Unit 3 AOS2a - Chapter 2: Macroeconomics: output, employment and income in the Australian economy

Question 1

What is another measure of economic activity?

Answer 1

Gross National Income (GNI) looks at total incomes which is another measure of economic activity.

Question 2

Explain the level of economic activity.

Answer 2

The concept of the “level” of economic activity is used to describe the general pace or speed at which productive activity is occurring nationally.

Question 3

How does economic activity have an impact on our material and non-material living standards?

Answer 3

🔹society can only satisfy its growing needs and wants for goods and services through more production or economic activity.
🔹 ⬆️ economic activity should immediately mean higher material living standards, since production creates jobs and rising incomes, allowing us to buy the things we want.
🔹there is the worrying realisation that this extra production has been extracted by using scarce non-renewable natural resources such as minerals, water, clean air, forests and oceans.
🔹 future generations will be unable to enjoy the same material and non-material benefits that we take for granted.

Question 4

Over the years what does the level of economic activity form?

Answer 4

A wave-like or cyclical pattern (this pattern is known as the business cycle).

Question 5

What is the business cycle?

Answer 5

This refers to the wave-like ups (recovery and boom) and downs (slowdown and recession) in a nations level of production or economic activity.

Question 6

When examining economic activity, what are the models or tools used?

Answer 6

. The business cycle
. 5 sector flow model
. Aggregate supply and aggregate demand diagrams

Question 7

What are the different levels of the business cycle?

Answer 7

. Boom/peak
. Contraction/slowdown
. Trough (perhaps a recession of depression) 
. Recovery/expansion
. Average growth trend
. Domestic economic stability 

The government aims to smooth out the business cycle (they do this via budgetary and monetary policies).

Question 8

What is the expansion/recovery phase?

Answer 8

This is where there is an expansion in economic activity or production, often slowly at first and then gaining pace. This occurred during 2009–10 to 2012–13.

Employment also begins to grow, meaning unemployment falls and inflation gradually accelerates.

Question 9

What is the peak phase?

Answer 9

This is a period of expansion in the level of economic activity. This occurred during 2007–08 and perhaps again in 2011–12.

Unemployment usually reaches its lowest level and inflation is at a high. If this peak occurs when the economy is stretched beyond its productive capacity (that is, a situation where there is full employment of resources and a nation is actually outside its production possibility frontier), a dangerous inflationary boom may result.

Question 10

What is the slowdown/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.

This is seen during 2008-2009, 2012-2013 and recently 2014-2015 (where GDP was recorded below 2.0%).

Question 11

What is the trough 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).

Question 12

What is a boom?

Answer 12

A boom is a period of strong spending and above-average levels of economic activity, usually associated with rapid demand inflation and very low unemployment.

Question 13

What is a recession?

Answer 13

A recession is a period of weak spending (two or more negative quarters of GDP growth) and is associated with high levels of cyclical unemployment.

Question 14

What is a depression?

Answer 14

A depression refers to a large economic downturn in production associated with very high cyclical unemployment, and is caused
by a significant fall in aggregate demand.

Question 15

What is the best situation for an economy to experience?

Answer 15

Domestic economic stability.

Question 16

What is domestic economic stability?

Answer 16

Domestic economic stability is a desirable or ideal level
of economic activity where, simultaneously, there is low inflation, a solid and sustainable rate of GDP and low unemployment.
. Here the pace of economic activity isn’t too rapid (causing an inflationary boom)
. Nor is it too slow (causing a recession where unemployment is high)

This desirable level of growth in GDP is at 2%.

In the 2013-2014 financial year the economy returned to trend growth (2.0%) and by the start of 2016 there were signs of economic rebalancing (a return to our stability point).

Question 17

What is stagflation?

Answer 17

Stagflation is a period of slow GDP growth (stagnation) along with high unemployment and rapid inflation.

It is a combination of the words stagnation and inflation as it is a incident where both occur.

Question 18

What is productive capacity?

Answer 18

Productive capacity is the potential level of national production of goods and services dictated by the quantity and efficiency of a nation’s resources. This determines the sustainable rate of economic growth in the long term.

A steeper trend line in the business cycle shows that the economy’s productive capacity is growing faster, enabling economic activity to rise more quickly without causing serious inflation.

Question 19

What is one of the most important influences on Australian material and non-material living standards?

Answer 19

The level of economic activity.

Question 20

What are the two types of productive activity?

Answer 20

Economic activity and non-market activity. (This is why measuring productive activity is difficult and inaccurate)

Question 21

Explain the following the of productive activity: Economic activity

This isn’t the greatest answer.

Answer 21

This is usually measured by Gross Domestic Product (GDP) and includes all production in a given time period. GDP only includes “market activity”, being that activity which can be measured.

