3. Economic Issues

Question 1

What is used to represent aggregate demand?

Answer 1

AD

Question 2

What is aggregate demand?

Answer 2

The total level of expenditure in an economy over a given period of time.

Question 3

What is aggregate supply?

Answer 3

The total level of income in an economy over a given period of time.

Question 4

What is used to represent aggregate supply?

Answer 4

Y

Question 5

What are the components of aggregate demand?

Answer 5

Y = C+I+G+X–M

C - consumption

I - investment

G - gov expenditure

X-M - exports-imports A.K.A Net Exports (NX)

Question 6

Finish the sentence…

“The economy is in equilibrium that is when the level of aggregate ?** and aggregate **? are ? “

Answer 6

The economy is in equilibrium that is when the level of aggregate demand and aggregate supply are equal.

Question 7

Name and describe the influences of consumption.

Answer 7

Consumer expectations - Expectations about future price rises and the general availability of goods will influence consumers’ decisions to spend or save their income. For example, if consumers expect a rise in income they tend to spend more and save less in the short term.

Interest rates - An increase in the general level of interest rates would discourage individuals from spending their money - as the cost of borrowing money is now higher - and therefore encouraging them to save.

The distribution of income - Low-income earners have a high APC and therefore are the highest contributors to the overall level of consumption and aggregate demand in an economy.

Question 8

What is consumption as a component of aggregate demand?

Answer 8

To figure out how consumption influences eco activity we must look at the factors that influence consumption for a given level of income. Put another way, our concern is with the proportion of total income that is spent on consumption, called the average propensity to consumer (APC).

Question 9

Name and describe the influences of investment.

Answer 9

Interest rates - Higher interest rates make it less attractive for firms to borrow funds making them less likely to invest in capital.

Government policies - A change in gov policies relating to investment allowances and tax concessions on capital goods. e.g if the gov allowed firms to claim the full cost of capital equipment immediately, instead of claiming depreciation over several years, reducing their tax liability.

Price/productivity of labour - Any change in the price or productivity of labour or technological innovations will affect the relative cost of capital compared with labour. For example, if the cost of labour increased or more advanced labour-saving technologies become available for the same cost.

Question 10

Name and describe the influences of gov expenditure.

Answer 10

Taxation/economic activity - When experience low activity, governments may increase expenditure and/or reduce the level of taxation to increase aggregate demand and boost growth. Alternatively, governments may reduce expenditure and the level of taxation to decrease aggregate demand and growth.

Question 11

Name and describe the influences of Exports - Imports/Net Exports.

Answer 11

Exchange rate - When Aus has a weaker exchange rate, domestic industries are more competitive as the relative cost to foreign consumers decreases, often resulting in increased net exports adding to aggregate demand and boosting growth.

Consumer tastes and preferences - Changing tastes and preferences in demands will influence the willingness of consumers to purchase products whether they may be imported or domestically produced.

International competitiveness - Australia’s agricultural industry is internationally competitive as it has a comparative advantage. This means that it can produce commodities more efficiently and at a lower cost for consumers, thereby making them more favourable on global markets.

Question 12

What is the formula used to calculate economic growth?

Answer 12

Economic growth % =

real GDP (current year) - real GDP (previous year) x 100 Real GDP (previous year)

Question 13

What is the formula used to calculate Real GDP?

Answer 13

Real GDP = nominal GDP x 100 CPI

Question 14

What is the formula used to calculate Nominal GDP?

Answer 14

Nominal GDP = real GDP x CPI 100

Question 15

Describe the relationship between aggregate demand and aggregate supply.

Answer 15

At equilibrium, aggregate demand is equivalent to aggregate supply in an economy. Therefore, if aggregate demand is equal to aggregate supply (production), this means that production is ALSO equal to the four components of aggregate demand (C + I + G + NX). This is significant as production (GDP) is the main measurement of economic growth. Therefore, we can observe economic growth through the four components of aggregate demand.

Question 16

How changes in both aggregate demand and aggregate supply influence economic activity?

Answer 16

A rise in the components of aggregate demand will stimulate economic activity, causing aggregate supply to increase production in order to meet demands. Consequently, an increase in aggregate supply will increase GDP as production levels rise, stimulating economic growth.

Question 17

What are the components of the leakages and injections formula -S+T+M = I+G+X?

Answer 17

Savings + Tax + Imports = Investment + Gov expenditure + Imports

Question 18

What happens to economic activity when Injections are greater than Leakages?

Answer 18

Injections > leakages = increased growth

Question 19

What happens to economic activity when Leakages are greater than Injections?

Answer 19

leakages > Injections = decreased growth

Question 20

What is the simple multiplier theory?

Answer 20

The multiplier effect refers to the increase in national income after an increase in any of the components of aggregate demand. That is, when one of the four components of aggregate demand increases by $1, this will have a multiplied effect on the increase in national income.

Question 21

How do changes in the MPC affect an economy’s growth?

