Unit 3 AOS2b - Chapter 3: Macroeconomic Activity and the Australian Government's Economic Goals Flashcards
What are the Australian government’s economic goals?
The Australian government aims to improve material and non-material living standards for all people. To best ensure the improvement in living standards the government aims to achieve 5 economic goals:
- Low inflation
- Strong and sustainable economic growth
- Full employment
- External stability
- Equity in the distribution of personal income
When goals 1, 2 and 3 are achieved we have domestic economic stability.
Explain the goal of low inflation.
The goal of low inflation (or stability of the currency) is achieved when the general level of prices for goods and services are increasing “fairly slowly” and within the target band of 2-3% “on average over the business cycle.”
Low inflation does not mean zero inflation, zero inflation and negative inflation (deflation) have an adverse effect on the economy because if people believe that prices will get lower then they will stop spending in order to save more of their money = struggle for businesses = ⬆️ unemployment = ⬇️ spending (a deadly cycle)
Come back
What are the problems caused by not achieving low inflation? (How it hurts other economic goals)
All these affect living standards
- High inflation will cause decreased economic growth because
- it drives up interest rates (RBA responds with ⬆️ interest rates) which undermines confidence and slows C and I
- inflation undermines business confidence (because ⬆️$ of inputs = ⬇️ I) - Higher inflation will cause increased structural unemployment because:
- inflation makes our X uncompetitive (think car industry)
(Structural unemployment is unemployment caused by many factors including changes that occur to bus. profitability) - High inflation hurts external stability because
- X becomes uncompetitive (because consumer switch to cheaper stuff) may lead to rise in CAD and even cause exchange rate to depreciate = reduced purchasing power - High inflation hurts income distribution because those in fixed incomes are least likely to negotiate wage rises that keep up with inflation.
- think people on welfare and people in low skilled jobs (already on bottom rung of ladder and now their purchasing power descreases further)
Who measures the inflation rate?
The inflation rate is measured by the Australian Bureau of Statistics (ABS). The most common indicator of the inflation rate is the Consumer Price Index.
What is the consumer price index?
This measures quarterly changes in the retail prices of locally made and foreign-made goods and services that represent a high proportion of the expenditure of metropolitan households living in capital cities.
The feature of CPI include the regimen, the price surveyed, the weighting of items and the base year.
Explain the features of CPI.
The regimen - this refers to the types of goods and services selected to measure changes in prices. The CPI measures the price changes of around 100000 individual items that are subdivided into eleven categories.
Price surveyed - The quarterly price survey is carried out in a representative range of metropolitan retail outlets spanning both the private sector and public sector.
Weighting of items - each item in the regimen in the regimen is weighted according to relative importance in overall household expenditure. Things that are expensive or frequently purchased have a greater bearing on index trends.
Base year - price changes over a period of time are compared to the price or cost in a representative starting year, or base year.
What are the limitations of CPI as a measure of inflation?
The CPI data provides a guide to general retail price trends in the Australian economy. However, the accuracy of the published inflation rate depends on several factors.
. Lack of representativeness of the prices
. Weighting limitations of items in the regimen
. The effect of once off volatile events on the headline inflation rate
Explain the following limitation of CPI as a measure of inflation: lack of representativeness of the prices
Only 100000 selected consumer items appropriate for metropolitan households are included in the CPI. Inflation rate figures may therefore be misleading indicators for people who do not live in capital cities.
Explain the following limitation of CPI as a measure of inflation: weighting limitations of items in the regimen
For some categories of households, the weighting of items in the regimen may be inap- propriate and unreflective of the actual pattern of expenditure. For them, this makes the figures less useful. For instance, if meat went up in price and caused the CPI to rise faster, the inflation figure would be misleading for vegetarian households.
Explain the following limitation of CPI as a measure of inflation: the effect of once off volatile events on the headline inflation rate
The rate of inflation, as measured by what is called the headline CPI is greatly affected by once-off, volatile and sometimes unavoidable events and developments that influence prices.
For some users like the RBA, the CPI fails to reveal the underlying or core rate of inflation in the absence of these unusual events.
The trimmed mean CPI and the weighted median CPI have been developed to measure the underlying rate of inflation. (These measures have smaller regimens that typically exclude various classes of volatile items eg. fresh fruit and vegetables)
What is headline inflation?
The inflation measured through this is usually higher than the true rate of inflation
Together with underlying rate of inflation it helps economists see what adjustments need to be made to interest rates
What is the underlying rate of inflation?
This tends to be a more accurate measure of inflation as it excludes volatile items which are affected by once off events. This includes taking out items like fresh fruit and vegetables (normally in the CPI regimen) which can easily be affected by events such as cyclones or droughts, which would usually cause higher measures of inflation.
