Chapter 4

Question 1

Define micro economics

Answer 1

The study of the individual parts of the economy that interact to make up the whole economy

Question 2

Define economic activity

Answer 2

Volume (or real value) of production, employment, incomes and expenditure in an economy

Economic activity generates goods and services to meet the needs and wants of households (the end users of the production), employment and income.

Question 3

Explain the purpose of Eco activity

Answer 3

Not too high = productive capacity may not be able to satisfy demand for that production – and demand inflation may occur
Not too low = there is not enough production and employment – these recessionary periods generally mean inefficient allocation of resources + low eco growth

Question 4

Define GDP

Answer 4

The final market value of all goods and services produced in the Australian economy over a given period of time – it is the same as the total ‘value added’ during each stage of the production process and is calculated every quarter by the ABS
The inclusion of the word “gross” indicates that it does not deduct the cost of capital deprecia

Question 5

Define chain volume GDP

Answer 5

An estimate of the real GDP in the economy – it involves using prices from previous periods and applying them to current period volumes

Question 6

the ABS uses 3 approaches to estimating the level of GDP over time:

Answer 6

The income approach (I) – based on the estimates of all the incomes earned in the economy
The expenditure approach (E) – based on the estimates of total expenditure on final goods and services
The production approach (P) - based on the estimates of total output produced. This is calculated by looking at the value added each stage of the production process

Question 7

What is the purpose / reason for real GDP

Answer 7

Given that the Australian Gov’t an economists are concerned about economic activity in terms of it’s impact on employment, income and living standards, statisticians have devised a away to remove the price effect so that any increase in the GDP is real in the sense that it represents an increase in the volume (or real value) of production.

Question 8

What is the chain volume measure of the GDP

Answer 8

The chain volume measure of the GDP is used by the ABS to provide an estimate of real GDP in the economy, in simple terms it involves using prices from the previous period and applying them to current period volumes, it is this that provides the most accurate measure of the economic growth in our economy which in turn provides and indication of how well the economy is performing in terms of income/wealth generation and improvements in (material) living standards
Growth in real GDP above 0 means the economy has experienced economic growth in real terms (after removing affects of inflation)

Question 9

Define gross national expenditure

Answer 9

Total expenditure by Australians on goods and services produced in Aus’t and the rest of the world

Question 10

Importance of GNE

Answer 10

If GNE is greater than the GDP it will mean that there is a shortfall of production compared to expenditure – this will mean the difference will be equal to the difference between exports and imports

Question 11

Define macro economics

Answer 11

The study of the economy as a whole focusing on aggregate variables such as national income, production and expenditure (real GDP), inflation, unemployment, the CAD and net foreign debt. It is therefore concerned with the “big picture” of how the economy works and how gov’t may influence

Question 12

Define AD

Answer 12

Total expenditure on Australian made goods and services

Question 13

Define demand factors

Answer 13

a factor that causes changes in economic activity via it’s impact on AD

Question 14

What is the aggregate demand formula

Answer 14

AD = C + I + G + X – M

Question 15

Explain the component consumption

Answer 15

The total value of all expenditures on individual and collective consumption goods and services incurred by resident households and non – profit institutions serving households
Represents about 60% of Ad – quite stable

Question 16

Explain the outlays of consumption

Answer 16

Expenditure on consumer durables such as cars, furniture and high value, long lasting household appliances (not including dwellings which are regarded as fixed assets (industry)
Consumer semi-durables e.g. clothing and shoes
Single use goods e.g. food, cigarettes and alcoholic drinks
Services such as hairdressing, dry cleaning and public transport.

