Unit 3, Area of Study 2 Domestic Stability

Question 1

Aggregate demand

Answer 1

The total expenditure on the goods and services produced in the economy over a period of time.

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

Question 2

Private consumption expenditure (C)

Answer 2

Total value of all expenditure on goods incurred by households.
Includes:

• Spending on durables (e.g. white goods, cars etc.)
• Consumer semi-durables (e.g. clothing)
• Non-durables (e.g. food)
• Services (e.g., dry cleaning)

60% of AD

Question 3

Private Investment Expenditure (I)

Answer 3

Total value of expenditure with the purpose of expanding the productive capacity and productivity of firms:

• Purchase of new equipment - Vehicles, Buildings (includes the construction of new homes), producers adding to inventories (includes a farmer buyer more cattle)
• 15 to 20% of AD but is the most volative component of AD, as during periods of low economic activity, businesses put a stop on expenditure on new capital goods such as equipment. This occured during CoVid.

Question 4

Government Expenditure (G1 and G2)

Answer 4

Includes expenditure by all levels of government (federal, state and local).

G1
Current expenditure on goods or services not capital in nature, therefore no on-going benefit created.
Refers to government consumption expenditure on the day-to-day operation of the public sector. This includes spending on wages and salaries of public sector employees (e.g., teachers, police officers, healthcare workers) and operational expenses such as office supplies and utilities.
Health, education, defence, office stationary, salaries
Relatively stable component of AD

G2
Capital expenditure refers to government investment expenditure on capital projects that contribute to long-term economic growth. This includes spending on infrastructure, such as roads, bridges, hospitals, schools, and public transport systems.
Physical hospitals, schools, roads (infrastructure)

• 20% of Aggregate demand

Question 5

Net Exports (X - M)

Also known as the Trade Balance

Answer 5

Also referred to as Net Exports (X – M) – also referred to as Trade Balance.

• X is spending on exports by foreign households, businesses, governments or other institutions.
• M is spending on imports by Australian households, businesses, governments or other institutions.
• (note: 60% of imports are used in the production process)
• Each about 20 to 24% of AD, but net effect about 4% (very volatile as subject to a variety of factors such as ER, global growth, levels of free trade etc.)

Question 6

Aggregate Demand
Factors that influence AD

Answer 6

1. Disposable income (Gross Income – Income tax)
2. Interest rates → cost of borrowing and incentive to save
3. Consumer confidence → General optimism or pessimism about the future state of the economy and job prospects – from a consumer’s perspective
4. Business confidence → General optimism or pessimism about the future state of the economy and ability to generate a profit – from a firm’s perspective.
5. Exchange rates
6. Levels of economics growth overseas

Question 7

Disposable income (impact AD)

Answer 7

What?: Disposable income is the amount of money an individual or household has available for spending and saving after paying taxes. It is calculated as:
Disp. Inc. = Gross Income – income tax)

How?:
Impacts purchasing power of consumers:

• ↑ real disposable income → ↑ in purchasing power → ↑ C → ↑ AD
• ↓ in real disposable income → ↓ purchasing power → ↓ C → ↓ AD

Question 8

Interest rates (impacts AD)

Answer 8

What?: - Cost of borrowing and incentive to save)

How?:
* Impacts portion of disposable income available for consumption (variable rate loans) → lower interest rates → lower repayments on existing loans → greater proportion of disposable income available for consumption → ↑ C → ↑AD

• Impacts the cash available to a business – cash flow effect (variable rate loans) → more cash available due to Iow interest rates → more attractive to borrow cash / less incentive to save, instead to spend → ↑ C and I → ↑AD
• High interest rates → greater incentive to save and not spend / less attractive to borrow cash → ↓ C and I → ↓AD

Question 9

Consumer confidence (impacts AD)

Answer 9

What?: General optimism or pessimism about the future state of the economy and job prospects – from a consumer’s perspective
How?:
* ↑ consumer confidence → optimistic → ↑ spending → ↑ C → ↑ AD
* ↓ consumer confidence → pessimistic → ↑ saving & ↓ spending → ↓ C → ↓ AD
* Sometimes referred to as Consumer Sentiment

Question 10

Business Confidence (impacts AD)

Answer 10

What?: General optimism or pessimism about the future state of the economy and ability to generate a profit – from a firm’s perspective.
How?:
* ↑ business confidence, producers more likely to spend on items that will expand their productive capacity, for example new equipment → ↑ I → ↑AD
* ↓ business confidence, producers less likely to spend on items that will expand their productive capacity, for example new equipment → ↓ in I → ↓AD

Question 11

Exchange rates (impacts AD)

Answer 11

What?: - the price of one currency in terms of another currency.