What are some recent trends in CPI and inflation?
The CPI rate reached 3.0% for the 2013-14 year (a trend of inflation staying within the target zone)
Falling world oil prices in the second half of 2014 along with declines in imported electronic prices = annual inflation rate figure below 2% by then end of the year.
Through 2014-15, inflation pressures remained low with the official CPI figure for the year coming in at 1.5% (partly due to the economic experiencing weaker growth for the year).
What is demand inflation?
This typically occurs in a boom when spending (demand) outstrips production (supply) and there are widespread shortages of goods and services.
Australia’s rate of demand inflation accelerates and eases to reflect changes in the cyclical level of AD and economic activity. It moves up, especially when spending or AD (AD = C + I + G + X − M) is excessively strong and running ahead of production (AS) in a situation where the economy is at or near its productive capacity.
How have demand-side conditions recently influenced demand inflation?
Changes in consumer confidence and disposable income:
- when confidence and disposable income increase = shortages (if it outstrips production) as firms can’t automatically catch up to increased demand = demand inflation accelerates
- seen in mid 2008 and then in 2009-2010 (contrast following GFC in 2008-2009)
Changes in the level of overseas economic activity and our terms of trade:
- favourable terms of trade and economic activity overseas = X sales and AD. If there is limited unused capacity = general shortages = higher rates of demand inflation
Changes in the exchange rate for the Australian dollar
Changes in interest rates and monetary policy set by the reserve bank of Australia
Etc.
What is a budget deficit?
A budget deficit occurs when the value of government outlays exceeds the value of government revenue in a given year.
AD graphing
When AD sits at the goldilocks point on AS = ideal levels of spending result in domestic economic stability and low inflation
When AD sits on the vertical part of AS = (excessive) demand exceeding the economy’s productive capacity resulting in widespread shortages and an inflationary boom (due to strong demand-side conditions)
When AD sits on the horizontal part of AS = (insufficient) supply exceeding the demand from households, businesses, governments and overseas for goods and services (due to weak demand-side conditions)
What is cost inflation?
Cost inflation exists when cost rises are passed on by firms as higher prices to protect their profit margins.
If it costs firms more to produce or sell their goods or services, then most businesses are eventually forced to pass on the cost rises to consumers in the form of higher prices at the counter. Failure to raise prices in response to higher production costs would otherwise mean lower profits, losses or even business failure.
How have supply-side conditions recently influenced cost inflation?
Rises in oil prices as a production cost:
- The cost of oil affects the cost of producing many things in our economy because it is not only used to produce goods but also transport many too. Between 2008–09 and 2012–13, there was a spectacular 84 per cent rise in oil prices, so prices had to be passed on.
Changes in climatic conditions affecting production:
- Adverse climatic conditions involving drought, floods, fires and storms, are an adverse aggregate supply-side factor that can affect the prices paid for meat, fruit and vegetables. This is because there is reduced production or supply and costs for farmers are higher. As happened between 2008 and 2013, these rises are then passed onto the consumer, again contributing to cost inflation pressures.
AS graphing
When AS moves to the left/up the AD line this shows new less favourable supply-side conditions = less supply. This causes cost inflation.
When AS moves to the right/down the AD line this shows more favourable supply-side conditions = more supply. However, this can cause over-supply/surplus.
Explain the goal of strong and sustainable economic growth.
The goals of strong and sustainable economic growth has 2 key aspects:
1) the rate of economic growth needs to be growing in a manner that does not adversely effect the other economic goals (Eco growth should be at the goldilocks point)
2) the rate of economic growth needs to be environmentally sustainable and not reduce the material and non-material living standards of current and future generations (this is why MAP and GPI are used)
What is a current account deficit?
This refers to the total value of current payments (debits) for goods, services, primary incomes and secondary incomes exceeding the total value of equivalent credits.
What are the effects of economic growth on the other economic goals?
- Low inflation
- high Eco growth tends to increase inflation, this is especially the case if production is at full full capacity - Full employment
- high Eco growth will increase employment as the Eco activity will generate jobs - External stability
- high Eco growth tends to increase spending (especially on imports) and therefore worsens external stability - Equity
- creation of jobs via Eco growth should improve equity, however, distribution of profits also has an impact.
How do you measure economic growth and living standards?
. GDP
. Chain volume/real GDP
Also alternate measures that give clearer indications of living standards as GDP assumes ⬆️ Eco growth = better living standards (when in reality there are positive and negative externalities that should be considered).
Explain GDP as a measure of economic growth.
