3.2 - Domestic Macroeconomic Goals Flashcards
Living Standards
The aggregate welfare of people in a country, made up of both material and non material factors
Material Living Standards
Refers to the level of economic wellbeing of individuals, and the quantity of tangible goods or services available for each person to consume
Non Material Living Standards
Refers to the quality aspects of a person’s daily existence
Factors Influencing Material Living Standards
- Access to goods and services:
o High access to goods and services achieves economic wellbeing and advances material living standards - Environmental quality:
o Depletion of non renewable resources at an excessive rate leads to shortages and price rises, thereby reducing material living standards - Physical and mental health:
o High quality health means individuals are more able to work, leading to higher incomes and improved economic wellbeing - Life expectancy:
o A longer lifespan means individuals are able to work for longer, so will have higher incomes and improved economic wellbeing - Crime rates:
o A high crime rate leads to higher insurance premiums, so less disposable income and reduced access to goods and services
o Higher crime rates also mean individuals have reduced access to goods and services as there is a higher likelihood of theft - Literacy rates:
o A higher literacy rate means individuals are able to access higher paying employment and higher skilled jobs, leading to greater income and better economic wellbeing
Factors Influencing Non Material Living Standards
- Access to goods and services:
o Improved access to goods and services leads to greater satisfaction - Environmental quality:
o Improved environmental quality leads to better opportunity for outdoor recreation - Physical and mental health:
o Improved health leads to lower stress and better quality of life - Life expectancy:
o Longer life expectancy allows for greater time with family and friends so improves quality of life - Crime rates:
o Lower crime rate leads to greater feelings of safety so allows for greater quality of life - Literacy rates:
o Greater literacy rates allow for greater communication skills so allows for greater quality of life
Economic Activity
Production, income and expenditure that takes place in the economy
Components of Aggregate Demand
- AD = C + I + G1 + G2 + X – M
- C – total expenditure of goods and services by resident households and non profit institutions servicing households
- I – expenditure with the purpose of expanding the productive capacity and productivity of firms
- G1 – government current expenditure, such as salaries, health and education funding, but does not include welfare spending
- G2 – government capital expenditure, such as infrastructure investment
- X – expenditure by foreign households and businesses on Australian goods and services, including international students and international travel to Australia
- M – expenditure by Australian households and businesses on overseas goods and services, including overseas travel
Factors Affecting Aggregate Demand
- Changes to the general level of prices
- Disposable income
- Interest rates
- Consumer confidence
- Business confidence
- Exchange rates
- Levels of economic growth overseas
Aggregate Supply
The total volume of good and services that all suppliers have produced and supplied over a period of time
Production
The total volume of goods and services produced over a given time period
Productivity
Outputs from a given level of inputs
Productive Capacity
The point at which production is occurring at the maximum level possible in an economy
Factors Affecting Aggregate Supply
- Changes to the general level of prices
- Quantity of factors of production
- Quality of factors of production
- Cost of production
- Technological change
- Productivity growth
- Exchange rates
- Climatic conditions
- Government regulation
- International supply chain disruption
Business Cycle
The cyclical movement of economic activity over time
Peak Stage of Business Cycle
- Nature:
o High economic growth
o High levels of inflation
o Low levels of unemployment - Causes:
o High consumer and business confidence
o Low interest rates
o High levels of global economic growth
o High disposable income levels
o High government spending
Contraction Stage of Business Cycle
- Nature:
o Lower economic growth
o Lower levels of inflation
o Rising levels of unemployment - Causes:
o Lower consumer and business confidence
o Higher interest rates
o Lower levels of global economic growth
o Lower disposable income levels
o Lower government spending
o Capacity constraints
Trough Stage of Business Cycle
- Nature:
o Low economic growth
o Low levels of inflation
o High levels of unemployment - Causes:
o Low consumer and business confidence
o High interest rates
o Low levels of global economic growth
o Low disposable income levels
o Low government spending
o Capacity constraints
Expansion Stage of Business Cycle
- Nature:
o Higher economic growth
o Higher levels of inflation
o Lower levels of unemployment - Causes:
o Higher consumer and business confidence
o Lower interest rates
o Higher levels of global economic growth
o Higher disposable income levels
o Higher levels of government spending
Goal of Strong and Sustainable Economic Growth
The highest growth rate possible, consistent with strong employment growth but without unacceptable inflationary, external or environmental pressures
(3-4% REAL GDP)
Formula: GDP Growth
GDP Growth= (Period 2-Period 1)/(Period 1) × 100
Reasons to Pursue Economic Growth
- Growth in real incomes from higher production → improved living standards
- Lower unemployment rate → improved living standards
- Increased tax revenue from incomes and profits → government able to increase spending on essential services without increasing public debt → improves living standards
Consequences if Growth is Too Low
- No growth to real income
- No fall to the unemployment rate
- Government may need to run a budget deficit to pay for essential services
- Ultimately will have a negative impact on living standards
Consequences if Growth is Too High