There are other measures which also give us an idea about economic activity. Eg. Gross National Income (which looks at total income). These types of measures look at “how much” is being “produced” or “earned” but does not consider how this is shared among total population.

Question 22

What is GDP?

Answer 22

This is an estimate of the level of economic activity. It represents the total annual value of goods and services produced by a nation over a period of time. It is measured by the Australian Bureau of Statistics (ABS) either annually or on a quarterly basis.

Can be in two broad categories
Page four of booklet

Question 23

Explain the following the of productive activity: Non-market activity

Answer 23

This consists of production that is not actually sold and occurs mostly within individual households, such as personal housework and gardening, or the black market. This means it is not included in GDP.

Volunteer workers and illegal transactions are also not included in economic activity.

Question 24

What are the three main types of measures (besides GDP) of economic activity?

Answer 24

1. Lagging indicator of economic activity
2. Coincident indicators of economic activity
3. Leading indicators

Question 25

Explain lagging indicators of economic activity.

Answer 25

Lagging indicators show changes in economic activity some time after the event has occurred because they take time to respond. Therefore they only tells the readers previous levels of economic activity and do not tell us what the economy is doing right now. GDP is an example of a lagging indicator of economic activity because it typically takes 3 months for the ABS to collect, process and release quarterly statistics.

Other lagging indicators of changing levels of economic activity include unemployment rates, CPI or inflation rates and changes in average weekly earnings.

Question 26

Explain coincident indicators of economic activity.

Answer 26

Coincident indicators move very closely with actual changes in the level of economic activity. They are regularly published in short intervals and more or less tell us what is happening right now. Here we think of monthly changes in retail sales.

For example, monthly changes in retail prices.

Question 27

Explain leading indicators of economic activity.

Answer 27

Leading indicators predict, in advance, where the economy is heading in the near future. While not completely reliable, they often forecast a change in activity before it actually occurs.

Examples of indicators in this category include the business confidence index, new housing approvals, monthly index of consumer sentiment and changes in economic activity among our major trading partners.

Question 28

What are the different patterns of economic activity?

Answer 28

1. Long-term trend patterns
2. Cyclical patterns
3. Seasonal patterns
4. Erratic patterns

Question 29

Explain the following behaviour/pattern of economic activity: Long-term trend patterns

Answer 29

If over a 10-year or longer period of time, the average direction of an indicator graph of economic activity is rising (despite some erratic short-term swings), it is often possible to talk of a long-term trend in the data. For instance, such a trend is evident if we look at Australia’s overall level of economic activity in the 73 years between 1940 and 2013. (Or 76 years between 1940 and 2016?)

Question 30

Explain the following behaviour/pattern of economic activity: Cyclical patterns

Answer 30

When statistics are plotted over a period of time and follow a fairly regular, wave-like arrangement where there are peaks and troughs, the pattern is regarded as cyclical. This is the normal behaviour of economic activity (GDP), unemployment, inflation and the current account deficit (CAD).

Question 31

Explain the following behaviour/pattern of economic activity: Seasonal patterns

Answer 31

Some statistical indicators of economic activity move in a similar direction during the same month(s) each year. This is typical of seasonal patterns and applies to some types of unemployment.

For example, seasonal unemployment is higher in December, January and February each year due to school leavers looking for employment; sales of snow- boards and skis are up in June, surfboards in December and soft drinks in January.

Question 32

Explain the following behaviour/pattern of economic activity: Erratic behaviour

Answer 32

Sometimes, there is no real pattern in the statistics for economic activity because they are reacting to once-off or erratic events.

These events include the sudden rise in the demand for hotel beds during Melbourne’s Commonwealth Games in 2006, the drop in air travel and tourism following the September 11 terrorist attacks in the US, the effects of the prolonged drought from 2002–10 on GDP, or the floods experienced in 2011 and 2013.

Question 33

What is the circular flow model?

Answer 33

The circular flow model of an economy illustrates how
the Australian economy works and how its different parts are interrelated. Additionally, it identifies some of the macroeconomic variables affecting our country’s economic conditions.

The model consists of five sectors and four flows.

Question 34

What are the 5 sectors in the circular flow model?

Answer 34

1. The household sector*
2. The business sector*
3. The financial sector
4. The government sector
5. The overseas sector

If S+T+M > I+G+X then circular flow of incomes decreases.
(Savings + Taxes + Import spending > Investment spending + Government spending + Export spending)

• = 2 main parts to model

Question 35

Explain the following sector of the circular flow model: The household sector

Answer 35

The household sector comprises all members of the population.

. Some members supply or sell their resources (natural, labour and capital resources) to business firms = flow 1
. and use the money received to demand or buy finished goods and services from businesses that help to satisfy their needs and wants = flow 3

Question 36

Explain the following sector of the circular flow model: The business sector

Answer 36

. The business sector purchases or demands resources from households = flow 2
. which are then converted into finished goods and services = flow 3

Firms supply or sell these final goods and services to the household sector.

