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)
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.
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 AD
- Changes in the general level of prices (inflation)
- 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
Factors that influence Aggregate Supply
- Changes in the general level of prices (inflation)
- 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
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.
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 (i.e., will provide no on-going benefit)
Health, education, defence, office stationary, salaries - Relatively stable component of AD
-
G2 → Capital expenditure Investment expenditure on goods of a capital nature (i.e., will provide an ongoing benefit)
Physical hospitals, schools, roads (infrastructure) - 20% of Aggregate demand
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.