Myra Azwan P4 B6

In 2009 there were huge fires in Australia which destroyed much property and countryside.
The government promised to allocate a large amount of money and resources to help with
the restoration of the area.

(a) With the help of diagrams explain what is meant by efficiency in the use of resources.
[12]

Efficiency is the optimal use of scarce resources to produce the largest possible output. Efficiency
can be split into two sections; productive and allocative. Productive efficiency it he most efficient
use of scarce resources and when the maximum output is produced with the minimum of
resources. In a diagram which illustrates the average total cost curve due to production at the
lowest possible cost, it is the minimum point of the average cost curve.

This is due to the possibility of firms having a number of average cost curves and production
needs to be on the lowest point on the lowest average total cost curve; technical efficiency. In an
economy, the production possibility curve shows productive efficiency. In the Figure 1.2 above,
there is a two-product economy and scarce resources are allocated to the production of these
goods. The curve shows the possible combinations of production for the two goods. When there
is a point inside the curve, A, it shows that there are unused resources that could be used for the
production of either one of those goods or a combination of both. Any point on the curve
however, show indicates that all resources are being used to produce a combination of the goods.
This is when productive efficiency is maximised.

Allocative efficiency however, is the quantity of output produced in regards to consumers’ best
satisfaction, emphasising that the right products are produced in an economy. This stems from
the utility derived from a particular combination of goods. In a diagram, this is when the price is
equal to the marginal cost of production (P=MC). In Layman’s terms, it is when the value put on
resources by the producer is equal to the value put on the product by the resources by the
consumer.

Myra Azwan P4 B6

Figure 2 above shows allocative efficiency in a perfectly competitive market. We can see where
MC intersects with the price represented by the horizontal demand line (D=AR=MR), showing that
the firm is producing at an allocative efficient output (Q1).

(b) Discuss the economic implications of the government’s approach to the situation. [13]

It is stated that the government was planning to allocate funds and resources to restore the areas
affected by the fires. The way the government chooses to do so may be through different policies
they implement throughout this period, such as fiscal or monetary policies, which all end up
affecting the government expenditure in the end.

The government may choose to use fiscal policies to provide funds for this approach. This is
when they adjust their spending levels as well as tax rates to influence the economy. The
government may choose to either spend more and tax less or tax more and spend less. The
government could increase spending on the restoration of the area, though subsidies or rewards.
For example, the government could choose to spend on better and more effective equipment to
rebuild and restore the area. The government could also subsidise food production and supplies
for those affected by the fires to manage the standard of living in affected areas. At the same
time, the government can lower taxes to approach the situation. The government can again
regulate goods and services tax and other indirect taxes to lower the burden of those who are
affected by the fires. If the government were to reduce taxes, household income would be
affected. Those affected by the fires would be able to use the money they would’ve spent on
taxes to purchase necessities or to cover other bills they might be struggling to pay (such as
damage and repair fees). However, those unaffected by the fires can enjoy this reduction of tax
and spend more on goods and services now that their disposable income has increased. They
can focus on other sources of income now that taxes (may also include direct taxes to business
owners) and improve their standard of living. If not managed, inequality among citizens may arise.
Generally, if government spending were to increase where it would only benefit those affected by
the fires, it would not have much impact on the economy as a whole.

Furthermore, the use of fiscal policy may affect other parts of the economy, and the government
will have to choose between what they should spend on in order to achieve the best outcome
(opportunity cost). A change in fiscal policy may affect employment levels as a reduction of tax
may lead to more workers being unemployed to cover the costs of bearing more of the tax
burden. If this were to be seen across the country, this may lead to further economic problems,
halting growth and development. The implementation of fiscal policy also brings about risks of
inflation if they do not plan accurately and balance between the right amounts of spending and
taxes to reduce/increase (which is hard to determine). When there is higher unemployment, there
is also a reduction in spending in the economy and people are looking to save their money for
necessities. With a surplus of goods in excess, it decreases the value of money and pushes prices
up further.

Monetary policy involves the use of money supply and interest rates, mainly used to achieve the
control of inflation, increasing consumption, growth and liquidity. If the government were to
increase money supply in an economy to stimulate spending and put more in the circulation of the
economy, the government can use this to spend on the restoration of the area. The government
will also be faced with the decision regarding imports and domestic goods. If the government
wanted to increase spending on the restoration, it cannot afford to have its import expenditure
exceed the domestic expenditure, and will likely impose measures like tariffs on imported goods.
This is to prevent consumption of imports, affecting the overall balance of payments (much like
the goal of autarky in Germany during the Second World War). A declining balance of payments
position would also affect the economy wholly, with a fall in confidence and reducing foreign
direct investment. In contrast, the government could increase their interest rates to attract this
investment, which might also increase the money in circulation to spend on the restoration.

Myra Azwan P4 B6

In conclusion, the government’s choice to allocate a large amount of money and resources to
restore the areas affected by the fire may have economic implications such as the situation of
employment, the choice between imported or domestic goods as well as how it affects
household/average incomes and expenditure patterns. Either way, the government would face
opportunity costs of these decisions and will have to decide what to allocate their money towards
that would produce the most benefit for the people and economy of Australia.