This means that Australian households and businesses both operate as buyers (demanders) and sellers (suppliers) of goods and services.

Question 37

Explain the following sector of the circular flow model: The financial sector

Answer 37

This is made up of the many types of financial institutions including banks, building societies, the stock exchange, credit unions and finance companies.

. All these organisations borrow household savings (‘S’) = leakage
. and lend these savings to creditworthy customers who use the money to finance their investment spending and business expansion (‘I’) = injection

Question 38

Explain the following sector of the circular flow model: The government sector

Answer 38

. Governments collect revenue from taxation (‘T’) and other sources = leakage
. and use this revenue to pay for government spending (‘G’) and other outlays that help to provide collective goods and services (public hospitals and schools) for use by society = injection

Question 39

Explain the following sector of the circular flow model: The overseas sector

Answer 39

. Each year Australia buys imports from abroad to help satisfy our wants (‘M’) = leakage
. and we also sell exports to people living overseas (‘X’) = injection

Question 40

What are the four flows in the circular flow model?

Answer 40

Connecting the main household and business sectors are four flows or streams whose value is measured in money terms ($) over a period of time such as a year. Two of these flows relate to the demand side of the economy and two relate to the supply side.

Flow no.1 - the supply of resources
Flow no.2 - total incomes or the demand for resources
Flow no.3 - total expenditure or aggregate demand
Flow no.4 - the flow of final goods and services supplied (GDP)

Question 41

Explain the following flow in the circular flow model: flow no. 1 - the supply of resources

Answer 41

Perhaps a starting point for economic activity is when the household sector supplies, or makes avail- able, resources for use by the business sector.

Question 42

Explain the following flow in the circular flow model: flow no. 2 -total incomes or the demand for resources

Answer 42

Here, the business sector purchases or demands resources by paying different types of incomes to the household sector. For instance:
. individuals selling labour are paid wages and salaries
. those lending money capital are rewarded with interest
. and allowing firms to use property helps owners gain income in the form of rent

Logically, the money value of all incomes paid to households (flow no. 2) will equal exactly the money value of all the resources sold (flow no. 1).

Question 43

Explain the following flow in the circular flow model: flow no. 3 -total expenditure or aggregate demand

Answer 43

Upon receiving income, the household sector will then dispose of it in different ways. This influences the total money value of spending on Australian-made goods and services which is called aggregate demand (AD). Some income ends up as leakages that lower AD, while some income results in injections that increase total spending.

Question 44

What is economic activity?

Answer 44

Economic activity is usually measured by Gross Domestic Product (GDP) and includes all production of goods and services in a given time period.
🔹This production can be a result of actions from individuals, firms and governments.
🔹Economic activity is mainly the process of converting scarce resources into goods and services designed to help satisfy society’s needs and wants.

Question 44

Explain how the household sector affects flow 3 of the five sector circular flow model.

Answer 44

Most household income is spent on private consumption of goods and services such as food and entertainment (‘C’). Income spent as ‘C’ re-enters the circular flow as part of AD.

Question 45

Explain how the financial sector affects flow 3 of the five sector circular flow model.

Answer 45

Some income is directed into savings in the financial sector. In themselves, savings (‘S’) are a leakage because they lower the level of ‘C’. However, the financial sector may inject ‘S’ back into the model by lending them to business firms wanting finance to expand their private investment spending (‘I’). This involves the purchase of plant and equipment and, being an injection, ‘I’ helps to lift the level of AD.

Question 46

Explain how the government sector affects flow 3 of the five sector circular flow model.

Answer 46

Another part of household income is devoted to paying government taxes. These, too, are classed as a leakage from the model because they lower the level of ‘C’. But again, money taken out through taxation may re-enter the circular flow if it is used to pay for government consumption and investment spending (‘G’). ‘G’ is, therefore, an injection into AD designed to help provide the community with collective goods and services, such as public roads or defence.

Question 47

Explain how the overseas sector affects flow 3 of the five sector circular flow model.

Answer 47

Some household income leaks out of the Australian economy as spending on imports (‘M’). Sometimes this leakage is partially or fully replaced by overseas spending on our nation’s exports (‘X’).

Here, ‘X’ is regarded as an injection or addition to the level of AD.
In summary, flow no. 3 represents the total value of expenditure on Australian-made goods and services.

This is called AD and it consists of C + I + G + X − M. The reason for subtracting M at this point is to exclude spending on imported goods and services, so that what remains is only the value of expenditure on Australian-made items. So far we have seen that the level of AD is influenced by the total value of leakages (made up of S + T + M) relative to the total value of injections (made up of I + G + X).

If there was a rise in leakages relative to injections, AD would fall. However, if there was a fall in leakages against a rise in injections, there would be an increase in AD or expenditure on Australian-made goods and services.

