Term 1 SA test Flashcards
exchange rate
the value of a currency in comparison to another currency
floating exchange rate
when the value of a currency is determined by demand and supply
trade weighted index (TWI)
The average value of the AUD compared to Australia’s major trading partners currencies, weighted according to their significance
Factors affecting the demand for and supply of AUD
- financial flows
- trade flows
- economic conditions
Factors affecting the demand for and supply of AUD - Financial flows
Level of Australian interest rates relative to overseas interest rates
- High domestic rates attract foreign investment,
creating higher demand for AUD
- Low domestic rates incentivise saving funds in
overseas banks, creating a high supply of AUD
Investment opportunities
- High opportunities domestically support high demand
for AUD
- High foreign opportunities create a high supply of
AUD
Speculation
- If there is an expectation of future appreciation, there
may be high demand for AUD
- If there is an expectation of a future depreciation
investors may sell AUD, increasing supply
Factors affecting the demand for and supply of AUD - trade flows
Exports
- High demand for domestic exports leads to high
demand for AUD
Imports
- High demand for imports results in high supply of AUD
Commodity prices and terms of trade
- Improvements in commodity prices and terms of trade
increase the value of exports, causing high demand
for AUD
- A decrease in commodity prices and terms of trade
decreases the value of exports, causing high supply of
AUD
Factors affecting the demand for and supply of AUD - economic conditions
Expansionary period
- Upturn in domestic and/or international business cycle
may increase demand for Australia’s exports, creating
high demand for AUD
Contractionary period
- A downturn in the domestic and/or international
business cycle may decrease demand for Australia’s
exports, creating a high supply of AUD
Tastes and preferences
- Affect demand of Aus exports and imports, and
therefore the demand and supply of the AUD
Changes in exchange rate - appreciation
An increase in the exchange rate of one currency in terms of another
Occurs when demand increases and/or supply decreases
changes in exchange rate - depreciation
A decrease in the exchange rate of one currency in terms of another
Occurs when demand decreases and/or supply increases
fixed exchange rate
When the government or RBA officially sets the exchange rate for an economy
clean float
pure demand-supply model with no central bank intervention (only exists in theory)
dirty float
a flexible exchange rate but managed to a certain extent
managed exchange rate
Any official intervention by a government in setting the exchange rate
Advantages of a flexible over fixed rate
More accurately reflects international competitiveness which encourages free trade
Dutch disease: a boom in one export causes an appreciation in exchange rates making other industries less competitive
Disadvantages of flexible over fixed rate
volatile or sudden changes cause future transactions to become uncertain, which heavily influences speculative investment
Depreciations may cause inflation, as imports are more expensive and this price increase can be reflected in the domestic interest rate
Direct intervention by RBA on exchange rates
The RBA buys/sells foreign exchange when the AUD goes either too high or too low
If AUD is too high the RBA sells AUD reserves to increase supply, and decreases its value
If the AUD is too low, the RBA buys AUD reserves to increase demand and increase its value
Indirect Intervention by RBA on exchange rates
Monetary policy: Interest rates set by the RBA have a secondary function of changing the interest rate between Australia and overseas
Effects of fluctuations in exchange rates on the economy - Positive Impacts of Appreciation
Cheaper imports may cause lower import inflation as prices are lower
Cheaper imports encourage allocative efficiency of resources resulting in a long term shift to more competitive industries
Cheaper imports mean consumers and firms can buy a greater quantity of products due to increased purchasing power, therefore improving living standards and lowering input costs
Valuation effect on debt decreases interest servicing costs on foreign debt and the overall AUD value of foreign debt
Effects of fluctuations in exchange rates on the economy - Negative Impacts of Appreciation
Exports are more expensive, and we expect a fall in the quantity demanded, leading to a long term loss of investors, causing slower economic growth
Cheaper imports may cause domestic firms to lose competitiveness which may increase unemployment
Valuation effect on assets
Effects of fluctuations in exchange rates on the economy - Positive Impacts of Depreciation
exports are cheaper, so we expect an increase in quantity demanded causing a long term increase in investment and economic growth
More expensive imports may cause domestic firms to increase competitiveness which may increase employment
Valuation effect on assets
Effects of fluctuations in exchange rates on the economy - negative Impacts of Depreciation
Imports are more expensive, which may cause imported inflation
More expensive imports decreases living standards and increases input costs due to decreased purchasing power
Valuation effect on debt
aggregate demand
the total demand over a period of time
aggregate demand formula
AD=C+I+G+(X-M)
consumption
spending by households, contributes to ~60% AD
Factors that influence consumption levels
interest rate levels, a person’s income level, MPC and the distribution of income
investment
spending by firms to increase productive capacity.