Answer 21

An increase in the Marginal Propensity to Consume (MPC) means that consumers are spending a larger proportion of their income. Furthermore, as MPC is used in the calculations of the multiplier, an increase in MPC will increase the multiplier. Once the multiplier has increased, a change in any of the components of aggregate demand will have a larger, multiplied effect on GDP - increasing economic growth.

Question 22

How do changes in the MPS affect an economy’s growth?

Answer 22

An increase in the Marginal Propensity to Save (MPS) means that consumers are saving a larger proportion of their income. Furthermore, as MPS is used in the calculations of the multiplier, an increase in MPS will decrease the multiplier. Once the multiplier has decreased, a change in any of the components of aggregate demand will have a smaller, multiplied effect on GDP - decreasing economic growth.

Question 23

Determine the impact of the (simple) multiplier effect on national income.

Answer 23

Every time there is an injection into the circular flow of income, there is likely to be a multiplied effect. This is because an injection of extra income leads to more spending, which creates more income, and so on. Therefore the simple multiplier effect may increase or decrease national income.

Question 24

What is Keynes theory?

Answer 24

British economist, John Maynard Keynes, developed a theory that states that the most important influence on economic growth was the total level of expenditure in the economy - that is, the level of aggregate demand. The Keynesian economic theory suggested that people would not necessarily spend their income just because goods were produced. If households and businesses were unsure of the future economic outlook, households would tend to spend less and save more and firms would be reluctant to invest in capital. This would result in an overall decline in aggregate demand, with falling production and rising unemployment.

Question 25

What is the formula used to find the simple multiplier effect using MPS?

Answer 25

K = 1 MPS

Question 26

What is the formula used to find the simple multiplier effect using MPC?

Answer 26

K = 1 1 - MPS

Question 27

What are the sources and effects of economic growth in Australia?

Answer 27

Sources

• Government policies
• Public and private investment in infrastructure projects
• Increased efficiency leading to higher production
• consumer confidence

Effects

Positive -

• Higher living standards
• Increased exports due to higher production
• Lower unemployment

Negative -

• Inflation
• Environmental degradation
• Worsen distribution of income

Question 28

How does an economy increase aggregate supply through improvements in efficiency and technology?

Answer 28

• An economy’s aggregate supply is determined by the quantity and quality of the factors of production - natural resources, labour, capital, and the ability of entrepreneurs to combine them efficiently to produce G&S
• Aggregate supply can be increased when a higher level of output can be produced for the same cost

Measures to improve efficiency The improvement of more efficient transportation, for example, planes instead of boats - improvement in efficiency of freight transport.

Adoption in new technologies Firms may adopt new efficient technologies to save money on labour. They may now produce more at a cheaper cost.

Question 29

What are some trends in the business cycle?

Answer 29

• Australia’s economic growth performance in recent times has been stable and sustained over a long period.
• Australia last experienced a recession in the early 1990s.
• Since 1991 Australia has experienced its longest period of sustained economic growth, averaging 3.2%p.a
• In 1990’s decade Australia averaged annual GDP rates of 3.3%p.a, compared to 2.7% of industrialised nations.
• In the 2000’s, Australia’s average growth rates dropped to 3.1%p.a, however still above the average of OECD countries.

Question 30

What is the formula used to calculate the unemployment rate?

Answer 30

Unemployment rate (%) = Number of persons unemployed x 100 Total labour force

Question 31

What is the formula used to calculate the labour force?

Answer 31

Labour force = Unemployed (but actively seeking work) + employed (full time & part-time)

Question 32

What is the formula used to calculate the labour force participation rate?

Answer 32

Labour force participation rate (%) = Labour force x 100 Population aged 15 or over

Question 33

What are the trends in unemployment?

Answer 33

• Early 1990s - the level of unemployment peaked to 10.7% due to the recession in Australia, this was the highest level since the Great Depression.
• The GFC saw a 2% increase in unemployment, but since 2010 Australia’s unemployment has stayed between 5-6%.
• The Treasury had predicted unemployment to stay stable in 2019/20 before COVID-19 hit.

Question 34

What are the types of unemployment?

Answer 34

Cyclical

• Cyclical unemployment is unemployment that results when the overall demand for goods and services in an economy cannot support full employment.

Structural

• Structural unemployment occurs because of a mismatch between the skills demanded by employers and those possessed by unemployed people.

Frictional

• Frictional unemployment is the period of unemployment between jobs. This occurs as it takes time to move between jobs as individuals must search for employment opportunities, attend job interviews and complete any administrative details.

Seasonal

• Seasonal unemployment occurs because of the seasonal nature of some jobs. Include tourist-related jobs and jobs associated with holiday seasons.

Underemployment -

• Individuals who have part-time or casual jobs but would like to work more hours per week are said to be underemployed. These workers are a significant problem in the labour market as they represent under-utilised labour resources.

Hidden

• Hidden unemployment refers to those individuals who are not counted in the official unemployment figures because they have given up actively seeking work or have gone back to school.

