Economics

The five macroeconomic objectives

sustainable economic growth

full employment

price stability

external stability

sustainable development

improved living standards.

Sustainable economic growth

Increase in a nation's production of goods and services (measured by real Gross Domestic Product) over time that meets current needs without depleting natural resources, damaging the environment, or compromising the ability of future generations to meet their own needs

GDP

definition: total market value of final goods and services produced in an economy over a period

Price changes

The rise or fall in the monetary value of a good, service, asset, or general price level over a specific period of time

Real vs nominal GDP

Nominal GDP is measured using current prices, so it can rise simply because prices have risen. Real GDP is adjusted for inflation, so it shows the actual change in the volume of goods and services produced; real GDP is used to measure economic growth.

Why is real GDP used to measure economic growth?

Real GDP removes the effect of price changes, so an increase means the economy is genuinely producing more goods and services—not just charging higher prices. This makes it a better measure of changes in output, employment and material living standards.

What is GDP per capita and why is it used to compare living standards?

GDP per capita is real GDP divided by population. It is used because it shows the average amount of output/income available per person, making it more useful than total GDP for comparing living standards between countries of different population sizes.

What is a recession?

A recession is a significant decline in economic activity, commonly defined as two consecutive quarters of negative real GDP growth. It usually involves falling output, rising unemployment, lower consumer spending and weaker business investment.

What are the four phases of the economic cycle?

Expansion, peak, contraction/recession and trough. During expansion, GDP, employment and inflationary pressure usually rise; during contraction, GDP and employment fall, while unemployment rises.

What is aggregate demand (AD)?

Aggregate demand is the total planned spending on goods and services in an economy at each price level. It is made up of consumption, investment, government spending and net exports.

What affects consumption (C)?

Consumption is affected by disposable income, consumer confidence, interest rates, wealth, inflation expectations and access to credit. For example, if interest rates rise, loan repayments increase and households may reduce spending on cars, holidays and other goods.

What affects investment (I)?

Investment is affected by interest rates, business confidence, expected profits, existing capacity use, technology and government policy. Lower interest rates make borrowing cheaper, so firms are more likely to invest in new machinery, buildings or technology.

What affects net exports (X − M)?

Net exports are affected by the exchange rate, overseas income levels, Australia’s international competitiveness, global demand and trade policies. A depreciation of the AUD makes Australian exports cheaper overseas and imports more expensive, which can increase net exports.

What happens to output and price level when AD increases?

An increase in AD shifts the AD curve right. In the short run, real output rises and the general price level rises; this can reduce unemployment but may create demand-pull inflation if the economy is close to full capacity.

Define Aggregate Supply

the total quantity of goods and services that firms across a national economy are willing and able to produce and sell at a given price level during a specific period of time

What happens to output and price level when AS decreases?

A decrease in short-run aggregate supply shifts AS left. Real output falls while the price level rises, creating stagflation—slower growth with higher inflation.

What is inflation and how is it measured?

Inflation is a sustained increase in the general price level over time. In Australia, it is mainly measured by the Consumer Price Index (CPI), which tracks changes in the price of a basket of goods and services bought by households.

What is demand-pull inflation?

Demand-pull inflation occurs when aggregate demand grows faster than the economy’s capacity to produce goods and services. Consumers, businesses or government spending pull prices upward because demand exceeds available supply.

What is cost-push inflation?

Cost-push inflation occurs when production costs rise, causing firms to increase prices to protect profit margins. Examples include higher wages, energy prices, raw-material costs or supply disruptions.

What is imported inflation?

mported inflation occurs when the price of imported goods rises, often because the Australian dollar depreciates or overseas prices increase. It raises the cost of imports for consumers and can raise production costs for firms using imported inputs.

What is the difference between headline and underlying inflation?

Headline inflation includes all items in the CPI, including volatile items such as fuel, fruit and vegetables. Underlying inflation removes or adjusts for volatile items, giving a clearer measure of the ongoing inflation trend; the RBA focuses more on underlying inflation when setting monetary policy.

What are the main types of unemployment?

Cyclical unemployment is caused by low aggregate demand during a downturn;

structural unemployment occurs when workers’ skills do not match available jobs;

frictional unemployment is short-term unemployment while people move between jobs;

seasonal unemployment follows seasonal work patterns. Other forms include hidden unemployment, long-term unemployment and underemployment

What is NAIRU?

NAIRU means the non-accelerating inflation rate of unemployment. It is the lowest unemployment rate that can be sustained without causing inflation to accelerate; trying to push unemployment below NAIRU may create demand-pull inflation.