Question 17

What is consumption affected by

Answer 17

Consumer confidence
Interest rates
Disposable income
Tax rates
Saving ratios

Question 18

Define disposable income

Answer 18

Disposable income – The total income that households have received in exchange for their participation in the production process plus government transfers less direct (income taxes). Also gross income less the direct taxes levied by governments

Question 19

How does disposable income affect ad

Answer 19

When real disposable income increases it means that after tax income has increased, in real terms providing the household sector with increased purchasing power
This is likely to increase consumption – boosting AD and leading to an increase in real GDP or economic growth

Question 20

Define consumer confidence

Answer 20

consumer’s general expectations about future economic prosperity

Question 21

How does consumer confidence affect AD

Answer 21

When the economy is growing strongly it will add to consumer + business confidence and consumers are more likely to increase their marginal prosperity to consume (more likely to spend a higher proportion of their income)
Businesses will be more likely to invest in new capital and equipment or expand capacity
Both consumers + business will be more willing to take on debt as they believe their capacity to service the debt into the future is enhanced – this will lead to further upward pressure on consumption and investment lifting AD and increasing the rate of eco growth.

Question 22

Define interest rates

Answer 22

cost of borrowing money

Question 23

Explain how interest rates (on demand side) affect Eco growth

Answer 23

Demand side = when interest rates increase household and business sectors are likely to reduce demand for goods and services as the cost of borrowing money is higher.
Households would be less likely to use credit cards or to take out loans for the purchase of consumer durables (tv / computers)
Similarly businesses are less likely to purchase new capital or expand operations

Further the higher cost of financing existing loans for household and businesses causes them to experience a reduction in funds available for spending reducing both consumption & investment
This ultimately results in a slower rate of eco growth

Question 24

Explain how the supply side component of interest rates affect Eco growth

Answer 24

higher interest rates – higher cost of financing existing business loans will tend to increase the cost of production for businesses, decrease the ability to expand supply and exert upward pressure on prices and inflation.
This than acts as a further resistant on eco growth as higher prices deter Consumption and reduce net exports (X-M)

Question 25

What are company tax rates

Answer 25

Company taxed in Aus’t is proportional taxes levied against company profits at a flat rate of 30%

Question 26

Explain how tax rates of the demand side affect ad

Answer 26

Demand side = Lower company tax will provide a medium to a long-term stimulus of AD as businesses will increase investment demand. This occurs because the after tax rate on investment projects will be higher as future profits will be taxed at a lower rate.

Businesses will be able to justify investment in more projects boosting AD and proving a long-term boost to eco growth once the investment projects become fully operational adding to the nations productive capacity

Question 27

Explain how tax rates on the supply side can influence ad

Answer 27

Supply side = impact is considered by an immediate reduction in production costs when company tax are deducted – this will enable business to reduce prices (increase willingness) which will stimulate AD and economic growth via an increase in consumption (as prices are lower) and net exports (as there is an increase in international competitiveness

Question 28

Explain the role of investment (I)

Answer 28

The purchase of new equipment, plant, buildings and vehicles. The purpose of investment is to expand (raise) the productivity capacity and productivity of firms (improve efficiency of labour and natural resources
Investment spending is usually undertaken with the purpose of generating additional goods and services in the future. Private investment expenditure is therefore a volatile component of AD as a business are continually changing their forecasts about future profitability
It comprises approx. 15-20% of AD

Question 29

Define company tax rates

Answer 29

Taxes paid by corporations, currently a flat (proportional 30% of profits but will fall to 29%

Question 30

What is investment affected by?

Answer 30

Company tax rates
Interest rates
Business confidence

Question 31

How does company tax affect ad (mainly investment)

Answer 31

if company taxes decreased members would retain a greater proportion of profits

Question 32

Define business confidence

Answer 32

The general business community’s perception of their future level of sales and profitability (also refers to business sentiment)

Question 33

Explain government expenditure

Answer 33

Government expenditure – Includes expenditure by all areas of government (federal, state and local) it is commonly broken up into G1 and G2:

Question 34

Define g1 and its factors

Answer 34

G1 – Government current (consumption expenditure) on goods and services that are non-capital in nature

This includes collective goods and services for current use necessary to run the gov’t, much of the spending goes towards the provision of government services such as; health, education and defence. It also includes spending for government departments on stationary, salaries and rent
Relatively stable component of AD

Question 35

Define g2

Answer 35

G2 – Government investment expenditure on goods that are of capital nature

Question 36

Define exports

Answer 36

Exports – Goods and services that are made in Australia and purchased by foreign residents
20% of AD

