During the early period of Australia, there had been significant difference between the unemployment and their inflation rate. Phillips curve an economic tool used to depict the inverse relationship of unemployment and inflation (DeLong, 1998) had shown that the sudden drop of unemployment rate in Australia in the early 1990’s by hiring relatively “young” workers from the labor pool had imposed a pressure for the wage rate to increase.
By the time the wage rate increase, in order for the profit of the companies not to be affected, what are they go to do is to pass that additional wage rate to the consumers by increasing their prices and so with the rest of the story. As we can see here, the influx of young laborers in the economy made the labor force to increase enough, enough for them to have bargaining power to their employers with regards to their wages (Henry, 2007).
If there had been an expansion in the demand of the consumers, see Appendix 1, I believe that those corporations operating in the market would take advantage of the situation by increasing not only their production level but also their prices since they think that consumers’ will still buy the goods even at a higher price due to their larger demand. This situation is very different with that of the wage rate increase. Here, it is not the production costs of the company that is being concerned but rather the expectation and the ability of the corporations to take advantages of various opportunities available in the market.
The reason for the inflationary demand to prevail is due to the fact that consumers would no longer care with the prices of the goods since they demand it greatly. With this, the increase in demand would just add up to the inflation rate made by the influx of “young laborers in the economy. But I believe that the inflationary effect of the increase in the consumer’s demand would just be on the short run. Meaning, the large demand of consumers would deplete due to the increase in the supply of the producers.
Little by little the demand of the consumers would now be fulfilled and they would no longer shortages in the market that would happen. At the end of the day, Australia experienced a significant level of inflation rate due to these driving factors. With regards to the inflation targeting of the government, one measure being used by policy makers to prevent much higher inflation rate, the idea behind it is to preserve the low level inflation rate after the recession years of the Australian market.
The Australian policy makers make their inflation rate to be “fixed” at 2-3%, low enough to have a sustainable development in the market (Stevens, 2003). As for the case wherein there would be no inflation targeting in the economy, see Appendix 2, well, prices would continue ballooning since the corporations and other businesses could raise their prices freely. As prices increases, the demand of the consumers from a specific good would surely decline as based from the law of demand which states that as price increases consumers demand less of that good (Curriculumlink.
org, 2007). The only benefit that the economy would get from not having inflation targeting is that there would be no laying-off of workers in this case since the wage rate burden would just be passed by the companies to the consumers. Having inflation targeting in the economy would mean that the companies would no longer have the chance to easily increase their prices just like before since they are being monitored by the government. By this, consumers would now enjoy goods that are cheaper which gives way for their demand to increases.
Price is one of the major determinants of consumer’s level of demand. The only consequence of this government strategy is that, corporations could no longer afford to have large amount of workers since they could not be able to pass anymore the burden on the additional operational expenses of the company with the hiring of more workers. As a result, they would laid-off those “excess” workers of the company in order to cut their operational costs on wages. By this, they would no longer have to increase their prices.
The laying-off of the workers would generally mean that the unemployment rate would now start to increase until it reaches a level corresponding to the 2-3% inflation of the economy. Question 2 Having a supply shock, let’s assume that the supply shock here is due to the increase of supply, in the market would mean there is a sudden increase in the amount of available goods in the market for a very short period of time. There could have been a lot of factors that contribute for this event to happen in the economy. It could be the cause of import flooding in the market.
It could also be the inventory liquidation of large corporations in the market. What ever may be the reason of its occurrence, the general effect in the market would still be the same- surplus. Having a surplus seems positive to our ears. But what most of us do not know is that there also negative effects on the welfare of most market parties in the economy. Like the significant drop in the prices could be detrimental to most of the businesses in the market since they could no longer be able to at least break even with the costs that they incur in producing those products (Tutor2u.
com, 2007). In order to save the welfare of these companies, the government would have to buy the excess goods in the market in order to prevent the price from further lowering and so with the fluctuation of inflation. Buying the excess goods in the market would at least lessen the available supply in the economy and thus, the demand of the consumers could increase again. The reason why the government has to buy those excess supplies in the economy is for the simply reason that they don’t what to fluctuate violently the inflation rate since they want to maintain it at a 2-3% level.
This is the reason why “things can be more difficult” for the economy to handle the occurrence of supply shock given that they are implementing inflationary targeting is because the government would spend much money in buying the excess supplies in the market in order to preserve their target inflation rate. Just imagine billions of dollars are being spent in order to finance this government policy. Well, there are certain cases wherein the government would have to buy the excess supplies in the economy in order to protect the interest of the small producers.
For instance, during the season of rice harvesting, it is expected that the supply of rice in the market would increase, prices of rice decreases due to the existence of excess supply of rice. Small farmers profit will be harmed by the lowering of the prices and in order to at least make the small farmers break even with the costs of planting rice, the government would buy the excess rice in the market and store it to warehouses which can be use during off-seasons of rice. This “support” from the government would somehow beneficial to small producers in the market.