Economic Activity

U2 AOS1

Aggregate Demand

Total expenditure on Australian made goods and services.

AD = C + I + G + (X - M)

Aggregate Supply

The total production of goods and services in the economy

Aggregate Supply Inputs

• Labour (efforts of workers to produce g&s)

• Capital (inputs that can measured and not labour - the tools used to produce g&s - machinery, buildings etc.)

• Productivity (everything apart from labour and capital used to produce g&s) any inputs can't be measured i.e. innovation and how efficiently inputs are turned into outputs.

Aggregate Demand - Graph

Total willingness of everyone in the economy to purchase g&s (sum of individual demand curves)

Downward sloping - willing to purchase more when the price is lower.

Aggregate Supply - Graph

Total willingness of everyone in the economy to produce g&s (sum of individual supply curves)

Upwards sloping - willing to produce more if you can sell at a higher price.

Output - Level of potential GDP

Amount of g&s demanded is the same as what can be supplied.

When labour and capital inputs are fully utilised.

This is not maximum amount possible, rather all available inputs are being used at their normal levels.

When AD exceeds AS - Temporary

• The economy could temporarily produce more g&s to meet an increase in AD (longer labour hours)

• Supply temporarily increases to meet demand but as a result there is upward pressure on prices

• Excess demand means actual GDP is more than our potential GDP

• Prices increase as it costs more to produce when the economy is beyond full utilisation (overtime pay)

When AD exceeds AS - Permanently

• AS increases permanently to meet AD if more labour or capital is available (population growth) or if productivity improves

• Increase the level of GDP in the economy for a given price level

• Increased GDP potential at the same price point

• Economy now sustains increase in AD without pressure on prices

• AD shifts to the right and the economy is at permanently higher level of GDP, equal to increased potential

Factors of AD & AS

• Levels of consumer and business confidence

• Interest rates

• Strong rates of growth experienced by trading partners

• Disposable income

• Exchange rate

• Terms of trade

AD factors

are those that change economic growth by influencing one or more of the components of AD.

AS Factors

are those that change economic growth by influencing the supply decisions of producers and/or the productive capacity of the economy.

Components of AD

• Consumption -

• Investment

• Government Spending

• Exports

• Inputs

Exports

Goods and services that are made in Australia and purchased by foreign residents.

Consumption

The total value of all expenditures on individual and collective consumption goods incurred by resident households and non-profit institutions.

Inputs

Goods and services that are made overseas and purchased by Australian residents

Investment

The purchase of new equipment and plant, buildings and vehicles, as well as the addition to inventories (or stock).

Government Spending

Expenditure by all areas of government (Federal, State and Local) and commonly broken up into G1 and G2.

Consumer Confidence

Refers to consumers’ perceptions of their economic well being in the future.

High it places upward pressure on consumption expenditure,

Low it places downward pressure on consumption expenditure AD.

Business Confidence

Refers business perception of their future levels of sales and profits.

High it contributes positively to growth in investment AD, Low it has a negative impact on investment AD.

Interest Rates

represent the cost of borrowing or alternatively the return offered to those lending money.

A fall in interest rates will stimulate AS by improving supply conditions for business.

A fall in interest rates will stimulate AD for various reasons including: lower savings and increased borrowings: and provide a rise in discretionary income for those with existing loans

Strong Rates of Growth experienced by Trading Partners

Increase in growth rates experienced by our trading partners – US and China is likely to increase the demand for Australian exports of consumer items, capital items, raw materials – fuel needed to grow the economy.

This increases net exports X-M and AD – economic growth for Australia.

Disposable Income

Disposable income is income earned minus personal income tax..

If income rises or income tax falls, disposable income increases.

Higher disposable income increases households' ability to buy goods and services, leading to higher consumption (C) and aggregate demand (AD).

Spending only increases if disposable income grows faster than inflation. If it grows slower, real purchasing power falls, reducing spending over time.

Exchange Rate

The exchange rate is the value of the AUS dollar against another country, such as the US dollar.

Higher AUD reduces AD because Australian exports become more expensive and imports become cheaper, reducing international competitiveness. Higher AUD improves AS for businesses using imported inputs, as imports become cheaper and production costs fall.

Lower production costs can reduce prices, increasing AD through higher consumer spending.

Terms of Trade (TOT)

TOT = Export Price Index ÷ Import Price Index.

TOT rises when export prices increase relative to import prices.

Higher TOT means Australia earns more from exports (X) and/or pays less for imports (M). This increases net exports (X − M), boosting aggregate demand (AD) and economic growth.

Gross Domestic Product (GDP)

The final market value of all goods and services produced in the Australian economy over a given period of time. It is the same as the total ‘value added’ during each stage of the production process and is calculated every quarter by the ABS.

GDP is most common method used by economists to measure the size of economy.

Economic Growth

An increase in the amount or level of national production that has occurred over time. Most commonly measured by changes in the level of real GDP.

What does GDP measure

it measures the total production of goods and services within an economy

GDP (E)

The change in GDP over time is referred to as economic growth. 

GDP (I)

Measures the total income derived through the process of producing g&s.

Households largest component is wages, for business profits.

GDP (P)

Measures the total value added to the economy.

Inputs are used to make outputs and it is the value added by using the inputs to produce a desired output. (Sandwich from ingredients - inputs - example).

Don’t count the inputs used in this calculation, as these inputs are the output of someone else and therefore already accounted.