How?: Impacts international competitiveness:

• a depreciation of the AUD → ↑ in international competitive → X cheaper in FC terms → more affordable for foreign consumers / M more expensive in AUD terms → less affordable for domestic consumers → ↑ X and ↓ M → ↑ net exports → ↑ AD
• a appreciation of the AUD → ↓ in international competitive → X more expensive in FC terms → less affordable for foreign consumers / M less expensive in AUD terms → more affordable for domestic consumers → ↓ X and ↑ M ↓ → ↓ net exports → ↓ AD

Question 12

Global economic growth (impact AD)

Answer 12

What?: levels of economic activity in the economies of our major trading partners.

How?:
* ↑ economic growth in the economies of our major trading partners → ↓ unemployment / ↑ disposable income for foreign consumers → ↑ spending on our X → ↑ AD
* ↓ in economic growth in the economies of our major trading partners → ↑ unemployment / ↓ disposable income for foreign consumers → ↓ spending on our X → ↓ AD

Question 13

Aggregate Supply

Answer 13

Aggregate Supply: represents the total volume of goods and services that all suppliers have produced and supplied over a period of time.

Aggregate Supply is influenced by the willingness and ability of producers to produce.

Question 14

Factors that influence Aggregate Supply

Answer 14

1. The quantity of the factors of production (labour, capital and natural)
2. The quality of the factors of production (labour, capital and natural)
3. Costs of Production – e.g. wages
4. Technological change
5. Productivity growth
6. Exchange rates
7. Climatic conditions
8. Other events such as government regulation or distruptions to international supply chains

Question 15

Quantity of factors of production impact AS?

Answer 15

What?: the volume of resource available to producers for production, e.g., labour resources.

How?:
An increase in factors of production (or resources) that producers have available to them will expand the nation’s productive capacity, improving producers ability to increase the volume of goods and services they are able to produce

Question 16

Quality of factors of production
(impact AS)

Answer 16

What?:
Refers to the productivity and efficiency of the resources (labour, natural and capital) used in the production process.

How?:
When producers have access to a high quality of factors of production (resources), this boosts the economies productive capacity by improving levels of efficiency for producers, improving their willingness and/or ability to produce (Aggregate Supply)

Question 17

Costs of production (impact on AS)

Answer 17

What?: Refers to the costs incurred by a business/producer in the process of producing goods or services.
These can include:
Labour costs in the form of wages or salaries
Costs of raw materials
Costs of equipment used in the production process
Costs of land and premises required to produce

How?:

A reduction in the costs of production lowers costs for businesses, making production more efficient and profitable. This enable producers to expand output, invest in capital, and hire more workers, increasing the productive capacity of the economy.

Question 18

Productivity Growth (impact AS)

Answer 18

**What?: **Productivity growth refers to the increase in the amount of goods and services (outputs) produced per unit of input over time.

How?: If productivity growth increases, this boosts the productive capacity of the economy and the ability of producers to increase levels of production improving Aggregate Supply by increasing the outputs produced by any given level of inputs and reducing per unit costs.

Question 19

Climatic conditions
(impact AS)

Answer 19

What?: Refer to weather patterns and environmental factors that impact the availability and productivity of a nation’s resources.

How?:
Impact of climate change on AS?
Extreme weather events:
* degradation of natural resources (e.g., drought negatively impacting farming land),
* Destruction of value infrastructure (e.g. floods and cyclones, can lead to the destruction of valuable infrastructure such as roads, rail and ports
Impact of droughts on producers?
* Reduces productivity of land and the agricultural sector.

All the above reduce the productive capacity of an economy by affecting the availability and efficiency of natural resources, agricultural output, and labour productivity.

Question 20

Exchange rates
(impact AS)

Answer 20

What?: the price of one currency in terms of another currency.

