for this was the very
success of developing economies such as Malaysia.
The article demonstrated that Pak Lah stressed on the government workforce to walk
their talk by providing more efficient civil service. Pak Lah insisted that the Treasury
speed up payments to contractors to enhance multiplier effect of money healthily
circulating in the economy.
The article explained that government action or policy can promote higher
productivity and faster economic growth by microeconomic reform to reduce barriers
to change and competitiveness such as inefficient public delivery system.

13. 13
QUESTION 9
Based on AD-AS graphical analysis, the Malaysian economy has continued to
expand year after year as depicted in the diagram below:
e2
AD=AE
eo
AD/AE
Y
90’s current
e1
AD-AS graphical analysis of the Malaysian economy
which expanded from the 50’s to current decade
70’s 90’s
50’s 70’s
45
Y = C+I+G+(X-M)
Y = C+I+G
Y = C+I+G+(X-M)
The macroeconomic dangers facing the BNM as the Ministry of Finance prepares
this year's federal budget are the uncertainties in the macro environment such as
possible political instability, global economic recession, war and natural disasters.
Budget is forecast revenue. Thus, if the government is having RM 140,000 million
revenue, the budgeted expenditure is RM 160,000 million.
There are uncertainties in preparing this year's (October 2007) national budget
because the data were keyed in March 2005, i.e. 18 months earlier. The national
budget is therefore not accurate.

14. 14
QUESTION 10
The Bank Negara decided to implement a Contractionary Fiscal Policy (CFP)
action. Thus, a Contractionary Monetary (CMP) takes effect.
The objective of the CMP is to reduce money supply [CMP → Ms
↓]
I expect the nominal interest rate to increase, the real interest rate and the money
supply to decrease [ i↑ → M0
↓]
This is because:
(i) increase in the interest rate leads to
(ii) increase in reserve requirement ratio
(iii) increase in people selling bonds
Where PC = Public Cash
BD = Bank Deposit,
When value V↓
 Ms
↓ i.e., Ms
= PC + BD
The circumstance which allows this type of policy action to be taken is when
demand-pull inflation occurs.
Demand-Pull Inflation due to increase in AD
Short term
Money
market
AD1
e1
Interest
rate %
Quantity of
Money
eo
Inflationary gap
ADo
po
p1
MS
By intervening in a key market for money, the short term money market, and affecting
the interest rate in that market, called the cash rate, the Bank Negara can influence
other interest rates in other markets.
This in turn affects interest sensitive spending - investment and consumer durables.

15. 15
The Bank Negara therefore indirectly affects spending, causing output and the level of
prices in the short run.
The Bank Negara takes account of economic conditions and sets a target cash rate
(rate banks charge one another for overnight loans).
The Bank Negara dealers then buy and sell government securities through open
market operations designed to achieve that target rate.
In essence, the Bank Negara is setting price of money, and allowing quantity of adjust
to achieve this price.
• The real balance effect - an increase in the price level decreases the real money
supply (and vice versa).
• Inter-temporal substitution effects - a fall in the price level will tend to bring
forward purchases of consumption and capital goods (and vice versa). The
price level also affects interest rates - the quantity of real money increases, the
demand for money falls, so interest rates fall, again shifting expenditure plans
from the future to the present.