AOS 2

Question 1

Economic activity

Answer 1

The level of economic activity simply describes the
general pace or speed at which productive activity is
occurring nationally.
Economic activity refers to actions of individuals,
firms and governments that help to generate the
production of goods and services, employment and
production and income.

Economic Activity
There are two main reasons economic activity irr
living standards.
1 . Society can only satisfy increasing needs and
through Increased production.
2. Higher levels of economic activity are not sustainable

Question 2

Living standards

Answer 2

Living standards are a measure of the welfare of the people in a Country and is made up material and non-material factors.

Question 3

Material living standards

Answer 3

Material living standards measure the ability of individuals to access to goods and services.
Individuals with a greater purchasing power are likely to experience a higher material standard of living because they are more able to access the goods and services that they desire.
The government can intervene in an effort for greater equality - usually through taxes, and therefore influence a more even spread of access to goods and services for individuals.

Question 4

Non-material living standards

Answer 4

Non-material living standards are more difficult to measure as they are made up of intangible things such as safety, freedoms, environment and leisure time.
Some of these are also subjective - what is important to one person may not be for the next.

Question 5

Factors affecting living standards

Answer 5

Access to goods and services 
Environmental quality
 Physical and mental health 
Life expectancy
Crime rates 
Literacy rates

Question 6

circular flow model

Answer 6

The model shows the flow of money, resources and goods and services in an economy. At the core there is the interaction between households and businesses, in product and factor markets. Model in book with explanations.

Question 7

business cycle

Answer 7

Is the cycle of how a business goes through cyclical movements with periods of above average and negative rates of growth.

Question 8

Business cycle phases: Expansion

Answer 8

Starting at low levels, there is an expansion in economic activity or production, often slowly at first and then gaining pace. After a time lag, employment also grows, unemployment often falls and inflation gradually accelerates.

Question 9

Business cycle phases: Peak (possible boom phase)

Answer 9

Eventually, a period of expansion in the level of economic activity reaches a peak, or upper turning point. Unemployment usually reaches its lowest level and inflation is at a high. AD is usually growing faster than AS.

Question 10

Business cycle: The downturn or contraction phase

Answer 10

Slowdowns or contractions in the level of economic activity normally follow a peak or boom. The growth in GDP slows or, if severe, production may even fall. Usually after a time lag, unemployment rates rise and inflation eases. Can be caused by fear or panic or unexpected events that have a negative effect on the level of AD.

Question 11

Business cycle: The trough (possible recession) phase

Answer 11

The trough represents the lowest point on the business cycle of economic activity. Sometimes this trough is simply a minor slowdown in the rate of economic growth, causing a slight rise in unemployment. But, if the level of national output actually falls (indicated by a drop in GDP during two consecutive quarters or a six-month period), this is technically termed a recession. Longer and even more severe troughs are called depressions where inflation may even be negative (there is deflation). Often caused by a lack of AD.

Question 12

Aggregate Demand

Answer 12

The total expenditure on final Australian made goods and services
AD formula: AD = C + I + G + X - M

Question 13

C = Private consumption expenditure

Answer 13

The total value of consumption of goods and services by households. It includes durable such as cars, furniture and high-value, long lasting appliances, clothing and footwear, Single-use goods such as foods, cigarettes, tobacco and alcohol. Makes up 60% of AD.

Question 14

I - Private investment spending

Answer 14

Investment spending is the expenditure on new equipment, buildings, vehicles and assets that will improve productive capacity and productivity of businesses. This is an investment in assets that will assist businesses in generating a revenue.
Spending by households on new housing is also included in this section.This can be volatile because business environments are constantly changing.
Makes up approx 15-20% of AD

Question 15

G = Government expenditure

Answer 15

G1 - Government consumption expenditure. This is the day to day government spending as part of its operations. It includes spending on health, education, public sector wages and as such is relatively stable.

G2 - Government investment spending. This is the spending on goods of a capital nature such as roads, railway, ports, new hospitals and schools. This is important because it adds to the productive capacity of the nation.

Question 16

X-M = Net Exports

Answer 16

X is spending on exports - Australian made goods that have been sold to overseas buyers. M is spending on imports - foreign made goods that have been purchased in Australia.
Net Exports is the Balance on Goods and Services. Exports and imports are highly volatile as they are easily impacted by a number of factors such as interest rates and exchange rates.

Question 17

Why do we deduct the value of imports from AD?