How?:
A change in the value of the Australian dollar will impact on the price of imports in AUD terms.
* Depreciation of the AUD, increases cost of imports in Australian dollar terms
* Appreciation of the AUD, decreases cost of imports in Australian dollar terms

Around 60% of imports into Australia are indeed used in some form for production purposes. This includes intermediate goods (materials and components used to produce other goods) and capital goods (machinery, equipment, etc.) essential for manufacturing and industry.

Question 21

Technological change
(impact AS)

Answer 21

What?:
Technological change significantly impacts aggregate supply (AS) by improving efficiency, productivity and contributing to a reduction in production costs  increasing the overall productive capacity of an economy.
Advanced technology reduces waste, errors, and inefficiencies, lowering per-unit costs.
New technology allows businesses to produce more output with the same inputs, shifting the AS curve to the right.
Recent examples:
* AI
* Development of the NBN in Australia improving speed of internet connections.

How?:
Technological change increases the productive capacity of an economy by improving the efficiency of production processes, leading to producers being able to produce a higher-level output with the same or fewer resources.

Question 22

Business Cycle

Answer 22

refers to the natural fluctuations in economic activity over time, characterized by four phases, peaks, troughs, contractions and expansions.

Question 23

Causes of a contractionary phase (Business Cycle)

Answer 23

• Rising interest rates = reduced spending funded by borrowing and rising household savings ratio.
• Declining consumer and business confidence (and associated impacts)
• Rising levels of household savings ratio
• Reduced purchasing power of consumers due to high inflation
• Falling levels of global economic growth
• Circular flow = leakages will start to rise and injections fall

Question 24

Causes of a Peak (Business Cycle)

Answer 24

• High consumer sentiment (confidence)
• High business confidence (sentiment)
• Greater propensity to spend / take on new debt / interest rates
• Household savings ratio low
• High levels of global economic growth
• Low interest rates
• Circular flow = leakages will be falling relative to injections

Question 25

Causes of a trough (Business Cycle)

Answer 25

* Low levels of spending due to low consumer confidence * High levels of household savings due to low consumer confidence * Low levels of investment due to low business confidence * Low levels of disposable income * Low interest rates * Low rates of global economic growth (even negative)

Question 26

Causes of an expansionary phase (Business Cycle)

Answer 26

* Low interest rates  increasing expenditure funded by loans and falling household savings ratio * Increasing / rebounding consumer sentiment (confidence) * Increasing consumption * Increasing / rebounding business confidence * Increased investment * Increased government spending through budgetary policy * Low interest rates – but these will start to rise as the expansion continues * Circular flow = injections greater than leakages

Question 27

Goal of strong and sustainable economic growth

Answer 27

The Government’s goal for strong and sustainable economic growth is to achieve the highest growth rate possible , consistent with strong employment growth but without running into unacceptable inflationary, external and/or environmental pressures (real GDP of 3 to 3.5%).

Question 28

Consequences of not achieving the goal of Strong and Sustainable Economic Growth (if growth is below 3%)

Answer 28

1. Lowering in the unemployment rate 2. Reduction real income growth 3. Increased ability of government to provide essential services and avoid rising levels of debt *Important to be able to explain why these are consequences, and the links the consequences have to living standards*

Question 29

Consequences of not achieving the goal of Strong and Sustainable Economic Growth (if growth is above 3.5%)

Answer 29

1. Environmental degradation 2. External pressures 3. Inflationary pressures *Important to be able to explain why these are consequences, and the links the consequences have to living standards*

Question 30

Goal of Full Employment

Answer 30

The level of unemployment that exists when the government’s economic growth goal is achieved and where cyclical unemployment is non-existent, generally accepted to be 4 to 4.5% (NAIRU)

Question 31

N.A.I.R.U (Non-accelerating inflationary rate of unemployment)

Answer 31

Refers to the level of unemployment at which inflation remains stable. It represents the lowest unemployment rate that an economy can sustain without causing inflation to rise – also referred to as natural rate of unemployment.

Question 32

Employed

Answer 32

When someone is 15 years of age and over and working more than 1 hour a week in return for some form of remuneration (such as wages).

Question 33

Unemployed

Answer 33

When someone is over 15, without work or working for less than one hour per week, and actively looking for (more) work.

Question 34

Under employed

Answer 34

Individuals that are employed but would prefer to be working more hours than they are currently working. (Also referred to as disguised unemployment)

Question 35

Disguised unemployment or Under-employment

Answer 35

Underemployed are individuals who have a job however, they would prefer to be working more hours and therefore are unemployed to an extent.