factors that influence investment levels
the cost of inputs, interest rates, profit levels, business expectations, tax rates and government policy
Government spending
spending by local, state and federal governments.
factors that influence government spending
policy objectives of the government (such as lower inflation and unemployment) and the general state of the economy
Net exports
expenditure by foreigners on domestically produced goods/services (exports) minus expenditure on foreign goods/services (imports).
factors that influence net exports
the global business cycle, exchange rate and commodity prices
aggregate supply
the total productive capacity of an economy when all factors of production are fully utilised over a period of time
equilibrium
I + G + X = S + T + M
the simple multiplier
The simple multiplier refers to the extent to which an initial change in autonomous expenditure is multiplied to give or result in a larger change in the equilibrium level of national income
MPC formula
MPC = 𝚫C/𝚫Y
multiplier formula
K = 1/(1-MPC)
K x change of income = new income
sources of eco growth in Aus
consumption by households, investment by business, government spending, net exports, technological change, labour productivity, capital productivity, education, R&D, access to more resources, immigration, 3 p’s - productivity, participation, population, natural resources, labour, capital
positive effects of economic growth
Higher GDP per capita improves living standards and economic development
Increased employment opportunities
Increased confidence due to high growth rates
Improvement in budgetary position
Increased innovation
more export revenue
higher levels of saving
negative effects of economic growth
Investment in new capital may cause short-term structural unemployment
May lead to higher inflation as higher AD pushes up prices
Worsened BOGS and increased CAD
Increased income inequality as high income earners disproportionately benefit from increased economic growth
Increased negative externalities due to conflict between growth and sustainability as the use of natural resources fuels short term growth, but threatens long term growth
ecologically sustainable development
the growth rate with economic benefits without environmental destruction
development that meets the needs of the present without compromising the ability of future generations
increase in AS
Capacity constraint is the point at which the economy approaches full employment and cannot grow any further
In the long run, AS must increase to match AD, because if it doesn’t then further AD will simply cause inflation
unemployment
people willing and able to work, actively seeking work, but unable to find employment
labour force
working age population who are employed or unemployed
working age population
labour force + people in the working age bracket that aren’t actively seeking work
participation rate
labour force/working age population
the percentage of people in the working-age population that are in the labour force
unemployment rate
Unemployment rate: unemployed/labour force x 100
the percentage of people in the labour force who are unemployed
trends in unemployment
Unemployment has increased due to COVID and the participation rate has fallen
Higher unemployment was experienced from mid 1970s onward due to high microeconomic reforms and structural changes within the Australian economy
Casualisation of the workforce has increased, increasing underemployment
types of unemployment
cyclical, structural, seasonal, frictional, hidden, long term, underemployment
cyclical unemployment
unemployment caused by a contraction in economic activity and aggregate demand. This generally occurs in the short-term during periods of economic downturn
Structural unemployment
structural (long-term) changes causing workers to become redundant or displaced. occurs when there is a mismatch between the jobs that are available and the people looking for work. Could result from a lack of required skills or the available jobs are a long way from job seekers, likely to face long term unemployment
frictional unemployment
people who are temporarily unemployed as they move between jobs, or when people transition into and out of the labour force
seasonal unemployment
certain work at certain times of the year can create unemployment that changes with seasons. Occurs at different points over the year because of seasonal patterns that affect jobs
Hidden unemployment
Those who are unemployed for more than 12 months and who have given up actively seeking work. Occurs when people are not counted as unemployed in the formal ABS labour market statistics but would probably work if they had the chance
long term
unemployed for more than 12 months. This can be linked to structural unemployment if a reskilling process is not undertaken
underemployment
part-time or casual workers who would like to work more hours than they are currently offered
Causes of unemployment
Economic growth levels - demand for labour is derived demand
Annual rate of economic growth must exceed the sum of the rate of productivity growth and labour force increases
Rising participation rates
Fiscal policy and monetary policy
Structural change
natural rate of unemployment
the level of unemployment at which there is no cyclical unemployment
NAIRU
the lowest unemployment rate which can be sustained without an increase in inflation
main groups affected by unemployment
Young people
Face high rates of unemployment due to the lack of experience, skills or education. In 2019, the unemployment rate for people aged 15-19 was 7% higher than the national unemployment rate
Aboriginal and Torres Strait Islanders
Have high rates of unemployment around 3-4 times the national average
Specific Regions
Such as country areas in Australia, where there are limited jobs available
Migrants
Often have limited English skills, may find it harder to obtain work, and hence experience higher unemployment
economic costs of unemployment
Opportunity cost
Economy is losing the opportunity of working to full capacity
Lower living standards
Lower purchasing power, disposable income and living standards
Loss of skills
May result in a rise of structural unemployment
Government costs
Increase social welfare and less taxation revenue
Lower wage growth
Greater supply of workers means firms can offer lower wages, which may also lead to increased income inequality as lower skilled workers may find it harder to negotiate wage rises