Question 37

Define imports

Answer 37

Goods and services purchased by Australians that are made overseas
24% of Ad

Question 38

Define a tariff

Answer 38

A form of ‘protection’ involving taxing on imports

Question 39

Explain how tariffs affect ad

Answer 39

supply side’ – can lower production costs and encourage greater supply
demand = This policy can have short term ‘demand side’ benefits for the Australian economy, in terms of reducing imports (reliance) boosting AD and eco growth

However tariffs can have long-term negative “supply side” side effects that are characterized by lower levels of productivity or efficiency, a higher cost structure for the economy, higher prices and lower AD and Eco growth e.g motor vehicle industry

Question 40

Define exchange rate

Answer 40

The value of the Australian dollar when compared to another currency, or a basket of currencies of our major trading partners

Question 41

Explain how the exchange rate affects Eco growth

Answer 41

If the AUD decreases = the demand side effects on economic growth are positive – there are 3 main reasons:
Exports in Aus’t that are ‘price takers’ (rely on the USD price of their goods when selling on world markets) will receive more income for any given volume of exports – each USD they receive for their product is now worth more than before. The rise in export income causes AD and economic activity to increase – despite the volume of exports being unchanged

Non price takers (tourism industries etc) will find that price competitiveness of there of their G+S in international markets will increase when the value of the AUD falls (e.g. if AUD fell but NZ dollar rose people would prefer to travel to AUS)

Important competing business in Aus’t will now be relatively more price competitive against imports as the lower AUD forces importers to pay more for imports thereby raising the price of imports – this causes consumers to shift away from imported goods to local goods – causing net exports and AD to rise = stronger rate of eco growth.

Question 42

Explain how overseas economic conditions affect ad

Answer 42

Increases in the rate of overseas economic conditions is likely to have a favorable impact on Aus’t rate of growth for 3 main reasons:

Likely to be increase demand for Aus’t exports of consumer items, capital items and raw materials needed to fuel the growth in overseas economies (china a developing country is still heavily dependent on Aus’t for raw materials)

Higher rates growth rates overseas may trigger inflationary pressures in those economies – resulting Australian’s demanding a smaller volume of imports and instead purchasing relatively cheaper domestic products (X-M) down

Strong growth will tend to improve consumer and business confidence and also provide a greater supply of foreign funds – that can be used to fuel Aus’t investment

Overall the higher overseas growth should boost C, I and (X-M) lifting AD and increasing the rate of eco growth

Question 43

Define terms of trade

Answer 43

The ratio of Australian exports prices to import prices (NOT QUANTITY)

Question 44

What is the terms of trade equation

Answer 44

Export price index
Terms of trade index = ——————————–
Import price index

Question 45

Why is a higher TOT typically good for Australia?

Answer 45

When the TOT increases it means we have been able to purchase more imports for any given volume of exports. It means we have experienced an increase in our purchasing power, reflected by a higher level for ‘real GDP income’

e.g when the prices for iron ore increase this will lead to an increase in the TOT and boost the incomes for mining companies for any given level of output (not affected by volumes changing)

The higher level of income enables companies to increase investment and boost factor incomes (wages / dividends) these factors are likely to boost consumption, investment and exports providing a stimulus to AD

More than 50% of Australia’s exports are commodity’s whose prices are largely determined by world markets

Question 46

Exports and imports are affected by

Answer 46

Tariffs
Exchange rates 
Overseas economic conditions 
Domestic conditions
Terms of trade

Question 47

Regarding consumption hoe much is typically spent overseas

Answer 47

20% 1/5th

Question 48

Define aggregate supply

Answer 48

The total value of goods and services available (in the market) for sale in an economy in a given time frame.