Economic growth occurs when there is an increase in the value of final goods and services produced in Australia from one year to the next. GDP is the measure used to identify the Eco growth year on year. It is usually expressed as an average of 3 estimates, being:
. GDP(E)
. GDP(I)
. GDP(P)
What is GDP(E)?
E = expenditure
This should be equal to the total annual market value of expenditure (AD). Here expenditure on GDP consists of C+I+G1+G2+(X-M).
What is GDP(I)?
I = income
This should be equal to the total market value of incomes paid to sellers of resources needed for production. Incomes here include:
wages + salaries + supplements + gross operating surplus/profit of firms.
What is GDP(P)?
P = production
This should be equal to the total market value of final goods and services produced each year. Total market value of sales - price pf all inputs purchased by firms.
Explain chain volume/real GDP as a measure of economic growth.
A measure of GDP which takes out the effect of inflation
Inflation and deflation affect the growth rate in the market value of national production = misleading impression of the actual size of GDP.
- Inflation would exaggerate the rise in the marketed value of goods and services produced and sold
- Deflation would cause the market value of output to be underestimated.
If nothing was done to compensate for this problem, our GDP figures would be almost meaningless, especially in times when general prices were rising or falling. The ABS now statistically removes the impact that annual price changes would have on the value of production measured at current or market prices by using a measure called chain volume GDP.
Chain volume GDP refers to the market value of goods and services produced by Australia, adjusted to remove the effect on the value of national production caused by changes in prices against a reference year.
What are the limitations of the GDP measure?
Non-market production is excluded: value of some types of non-market production is excluded from the GDP figures because its value is too difficult to calculate (eg. illegal production part of the black economy, home repairs, volunteer work).
Quality changes are ignored: in some cases quality can increase whilst the price paid/value of production actually decreases.
Calculation involves possible error: this is due to the fact that the value of some production included in GDP must be estimated.
Distribution of GDP not expressed: GDP fails to show how some people benefit more than others, because not everyone benefits equally.
GDP does not tell the story of non-material living standards: this is because a large chain volume GDP is considered to automatically make people better off.
What are the alternative ways of measuring Australia’s Living Standards?
. Genuine Progress Indicator (GPI)
. Measuring Australia’s Progress (MAP)
What is the Genuine Progress Indicator?
This uses the same personal consumption data contributing to GDP, but it p makes positive and negative adjustments to it. This so it reflects the good or bad effects of different types of activity and spending on society’s welfare.
So measuring economic growth with more concern for living standards
What is Measuring Australia’s Progress?
MAP is a statistical “tool” used by the ABS to examine progress across both material and non-material living standards. This helps to indicate whether life in Australia is actually getting better.
It measures across 4 broad categories, being:
. Society (health, life expectancy, crime)
. Economy (national income, unemployment, inflation)
. Governance (informed public debate, trust and effective governance)
. Environment (waste and recycling, greenhouse gas emissions and land)
Areas are marked with either a tick (progress), cross (regress), question mark (not enough data) or line (no or little change).
(With this range of measures we are able to build up a picture of our material and non-material well being).
What are the limitations of MAP?
. Living standards cannot be condensed to a single statistic or figure, meaning you can’t say living standards have improved just because there are more ticks than crosses.
. This is because the selection of specific measures is subjective (meaning some people see improvements in health as more important as improvements in crime rates).
. There is also inadequate statistical data, meaning the ABS does not measure all aspects
Subjective
Recent trends in Australia’s economic growth and living standards.
GDP per capita has grown steadily over the last decade (generally viewed as indicating a rise in material wellbeing for all Australians).
GDP (chain volume measure) was below 1% in June 2015, whilst Real GDI was at 0%. (Percentage changes)
Explain the goal of full employment.
The goal of full employment describes achieving the lowest possible rate of unemployment without causing inflation. Therefore we aim for zero cyclical unemployment. Because we will always still have a level of unemployment due to structural, frictional, seasonal and hardcore unemployment. Economists currently state that:
Zero cyclical unemployment = natural rate of unemployment = aggregate of frictional, structural, seasonal and hardcore unemployment (FSSH) = 4.5% unemployment
What is employment?
Employment is when people aged 15 and over have a paid job and work for more than one hour per week.
What is unemployment?
Unemployment is when those aged 15 and over who are actively looking for work cannot find a job.
What is the unemployment that is unavoidable?
Natural unemployment of perhaps around 4.5–5 per cent is unavoidable, even in a healthy economy. It occurs due to the existence of frictional, structural, seasonal and hard-core factors.
FSSH
What is the labour force?
