Question 1: On April 24, 2013 a factory collapse in Savar, Bangladesh killed more than
1,100 workers. Most of these workers were employed by factories producing garments
for Western markets, including Australia. Such tragic incidents have led to a concerted
effort by some retailers to sell ethically-produced clothing.1 These retailers are essentially
betting (hoping?) that consumers will appropriately value such clothing. Is there any
evidence to support this? A study conducted by the research firm McCrindle found that
eight out of 10 Australian consumers are willing to buy a product that has a charitable
component over one that does not as long as the price between the two are similar.2 This
need for prices to be similar highlights the challenge faced by many socially conscious
retailers. As long as a garment produced in a safe workplace costs more than a similar
garment produced in an unsafe workplace, the retail price for the former will always be
higher. This may explain why, when it comes to buying ethical clothing, Australian
consumers “do not put their money where their mouth is”.3
Motivated by the behaviour of Australian consumers referred to above, consider a
1By ethically produced I mean garments that are produced in safe workplaces. In other words, I
am leaving out concerns about the use of sustainable production methods in the worldwide garments
industry. All of our conclusions about how to induce consumers to switch to garments produced in safe
workplaces also apply to a scenario where we are interested in inducing consumers to buy garments
produced using sustainable methods.
2As reported in Carmody, Broede, 2014. “Australian shoppers prefer ethical and Fairtrade products:
study.” Smart Company, May 30.
3Han, Misa, 2016. “Slow fashion a poor fit for mainstream consumers.” Australian Financial Review,
April 22.
1
model where a consumer must decide how much of a garment to buy. Suppose that this
garment comes in two varieties: (a) a low quality variety that is produced in an unsafe
factory overseas and (b) a high quality variety that is produced in a safe factory overseas.
Let us suppose that this consumer’s preference for the two varieties can be represented
by the following utility function:
u = XL + XH (1)
where XL = 0 is the number of units of the low-quality variety that she purchases and
XH = 0 is the number of units of the high-quality variety that she purchases. Let the
price of these varieties be PL and PH respectively and let this consumer’s income be I.
(a) [2 marks] Suppose that PH > PL. How much of each variety will this consumer purchase?
Use a diagram with XH on the horizontal axis to explain.
To see whether we can induce this consumer to buy more of the high-quality variety,
now suppose that the consumer’s utility not only depends on her purchase of each variety,
but also on her reputation in society. This means that we can now write her utility
function as follows:
u = XLR + XH (2)
where
R = D + vXH (3)
represents her reputation in society. This reputation is an increasing function of the
amount of the high-quality variety that she purchases. In other words, in this model,
the consumer’s decision to purchase the high-quality variety is motivated by both the
utility that this decision will provide as well as the enhancement to her reputation. This
means that purchasing XH allows this consumer to engage in “virtue signaling”. That
is, it allows her to signal to the rest of society that she is a socially conscious consumer
that buys ethical garments. We will assume that buying the low-quality variety does not
affect her reputation.
In this model, D represents this consumer’s baseline reputation. It is her reputation
if she chooses to not purchase the high-quality variety at all. In contrast, v represents
the increase in her reputation from a one unit increase in the her purchase of XH.
(b) [10 marks] Suppose that PH = 2 and I = 20. Using this information as well as (2) and
(3), find this consumer’s optimal consumption of each variety. The optimal consumption
levels should be a function of PL, D, and v.
Now suppose that a group of socially conscious retailers develop a campaign to induce
more consumers to purchase ethical garments. The key element of their campaign
will be to attach a label to their garments that will certify that the garment has been
produced in a safe workplace overseas. The advantage of this symbol is that it will allow
a consumer to signal to society that she is socially conscious. That is, the symbol will
allow the consumer to enhance her reputation by purchasing the high-quality variety.
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(c) [4 marks] Let us assume that the use of this symbol increases this consumer’s v from
0.5 to 1. You can also assume that D = 3, PL = 0.5, PH = 2, and I = 20. Use a
diagram with XH on the horizontal axis to illustrate this consumer’s indifference curve
for both values of v. Can you infer from this diagram alone whether the higher v makes
this consumer better off or not? Explain. [Hint: when drawing the diagrams for this part
you can assume a fixed value of u = 130.13.]
(d) [2 marks] One way to measure the magnitude of the effect of a change in v on XH is
to calculate an elasticity. Specifically, define the elasticity of XH with respect to v, e
v
, as
e
v =
Percentage change in XH
Percentage change in v
Calculate this elasticity when v changes from 0.5 to 1. You can continue to assume
that D = 3, PL = 0.5, PH = 2, and I = 20.
Another way to increase the consumption of XH is to tax XL. This tax will raise
the price of XL, PL. We can measure the impact of such a tax using the elasticity of XH
with respect to PL. Let this be defined as
e
PL =
Percentage change in XH
Percentage change in PL
(e) [3 marks] Calculate this elasticity when PL changes from 0.5 to 1. Here you can
assume that D = 3, v = 0.5, PH = 2, and I = 20. Compare this elasticity with the one
you calculated in part (d). What does this imply about the effectiveness of a tax on XL
relative to exploiting a consumer’s desire to engage in virtue signaling?
(f) [4 marks] State and explain two limitations of this model that might lead you to be
unconvinced that virtue signaling is more effective than the tax