Question 48

Explain the following flow in the circular flow model: flow no. 4 - the flow of final goods and services supplied (GDP)

Answer 48

Flow no. 4 is the total value (in $) of finished goods and services produced or supplied by the business sector over a period of time. This flow reflects the overall level of Australian economic activity and is commonly measured by gross domestic product (GDP).

Question 49

Using the circular flow model, what two things can affect the size of GDP (macroeconomic indicator of economic activity)?

Answer 49

The level of aggregate demand and the level of aggregate supply.

Question 50

Explain the importance of aggregate demand for the short-term cyclical level of economic activity.

Answer 50

GDP or economic activity (flow no. 4) depends on AD (that is, flow no. 3 or total annual value of expenditure on Australian-made goods and services made up of C+I+G+X−M).

In turn, AD is also affected by the total value of leakages (S + T + M) relative to the total value of injections (I + G + X).
AD (C + I + G + X − M) = GDP and the short-term cyclical level of economic activity, hence, in terms of the ups and downs of the business cycle, an increase in leakages relative to injections will see a drop in AD.

This usually causes a contraction or slowdown in the level of economic activity. If this fall in activity is severe, there may even be a recession or depression. By contrast, a fall in leakages relative to injections will result in a rise in AD. As a consequence, there will be an expansion in the level of economic activity, possibly ending in an inflationary boom if the economy is already operating close to its productive capacity.

Question 51

Explain the importance of aggregate supply for the long-term structural level of economic activity.

Answer 51

Despite the great importance of AD in determining the current level of economic activity in an economy, aggregate supply-related factors in our circular flow model also affect the economy’s speed limit or potential rate of economic growth.

Over a number of years, the economy’s productive capacity or potential for supplying goods and services normally grows. The total or aggregate supply (AS) of goods and services that a nation can potentially produce is especially affected by the availability of a nation’s resources and the efficiency with which these are used.

This is one reason why the long-term or average trendline shown on the business cycle diagram slopes upward and to the right, at around 3.25 per cent per year in Australia’s case.

Question 52

Define aggregate demand (AD).

Answer 52

AD represents the total spending on all goods and services in the economy in a given year. As a macroeconomic variable, it consists of expenditure from different sources including:

. private consumption spending by households (C)
. private investment spending by businesses (I)
. consumption spending by governments (G1)
. investment spending by governments (G2)
. and net overseas expenditure made up of spending on our exports (X) from abroad minus spending on imports (M) by local residents.

These are the components of the AD equation

Question 53

What is the aggregate demand equation?

Answer 53

AD = C + I + G1 + G2 + (X - M)

Question 54

What is the effect of cyclical changes in aggregate demand on economic activity?

Answer 54

. Rising AD causes economic activity to expand
. Slowing AD causes economic activity to contract
. AD can create ‘ideal’ conditions of domestic economic stability

Question 55

Explain how rising AD causes economic activity to expand.

Answer 55

When AD and its components grow strongly firms generally see growing sales, lengthening orders and falling stocks of unsold goods and services. Businesses respond by expanding their levels of production or output supplied, as long as unemployed resources or unused productive capacity are available.

When most firms are able to achieve this, the result is an expansion in the level of economic activity. However, if there is no unused productive capacity, rising AD results in widespread shortages of goods and services. This causes generally rising prices or demand inflation, typically found in booms.

Question 56

Explain how slowing AD causes economic activity to contract.

Answer 56

By contrast, when AD and its components decline firms notice generally falling sales, the absence of orders, and rising stocks of unsold goods and services.

Businesses are then forced to cut their output supplied to prevent further overproduction.

If most firms do this, a general slowdown in the level of economic activity occurs, possibly ending in a recession or depression if this contraction was severe.

Additionally, the slowdown would cause higher unemployment and possibly lower inflation, if most firms cut prices to help clear their excess stocks.

Question 57

Explain how AD can create ‘ideal’ conditions of domestic economic stability.

Answer 57

The level of economic activity is ideal only when the level of AD is neither excessive, causing an inflationary boom, nor insufficient, causing unemployment and recession.

Here, the economy could experience the benefits of domestic economic stability. Armed with this knowledge, governments use various policies, such as changes in taxes, government spending and interest rates, to try to stabilise the level of AD to reduce economic instability.

Question 58

What are the components of Aggregate Demand?

Answer 58

. Private Consumption (C)
. Private Investment (I)
. Government Consumption (G1)
. Government Investment (G2)
. Net Exports (X-M)

They respond to demand-side factors

Question 59

Explain the following component of aggregate demand: Private Consumption (C)

Answer 59

This includes household expenditure designed to help satisfy our immediate needs and wants for durable and single use goods as well as services. It represents 60% of AD and is susceptible to the influence of aggregate demand-side factors.