The labour force includes people over 15 years old who are able and willing to work and are either employed or unemployed.
Meaning students aren’t counted (btw don’t get this confused with the participation rate participation rate = total of labour force/everyone over 15)
What is cyclical unemployment?
Cyclical unemployment is the loss of jobs due to weak aggregate demand-side conditions, a lack of AD and a downturn in economic activity or recession.
What is unemployment due to structural change?
This is also known as structural unemployment and can arise as a result of:
. new technology making some jobs obsolete
. the mismatch of skills held by the unemployed to the jobs available
. business relocation or closures
. cost cutting
. rationalisation by firms such as the introduction of cost cutting measures
. and some government microeconomic policies
What is unemployment due to frictional influence?
Frictional unemployment is when people are unemployed between one job and the next.
What is unemployment due to seasonal factors?
Seasonal unemployment is unemployment that occurs at the same time each year; for example, shearing sheep and fruit picking are seasonal.
What is unemployment due to hard-core aspects?
Hard-core unemployment arises due to personal characteristics that make holding down a job difficult. Eg. a person with a criminal record may find obtaining employment difficult or a person who has been rejected many times and has now lost confidence.
What is NAIRU?
This is another way to remember the goal of full employment. We aim for Non-Accelerating Inflation Rate of Unemployment.
How can the failure to achieve full employment effect the other economic goals?
- Economic growth - unemployment will decrease Eco growth and therefore material living standards. Also unemployment tends to decrease personal wellbeing and raise crime rates which brings down non-material wellbeing too.
- Inflation - unemployment tends to assist the achievement of low inflation.
- External stability - unemployment will effect both X and M, final outcome will vary.
- Distribution of income - unemployment will always worsen the distribution of income because unemployment benefits are lower than paid employment.
How is unemployment measured?
The ABS conducts a survey and month to examine the state of play in the labour force. Some key aspects of these measurements are:
. The labour force
. Employed persons
. Unemployed persons
How does the ABS define employed and unemployed persons?
The ABS defines employed people as working either full time or part time and being aged over 15.
The ABS defines unemployed people as those who are actively looking for full time or part time work but are unable to find it. They are able and willing to take up a job and are over 15 to.o.
How is unemployment calculated?
When calculating unemployment we need to consider a few different measures:
1) participation rate = people in labour force\everyone over 15.
2) unemployment rate - represents % of the labour force who are participating but can’t find work.
What are job vacancies?
Job vacancies are job offers advertised by firms looking for staff to fill them.
What is the underutilisation rate?
This includes the unemployment rate as well as the underemployed.
What is hidden unemployment?
Hidden unemployment includes people who would like work but who are discouraged from seeking jobs for various reasons, such as a repeated failure to find work, and who have left the labour force and are therefore no longer ‘actively looking for work’.
What is disguised unemployment/underemployment?
This is where individuals have jobs but are underemployed and
not working to capacity, such as in part-time jobs with limited hours.
What are the recent trends in unemployment?
June 2015 (000's) Total employed: 11772 Full-time: 8158 Part-time: 3614 Total unemployed: 75 Unemployment rate: 6.1% Participation rate: 64.8% Under utilisations rate: 14.6% = 8.5 (underemployed rate) + 6.1 (unemployment rate)
In 2nd half of 2015, the unemployment rate fell to 5.9%
Explain the goal of external stability.
The goal of external stability is a desirable situation which is achieved if Australia is living within its means and able to meet its international financial obligations. Generally this is indicated by:
. A low Current Account Deficit (CAD) to GDP ratio
. sustainable Net Foreign Debt (NFD)
. and a stable exchange rate
What is the current account deficit?
The CAD is a statistical record of the financial transactions between Australia and the rest of the world. The CAD is one half of the balance of payments. The other half is known as the Capital Account.
The key information for the capital account is that it is in surplus when the current account is in the deficit and approximately by the same amount.
How is the current account deficit measured?
Through the balance of payments account.
When debits for imports exceed credits for exports there is a current account deficit.
What is the balance of payments? (look at year 11 flashcards)
This is annual statistical record of the money value of both current, capital and financial transactions between Australia and the rest of the world.
When there is a current account deficit there is a capital and financial account surplus.
What is the current account? Year 11 flashcards
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What are the 4 sub-accounts of the current account?
. Net goods
. Net services
. Net primary incomes
. Net secondary incomes
Explain the following sub-account of the current account: net goods
This is the difference in total value between export credits for goods sold overseas minus import debits for goods purchased from abroad.
Goods sold overseas - also called merchandise (eg. wool, minerals and manufactured items.
Goods purchased from abroad - eg. oil, electronic equipment and machinery.
