Chapter 6 Economics

Laissez-faire market

often fails, necessitating government intervention.

CFI equilibrium

S + T + M = I + G + X (leakages = injections)

Paradox of thrift

When people save more during economic downturns, consumption is reduced. This leads to reduced production, income, and higher unemployment. Creates leakages, reduces injections.

Economic objectives

Economic Growth: 3-4%, Full Employment: 3.5-5%, and Price Stability: 2-3%.

Nominal GDP

Measured at current prices, not adjusted for inflation

Real GDP

Adjusted for inflation, showing actual economic growth.

Methods of measuring GDP

Production approach, Income approach, and Expenditure approach.

Production approach

measures total value of final goods and services

Income approach

measures income from resources

Expenditure approach

measures total spending, excluding imports.

Challenges of GDP as a measure of success

May not reflect social well-being, environmental impact, or wealth distribution.

Aggregate demand

The total output demanded is at different price levels. AD = C + I + G + (X-M). factors affecting AD include income, wealth, interest rates, and government policy.

Keynesian Theory

advocated for gov intervention to smooth extreme fluctuation in unemployment and inflation by managing aggregate demand.

Multiplier effect

a small increase in autonomous expenditure results in a larger increase in GDP due to the multiplier effect.

Aggregate Supply

the total output produced at various price levels. It has a direct relationship with price level. Factors that shift AS include changes in productivity, wages, and fuel costs.

Deflationary Gap

AD is less than full employment level of output

Inflationary Gap

AD exceeds full employment output

Fiscal Policy

Managed by the government (taxation, government spending).

Monetary Policy

Managed by the central bank (interest rates, money supply

Global Effects on the Economy

International factors like tariffs, quotas, trade agreements, and exchange rates affect a nation's economy. Australia is influenced by foreign economic policies but has limited control over them.

What is the primary role of the government in macroeconomics?

To achieve economic objectives ensuring continued improvements in the standard of living by optimizing the use of limited resources.

What are the three key macroeconomic objectives governments aim to achieve?

Internal stability, external stability, and an improved standard of living.

What is internal stability?

Full employment and price stability.

Define external stability in macroeconomic terms.

Maintaining a balanced Balance of Payments (BOP) and sustainable external debt relative to GDP.

What does full employment mean in macroeconomics?

An unemployment rate of 3.5%-5%, accounting for frictional, structural, and seasonal unemployment but avoiding inflationary pressure.

What is the definition of sustainable economic growth?

Growth in GDP between 3%-4%, ensuring resource sustainability without creating significant future problems.

Why is GDP considered limited in measuring economic performance?

GDP doesn’t include non-market production, measure quality changes, account for wealth distribution, or reflect environmental and social impacts.

What are alternatives to GDP for measuring economic performance?

Steel consumption, energy consumption, housing approvals, retail sales, new motor vehicle registrations, and consumer credit.

Name the types of unemployment.

Cyclical, frictional, structural, seasonal, and hidden unemployment.

What is underemployment?

Full-time workers on reduced hours or part-time workers who want more hours.

What are the three types of inflation?

Demand-pull inflation, cost-push inflation, and imported inflation.

Define the Phillips Curve.

A graphical representation showing the inverse relationship between inflation and unemployment.

What is stagflation?

A situation in which an economy experiences high inflation, high unemployment, and stagnant economic growth.

What is the Balance of Payments (BoP)?

A summary of a nation's transactions with the rest of the world, including the current account and capital account.

How does high inflation affect the economy?

It reduces purchasing power, puts upward pressure on interest rates, reduces international competitiveness, and can lead to bracket creep in taxation.

What is the opportunity cost in economic terms?

The value of the next best alternative forgone when making a decision, such as producing one good over another.

What are the objectives for improved standard of living?

Quality of life indicators such as health standards, education, job quality, and happiness levels.

How does income inequality affect economic growth?

It can encourage entrepreneurship and skill attainment but may also lead to social issues like crime, poor health, and unemployment among poorer populations.

What are economic indicators, and what types exist?

Indicators are used to assess economic activity. They include leading (e.g., factory overtime), coincident (e.g., retail sales), and lagging indicators (e.g., unemployment).

What is the government's role in managing the economy?

Allocating resources, distributing income and wealth, and stabilizing the economy through fiscal, monetary, and external policies.

What is the government budget?

The government’s planned revenues (taxes) and expenditures for the next financial year.

What is the Mid-Year Economic and Fiscal Outlook (MYEFO)?

A report released each December that updates economic forecasts based on current conditions.

What are the three main types of government income?

Direct taxes (income tax, Medicare levy), indirect taxes (GST, customs duty), and other revenues (sale of government assets).

What are the four principles of taxation?

Equity, ease of collection, certainty, and convenience.

What is a proportional tax?

A flat rate tax where everyone pays the same percentage of income, regardless of earnings.

What is a progressive tax?

A tax system where the tax rate increases as income increases, such as Australia's income tax system.

What is a regressive tax?

A tax where the proportion of income paid in tax decreases as income rises, affecting low-income earners more.

What is 'Bracket Creep'?

When inflation causes wages to increase, pushing individuals into higher tax brackets, resulting in higher taxes despite no real increase in purchasing power.

What are indirect taxes?

Taxes such as GST and excise duties that are passed onto consumers through higher prices.

What is a fiscal deficit?

