Year 12 Economics.
Where the model has to explain the news.

Walkthrough

Step 1 — The cash rate is the rate at which banks lend overnight reserves to each other. An RBA increase makes overnight funding more expensive for commercial banks. Step 2 — Commercial banks pass the higher funding cost through to mortgage rates, business lending rates, and savings deposit rates. Variable-rate mortgages adjust within weeks; fixed-rate mortgages adjust as borrowers refinance or roll off fixed terms. Step 3 — Higher borrowing costs reduce household disposable income (existing mortgage holders have higher repayments) and reduce new credit demand (households and businesses delay or cancel debt-funded purchases). Higher deposit rates marginally encourage saving over spending. Step 4 — Lower consumption and investment reduce aggregate demand. With aggregate demand below productive capacity, firms face less pricing power and inflation pressure eases. Step 5 — Time lag. The full effect typically takes 12-18 months — sometimes longer when the housing market and fixed-rate mortgage rollovers are involved. The RBA Statement on Monetary Policy explicitly acknowledges this lag in its rate decisions. Step 6 — Limitations. Monetary policy is a blunt instrument — it affects the whole economy uniformly even when inflation is driven by specific sectors (e.g. energy, housing). It is also constrained when the source of inflation is supply-side (e.g. global oil prices, supply chain disruption), because raising rates does not increase supply. In those cases, fiscal or structural responses may be needed alongside monetary policy. Finally, the distributional effect is uneven: variable-rate mortgage holders bear the burden quickly, while renters and outright owners are less directly affected. High-band response distinguishes itself by including the lag and the limitations, not just the textbook transmission chain.

Walkthrough

Step 1 — Diagram setup. Axes: Price on vertical, Quantity on horizontal. Draw the domestic supply curve (upward) and domestic demand curve (downward). Add the world price line at P_w (horizontal — assume Australia is a price taker in steel). At P_w, domestic supply is Q_s and domestic demand is Q_d, with imports = Q_d − Q_s filling the gap. Step 2 — Apply the tariff. The world price plus tariff becomes P_w + $5 (a new horizontal line above the world price). At the new higher price: domestic supply rises to Q_s' (more domestic producers find it profitable to supply), domestic demand falls to Q_d' (consumers reduce purchases at the higher price), imports fall to Q_d' − Q_s' (smaller gap). Step 3 — Effects: • Domestic price rises from P_w to P_w + $5. • Domestic supply rises (Q_s → Q_s'). • Domestic demand falls (Q_d → Q_d'). • Imports fall. • Government revenue = $5 × (Q_d' − Q_s'), shown as the rectangle on the diagram between P_w and P_w + $5, bounded by Q_s' and Q_d'. • Producer surplus rises (domestic producers benefit from the higher price). • Consumer surplus falls (consumers pay more and buy less). • Deadweight loss appears as two triangles on the diagram — one on the supply side (production inefficiency: higher-cost domestic supply replaces lower-cost imports) and one on the demand side (consumption loss: consumers who would have bought at the world price are priced out). Step 4 — Net welfare. The loss in consumer surplus exceeds the gain in producer surplus plus government revenue, by the area of the two deadweight loss triangles. The economy is worse off in aggregate, even though specific groups (domestic producers, government) gain. Common mark loss: students draw the tariff as a shift in the supply curve. It is not. The tariff raises the effective import price, which raises the horizontal world-price line — domestic supply and demand curves do not shift. The change in domestic quantity supplied is movement along the supply curve, not a shift.