Question 60

Explain the following component of aggregate demand: Private Investment (I)

Answer 60

This involves private business spending on physical, plant, manufactured materials and equipment used to make other other goods and services. It’s levels are quite unstable and actually causes economic instability. It’s growth also responds to aggregate demand-side factors.

This expenditure not only helps raise our nation’s productive capacity and make poss- ible the production of other goods and services, but it should also improve the efficiency of labour and natural resources.

Question 61

Explain the following component of aggregate demand: Government Consumption (G1)

Answer 61

This is government/public expenditure on goods and services used to help satisfy the community’s needs and wants. It includes spending on staff wages for government departments. In recent years, G1 has averaged around 17 per cent of AD

Question 62

Explain the following component of aggregate demand: Government Investment (G2)

Answer 62

This incorporates public expenditure on capital equipment (infrastructure) such as buildings, roads and railways. It is used to help satisfy societies wants, expand Australia’s productive capacity and improve the efficiency of other resources. It represents only about 3% of AD and its level changes as a consequence of macro- economic demand-side factors.

Question 63

Explain the following component of aggregate demand: Net Exports (X-M)

Answer 63

This represents the balance or difference between foreign spending on Australian goods and services (exports) minus our spending on foreign goods and services (imports). As a proportion of AD, X and M, each represents about 18 to 24 per cent.

Question 64

What are the different macroeconomic demand-side factors affecting the level of AD? (Include the components of AD influenced by them)

Answer 64

. Consumer confidence (C & M)
. Business confidence (I & M)
. Economic activity overseas among our trading partners (X & I)
. Household disposable income (C & M)
. The exchange rate (X & M)
. The terms of trade index (X & M)
. Credit growth (C, I & M)
. A country’s population growth rate (C, G1, G2, & M)
. Budgetary policy (C, I, G1, G2, X & M)
. Interest rates (C, I, X & M)

Question 65

Explain how the following macroeconomic demand-side factor affects the level of AD: Consumer confidence or sentiment

Answer 65

This describes household expectations regarding future income, employment and inflation. The confidence of consumers effects the decision of households. High confidence results in more spending on local or foreign-made goods and services, whilst low confidence results in households saving their income.

⬆️ Consumer Confidence = ⬆️ Private/Household Consumption + ⬆️ Import spending = ⬆️ AD

And vice versa

Question 66

Explain how the following macroeconomic demand-side factor affects the level of AD: Business confidence

Answer 66

This describes business expectations regarding future sales and profit and therefore effects future investment. Business confidence affects business investment spending on plant and equipment. Optimistic firms expect higher future sales and profits and therefore lift “I” in new plant and equipment in order to expand their productive capacity. Here, their spending tends to accelerate AD and economic activity. By contrast, the reverse occurs if general business pessimism sets in.

Can also effect import spending

Question 67

Explain how the following macroeconomic demand-side factor affects the level of AD: Economic activity overseas among our trading partners

Answer 67

This describes economic activity overseas especially for our key trading partners. This factor alters their demand for our “X” of locally made commodities, services and manufactured goods, and may possibly influence foreign “I”.

After a time lag, a downturn in activity overseas usually means weaker X sales and AD in Australia, thereby slowing domestic economic activity. However, the reverse applies if activity abroad rises.

Question 68

Explain how the following macroeconomic demand-side factor affects the level of AD: Household disposable income

Answer 68

This refers to the money available for spending by individuals after tax us laid and/or benefits are received. This affects household “C” of local and foreign-made goods and services.

⬆ disposable income = ️⬆️️ in “C” and “M”
And vice versa

And vice versa

Question 69

Explain how the following macroeconomic demand-side factor affects the level of AD: The exchange rate

Answer 69

This describes the value of the Australia dollar when swapped for foreign currencies.

An appreciation means an ⬆️ in $AUD value compared to say $USD =
⬆️ M and ⬇️ X = ⬆️ AD

A depreciation mean a ⬆️ in $AUD value compared to $USD = ⬇️ M ⬆️ X = ️️️️ ⬆️ AD

Question 70

Explain how the following macroeconomic demand-side factor affects the level of AD: The terms of trade index

Answer 70

This describes the price out our exports compared to the price of imports. When terms of trade increases (favourable) it means our export prices are relatively higher than our import prices.

⬆️ T.o.T = ⬆️(X-M) = ⬆️ AD

Question 71

Explain how the following macroeconomic demand-side factor affects the level of AD: Credit growth

Answer 71

Credit growth influences the volume of household and business finance available for purchasing consumer and capital goods, through borrowing from the financial sector. It therefore greatly effects consumer and household borrowing.

⬆️ rate of credit growth = ⬆️ C, ⬆️ I and ⬆️ M = ⬆️ AD
And vice versa

Question 72

Explain how the following macroeconomic demand-side factor affects the level of AD: A country’s population growth rate

Answer 72

A country’s population growth rate is influenced by both the net natural increase in population (births minus deaths) and by net migration (immigration minus emigration). In turn, this will especially alter expenditure on C, G and M.