Answer 17

The value of imports are included in the other components of AD so we need to deduct the value of imports so that we can calculate the value that has been added in Australia.

Question 18

Factors the can influence the level of Aggregate Demand

Answer 18

● Changes in the general price level
● Disposable income
● Interest rates
● Consumer confidence
● Business confidence
● The exchange rate
● Rates of economic growth overseas

Question 19

Aggregate Supply

Answer 19

Aggregate supply is the total volume of goods and services that all suppliers have produced and supplied over a period of time.
AS is a measure of the ability of an economy to make available the goods and services to meet demand.
Aggregate supply is closely linked to the production possibility frontier. When an economy has reached the point that it is supplying the maximum possible at that point in time, it has reached productive capacity.

Question 20

Changes in the general level of prices

Answer 20

The general price level (inflation, as measured by the CPI) has a clear relationship with AS.
As AS increases, it will put downward pressure on prices as an excess of goods and services encourages producers to lower prices to clear the stock. Decreases in AS will tend to put upward pressure on prices as a result of the shortages of goods and services in the economy.
Increases in price that come from increased AD, will encourage suppliers to provide more goods for the market (expansion) and lower prices will encourage producers to provide fewer goods and services.

Question 21

Quantity of the factors of production

Answer 21

The availability of resources as factors of production will impact on AS
○ E.g Scarcity of water makes it harder to produce crops

Question 22

Quality of the factors of production

Answer 22

Quality of resources can also improve (or worsen) AS

○ Farming methods to improve (or perhaps harm) the quality of the soil will impact the volume of crops and AS

Question 23

Costs of production

Answer 23

Lower costs of oil, labour, technology will improve supply side conditions making it cheaper for firms to produce goods and services
Cheaper costs improve competitiveness and allows AS to increase.

Question 24

Technological change

Answer 24

Advances in technology has improved the way firms operate.

● Use of technology has improved productivity and often lowered costs of production allowing AS to improve.

Question 25

Productivity growth

Answer 25

Productivity describes how efficiently resources are being used in the production process. It is measured as the output per unit of input.
● Productivity growth occurs when:
○ More goods and services are produced from the same or fewer resources
○ Costs of production fall because costs per unit decreases if the increase in output is greater than the increase in input required.

Question 26

Exchange rates

Answer 26

Exchange rates affect the costs of production
● A depreciation of the AUD will make it more expensive for firms to
purchase inputs from overseas for use in the production process.
● An appreciation of the AUD will make it easier for firms to increase supply as it will be cheaper to import factors of production.

Question 27

Climatic conditions and other supply shocks

Answer 27

Favourable weather conditions increases the availability of resources used to make goods and services and helps to reduce costs.
● On the other hand, adverse weather events (floods, drought, fire etc) can result in significant disruption to supply.
● Covid-19 is an example of another supply shock on the economy – negatively impacting on productive capacity and/or ability to supply goods and services.

Question 28

AD curve

Answer 28

AD Curve
The aggregate demand curve shows an inverse relationship level of prices and the total quantity of output. It will be a downward slop.

Question 29

Why is AD sloping down?

Answer 29

• The wealth effect
Higher general prices reduce the purchasing power of any given amount of savings. Public feel poorer as prices are rising
Falling prices increases purchasing power. Public feel wealthier
Changes in price can affect the purchasing power and impact consumption expenditure and therefore AD.

• Interest rate effect
A fall in general prices means consumers have more income to save
Less incentive to borrow because purchasing power has increased
Less demand for borrowing money puts downwards pressure on interest rates
Lower interest rates can stimulate Investment spending.

• International competitiveness
If general prices fall in Australia and other countries prices remain the same our international competitiveness improves.
Exports are more attractive to overseas buyers
Domestic products become more attractive compared to imports
Net export improve and increases AD.

Question 30

AS curve

Answer 30

AS Curve
• AS curve represents the real value of production that producers are willing and able to supply at various general prices.
• An increase in prices is likely to be associated with an increase in AS.

Question 31

Changes in AD and AS

Answer 31

AD factors:
Interest rates, consumer confidence, business confidence, exchange rate, rates of economic growth overseas, disposable income

AS factors:
quantity of factors of production
Quality of factors of production
technological change
producitivity growth
exchange rate
climate conditions and other disruptions

Question 32

Strong and sustainable growth

Answer 32

Economic growth is where there is an increase in the level of production over time
Strong and sustainable growth occurs when there is the highest growth rate
possible that is consistent with strong employment growth without unacceptable
inflationary, external or environmental pressures.
What is considered to be a strong and sustainable growth rate will differ from time
to time depending on other factors such as productivity and international growth,
but currently it is considered to be in the range of 3 - 3.5%p.a.