When government expenditure exceeds tax revenue, leading to an expansionary fiscal stance.

What is a fiscal surplus?

When government tax revenue exceeds expenditure, leading to a contractionary fiscal stance.

What are discretionary fiscal policies?

Deliberate government actions to change tax rates or expenditures to influence the economy.

What are automatic stabilizers?

Economic mechanisms like unemployment benefits and income tax that adjust naturally based on the state of the economy.

What is ‘Crowding Out’?

When government borrowing increases competition for funds, leading to higher interest rates and reduced private sector investment.

What are some global influences on fiscal policy?

Events such as pandemics, wars, changes in oil prices, and the influence of multinational corporations.

What is monetary policy?

Monetary policy involves the Reserve Bank of Australia (RBA) changing interest rates to influence the cost and availability of credit.

How does the RBA expand economic activity through monetary policy?

By lowering interest rates (cash rate), which boosts consumer spending and business investment, increasing Aggregate Demand (AD) and employment.

How does the RBA ease economic activity?

By raising interest rates, reducing consumer spending and business investment, which decreases AD and lowers inflation.

What is the cash rate?

The rate banks pay to borrow from other banks, which influences retail and wholesale interest rates.

What is the RBA's key operational objective?

To maintain inflation between 2% and 3%.

How does inflation targeting benefit Australia?

It helps maintain currency stability, full employment, and economic prosperity.

What are the two main instruments of monetary policy?

Altering the cash rate and changing the money supply.

What is a basis point?

One hundredth of one percent (0.01%). A 1% change equals 100 basis points.

What is the impact of lower interest rates?

They discourage saving, encourage borrowing and investment, reduce debt costs, and may lead to a depreciation of the AUD.

What is the impact of higher interest rates?

They encourage saving, discourage borrowing and investment, increase debt costs, and may lead to an appreciation of the AUD.

What is the Transmission Mechanism in monetary policy?

Changes to the cash rate affect interest rates, which influence spending, investment, AD, and inflation.

What are inside lags in monetary policy?

The time it takes to recognize the state of the economy and decide on the appropriate policy.

What are outside lags in monetary policy?

The time it takes for the effects of a policy decision to impact the economy.

What are the limitations of monetary policy?

Long time lags before changes in the cash rate affect real economic outcomes, sometimes taking 1-2 years to have a full effect.

How do interest rate changes affect the exchange rate?

Lower rates encourage capital outflow, leading to a depreciation of the AUD, while higher rates encourage capital inflow, leading to appreciation.

Why might banks delay passing on cash rate cuts?

Banks base their response to cash rate changes on their own commercial considerations.

How does monetary policy affect the housing market?

Changes to interest rates quickly impact investment spending and the housing market, which are sensitive to rate fluctuations.

What are some competing objectives of monetary policy?

Balancing economic growth, inflation control, and avoiding financial hardship for indebted homeowners during interest rate adjustments.

What is the advantage of monetary policy over fiscal policy?

It has shorter inside lags and greater independence from political influences.

What are microeconomic policies?

Microeconomic policies focus on the economic behavior of individual units like firms, individuals, and governments, affecting resource allocation and prices.

What are supply-side policies?

Government initiatives aimed at increasing resource efficiency and productivity to make Australian industries more competitive.

What is structural change?

Industry-wide changes in production patterns leading to some industries or occupations disappearing and new ones emerging.

What are the main areas of supply-side reform?

Infrastructure, education and training, deregulation, competition policy, labor market reform, taxation reform, and trade policies.

How do microeconomic reforms increase output?

By reducing business costs, improving efficiency, and increasing productivity, which lowers prices, encourages investment, and shifts the long-run Aggregate Supply (AS) curve to the right.

What is productive efficiency?

The ability of an economy to produce the maximum output from a given quantity of resources at the lowest cost.

What is dynamic efficiency?

The ability of an economy to adapt to changing consumer demands by reallocating resources and adopting new technology.

What is allocative efficiency?

Using resources in combinations that generate the maximum benefits for society.

How do microeconomic reforms relate to domestic macroeconomic objectives?

They aim to maintain economic prosperity, improve living standards, and promote equity in wealth distribution across generations.

What are publicly owned business enterprises (GBEs)?

Government-established enterprises that provide competition in markets where natural monopolies exist to reduce prices and improve service quality.

Why have many GBEs been privatized?

Privatization is based on the assumption that privately owned enterprises are more efficient due to competition.

What are examples of infrastructure investments in Australia?

The Sydney Harbour Bridge (1932), Snowy Mountains Hydro (1974), and Trans-Australian Railway (1974).

How does infrastructure contribute to economic growth?

It provides employment, delivers new goods or services, and helps utilize resources in productive ways, accounting for a significant portion of GDP.

How do education and training contribute to economic growth?

By equipping workers with skills needed for new industries, as seen with free university education (1974) and the HECS system (1989).

Why is research, development (R&D), and innovation important?

R&D is crucial for innovation but costly, and there is no guarantee of success in developing new products or processes.

What are the goals of labor market reform?

To control inflation, reduce unemployment, protect workers' incomes and working conditions, and provide a framework for resolving industrial disputes.

What was a major feature of taxation reform in Australia?

The introduction of the Goods and Services Tax (GST).

What is the issue with Australia's optimum population?

The rapidly growing population, concentrated in eastern seaboard cities, lacks adequate infrastructure support, putting pressure on the natural environment.