Australian Financial Review

This article is extracted from Australian Financial Review July 17, 2015
Author: Rose Powell
Australian dollar’s next stop? US65¢ predicted as commodity prices decline

by Rose Powell
Falling commodities prices have slammed the currencies of resource and agriculture-heavy
economies, including Australia, where analysts are forecasting the dollar to weaken further, possibly
to US65¢.
Major fund manager BlackRock is forecasting a continued slide to US70¢ by the end of the year.
Capital Economics went further, anticipating an even faster fall to US65¢ by the end of 2016.
On Friday the Australian dollar was trading at US74¢, down 1.51 per cent in the past week.
The currencies of commodity-heavy economies such as Australia are the worst-performing this year
as falling commodity prices pressuring similar countries New Zealand and Canada to cut interest
rates as markets ready for them to continue to drop.

1

While Australia grapples with lower key commodity value such as iron ore, deteriorating commodity
prices forced the Bank of Canada to lower its benchmark to 0.5 per cent in a bid to stimulate the
economy on Thursday night.
New Zealand is also expected to cut rates again, from 3.25 per cent to 3 per cent as dairy prices
continue to decline.
“The dollars of Australia, New Zealand and Canada have been three of the worst-performing major
currencies so far this year. Despite the fact that they have already fallen a long way, we expect them
to weaken further,” Capital Economics John Higgins said.
Commonwealth Bank chief currency strategist Richard Grace said the declining commodity prices
were creating huge and sustained impact on the dollar and economy.
“The dollar is very sensitive to commodity prices,” Mr Grace said. “Commodity prices and terms of
trade are the clearest long-run indicators for the Australian dollar and economy.”
He added interest rates were likely to stay low or be cut again as the Reserve Bank of Australia (RBA)
dealt with below-trend gross domestic product and softer domestic demand that is placing upwards
pressure on unemployment.
If the dollar declines too far, Australia’s terms of trade could become so steep that businesses cut
back on importing new technologies, influencing their international competitiveness, which flows
through to employment concerns.
“Capital imports have been falling for a few years because mining investment has slowed so much,”
Mr Grace said. “We’ve not seen a threshold with the dollar crossed yet, but it would be difficult for
retailers to raise prices amid upward pressure on unemployment.”
Commodity prices are likely to continue to decline. Last week, the International Monetary Fund
revised down its forecast for global growth, indicating the glut of commodities is likely to push prices
down as demand slows.

2

“Financial markets are pricing in about an 80 per cent chance of an additional interest rate cut [in
Australia] by February 2016,” Mr Grace said.
Capital Economics is anticipating an interest rate cut of 0.5 per cent to 1.5 per cent by the RBA before
the March 2016.
While Australia, Canada and New Zealand are preparing to cut rates, the United States and United
Kingdom are likely to raise rates later this year, which would cause a further decline in value for the
Aussie.
The greenback reached a six-week high at the end of the week as the European Central Bank
announced liquidity boosting measures for Greece.
Fairfax Media Australia

Assignment
From the article titled ‘Australian dollar’s next stop? US65¢ predicted as commodity prices
decline’ (Australian Financial Review July 17, 2015), answer the following questions.
(a) Briefly summarise the main issues discussed in this article? [Not exceeding 200 words] –
(25 Marks)
(b) Using Demand and Supply model of exchange rate determination briefly explain how
AUD is determined in the forex market, and what factors influence its fluctuations. – (15
Marks)
(c) Using exchange rate data from Reserve Bank of Australia and graphs (monthly data of
last three years) analyse the movement of AUD relative to that of the US dollar? Is it in line
with the world commodity price movement during this period? Are there any other factors
contributing to this behaviour of the Australian dollar? – (25 Marks)
(d) Do you think that the AUD will fall as low as US 65C by the end of 2016? Justify your
answer. What advantages do you think Australia will have in such a scenario? – (15 Marks)
(e) If the market rate is US 65C then what action could the Reserve Bank of Australia take in
order to maintain the exchange rate at US 70C, and what side effects might this action have
on the Australian economy? Do you think that such actions would be effective? – (20 Marks)
Word Limit: 2000 words maximum. Word count (excluding references) must be provided.
Excess words will not be marked.

3

Instructions
1. This assignment is marked out of 100 and is worth 25 per cent of overall marks.
2. At least 4 relevant references are required regarding the issue featured in your
allocated topic.
3. Turnitin Report: It will be compulsory for all students to submit the written
assignment (final version) into the Turnitin system before submitting the hard copy to
the tutor. Students are encouraged to submit drafts of the assignment before the due
date, enabling students to check their referencing and rectify any issues before
submission of the final version.
a. In the absence of the submission of the Turnitin report, a zero mark will be
awarded for this assignment task.
b. A similarity index of less than 10 per cent is expected in your assignment.
Zero tolerance applies for plagiarism
4. Hand in your hard copy of the assignment to the tutor on or before Week 8 of
Trimester 3. Penalty applies for late submission.