Question 49

Define supply factors

Answer 49

A factor that causes changes in economic activity via it’s impact on AS

Question 50

Define capacity utilisation

Answer 50

The rate at which industries are producing in relation to maximum capacity

When an economy has reached the point where it is supplying the maximum possible at that point in time it is said to have reached ‘productive capacity’

This is difficult to measure and as a result policy makers rely on other statistics to give an indication of how close the economy is to ‘productive capacity’

Question 51

The ability and willingness of firms to supply goods and services is influenced by

Answer 51

Factors affecting the quantity and quality of productive resources and their availability – as these increase business are able to increase supply e.g discovery of new resources & a drought

Factors affecting the costs of production and profits. If costs are reduced and profits increase business are more likely and willing and able to increase supply e.g. Costs of operating in Aus’t is high compared to China

Factors affecting efficiency and productivity, as efficiency and productivity increase business are generally willing and able to increase supply e.g. advances in technology means greater volumes of output can be generated per hour worked – this lowers the costs per unit and also increases the amount that can be produced from given inputs performance based contracts may also motivate some workers to increase their output

Question 52

Other contributing factors of aggregate supply

Answer 52

Other contributing factors {RIPPEX}
Real
Real unit labour costs
Interest rates 
Productivity
Participation rate
Exchange rates

Question 53

Define real unit labour costs

Answer 53

The average cost of labour (adjusted for inflation) divided by average labour productivity

RULC^ = cost of production^ = firms willingness to supply will decrease = therefore AS will decrease {no relation to demand}

Question 54

Define productivity

Answer 54

The volume of output that is produced from a given number of inputs (labour + capital resources) Refers to how well factors of production combine to produce G+S

Question 55

How can productivity influence Eco growth

Answer 55

Common form of productivity is ‘labour productivity’ – measured as total output (GDP) divided by total hours worked

An increase in productivity should increase eco growth over time because any volume of output can be produced with fewer resources thereby enabling a business to experience lower production costs.

Per unit costs of production will likely fall (labour)
Thus there is greater CAPABILITY

Question 56

Explain how interest rates (supply side) can alter Eco growth

Answer 56

Higher interest rates can act as a supply factor restraining growth.
The higher cost of financing existing business loans will tend to increase the cost of production for the business – decreasing their ability to expand supply + exert upward pressure on prices + inflation.

This then acts as a deterrent on eco growth as higher prices deter Consumption and net exports (X-M

Question 57

Define participation rate

Answer 57

The percentage of the total ‘working age’ population (over 15) that is a member of the labour force

Question 58

Explain how the participation rate can influence ad and Eco growth

Answer 58

When the participation rate increases this will reflect a bigger labour supply and greater competition for jobs will exist, this exerts a downward pressure on labour cost (unit labour costs are likely to fall)
Extra number of people looking for work will minimize the chance of wage increases within the market

In addition higher labour supply increases pressure on those already employed to lift performance this having a favorable effect on labour productivity

The lower unit labour costs should result in lower average cost of production for the business, leading to a fall in inflation and a boost in Ad and eco growth.

Question 59

Define the exchange rate

Answer 59

The value of the Australian dollar when compared to another currency, or a basket of currencies of our major trading partners

Question 60

Explain how the supply side of the exchange rate can lead to Eco growth

Answer 60

A higher Australian dollar tends to restrain economic growth + depreciating AUD tends to stimulate economic growth

The lower value of the Australian currency will result in relatively more expensive intermediate imports and capital imports – thus increasing the cost of production therefore negatively impacting AD + eco growth

A higher Aud – imports as inputs of production become relatively cheaper = cost of production decreases – willingness increases – AS ^

Question 61

Explain the model of AD and As

Answer 61

The relationship between Ad and the general level of prices in the economy is similar to the relationship between demand for an individual good and service and the price; an inverse relationship – the AD is therefore downward slopping but for different reasons

Growth in general level of prices will decrease the ‘purchasing power’ of a given nominal income and reduce the level of real amount that can be spent on goods and services
Higher prices in Aus’t may reduce Australia’s international competitiveness and result in substitution towards cheaper (imported) goods and services

Question 62

Negatives of aggregate supply

Answer 62

AS output increases and the economy approaches productive capacity becomes increasingly difficult to expand production – if the economy reaches productive capacity the AS curve would
When economy Is at productive capacity the capacity constraints limit the economy form producing more g + s

be vertical because the increase in AD could not be met and the resulting shortages in multiple markets would cause prices to rise across the economy.