Question 33

Measuring economic growth

Answer 33

Gross Domestic Product (GDP) - the final market value of all goods and services
produced in Australia over a given time frame.

Question 34

Why pursue economic growth?

Answer 34

Growth in real incomes
Growth in production typically means growth in incomes (wages, dividends,
interest). This allows some people in society better access to goods and
services which satisfy their needs and wants, improving their material standard
of living.

Lowering the unemployment rate
If economic growth exceeds growth in productivity, it will tend to result in more
demand for labour which will improve the unemployment rate. Improving material and non material living standards.

Increased ability of government to provide essential services
Economic growth leads to an increase in revenue for the government (through
more taxes such as company, personal income, GST, stamp duties etc). In addition
to this, the government is likely to spend less on transfer payments as the
unemployment rate falls.

Question 35

Why a growth rate target of 3.5%

Answer 35

Growth rate should exceed growth in productivity so as to avoid ‘jobless growth’
Growth rate should be greater than the population growth rate to improve material
living standards.
Growth rate should be sustainable and not be at the cost of future generations.

Question 36

The goal of full employment

Answer 36

The level of unemployment that exists when the goal of economic growth is achieved and cyclical unemployment is avoided.
The full employment objective involves the attainment of the lowest unemployment rate possible before inflation begins to accelerate. This is known as the Non Accelerating Inflation Rate of Unemployment (NAIRU) and is typically about 5%.

Question 37

Labour Force

Answer 37

The labour force is all those aged 15 and over who are willing and able to work. Therefore the labour force includes all those who are employed and unemployed.

Employed: anyone over the age of 15, working for more than 1 hour per week for remuneration.

Unemployed: Over the age of 15, without work or working less than 1 hour per week and actively seeking work.

Unemployment rate: The percentage of the labour force that is unemployed.

Question 38

Labour forces

Answer 38

Hidden unemployment: Excluded from employment statistics because they have been discouraged about job prospects and are not actively seeking work.
Underemployment (disguised unemployment): The
underemployed are people who are classified as employed, but would prefer to work more hours.

Question 39

Causes and types of unemployment

Cyclical Unemployment

Answer 39

Cyclical Unemployment
Cyclical unemployment is caused by weak AD. A fall in AD (or slow growth) means producers will need less labour in production, increasing the unemployment rate.
such as Consumer confidence
● Economic growth in trading partners
● Interest rates
● Exchange rate

Question 40

Causes and types of unemployment

Natural Unemployment

Answer 40

Natural Unemployment
Structural unemployment - where the skills of the unemployed do not match the skillsrequired by industry. This essentially means that the structure of industry has changed
or that a proportion of the working age population has not ensured they have the
adequate education or training to secure jobs. Can be caused by:
○ Technology
○ Fashions and tastes
○ Outsourcing
○ Business restructuring
○ Microeconomic reforms

Seasonal unemployment
Occurs for some workers, but only at certain times of the year
e.g. fruit pickers, ski instructors, etc

Frictional unemployment - where workers move from one job to
another

Hard core unemployment - those unable to find a job due to mental/physical characteristics that cause repeated job
rejections.

Question 41

Consequences of Unemployment

Loss of GDP

Answer 41

Loss of GDP
Multiplier benefits are lost (higher incomes earned being spent on goods and services, creates additional employment opportunities and income generation
and improved living standards over time).Labour resources not being used so productive capacity of a nation is not being achieved. However, less job security can motivate the employed to be more productive or
accept a lower wage, reducing real unit labour costs which can help reduce prices and improve competitiveness to stimulate AD and real GDP.

Question 42

Consequences of Unemployment

Loss of tax revenue

Answer 42

Loss of tax revenue
Higher unemployment will negatively impact on the federal budget outcome. This is because fewer people are paying income tax and more people are likely to receive transfer payments from the government. This weakens the government’s ability to provide essential services for Australians, lowering the standard of living.

