Unit 3, Area of Study 2 Domestic Stability Flashcards
Aggregate demand
The total expenditure on the goods and services produced in the economy over a period of time.
(C + I) + (G1 + G2) + (X - M)
Private consumption expenditure (C)
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
Private Investment Expenditure (I)
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.
Government Expenditure (G1 and G2)
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
Net Exports (X - M)
Also known as the Trade Balance
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.)
Aggregate Demand
Factors that influence AD
- Disposable income (Gross Income – Income tax)
- Interest rates → cost of borrowing and incentive to save
- Consumer confidence → General optimism or pessimism about the future state of the economy and job prospects – from a consumer’s perspective
- Business confidence → General optimism or pessimism about the future state of the economy and ability to generate a profit – from a firm’s perspective.
- Exchange rates
- Levels of economics growth overseas
Disposable income (impact AD)
What?: gross income minus income tax.
How?:
Impacts purchasing power of consumers:
- ↑ real disposable income → ↑ in purchasing power → ↑ C → ↑ AD
- ↓ in real disposable income → ↓ purchasing power → ↓ C → ↓ AD
Interest rates (impacts AD)
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
Consumer confidence (impacts AD)
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
Business Confidence (impacts AD)
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
Exchange rates (impacts AD)
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
Global economic growth (impact AD)
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
Aggregate Supply
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.
Factors that influence Aggregate Supply
- The quantity of the factors of production (labour, capital and natural)
- The quality of the factors of production (labour, capital and natural)
- Costs of Production – e.g. wages
- Technological change
- Productivity growth
- Exchange rates
- Climatic conditions
- Other events such as government regulation or distruptions to international supply chains
How do changes in the quantity of factors of production impact AS?
An example: An increase in the labour force participation rate will lead to an increase in the quantity of factors of production, as greater proportion of the working age population join the labour force increase labour resources available , boosting producers ability to increase the total volume of goods and services in the economy over a given period of time due to an increase the productive capacity of the economy.
Quality of factors of production
(impact AS)
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)
Costs of production (impact on AS)
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.
Productivity Growth (impact AS)
**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.
Climatic conditions
(impact AS)
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 cylcones, 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.
Exchange rates
(impact AS)
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.
Technological change
(impact AS)
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.
Business Cycle
Business Cycle: the cyclical movement of economic activity over time.
Causes of a contractionary phase (Business Cycle)
- Due to high inflation, capacity constraints, higher interest rates the market will correct itself (meaning consumers will increase savings to decrease their debt)
- Increasing volume of production becomes difficult = reduced derived demand for labour = increased unemployment rate.
- Increasing inflation
- Peak that results in a “correction”
Consumer and business confidence declinesFall in private consumption and investment with households saving more and de-leveraging due to uncertainty Rate of economic growth slows à Increased unemployment, confidence drops, inflation comes down due to reduced demand inflationary pressures - Circular flow = leakages will start to rise and injections fall
Causes of a Peak (Business Cycle)
- Increased (high) consumer sentiment (confidence)
- Increased (high) business confidence (sentiment)
- Greater propensity to spend / take on new debt / interest rates
- Household savings ratio may fallHigh levels of global economic growth
Causes of a trough (Business Cycle)
- Reduced levels of spending due to low consumer confidence
- Higher levels of household savings due to low consumer confidence
- Reduced levels of investment due to low business confidence
- Low levels of disposable income
- Slow rates of global economic growth
Causes of an expansionary phase (Business Cycle)
In trough:
- Relatively low inflation rate
- Lower labour costs
- Lower interest rates
Causes of an expansion
- Increasing consumer sentiment (confidence)
- Increased consumption
- Increasing business confidence
- Increased investment
- Increased government spending through budgetary policy
- Low interest rates
Consequences of high inflation
Erodes purchasing power - A greater proportion of disposable income is required to purchase the same basket of goods and services.
Resource misallocation - Inflation undermines efficiency in allocation of resources / distorts the allocation of resources - With prices rising, this can send false price signals to producers that there are profit making opportunities
Reduces international competitiveness, i.e. local producers are at a competitive disadvantage
Redistributive effects - low income earners hit with rising prices eroding their purchasing power, whilst high income earners are more able to take advantage of rising asset prices through investing any savings (e.g., investment houses, shares, term deposits etc.)
Savings and investment - Distorts savings and investment decisions as households have less incentive to save, given that inflation erodes the value of future consumption (i.e. savings today) and businesses will therefore have less access to relatively cheap savings for investment - leads to lower living standards in the future as they have less savings.