Long term

• To be classified as long-term unemployed, an individual must have been unemployed for a period of 12 months or more. The long-term unemployed have started out originally as cyclically unemployed persons - an economic downturn may have caused a person to lose their job.

Hardcore unemployment

• Hard-core unemployment refers to those individuals who might be considered unsuitable for work because of personal reasons such as mental illness, physical disabilities or drug addiction.

Question 35

What is the Non-accelerating inflation rate of unemployment (NAIRU)?

Answer 35

The theory behind NAIRU is that some level of unemployment is inevitable and efforts to reduce employment below this “natural” level will be counterproductive. This natural rate of unemployment, commonly called NAIRU, is comprised of frictional, seasonal, structural and hard-core unemployment. When unemployment is above the NAIRU, there is spare capacity in the labour market, which suggests that policymakers should stimulate economic growth with the aim of reducing employment. When unemployment is already at or below the NAIRU, an increase in economic growth will increase inflationary pressures, because employers will be forced to raise wages to compete for workers who are already in employment.

Question 36

What are the main groups affected by unemployment?

Answer 36

• Indigenous population
• Teenagers (youth)
• Migrants of non-english speaking backgrounds
• Workers with low levels of educational qualifications tend to experience higher levels of unemployment
• Workers who are semi-skilled or unskilled have unemployment rates of between 7-10%, while professional managers have rates between 1-5%.

Question 37

What are the economic costs of unemployment?

Answer 37

Opportunity cost

• There is a loss of income and output in production - negatively affecting economic growth.

Poverty trap

• A result of unemployment, this essentially leads to increased transfer payments, which causes a reallocation of government resources to accommodate this.

Distribution of income​

• The wealthy are generally unaffected by unemployment and continue to make monetary gains. The lower-income earners are more susceptible to lose their jobs or having their wages decreased. This creates a more unequal distribution of income within the economy - rich get richer and poor get poorer.

Increase Tax burden

• As there are fewer people working, fewer people are paying tax therefore the government receives less revenue.

Question 38

What are the social costs of unemployment?

Answer 38

Mental health issues

• Unemployment may increase rates of suicide, domestic violence and crime as individuals become disconnected from society.

Increased inequality

• Youth and unskilled labour tend to be affected most by unemployment, therefore creating increased inequality between low-income and high-income earners. (similar to economic cost relating to the unequal distribution of income)

Question 39

How may NAIRU be reduced?

Answer 39

The NAIRU cannot be reduced through wage cuts but can be reduced through increased education, training and improvement of skills among workers.

Question 40

Name two causes of unemployment?

Answer 40

Constraints of economic growth

• Significant constraints in economic growth will lead to a situation where the economy will struggle to create enough jobs to reduce unemployment.

Rising participation rates

• An increase in the labour force participation rate will tend to increase the unemployment rate in the short term. This is because the labour force will increase, however, there is a time lag until those individuals find employment.

Question 41

What is NAIRU?

Answer 41

The theory behind NAIRU is that some level of unemployment is inevitable in an economy, and efforts to reduce employment below this “natural” level will be counterproductive.

Question 42

What are the main groups affected by unemployment?

Answer 42

• Indigenous population
• Teenagers (youth)
• Migrants of non-english speaking backgrounds
• Workers with low levels of educational qualifications tend to experience higher levels of unemployment.
• Workers who are semi-skilled or unskilled have unemployment rates of between 7-10%, while professional managers have rates between 1-5%.

Question 43

What types of employment is NAIRU comprised of?

Answer 43

NAIRU is comprised of

• frictional
• seasonal
• structural
• hard-core unemployment

Question 44

What does it mean when unemployment is above the NAIRU?

Answer 44

When unemployment is above the NAIRU, there is spare capacity in the labour market, which suggests that policymakers should stimulate economic growth with the aim of reducing employment.

Question 45

What are the effects of unemployment?

Answer 45

• Economic costs
• social costs

Question 46

What are the economic costs associated with the effects of unemployment?

Answer 46

Opportunity cost

• There is a loss of income and output in production, negatively affecting economic growth.

Poverty trap

• A result of unemployment, this essentially leads to increased transfer payments, which causes a reallocation of government resources to accommodate this.

Distribution of income

• The wealthy are generally unaffected by unemployment and continue to make monetary gains. The lower-income earners are more susceptible to lose their jobs or having their wages decreased. This creates a more unequal distribution of income within the economy - rich get richer and poor get poorer.

Increase tax burden

• As there are fewer people working, fewer people are paying tax therefore the government receives less revenue.

Question 47

What are the social costs associated with the effects of unemployment?

Answer 47

Increased inequality

• Youth and unskilled labour tend to be affected most by unemployment, therefore creating increased inequality between low-income and high-income earners. (similar to economic cost relating to the unequal distribution of income)

Mental health issues

• Unemployment may increase rates of suicide, domestic violence and crime as individuals become disconnected from society.

Question 48

What is the formula used to calculate inflation?

Answer 48

Inflation = Current CPI (this year) - previous year’s CPI x 100 previous years CPI