Question 43

Consequences of Unemployment

Greater income inequality

Answer 43

Greater income inequality
The gap between the well off and the poor will grow when
unemployment is high. The lowest income earners will receive a smaller share of Australia’s total income.
More people will be unable to afford the goods and services to give them a reasonably decent standard of living

Question 44

Consequences of Unemployment

Reductions in living standards

Answer 44

Reductions in living standards
As people move from employed to unemployed, their income will fall and they will no longer be able to access the goods and services they require to live life to a decent material standard of living. Unemployed persons can also face lower non-material standard of living due to the stigma attached to the unemployed and possible
lower sense of self-worth/self-esteem. Social costs can include higher crime rates, social exclusion and
homelessness.

Question 45

Inflation

Answer 45

Inflation refers to a sustained increase in the general or average price level over time.

Question 46

Stability of the Australian currency

Answer 46

The goal of low inflation (stability of the currency) refers to a rise in general prices of 2-3% over the course of the business cycle, as measured by the CPI.
This is an important goal as it helps to protect purchasing power and living standards in Australia.
The RBA has the responsibility of achieving the economic goal of stability of the Australian currency.

Question 47

Why a target of 2-3%

Answer 47

A target range of 2-3% allows for some flexibility. A target at the upper range allows for the achievement of other economic goals such as economic growth or employment growth.

Question 48

Why not an inflation rate of zero?

Answer 48

Consumers may delay purchases if they expect prices to fall. As a result, falling prices – a situation called ‘deflation’ – can lead to lower spending. Businesses could respond by laying off workers or reducing wages which, in turn, places further downward pressure on demand and prices.

Businesses facing difficult conditions may find it hard to reduce the real wages of their employees and may resort to laying off workers instead. This is because businesses that need to decrease their real wages usually choose to allow their nominal wages to grow at a rate that is below the general rate of inflation, and if inflation is very low this is more difficult todo.

Question 49

Deflation v Disinflation

Answer 49

Deflation is a decrease in the general price level which means that prices on average are falling.
Disinflation refers to a fall in the inflation rate. For example, inflation in Year 1 might be 3% and in Year 2 it falls to 2.5%. This is disinflation, as prices have continued to rise (by 2.5% on the previous year) but they have increased at a slower rate than previously.

Question 50

Measurement of Inflation - CPI

Answer 50

Consumer Price Index (CPI) is a measure of consumer price inflation and measures the changes in prices of goods and services purchased by the average Australian household.
Calculated by the Australian Bureau of Statistics (ABS) on a quarterly basis.
Surveys prices of a ‘basket’ of over 100,000 goods and services typically purchased by households in the capital cities of Australia.
Goods are categorised and groups are weighted to reflect their importance to typical households to more accurately reflect the impact of the price changes.
An index allows us to calculate an average of a wide range of goods and services over time compared to a base period. By comparing the CPI to the base period, we can easily see the changes that occur during that time frame.

Question 51

Rate of inflation

Answer 51

The quarterly rate of inflation is calculated by using the index number for two particular quarters and determining the growth rate between these quarters.

The annualised rate of inflation for the quarter is obtained by multiplying the quarterly inflation rate by 4.

The annual rate of inflation is obtained by calculating using the index numbers for the corresponding quarter in each year.

Question 52

Inflation

Answer 52

Headline inflation is the rate of inflation without any adjustments or alterations.

Underlying inflation is derived from the CPI, however it has been adjusted to give a more accurate measure of inflationary pressures in the economy. The two main indicators of underlying inflation are the trimmed mean and weighted median.

Trimmed mean is the average rate of inflation after trimming away the items with the largest price changes. It is the weighted average of the middle 70% of items.

Weighted median is the inflation rate of the item at the middle of the price changes in the CPI basket.

Question 53

Consequences of high inflation

Answer 53

High inflation has significant negative consequences for the economy including:
Erosion of purchasing power
Distorting the allocation of resources
Loss of efficiency
Savings and investment
Inflation and interest rates more generally
Loss in international competitiveness
Damaging business confidence
Wage price spiral
Inflation and the government’s goals more generally

Question 54

Causes of inflation

Answer 54

Demand inflation
Caused by demand side factors that have lead to an increase in AD including disposable incomes, interest rates and consumer and business confidence. As increases in AD push an economy closer to productive capacity, producers find it difficult to keep up with demand which then places pressure on prices.

Cost inflation
Caused by supply side pressures including costs of production, technological change and productivity growth. If supply side conditions become less favourable, the AS curve will shift to the left, resulting in increases in prices.