- Growth may not be sustainable, leading to:
o Inflationary pressures
o Environmental pressures
o External pressures → falling net exports → falling aggregate demand - Ultimately will have a negative impact on living standards
Employed
When someone of working age is working for more than 1 hour a week for remuneration
Unemployed
When someone of working age is not working but actively seeking employment
Hidden Unemployment
Individuals not seeking work so are not included as unemployed
Underemployed
Individuals who are employed but would prefer to be working more hours
Long-Term Unemployed
Individuals unemployed for more than 12 months
Goal of Full Employment
The level of employment that exists when the government’s economic growth goal is achieved and where cyclical unemployment is non existent
(4-4.5% NAIRU)
NAIRU
The lowest level of unemployment without causing inflationary pressures
Formula: Labour Force
Labour Force= Employed+Unemployed
Formula: Unemployment Rate
Unemployed/(Labour Force) × 100
Formula: Labour Force Underutilisation Rate
(Unemployed+Underemployed)/(Labour Force) × 100
Formula: Labour Force Participation Rate
(Labour Force)/(Working Age Population) × 100
Impacts of Changes to Labour Force Participation Rate
- Increase in participation rate → short term increase to unemployment but eventually placed downward pressure on wages and upward pressure on productivity
- Decrease in participation rate → short term decrease to unemployment but eventually placed upward pressure on wages and downward pressure on productivity
Structural Unemployment
When the skills of the unemployed do not match the skills required by the economy
Seasonal Unemployment
When a person is unemployed because their skills are only demanded during certain times of the year
Frictional Unemployment
When a person is unemployed for a time while they are moving from one job to another
Hardcore Unemployment
When a person is unemployed due to mental, physical or other characteristics that prevent them from receiving a job offer
Cyclical Unemployment
Unemployment that occurs when the economy is not operating at full capacity due to AD deficiencies
Consequences of Unemployment
- Loss of GDP – as the economy is not operating at full capacity and lower incomes reduce AD
- Loss of tax revenue – reduced income means reduced income tax revenue
- Greater income equality – more individuals reliant on welfare increases the gap between high and low income earners
- Reduced living standards – unemployment lowers income so reduces ability to purchase goods and services, thereby reducing material living standards, while lower self esteem and higher crime reduce non material living standards
Goal of Low Inflation
Achieve a sustained increase to the general level of prices between 2-3% on average over the medium term
Inflation
A sustained increase in the general level of prices over time
Disinflation
A reduction in the rate of inflation (slowing inflation)
Deflation
A decrease in the rate of inflation (negative inflation)
Measuring Inflation
Consumer Price Index – calculated by measuring changes in prices over a ‘basket’ of 100k goods and services, with weighting applied to each category
Formula: Inflation Rate
(Price Index (period 2)-Price Index (period 1))/(Price Index (period 1)) × 100
Headline Inflation
Captures price movements of all goods and services included in the CPI
Underlying Inflation
Excludes volatile items, such as fruit, vegetables and fuel
Causes of Inflation
- Demand inflation: caused by changes to aggregate demand
- Cost inflation: caused by changes to aggregate supply, supply side pressures or capacity constraints
Consequences of Too High Inflation
- Erodes purchasing power: a greater proportion of income is required to purchase the same amount of goods and services, leading to reduced access to goods and services and lower material living standards
- Distortion of spending and investment decisions: rising prices can send false price signals to producers, leading to them reallocating resources despite no reduction to profit making opportunity
- Reduction to international competitiveness: exports becoming more expensive in foreign currency terms → Australian goods and services becoming less competitive in foreign terms
- Lower returns on investment: households have less incentive to save as the value of future consumption will be reduced
- A wage price spiral may form: increasing inflation → real wages fall → workers demand higher wages → businesses seek to protect profits by increasing prices → inflation accelerates
Consequences of Too Low Inflation
- Delayed consumption: consumers may delay purchase as they expect prices to fall → reduced private consumption expenditure
- Unemployment: business spending declines due to lower business confidence → reduced demand for labour
Role of Households
- Supply/sell their resources to firms
- Use income to demand finished goods and services from businesses
Role of Businesses
- Purchase resources from households
- Convert resources into goods and services
Role of Financial Sector
- Borrow savings from households
- Lend savings to customers, who then use this for private investment expenditure
Role of Government Sector
- Collects revenue from taxation
- Spends revenue as G1 or G2
Role of External Sector
- Includes imports of foreign goods demanded by Australians, and exports of Australian goods demanded by foreigners
Aggregate Demand
- Total expenditure on the goods and services produced in the economy over a period of time
Importance of Aggregate Demand
Tells us the total potential expenditure on goods and services
Importance of Aggregate Supply
Tells us the total potential output of an economy at any given time
Impact of Low Unemployment on Inflation
- Increased cost of production → cost inflation
- Increased disposable incomes → demand inflation
Impact of Government Regulation on Aggregate Supply
- Reduced productivity
- Reduced willingness to produce due to additional requirements/restrictions
Relationship between Low Inflation and Strong and Sustainable Economic Growth/Full Employment
Low inflation is a precondition for other goals