Question 36

Hidden Unemployment

Answer 36

Unemployed not included in the calculation of unemployment as they have given up looking for work (i.e. not actively seeking work).

Question 37

Unemployment rate (formula) You need to be able to calculate this

Answer 37

Question 38

Labour Force Participation Rate

Answer 38

The portion of the working age population that is participating in the labour force (i.e., either employed or actively seeking work, unemployed).

Question 39

Labour Force Underutilisation Rate

Answer 39

The proportion of the of the labour force that is ‘underutilised’, or the proportion of individuals not working the number of hours they would like to. This includes those who are unemployed and under-employed.

Question 40

Hardcore unemployment

Answer 40

Where a person is unemployed due to mental, physical or other characteristics that prevent them from receiving a job offer.

Question 41

Frictional unemployment

Answer 41

Where a person is unemployed for the period of time while they are moving from one job to another.

Question 42

Cyclical unemployment

Answer 42

Unemployment that occurs when the economy is not operating at its full capacity due to AD deficiencies.

Question 43

Long term unemployed

Answer 43

Being unemployed for more than 12 months

Question 44

Consequences of not achieving the goal of full employment **(Unemployment above 4.5%)**

Answer 44

1. Loss of gross domestic product (GDP) 2. Loss of tax revenue 3. Greater income inequality

Question 45

Goal of Low and Stable Inflation (Price Stability)

Answer 45

Goal of low inflation is to achieve a sustained increase in the general level of prices of between 2 – 3% on average over the medium term.

Question 46

Consumer Price Index

Answer 46

Collects prices of over 100,000 goods and services that are purchased by average metropolitan Australian households in the eight capital cities. This is called a ‘basket’. Each of these goods is then categorised in 11 groups and sub-divided again into sub-groups.Weights are then attached to each group to reflect their relative importance to the typical household.

Question 47

Cost inflation

Answer 47

Inflation caused by changes in factors that impact on aggregate supply or supply side pressures or capacity constraints.

Question 48

Demand inflation

Answer 48

Inflation caused by changes factors that increase or decrease Aggregate Demand (important to note, mainly occurs when economy close to or approaching productive capacity)

Question 49

Factors that influence both material and non-material living standards (PEACLL)

Answer 49

1. Physical and mental health 2. Environmental quality 3. Access to goods and services 4. Crime rates 5. Literacy rates 6. Life expectancy

Question 50

Consequences of not achieving low and stable inflation **(Below 2%)**

Answer 50

1. Delayed spending by consumers and businesses 2. Increase in unemployment

Question 51

Consequences of not achieving low and stable inflation **(Above 3%)**

Answer 51

1. Erodes purchasing power 1. Development of a wage price spiral 1. Distortion of spending and investment decisions 1. Lower returns on investment 1. Reduces international competitiveness

Question 52

Gross Domestic Product (GDP)

Answer 52

Gross Domestic Product = total market value of all goods and services produced in the Australian economy over a given period of time. * Nominal GDP – is the dollar value of the goods and services produced in a time period, which depends on the volume of what was produced and the price of what was produced. * Real GDP – captures on the volume that was produced by removing the impact of changes in price or inflation. * Real GDP also referred to as “the chain volume measure of GDP” * Real GDP per capita – one measure of material living standards

Question 53

Headline Inflation / Consumer Price Inflation

Answer 53

captures price movements of all goods and services contained in the CPI (normal) à referred to as “headline rate of inflation” or “headline inflation”.

Question 54

Inflation Formula

Answer 54

Question 55

Material living standards

Answer 55

Refers to the level of economic wellbeing of individuals and the quantity of tangible or physical goods and services available for each person to consume.

Question 56

Nature of a contractionary phase (Business Cycle)

Answer 56

* Slowing rates of economic growth * Decreasing levels of inflation / disinflation * Increasing levels of unemployment / fewer job vacancies * Increasing under-utilization rate (i.e., plenty of spare capacity in the economy available to increase volume of production), particularly in the labour market in the form of unemployment and under-employment.

Question 57

Nature of a Peak (Business Cycle)

Answer 57

* Strong rates of economic growth / perhaps unsustainable growth? * High levels of inflation * Low levels of unemployment * Spending and confidence are high * Production is strong and capacity is heavily utilised.