Overall, an acceleration in population growth rate, tends to lift AD, while a fall tends to slow AD and economic activity.

Question 73

Explain how the following macroeconomic demand-side factor affects the level of AD: Budgetary policy

Answer 73

Budgetary policy relates to annual changes in expected government receipts and outlays. Clearly, tax rates, outlays on welfare or industry assistance for exporters and government spending on education or foreign defence purchases can all help change expenditure on C, I, G, X and M.

For instance, a budget surplus where receipts exceed outlays generally tends to slow AD and economic activity, relative to a budget deficit where outlays exceed receipts.

Question 74

Explain how the following macroeconomic demand-side factor affects the level of AD: Changes in interest rates

Answer 74

Changes in interest rates by the Reserve Bank of Australia (RBA) are part of monetary policy. As a government policy, interest rates can change expenditure on C and I items purchased using borrowed money.

In addition, rates can also alter the levels of credit used to finance the production of future X or credit-based spending on M.

⬆️ interest rates tends to slow C and I = weakened domestic AD and economic activity
And vice versa

Question 75

Define consumer and business confidence.

Answer 75

Consumer confidence describes the level of household optimism or pessimism about future employment prospects and income. This affects the levels of saving and consumption spending.

Business confidence relates to the level of optimism or pessimism by a firm about its future sales and profits. It affects the level of business investment spending.

Question 76

Define disposable income, exchange rate and terms of trade.

Answer 76

Disposable income is spendable income after receiving government income support and paying personal income tax.

Exchange rate is the price or value of our currency when swapped for other currencies.

Terms of trade represent the ratio of general prices received for our exports relative to the general prices we pay for imports.

Question 77

Define Aggregate Supply (AS).

Answer 77

Aggregate supply is the total annual quantity of all finished goods and services produced by every business in the Australian economy. It represents the sum of the quantity of goods and services supplied by all types of firms operating in various markets scattered across the country.

Aggregate supply can be affected by a large number of factors, each of which can be graded under three broad categories. These categories include Availability, Cost and Efficiency (ACE).

Question 78

Explain the effect of changes in aggregate supply on economic stability.

Answer 78

In the short and medium terms, a nation’s overall level of economic activity largely reflects variations in AD and changing demand-side conditions.

However, in the long term it is impossible to increase the level of economic activity and production in a country simply by spending more and more.

The economy soon hits its productive capacity or limit for aggregate supply (AS). When this point is reached, further increases in the aggregate volume of goods and services supplied depend on an overall increase in a nation’s ‘ability’ or ‘motivation’ to produce.

Question 79

What are aggregate supply-side factors?

Answer 79

Aggregate supply-side factors are the main determinants of a nation’s long-term productive capacity or potential level of GDP (for example, quantity and productivity of resources), affecting the volume and/or efficiency of resources.

Question 80

Explain how more favourable aggregate supply-side conditions can increase economic activity.

Answer 80

They equal lowered production costs, higher profitability levels for firms, and increased worker productivity. This means firms are more able and motivated to produce. Equals increase in nations productive capacity or AS and higher potential and sustainable levels of economic activity.

Question 81

Explain how less favourable aggregate supply-side conditions can slow economic activity.

Answer 81

If less favourable aggregate supply-side conditions develop generally in an economy and cause productive capacity to shrink, AS must also decline. This reduces our potential or sustainable level of economic activity, even if there is a sufficient level of AD to warrant higher production.

Question 82

Explain how less favourable aggregate supply-side conditions can slow economic stability. EXTRA

Answer 82

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Question 83

What are the supply-side conditions that can affect aggregate supply?

Answer 83

. Resources availability and efficiency 
. Growth in business profit levels
. Business bankruptcy rates
. Real unit labour costs (RULCs)
. Legal minimum wages
. Federal workplace wage agreements
. Interest rates
. Productivity 
. The exchange rate
. Strike levels
. Labour force participation rates
. Aggregate hours worked
. The rate of net migration
. Price of materials used in manufacturing 
. State and local government charges
. Government aggregate supply-side policies

Question 84

Explain the following supply-side condition that can affect aggregate supply: The quantity of resources available

Answer 84

The quantity of resources available and how efficiently they are used affects a nation’s long-term productive capacity or potential supply of goods and services.

Extra resources (natural, capital and labour) used productively make it feasible for a nation to shift its current production possibility frontier outwards, thus growing the level of productive capacity.

Eg. Discovery of minerals or technology, or effective education and training (improves labour force), implementation of tariff reduction.

