3.3 Macroeconomics and living standards

Question 1

What is macroeconomics?

Answer 1

focuses the economy as a whole. Examines the overall performance of a country’s economy, e.g. its economic growth, unemployment rate, inflation, and improvement in material and non-material living standards.

Question 2

Why do we study macroeconomics?

Answer 2

helps us understand how different factors, such as government policies, changes in interest rates, or global events, can impact the economy and people’s living standards. Economists and governments can better predict and manage the economy to improve the wellbeing and prosperity of all people in a country.

Question 3

What is economic activity?

Answer 3

in macroeconomics, economic activity refers to the overall level of production and consumption of goods and services in an economy over a certain period of time.

Question 4

How does economic activity work?

Answer 4

• When businesses in an economy produces goods and services this means businesses will increase their demand for labour resources which increases employment in the economy.
• More employment leads to an increase in household income, which means people are able to spend more money on goods and services - leading to an increase in production, and we start at the beginning again.

Question 5

What are material living standards?

Answer 5

• Defined as the degree to which a citizen can access goods and services (highly dependent on income)
• is measurable (quantifiable)
• Measured by Gross Domestic Product (GDP) per capita, or Gross National Income per capita (GNI)

Question 6

What are non-material living standards?

Answer 6

• defined as referring to one’s wellbeing and quality of life (less dependent of income)
• difficult to measure (qualitative)
• determined by quality of physical and mental health, environmental quality, life expectancy, crime rates and literacy rates etc.

Question 7

What is inflation

Answer 7

is a term used to describe the general increase in prices of goods and services in an economy over time. When the average prices of goods and services go up, the purchasing power of your money decreases, which means you can buy fewer things with the same amount of money

Question 8

What is the target for inflation?

Answer 8

between 2-3% over time. A small amount of inflation is expected in a healthy economy, but any higher than 3% and it will start to have a detrimental impact on the living standards of Australians.

Question 9

What is the rate of inflation in Australia?

Answer 9

is 6% (June Quarter 2023), which is over double the target. This indicates that inflation is a problem in the macroeconomy of Australia and will have negative effects on households and businesses in Australia.

Question 10

Why is inflation so bad?

Answer 10

While there are numerous negative consequences of high inflation, we just focus on two:

-Reduced purchasing power
-Wage-price spiral

Question 11

What is reduced purchasing power?

Answer 11

When inflation is high, the prices of goods and services increase rapidly. As a result, the same amount of money can buy fewer goods and services. This means that households’ purchasing power decreases, which can lead to a decrease in their material standard of living as they have lower access to goods and services.

Question 12

What is the wage-price spiral?

Answer 12

a self-reinforcing cycle where high inflation and loss of purchasing power leads workers to demand higher wages from their employers. Higher wages then increase the costs of labour for businesses which then mean they often have to increase the prices of their goods even more, which then leads to workers asking for even higher wages and so on.

Question 13

What are the causes of inflation?

Answer 13

• excessive spending in the economy
• Costs of production

Question 14

How does excessive spending in the economy lead to inflation?

Answer 14

If there is more money available than there are goods and services to buy, this will lead to shortages of goods and services in the economy and prices will go up because people will be willing to pay more to get what they want. This is often referred to as ‘too much money chasing too few goods’.

Question 15

How do costs of production lead to inflation?

Answer 15

Another factor that can cause inflation is when the cost of producing goods and services goes up. For example, if the cost of land, labour or capital resources increases, the price of the finished product will likely go up as well.

Question 16

What policies are used to decrease high inflation?

Answer 16

While there are many policies that can be used by a government or government organisation to lower inflation, we will focus on the main one currently being used in Australia to decrease high inflation, which is increasing interest rates. This is a policy implemented by the Reserve Bank of Australia.

Question 17

Who is the Reserve Bank of Australia?

Answer 17

The Reserve Bank of Australia (RBA) is the central bank of Australia. It is a government organisation that is responsible for conducting ‘monetary policy’ (monetary = relating to money). The RBA’s main objective is to maintain price stability, which means keeping inflation low and stable over the medium term, around 2-3%. The RBA uses interest rates to accomplish this.

Question 18

What is an interest rate?

Answer 18

• An interest rate is the cost of borrowing money.It represents the amount of money that a borrower has to pay on top of the amount borrowed, or that a lender receives as compensation for lending the money.

usually expressed as a % of the amount borrowed

Question 19

How does the Reserve Bank of Australia (RBA) use interest rates to decreases inflation?

Answer 19

one of the main causes of the high inflation in Australia is excessive spending on goods and services. If the RBA uses monetary policy to increases interest rates, this will lead Australians spending less money which will hopefully decrease inflation over time. In the last 12 months the RBA has increased interest rates by 1.5%.

Question 20

How does higher interest rates impact high inflation?

Answer 20

• Higher costs of borrowing
• Increased saving
• Increase mortgage repayments

Question 21

How do higher costs of borrowing impact high inflation?

Answer 21

higher interest rates create a disincentive to borrow money as people will have to pay back more for it. This means less money and spending in the economy which will slow increases in inflation.

Question 22

How does increased saving impact high inflation?

Answer 22

when interest rates are higher, it also means people will receive a higher interest rate in their savings account. This makes it more attractive for people to save instead of spend, slowing excessive spending and likely slowing inflation.

Question 23

How do increased mortgage repayments impact high inflation?

Answer 23

for households with variable rate mortgages (home loans), it will make their monthly repayments increase, lowering the amount of money they have to spend every month, which again will likely reduce excessive spending and decrease inflation over time.