Question 58

Nature of a trough (Business Cycle)

Answer 58

* The minimum point of a cycle * Low levels of production (GDP / Economic growth) = high unemployment * Decreased inflation / deflation can occur * Under-utilisation of capacity

Question 59

Nature of an expansionary phase (Business Cycle)

Answer 59

In trough (prior to an expansion) * Relatively low inflation rate * Lower labour costs * Lower interest rates **Nature of an expansion** * Increasing levels of production (GDP growth) * More job vacancies / falling unemployment * Inflationary pressures building in the economy

Question 60

Non material living standards

Answer 60

refer to quality aspects of a person’s daily existence.

Question 61

Real vs Nominal GDP (and for other measures)

Answer 61

* Nominal GDP – is the dollar value of the goods and services produced in a time period, which depends on the volume of what was produced and the price of what was produced. * Real GDP – captures on the volume that was produced. * Real GDP also referred to as “the chain volume measure of GDP” * Real removes the impact of inflation on the measures.

Question 62

Reasons for pursuring the goal of strong and sustainable economic growth

Answer 62

Growth in real income (helps raise real incomes) 1. **Growth in real income** = greater access to goods and services = improved material living standards / greater happiness and reduced stress = improved non-material living standards. 2. **Lowering in the unemployment rate** (economic growth creates jobs)üPositive relationship between growth and employment through “derived demand for labour” or DD4L 3. **Increased ability of government** to provide essential services and avoid rising levels of debt. 4. And the overall link that all of the above has to the economic prosperity of the nation in the form of **improved living standards**.

Question 63

What is meant by N.A.I.R.U?

Answer 63

**Non-accelerating inflationary rate of unemployment** - refers to the level of unemployment at which inflation remains stable. It represents the lowest unemployment rate that an economy can sustain without causing inflation to rise – also referred to as **natural rate of unemployment**.

Question 64

Seasonal unemployment

Answer 64

Where a person is unemployed because their skills are only demanded during certain times of the year. Examples include snow ski instructors and fruit pickers

Question 65

Structural unemployment

Answer 65

The skills of the unemployed do not match the skills required by the economy. (in other words there is a mismatch between the skills of the unemployed and the skills that are needed for the jobs available). An example is the recent shut down of car manufacturing in Australia.

Question 66

Consequences of not achieving the goal of full employment **(below 4%)**

Answer 66

Demand Inflationary pressures due economy pushed toward productive capacity leading to low labour under-utilisation rate, demand exceeds supply and prices rise (means that NAIRU is not being achieved)

Question 67

The circular flow model of an income

Answer 67

The model, shows the flows of production, income and consumption that occur as a result of transactions between the Business and Household sector. * **Flow 1: Household sector** provides resources (e.g. labour, capital and/or natural resources) to the business sector. * **Flow 2: Business** provide income (e.g, wages, dividends, interest, profits and rent) to the Household sector * **Flow 3:** Part of this income is then consumed via the purchase of goods and services from the business sector. * **Flow 4**: Total real value of production in the economy, i.e. real GDP. * **Leakages:** part of income earned by households is not immediately spent on Australian goods and services, instead is diverted through the Financial Sector, Government Sector and External Sector. * **Financial Sector**: savings (Leakage) and investment (injection) - money used in C (Private consumption expenditure) or I (Private investment expenditure). * **Government Sector:** taxes (Leakage) & govt spending on infrastructure (injection) or via C (private consumption expenditure) once welfare transfers are spent. * **External sector:** spending on imports (leakage), which decreases AD and spending on exports (injection) which increases AD.

Question 68

Underlying inflation rate

Answer 68

Excludes the “volatile items” of fruit, vegetables and fuel à “CPI all groups excluding volatile items”.

Question 69

Gross National Expenditure

Answer 69

Total expenditure by Australians on goods and services produced in Australia and the rest of the world GNE = C + I + G

Question 70

Deflation

Answer 70

Refers to a sustained decrease in the general level of prices across an economy over a period of time. It is typically measured by a negative inflation rate. A decrease in the average price level over time. Literally a negative inflation figure.

Question 71

Disinflation

Answer 71

Refers to a decrease in the rate of inflation over a period of time, meaning that prices are still rising but at a slower rate than before, for example, quarter ending March 2017 inflation is 1.9% and then quarter ending June 2017 comes in at 1.5%.