Question 63

Define the business cycle

Answer 63

The cyclical movement of the economic activity, over time with periods of above average rates of economic growth and periods of negative and low rates of growth – also referred to as economic cycle

Question 64

Explain the business cycle

Answer 64

The business cycle is also referred to as the economic cycle or the trade cycle. Over time, the level of economic activity (and therefore the rate of economic growth) fluctuates. It seems to go through a cyclical movement with periods of above average (and some might consider excessive)
Rates of economic growth and periods of negative or low rates of growth. By looking at the rate of economic growth over an extended period, there appears to be peaks, troughs, recoveries and downturns.
All cycles are characterized by peaks, troughs, recoveries and downturns;
Not all peaks result in ‘Booms’ in economic activity;
Not all troughs result in ‘recessions’;
The length of each economic cycle is rarely the same (e.g. the length of one recovery and peak may be much longer than the recovery or peak experienced in the previous economic cycle

Question 65

Explains what books are associated with

Answer 65

Booms are associated with very high rates of growth in production, but not all peaks in the business cycle will be considered booms. Conversely, troughs are associated with very low rates of growth in production, but not all troughs will be considered a recession.

Question 66

Explain stage 1 the peak

Answer 66

During a peak the economy is usually experiencing strong rates of economic growth – consumer and business confidence are high which may encourage greater prosperity to spend and take on new debt. The strong growth in demand will encourage firms to expand production, leading in an increase for demand for labour.
If the peak is considered to be a boom then the rate of eco growth may be considered excessive and unsustainable (likely to be inflationary pressures in the economy) Asset prices may increase rapidly and there will tend to be a significant increase in Australia’s CAD. Generally a boom is unsustainable and the economy will eventually move

Question 67

Define a boom

Answer 67

Period of very high rates of growth in production (or real GDP) that is likely to be unsustainable

Question 68

Explain stage 2 the contraction / downturn

Answer 68

The excessive rates of inflation and the existence of capacity constraints that characterize a boom (peak) in the bus cycle should mean that increasing volume of production becomes more difficult.

High inflation, high interest rates and strong growth in asset prices that result in overvalued assets (property, shares) typically results in market ‘correction’ that eventually leads to a fall in private consumption and investment as more households save and deleverage (reduce their debt burden)

The rate of economic growth will eventually slow – some resources will become unemployed, confidence deteriorates and further inflation falls.

Question 69

Define a contraction

Answer 69

downturn in economic activity

Question 70

Explain stage 3 the trough

Answer 70

Where economic activity reaches its minimum point in the cycle. A trough is usually associated with low or negative rates of economic growth.
Lower rates of growth mean that firms will need fewer factors of production and the (unemployment & underemployment) should start to rise.
The inflation will generally fall in a trough, if the downturn is bad enough – deflation can result where the general levels of prices fall

Question 71

Define a trough

Answer 71

A period of very low rates of growth in production (or real GDP) or the lowest point in the business cycle

Question 72

Explain stage 4 recovery

Answer 72

During the trough the relatively low inflation rate combines with lower labour costs and lower interest rates to spark an economic recovery.

Question 73

Define recovery

Answer 73

Pick up levels in economic activity

Question 74

How does stagflation occur

Answer 74

While a boom is normally characterized by; strong production, high inflation and low unemployment and a recession is associated with weak production, low inflation and high unemployment. It is still possible to have periods of low economic growth, high unemployment rates and high interest rates – this is known as ‘Stagflation’

Question 75

How can the Government stabilise the flaucations in the business cycle

Answer 75

Given the highly cyclical nature of economic activity over time, the Government tends to use Macroeconomic demand stabilization policies to temporarily replace the lack of demand during a trough and constrain growth during a peak

Question 76

Define stagflation

Answer 76

Period of low economic growth, high unemployment rates and high inflation rates

Question 77

What is the purpose of economic activity

Answer 77

The purpose of economic activity is to increase the living standards of the society and the individual. The easiest way to measure this is looking at the Real GDP per capita (person) giving a general view of the purchasing power of an individual within a country
(not taking non-market transactions into account)

Question 78

Explain the importance of Eco growth over a period of time

Answer 78

Over time economic growth should lead to an increase in living standards, an increase in the volume of goods and services produced meaning the real incomes increase and the average person can purchase more goods and services

Increases in GDP are also important for employment for labour resources. Increase in productivity ^ increase in population^ and implementation of technology in the production process, greater volume of goods and services ^ must be produced to keept unemployment steady.
If unemployment rate is to fall a higher rate of growth is needed – therefore growth is needed to boost employment and therefore the real income of the population.