Consequences of not achieving the goal of Strong and Sustainable Economic Growth (if growth is below 3%)
- *If growth is below 3%**
- *Growth in real income** – if growth is too low, then this won’t happen.
Lowering in the unemployment rate – if growth is too low, then this won’t happen.
Increased ability of government to provide essential services and avoid rising levels of debt - if growth is too low, then the government will need to run a budget deficit in order to provide essential services, and without tax revenue to pay for this, they’ll have to borrow increasing levels of government debt.
Negative overall impact on material and non-material living standards.
Consequences of not achieving the goal of Strong and Sustainable Economic Growth (if growth is above 3.5%)
- *If growth is above 3.5%**
- *Growth in real income**
lowers unemployment rate
improves ability of government to provide essential services and avoid rising levels of debt
However:
Sustainable?
Can create inflationary pressures which could impact negatively on real income growth.Can create external pressuresCan create environmental pressures through depletion of natural resources and degradation of the environment.Negative impact on material and non-material living standards.
Consequences of unemployment
Loss of gross domestic product (GDP).Loss of tax revenue.Greater income inequality.Reduction in living standards.
Consumer Price Index
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.
Cost inflation
Inflation caused by changes in factors that impact on aggregate supply or supply side pressures or capacity constraints.
Cyclical unemployment
Unemployment that occurs when the economy is not operating at its full capacity due to AD deficiencies.
Demand inflation
Inflation caused by changes factors that increase or decrease Aggregate Demand (important to note, mainly occurs when economy close to or approaching productive capacity)
Disguised unemployment or Under-employment
Underemployed are individuals who have a job however, they would prefer to be working more hours and therefore are unemployed to an extent.
Employed
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).
Factors that influence both material and non-material living standards (PEACLL)
- Physical and mental health
- Environmental quality
- Access to goods and services
- Crime rates
- Literacy rates
- Life expectancy
Frictional unemployment
Where a person is unemployed for the period of time while they are moving from one job to another.
Goal of Full Employment
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)
Goal of Low Inflation (Price Stability)
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.
Goal of strong and sustainable economic growth
The Government’s goal for strong and sustainable economic growth is to achieve the highest growth rate possible (real GDP of 3 to 3.5%), consistent with strong employment growth but without running into unacceptable inflationary, external and/or environmental pressures.
Gross Domestic Product (GDP)
Gross Domestic Product = total market value of all goods and services produced in the Australian economy over a given period of time.
Hardcore unemployment
Where a person is unemployed due to mental, physical or other characteristics that prevent them from receiving a job offer.
Headline Inflation / Consumer Price Inflation
captures price movements of all goods and services contained in the CPI (normal) à referred to as “headline rate of inflation” or “headline inflation”.
Hidden Unemployment
Unemployed not included in the calculation of unemployment as they have given up looking for work (i.e. not actively seeking work).
Inflation Formula
Labour Force Participation Rate
The portion of the working age population that is participating in the labour force (i.e., either employed or actively seeking work, unemployed).
Labour Force Underutilisation Rate
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.
Long term unemployed
Being unemployed for more than 12 months
Material living standards
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.
Nature of a contractionary phase (Business Cycle)
- 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.
Nature of a Peak (Business Cycle)
- 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.
Nature of a trough (Business Cycle)
- The minimum point of a cycle
- Low levels of production (GDP / Economic growth) = high unemployment
- Decreased inflation / deflation can occur
- Under-utilisation of capacity
Nature of an expansionary phase (Business Cycle)
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
Non material living standards
refer to quality aspects of a person’s daily existence.
Real vs Nominal GDP (and for other measures)
- 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.
Reasons for pursuring the goal of strong and sustainable economic growth
Growth in real income (helps raise real incomes)
- Growth in real income = greater access to goods and services = improved material living standards / greater happiness and reduced stress = improved non-material living standards.
- Lowering in the unemployment rate (economic growth creates jobs)üPositive relationship between growth and employment through “derived demand for labour” or DD4L
- Increased ability of government to provide essential services and avoid rising levels of debt.
- And the overall link that all of the above has to the economic prosperity of the nation in the form of improved living standards.
Seasonal unemployment
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
Structural unemployment
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.
The circular flow model of an income
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.
Under employed
Individuals that are employed but would prefer to be working more hours than they are currently working. (Also referred to as disguised unemployment)
Underlying inflation rate
Excludes the “volatile items” of fruit, vegetables and fuel à “CPI all groups excluding volatile items”.
Unemployed
When someone is over 15, without work or working for less than one hour per week, and actively looking for (more) work.
Gross National Expenditure
Total expenditure by Australians on goods and services produced in Australia and the rest of the world
GNE = C + I + G
