Question

Using the short-run model, describe the likely effects on Australian aggregate out- put in the short run in each of the following circumstances. Provide brief explanations (2 points each) a) There is deep recession in Europe. b) (Australian) housing values rise above their trend c) Mortgage lenders (in Australia) raise interest rates. d) The (Australian) government decides to close 20 percent of its military bases around the country. e) The long-run interest rate rises.

Answer 1

a)

Due to deep recession in Europe, the demand for Australian goods by Europeans will fall as people will start demanding less imports. Therefore, aggregate output will fall.

------------------------------------------------------------------------

b)

If the housing values rise above the trend, people will have an unanticipated gain in their wealth in the form of the increased value of their asset and therefore, they'll demand more of the goods to utilize that increased wealth and so, aggregate output increases.

------------------------------------------------------------------------

c)

If mortgage lenders raise interest rate, it will become expensive for people to take loans and therefore, they will have less money to spend. This will reduce the aggregate output.

------------------------------------------------------------------------

d)

Closing 20% of military bases will make the country more prone to attack from other countries but will also result in laying off the people who were working in those bases. This will increase the unemployment, reduce the money that people will have and so does the demand. Thus, aggregate output will fall.

------------------------------------------------------------------------

e)

If government raises long run interest rate, it will become expensive for people to take loans and therefore, they will have less money to spend. This will reduce the aggregate output.