Q3.

The goods and services tax (GST) was introduced in Australia on 1 July 2000. The preceding months before the GST became active saw a spike in consumption as consumers rushed to purchase goods that they perceived would be substantially more expensive with the GST. The effects of the surging demand on inflation and the central bank's policy responses (i.e., cash rate, the policy interest rate in Australia) are illustrated in Figure 1.

• Using the Aggregate Demand and Aggregate Supply framework, explain what happened to output and the price level when Australia introduced GST in the short run and in the long run. For simplicity, you may assume that the introduction of GST had no effects on the supply side of the economy.
• Draw a diagram using the Aggregate Demand and Aggregate Supply to explain your answer.

Inflation and Monetary Policy % Cash rate 7 Introduction 7 of the GST 6 6 5 5 4 4 3 3 2 2 1 Inflation* O 0 1993 1998 2003 2008 2013 2018 Treasury underlying inflation prior to the September quarter 1998; thereafter, year-ended CPI inflation Sources: ABS; RBA Figure 1: Inflation and monetary policy in Australia