⬆️ A and ⬆️ E = ⬆️ AS

Question 85

Explain the following supply-side condition that can affect aggregate supply: Growth in business profit levels

Answer 85

Growth in business profit levels (total sales revenue minus production costs) affects business survival, AS and economic activity. Without good profits as a favourable supply-side factor, firms will not invest in new plant and equipment to increase Australia’s productive capacity or supply.

⬆️ business profits (attracts more business) = ⬆️ availability = ⬆️ AS

Question 86

Explain the following supply-side condition that can affect aggregate supply: Business bankruptcy rages

Answer 86

Business bankruptcy rates refer to business closures due to a lack of profitability. This influences the nation’s productive capacity or supply, as well as levels of unemployment.

High bankruptcy rates tend to slow domestic economic activity as uncompetitive firms close down.

⬇️ bankruptcy rates (more firms) = more products produced = ⬆️ availability = ⬆️ AS

Question 87

Explain the following supply-side condition that can affect aggregate supply: Real Unit Labour Costs (RULCs)

Answer 87

Real unit labour costs (RULCs) represent the average level of wages and ‘on costs’ per unit of output produced compared with trends in average prices received by businesses for output sold.

⬇️ RULCs = ⬇️ costs = ⬆️ AS

Question 88

Explain the following supply-side condition that can affect aggregate supply: Legal minimum working age

Answer 88

With the decrease of the legal minimum working age comes the growth of the labour force (more labour inputs).

Increased availability and decreased costs (cost less to hire minors)

Question 89

Explain the following supply-side condition that can affect aggregate supply: Federal workplace wage agreements

Answer 89

Federal workplace wage agreements result in various pay rises agreed on a firm-by-firm basis. While these wage outcomes may have a demand-side effect and influence spending, they can also be regarded as a production cost affecting business profits and AS.

Rises in average wages under enterprise agreements tend to have an adverse supply-side effect on productive capacity and AS, and the potential rate of economic activity, unless they are accompanied and offset by efficiency rises.

Therefore workplace agreements that favour businesses = decreased costs = AS

Question 90

Explain the following supply-side condition that can affect aggregate supply: Interest rates

Answer 90

Interest rates represent the cost or price of credit expressed as a percentage. Interests can be both demand and supply-side factors.

Higher rates are seen as unfavourable because they make businesses less competitive, weaken profits, cause closures and thus reduce AS.
By contrast, cheaper interest rates are a favourable supply-side factor that improve business conditions, boost AS and accelerate the potential rate of economic activity.

Question 91

Explain the following supply-side condition that can affect aggregate supply: Productivity

Answer 91

Total number of outputs in comparison to inputs.

Productivity measures the efficiency or output gained from a certain quantity of productive inputs. GDP per hour worked is a measure of labour productivity.

Worker or labour productivity is commonly indicated by the change in GDP per hour worked. Productivity has a dramatic impact on a nation’s productive capacity and the supply of goods and services.

When efficiency rises as a favourable supply-side factor, costs per unit of output are reduced and profits tend to rise. This makes producers keener and more able to increase AS and economic activity.

However, falling profitability as an unfavourable supply-side factor weakens business condition and cuts AS.

Question 92

Explain the following supply-side condition that can affect aggregate supply: The exchange rate

Answer 92

The exchange rate is the price of the Australian dollar measured in terms of other currencies used in international trade. (This too can be seen as an aggregate demand-side factor because it affects X, M and AD).

However, it is also an aggregate supply-side factor because rises and falls in the dollar alter the production costs of local firms using imported equipment and materials. This has an impact on profits and the willingness and ability of companies to supply goods and services.

A depreciation (fall) of the Australian dollar is an unfavourable supply-side condition because it tends to make the cost of imported equipment dearer, so firms find it harder to be competitive and make a profit = AS is reduced and economic activity slows.

A stronger dollar is seen as favourable for Australian dollar (although on the demand side the rise is possibly unfavourable since it weakens AD).

Question 93

Explain the following supply-side condition that can affect aggregate supply: Strike levels

Answer 93

Strike levels are one measure of worker industrial unrest. They interrupt the supply of labour and the production of goods and services, especially if their coverage is national.

Higher strike levels are seen as an unfavourable supply-side condition. They make firms less able to produce, erode profitability and reduce AS and economic activity.

By contrast, much lower strike levels are seen as a favourable supply-side development that help lift productive capacity and AS.

Question 94

Explain the following supply-side condition that can affect aggregate supply: Labour force participation rates

Answer 94

Labour force participation rates refer to the proportion of the population aged over 15 years who are members of the labour force (that is, they are either employed or unemployed).

Rising participation rates can mean that the size of the workforce is larger and there is more labour available. This extra supply of labour resources is a favourable condition because it helps to expand productive capacity, increase AS and lift the potential level of economic activity.

Question 95

Explain the following supply-side condition that can affect aggregate supply: The annual percentage change in aggregate hours worked

Answer 95

The annual percentage change in aggregate hours worked affects the amount of labour resources available for production.

