VCAA Economics An introduction to microeconomics: the market system, resource allocation and government intervention

Answer(s) could include:

Tariff diagram:

• price – Y axis, quantity – X axis
• tariff originally set to raise price in market and raise government revenue eliminated
• domestic supply falls, imported supply rises
• domestic consumption expands.

Tariff explanation and short-term effects:

• reduction in price for consumers and expansion in domestic consumption
• switches consumption from domestic producers to imports
• decrease the cost for domestic producers if an imported capital item
• domestic suppliers sell less for less
• possible reduction of government revenue from tariff
• reference to DWL and market effects (CS, PS, TS).

Subsidy diagram:

• price – Y axis, quantity – X axis
• supply curve shifts to the left for domestic suppliers (decrease)
• increased gap between local supply and local demand
• price remains at world price
• domestic consumption is unchanged.

Subsidy explanation and short-term effects:

• increased domestic costs as subsidy removed
• lower competitiveness against imports
• decreased domestic production
• imports increase
• reduction of Government subsidy cost.
• reference to DWL and market effects (CS, PS, TS).

Longer term effects of tariff elimination:

• reduction in retaliatory tariffs
• less Government revenue for spending in other areas
• increase in economic output and employment through increased free trade
• structural change in the economy as resources such as labour shift from uncompetitive trade exposed industries to competitive industries
• higher national income.

Longer term effects of subsidy elimination:

• efficient producers are advantaged
• decreased burden on the tax payer
• promotes innovation in the economy
• government expenditure can be re-allocated to more effective areas of social need.

Answer(s) could include:
Model:

• Fully labelled exchange rate model, correctly showing either increased demand for AUD or decreased supply of AUD

Factors:

• demand for mineral commodities, e.g. high prices for iron ore, gold, coal
• strong economic growth in China, increase quantity of exports
• foreign investment entering Australia
• terms of trade, high prices for mineral commodities
• interest rates (differential rising)
• lower domestic growth in Australia
• declining global interest rates (reducing debt servicing flows).

Answer(s) could include:

Positives:

• domestic businesses (such as retailers, manufacturers and farmers) gain when they import components/inputs/capital goods – now cheaper with the higher AUD
• lower production costs, therefore higher profits
• Australian businesses that sell imported goods will benefit (retail).

Negatives:

• domestic import-competing firms negatively impacted
• exporters have reduced income (less competitive), depending on demand elasticities, contracts
• decreases foreign investment, e.g. less capital flows into share market and bonds.

Other answers could include:

• size of the effect is determined by:
  (i) elasticity of demand for Australian produced goods
  (ii) drag effect of exports declining having long term negative impacts on the business sector.

A fiscal opportunity cost involves the choice between a budget decision chosen and the next best spending alternative, e.g. to increase defence spending instead of additional spending on education.
Significant and long-term expenditure restricts the government's capability to stabilise the economic cycle over time, because it locks in higher recurring spending. In this situation, the government would be less able to respond to peak or trough economic conditions.