Question 79

How may GDP per capita be a misleading indicator

Answer 79

The distribution of income is highly uneven – if a small % of the population is extremely wealthy while the most of the population lives in poverty – than standards of living may be disguised by focusing on the mean income.
GDP does not include all non market transactions so that the true value of goods and services consumed by individuals is not considered.

Question 80

Define living standards

Answer 80

The aggregate welfare of people in Australia, made up of both material factors such as (access to goods and services) and non-material factors (such as quality of life)

Question 81

Explain the characteristics of living standards

Answer 81

Non material standards is hard to measure and compare – can not be simply done through goods + service and GDP
Health of natural environment and leisure time has a strong inverse relationship (time famine)
Lack of crowding
Freedom
Happiness
Health/life expectancy
Stress

Question 82

Explain long term economic prosperity

Answer 82

Long term economic prosperity
The main concern is that the ruthless pursuit of economic growth can not be sustained – thus influencing living standards.
In order to produce more g+s each year more resources are consumed and more waste is disposed
Thus the gov’t aims to improve living standards in the long-term through focusing on ‘sustainable-development’ (renewable energy

Question 83

Define sustainable development

Answer 83

development that meets the needs of present without compromising the ability of future generations to meet their own needs

Question 84

Explain environmental quality

Answer 84

There is sometimes a trade off between the protection of the environment and the pursuit of economic growth.
Short term getting lots of G+S = (MLS^) in the long term both material and non material living standards will fall
Environmental quality itself is a part of NMLS
It is also fundamental in achieving MLS as it is a source for which more eco activity depends on

Long term prosperity also depends on limiting the damage we do to the environment (global warming)
Our long term economic prosperity depends on our ability to manage natural resources sustainably and manage waste from production and consumption so that it does not impact on future generations living standards.

Question 85

Explain income per capita

Answer 85

depends directly on growth in GDP – as the volume of goods and services increases from year to year the income generated also does in real terms.

Meaning more income is available for distribution to those who participate directly or indirectly in the production process.

Volume of production rises ^ (GDP) so does income from extra production therefore so does the ability to satisfy more needs and wants through buying more G+S (MLS^)
Growth in GDP will lead to greater gov’t revenue = more public goods and services (MLS

Question 86

Explain the income distribution

Answer 86

Equitable income is essential for living standards to be maintained – living standards are not just one persons they are all of society’s
One theory suggests that the best way to boost economic growth in a country and therefore living standards is to minimize taxes on businesses and high income earners - it is argued that a low tax burden encourages people to work harder (knowing the keep more) and offers an incentive to take entrepreneurial risks

Encouraging business and wealthy households to invest, greater volumes of G+S can be produced at lower prices – resulting in increased employment opportunities for middle to low-income earners, which eventually increase their purchasing power. Eventually everyone’s (MLS^)

If the labour market was purely driven by market forces with no intervention for low skilled workers or those with weak barging skills / positions than the gap between high and low income earners would be vast = trade off between equity and efficiency

Question 87

Define the trickle down affect

Answer 87

A theory that suggests that the way to boost economic growth in a country is to minimize taxes on a business and high income earners in order to promote efficiency and productive gains - through encouraging business and wealth households to invest – greater volumes of G+S can be produced at lower prices resulting in increased employment opportunities for middle / lower income earners – increasing material living standards and purchasing power.

Question 88

Define labour costs

Answer 88

The cost of business employing labour including wages salaries paid to employees and any additional costs associated with their employment

Question 89

Define inter temporal efficiency

Answer 89

How well resources are used over periods of time

Question 90

Define productive capacity

Answer 90

The point at which the production is occurring at the maximum level possible in the economy

Question 91

Define economic growth

Answer 91

An increase in the amount of national production that has occurred over time - most commonly measured by changed in the level of GDP