If people work longer hours (perhaps through overtime, taking a second job, or moving into full-time employment), this should help grow the nation’s productive capacity, increase AS and lift the sustainable rate of economic growth.

Question 96

Explain the following supply-side condition that can affect aggregate supply: The rate of net migration

Answer 96

The rate of net migration to Australia also affects the size and skills of Australia’s labour force. It equals the rate of immigration - the rate of emigration.

It helps to increase the quantity and efficiency of labour resources and should help to increase productive capacity or AS, and the sustainable rate of economic growth.

Question 97

Explain the following supply-side condition that can affect aggregate supply: Prices of materials used in manufacturing

Answer 97

Prices of materials used in manufacture can include both local and imported inputs. These materials could be raw materials, semi-processed or finished goods.

Since firms need to purchase these to undertake production, such prices are regarded as a production cost and, hence, a supply-side factor.

A rise in the cost of these materials is an unfavourable development because it may depress profit levels and therefore makes firms less willing and able to produce competitively.

AS and the potential rate of economic activity are lifted if the cost of materials as a supply-side factor falls.

Question 98

Explain the following supply-side condition that can affect aggregate supply: State and local government charges

Answer 98

State and local government charges (eg. for electricity, water and other utilities) are a supply-side factor since they affect a firm’s production costs and profits.

Higher charges are an unfavourable condition. They slow AS because they erode the ability and willingness of businesses to produce and may lead to business closures.

By contrast, if these charges are kept low, supply-side conditions become more favourable, leading to increased productive capacity and AS.

Question 99

Explain the following supply-side condition that can affect aggregate supply: Government aggregate supply-side polices

Answer 99

Government aggregate supply-side policies are cost cutting, efficiency-promoting reforms such as deregulation of the labour market and trade liberalisation including tariff cuts, some supply-side aspects of budgetary policy such as large national infrastructure projects and lower tax rates, and immigration policies.

These measures can have a substantial beneficial impact on business efficiency, production costs, profits, business expansion and closures, resource allocation, productive capacity, employment, incomes and living standards.

Question 100

Define productivity and the participation rate.

Answer 100

Productivity measures the efficiency or output gained from a certain quantity of productive inputs. GDP per hour worked is a measure of labour productivity.

The participation rate is the proportion of people aged 15 and over who are members of the labour force.

Question 101

What are aggregate demand-supply diagrams?

Answer 101

The aggregate demand–supply diagram is used to illustrate the key sets of influences or factors affecting spending and productive capacity on an economy’s equilibrium level of GDP or economic activity.

Question 102

What supply-side factors effect availability?

Answer 102

. Resource availability and efficiency
. Rate of net migration
. Business profits 
. Bankruptcy rates 
. Legal minimum working age
. Labour force participation rate
. Strike levels
. Aggregate hours worked

Question 103

What supply-side factors effect cost?

Answer 103

. Workplace agreements
. Interest rates
. Real unit labour costs
. Legal minimum working age
. Price of materials 
. Exchange rates
. State and local government fee taxes
. Government supply policies

Question 104

What supply-side factors effect efficiency?

Answer 104

. Resource availability and efficiency

. Strike levels

Question 105

Explain what movement of the aggregate demand line means.

Answer 105

Generally stronger demand-side conditions means that buyers are prepared to purchase larger quantities of local products at all given price levels. This means that the whole AD line shifts up and to the right (an increase in total expenditure from AD1 to AD2).

However, nationally weaker demand-side conditions move the whole AD line down and to the left (a decrease in total expenditure from AD1 to AD0).

Question 106

Explain the aggregate supply curve.

Answer 106

. The horizontal section of the AS line exists at low levels of national output or supply, where there is plenty of unused productive capacity. In this area, firms would find it very easy to increase their production levels in response to little or no rise in the general level of prices.
. The upper or vertical zone of the AS line is where there is generally no unused productive capacity. Here, real national production is at its physical limit because all resources are fully employed. Even large rises in the general price level and the offer of huge profits are not enough for an actual increase in the volume of national production. This is simply because firms cannot get hold of the extra resources that they would require to further lift GDP.
. Between these extremes, there is the intermediate zone on the AS line located at the elbow where the line starts to bend upwards. This corner section indicates the gradual onset of full employment where the little excess capacity remaining soon gives way to no unused capacity at all. Moving upwards into this zone, bigger and bigger general price rises are needed to make extra production profitable.

Question 107

Explain what movement of the aggregate supply line means.

Answer 107

The onset of generally more favourable supply-side conditions that improve national productive capacity, cause the AS line to increase or move outwards from AS1 to AS2. Here, most firms become more willing and able than previously to lift supply.

By contrast, generally less favourable supply-side conditions result in a decrease in the AS line that shifts inwards from AS1 to AS0. Producers are less willing and able to produce, and capacity is cut.