Intergenerational poverty
social costs of unemployment
Increased inequality
Increased inequality can lead to increased mental health issues, crime rates, alcohol abuse and family tensions
Low self esteem and dignity
People may experience reduced motivation which can lead to hidden unemployment
inflation
Sustained increase in the general price level over a period of time, usually over one year
headline inflation
Most commonly used rate
Found using CPI
measures changes in the prices of a selected regimen of consumer goods and services over time by using price index numbers
Inflation rate = [(current CPI - Previous CPI)/Previous CPI] x100
Doesn’t measure all goods and services
Lags (doesn’t reflect current performance)
underlying rate
Headline Rate - Volatile Factors
Unusual movements can distort understanding of inflation
More accurate and preferred
government inflation goals
RBA sets target of 2-3% over the business cycle on average Avoid hyperinflation Extremely rapid inflation where prices escale quickly : over 50% per month Decreases the real value of money Decreases purchasing power Increases cost of living Avoid deflation Price levels decline Anticipate lower prices in future Consumers save rather than spend Decreased aggregate demand Decreased economic activity May lead to a recession
causes of inflation
demand inflation
cost inflation
inflationary expectations
imported inflation
demand inflation
Demand side source
When increases in aggregate demand exceed increases in aggregate supply
demand increases faster than production can, resulting in shortage of goods, consumers compete, increasing prices and causing inflation
Usually occurs during a boom
Causes
Any increase in aggregate demand - consumption, investment, government spending, net exports
inflationary expectations
Consumers expect higher inflation so planned purchases brought forward, spending increases in the short term, increase demand-pull inflation
cost inflation
Supply side
Occurs when production costs rise, forcing firms to increase their prices to preserve profit margins
Production costs increase, firms produce fewer goods and services at any price, aggregate supply falls
Factors that make production costs increase
Wages
Cost of raw materials, equipment, or services
imported inflation
Inflation due to an increase in the cost of imports
Overseas sector
If AUD is comparatively weak and inflation is high overseas, the cost of imported raw materials and equipment rises, increases productions costs for firms, increasing prices
negatives of inflation
Constraint on economic growth in the long term
Distorts consumer spending and saving decisions - increase short term spending which decreases long term growth
When inflation is too high, contractionary monetary policy or fiscal policy is implemented, decreasing demand, reducing economic growth
Reduction in international competitiveness
With high inflation, cost of Aus products and inputs increases, exports decrease and import spending increases, decreasing our international competitiveness and causing a deterioration of trade balance and current account, reduces AD
Depreciation of Exchange Rate
Inflation reduces real value of money, so AUD is worth less, leading to currency depreciation
Inflation undermines investor confidence, decreasing demand for AUD resulting in currency depreciation
benefits of inflation
Avoids deflation
Deflation usually comes with low economic growth and high unemployment
Consumers delay spending, waiting for prices to drop further, dampening AD
Relationship to Unemployment
Indirect effect
Strong correlation between high inflation and low unemployment
effect of inflation on income earners
Loss of purchasing power
High inflation worsens income distribution
Skill Levels
As prices rise, workers seek higher wages. The higher the skills and qualifications, the more bargaining power to get higher wages as they are harder to replace
Income is redistributed from low to high skilled workers
Income Type
Indexed - automatically adjusted to inflation e.g. pensions and welfare recipients
Fixed - don’t adjust to inflation
effects of inflation on borrowers and lenders
Lenders
Negative impact
receive a certain percentage of their savings each period, as the general price levels rise, these interest repayments are worth less
Borrowers
Positive impact
Interest repayments are worth less
Borrowers technically are paying back less money
effects of inflation on real asset owners
Real Assets - physical assets that have worth e.g. property, land, commodities
Inflation causes the monetary value of assets to rise, making their owners wealthier
effects of inflation on firms
The effect inflation has on firms depends on the type of firm or market
Benefits monopolies as there are no alternatives
Import competing firms will suffer as consumers can buy cheaper foreign alternatives
effects of inflation on government
Benefits from increased taxation revenue
Government expenditure increase
cost of providing public goods becomes higher
Welfare payments are more expensive
lorenz curve
A graphical representation of income distribution. A 45° upward sloping line indicates the line of perfect equality
gini coefficient
Measure of income distribution calculated by using the lorenz curve
= Area A/(Area A+B)
coefficient of 0 represents perfect inequality
The higher the coefficient, the more inequality in an economy
Income
money and other benefits received by individuals in return for the factors of production, such as land, labour, capital and enterprise. It also includes social welfare or transfer payments
bilateral exchange rate
measures the value of a unit of domestic currency relative to another currency
real gdp calculation
(nominal GDP/1) x 100/CPI
Sources of income as a percentage of household income
Wages and salaries ~ 55.8% Profits ~ 18.5% Rent, interest and dividends ~ 11.5% Social benefits~ 8.6% Other ~ 5.6%
Progressive taxation
the more you earn the more you pay - reduces inequality
Proportional tax
doesn’t reduce equality as it takes a standard proportion of income from all
Regressive tax
impacts lower income earners more than high income earners
Transfer payments
such as age pensions, unemployment benefits and more exist to protect those who cannot earn a sufficient amount of income for themselves
wealth
the value of assets owned by individuals, including property, consumer durables, and financial assets.