4

Australian Financial Review

This article is extracted from Australian Financial Review July 17, 2015
Author: Rose Powell
Australian dollar’s next stop? US65¢ predicted as commodity prices decline

by Rose Powell
Falling commodities prices have slammed the currencies of resource and agriculture-heavy
economies, including Australia, where analysts are forecasting the dollar to weaken further, possibly
to US65¢.
Major fund manager BlackRock is forecasting a continued slide to US70¢ by the end of the year.
Capital Economics went further, anticipating an even faster fall to US65¢ by the end of 2016.
On Friday the Australian dollar was trading at US74¢, down 1.51 per cent in the past week.
The currencies of commodity-heavy economies such as Australia are the worst-performing this year
as falling commodity prices pressuring similar countries New Zealand and Canada to cut interest
rates as markets ready for them to continue to drop.

1

While Australia grapples with lower key commodity value such as iron ore, deteriorating commodity
prices forced the Bank of Canada to lower its benchmark to 0.5 per cent in a bid to stimulate the
economy on Thursday night.
New Zealand is also expected to cut rates again, from 3.25 per cent to 3 per cent as dairy prices
continue to decline.
“The dollars of Australia, New Zealand and Canada have been three of the worst-performing major
currencies so far this year. Despite the fact that they have already fallen a long way, we expect them
to weaken further,” Capital Economics John Higgins said.
Commonwealth Bank chief currency strategist Richard Grace said the declining commodity prices
were creating huge and sustained impact on the dollar and economy.
“The dollar is very sensitive to commodity prices,” Mr Grace said. “Commodity prices and terms of
trade are the clearest long-run indicators for the Australian dollar and economy.”
He added interest rates were likely to stay low or be cut again as the Reserve Bank of Australia (RBA)
dealt with below-trend gross domestic product and softer domestic demand that is placing upwards
pressure on unemployment.
If the dollar declines too far, Australia’s terms of trade could become so steep that businesses cut
back on importing new technologies, influencing their international competitiveness, which flows
through to employment concerns.
“Capital imports have been falling for a few years because mining investment has slowed so much,”
Mr Grace said. “We’ve not seen a threshold with the dollar crossed yet, but it would be difficult for
retailers to raise prices amid upward pressure on unemployment.”
Commodity prices are likely to continue to decline. Last week, the International Monetary Fund
revised down its forecast for global growth, indicating the glut of commodities is likely to push prices
down as demand slows.

2

“Financial markets are pricing in about an 80 per cent chance of an additional interest rate cut [in
Australia] by February 2016,” Mr Grace said.
Capital Economics is anticipating an interest rate cut of 0.5 per cent to 1.5 per cent by the RBA before
the March 2016.
While Australia, Canada and New Zealand are preparing to cut rates, the United States and United
Kingdom are likely to raise rates later this year, which would cause a further decline in value for the
Aussie.
The greenback reached a six-week high at the end of the week as the European Central Bank
announced liquidity boosting measures for Greece.
Fairfax Media Australia

Assignment
From the article titled ‘Australian dollar’s next stop? US65¢ predicted as commodity prices
decline’ (Australian Financial Review July 17, 2015), answer the following questions.
(a) Briefly summarise the main issues discussed in this article? [Not exceeding 200 words] –
(25 Marks)
(b) Using Demand and Supply model of exchange rate determination briefly explain how
AUD is determined in the forex market, and what factors influence its fluctuations. – (15
Marks)
(c) Using exchange rate data from Reserve Bank of Australia and graphs (monthly data of
last three years) analyse the movement of AUD relative to that of the US dollar? Is it in line
with the world commodity price movement during this period? Are there any other factors
contributing to this behaviour of the Australian dollar? – (25 Marks)
(d) Do you think that the AUD will fall as low as US 65C by the end of 2016? Justify your
answer. What advantages do you think Australia will have in such a scenario? – (15 Marks)
(e) If the market rate is US 65C then what action could the Reserve Bank of Australia take in
order to maintain the exchange rate at US 70C, and what side effects might this action have
on the Australian economy? Do you think that such actions would be effective? – (20 Marks)
Word Limit: 2000 words maximum. Word count (excluding references) must be provided.
Excess words will not be marked.

3

Instructions
1. This assignment is marked out of 100 and is worth 25 per cent of overall marks.
2. At least 4 relevant references are required regarding the issue featured in your
allocated topic.
3. Turnitin Report: It will be compulsory for all students to submit the written
assignment (final version) into the Turnitin system before submitting the hard copy to
the tutor. Students are encouraged to submit drafts of the assignment before the due
date, enabling students to check their referencing and rectify any issues before
submission of the final version.
a. In the absence of the submission of the Turnitin report, a zero mark will be
awarded for this assignment task.
b. A similarity index of less than 10 per cent is expected in your assignment.
Zero tolerance applies for plagiarism
4. Hand in your hard copy of the assignment to the tutor on or before Week 8 of
Trimester 3. Penalty applies for late submission.

4