sources of wealth
Accounts held with financial institutions (5.8%)
Owner occupied property and other property (56.7%)
Superannuation (17.8%)
dimensions and trends of income inequality
Gender
In Aus there is a 14% pay gap between men and women
Women are more likely to have to take time off work for children, preventing them from earning more
Age
Income varies over a person’s life due to experience and skills
Younger people typically earn lower incomes due to less experience
People over 60 find it more difficult to gain employment as they approach retirement age and may receive lower pay
Occupation
Jobs with higher skill levels generally pay higher and those with successful businesses
Ethnic Background
Those with limited english skills often have difficulty in obtaining skilled work where proficient english is required
Family Structure
Single parents have a low weekly income, whereas couples without dependent children have the highest income
economic benefits of inequality
incentive effect: people will seek to increase skills, education, productivity and geographical mobility if they are motivated to earn more
Encourages entrepreneurialism: people are willing to accept investment, risk, and innovation for higher profits
Higher Savings: higher incomes lead to more savings, which may result in less reliance on overseas borrowing, which may improve CAD
social benefits of inequality
Incentivises community values: including hard work, the importance of skills, education and dedication
economic costs of inequality
Overall utility is not increased: due to the law of diminishing marginal utility, when high income earners earn more they find less utility from this increase in income
Consumption and Economic Growth decreases: higher income earners have a lower MPC compared to low income earners, hence adding less to AD
Government Welfare: increases with increased income inequality
social costs of inequality
Class division: increased income inequality can cause tension and conflict, and a possible poverty cycle and discrimination
Decreased Well being: less economic development for lower income earners can affect health outcomes or crime rates
nominal gdp
the dollar value of the goods and services produced in a time period, which depends on the volume of what was produced and the prices of what was produced
nominal gdp calculation
(value yr 2 - value yr 1)/value year 1 x100
real gdp calculation
𝚫volume/volume yr1 x100
factors that affect AS
labour, capital and productivity
income distribution data
highest 20% : 42% lowest 20%: 6% second 20% : 20% middle 20%: 17% fourth 20%: 23%
wealth distribution data
highest 20% : 64% lowest 20%: 1% second 20% : 5% middle 20%: 11% fourth 20%: 20%
private costs
the expenditure by producers on resources to produce output and by consumers in buying g/s
social costs
the cost imposed on society as a result of private costs
private benefits
profits made by producers and satisfaction gained from consumption by consumers
social benefits
positive effects of private production on the community
market failure
where the price/market system fails to take into account social costs and benefits
private good
excludable - those that are unable to pay form them are excluded from enjoying them
rival - if a good is consumed by 1 person, it is unable to be consumed by another
public goods
non-excludable - people can’t be excluded from using them
non-rival - one person’s consumption doesn’t affect another’s
free riders
individuals that benefit from the good or service whether they pay for it or not
renewable resources
can be used repeatedly and replaced naturally
non-renewable resources
supply is finite - it can’t be replaced fast enough to keep up with consumption of it
government policies for environmental issues
carbon tax emissions trading scheme minerals resource rent tax paris agreement emissions reduction fund renewable energy target snowy mountains hydro scheme
real gdp
the national output of goods and services adjusted for changes in inflation over time