What is the multiplier effect?

The multiplier effect occurs when an initial increase in spending creates a larger total increase in GDP. For example, government spending on infrastructure pays workers, who spend part of their income elsewhere, creating further income and spending throughout the economy.

What is fiscal policy and how does it affect AD?

Fiscal policy is the use of government spending and taxation to influence aggregate demand.

Expansionary Fiscal Policy

The government increases spending, cuts taxes, or raises transfer payments. This creates a budget deficit to boost demand, create jobs, and stimulate growth during recessions

Contractionary Fiscal Policy

The government reduces spending or raises taxes. This creates a budget surplus to slow down rapid economic growth and cool down high inflation

Neutral Fiscal Policy

Government spending is fully funded by tax revenue. This approach is used when the economy is stable and in equilibrium, meaning the policy has a neutral effect on overall activity

What is the difference between automatic stabilisers and discretionary fiscal policy?

Automatic stabilisers work without a new government decision, such as progressive income tax and welfare payments: tax revenue falls and welfare spending rises in a downturn, supporting AD. Discretionary policy requires a deliberate government decision, such as announcing new infrastructure spending or changing income-tax rates.

What is monetary policy and how does it work?

Monetary policy is the Reserve Bank of Australia’s use of the cash rate to influence economic activity and inflation. When the RBA lowers the cash rate, borrowing becomes cheaper, saving becomes less attractive, spending and investment tend to rise, and AD increases; raising the cash rate works in the opposite direction.

What are supply-side

Supply-side policies aim to increase the economy’s productive capacity by improving productivity, efficiency and competitiveness.

What is economic growth?

An increase in the production of goods and services in an economy over a specific period, usually measured by the increase in real GDP.

What are the main drivers of economic growth?

A larger or more skilled labour force, increased capital investment, and technological improvements that make production more efficient.

How is economic growth measured?

Using real GDP growth and real GDP per capita. Real GDP removes inflation, so it shows changes in actual production rather than price changes.

What is full employment?

A situation where everyone willing and able to work can find a job. It does not mean 0% unemployment.

What is the difference between nominal and real GDP?

Nominal GDP is measured at current prices and includes inflation; real GDP is adjusted for inflation and shows the true change in output.

What is real GDP per capita?

Real GDP divided by population. It shows average output or income per person and is often used to compare living standards

Why is full employment not zero unemployment?

Frictional and structural unemployment still exist. Full employment means there is no cyclical unemployment caused by weak aggregate demand.

What is frictional unemployment?

Short-term unemployment that occurs when workers are between jobs, entering the workforce, or searching for a new position.

What is structural unemployment?

Long-term unemployment caused by a mismatch between workers’ skills or location and the jobs available, often due to technological or industry change.

What is price stability?

A low and stable rate of inflation, generally within the RBA’s 2–3% target band, so households and businesses can plan with confidence.

Why is low and stable inflation beneficial?

It reduces uncertainty, supports long-term investment and borrowing, protects low-income households from sudden price rises, and supports steady growth.

What is external stability?

Australia’s ability to meet its international financial obligations and maintain sustainable economic relationships with the rest of the world.

What is equity in income distribution?

The fairness of how income, wealth and resources are distributed across individuals and groups in society.

What does improving living standards mean?

Raising well-being and quality of life through higher real incomes, productivity growth, employment, affordable essentials and better access to services.

Why do economic objectives conflict?

Policies that improve one objective can worsen another. For example, expansionary policy may reduce unemployment but increase inflation and worsen the budget balance

What is the trade-off between low unemployment and low inflation?

Reducing unemployment usually requires higher aggregate demand, which can create demand-pull inflation if the economy is near productive capacity.

How are economic indicators used?

They measure economic performance and are compared with government targets to assess whether objectives such as growth, employment and price stability are being achieved

What is fiscal policy?

• The use of government spending and taxation to influence aggregate demand, economic activity, employment and inflation.

What is government expenditure?

• Total public-sector spending on goods, services, infrastructure and social protection, including transfer payments.

What are transfer payments?

One-way government payments, such as unemployment benefits or pensions, where no good or service is provided in return

What is a budget deficit, surplus and balanced budget?

• A deficit occurs when spending exceeds revenue; a surplus occurs when revenue exceeds spending; a balanced budget occurs when revenue equals or exceeds spending.

What is expansionary fiscal policy?

Increasing government spending or cutting taxes to raise aggregate demand, stimulate growth and reduce unemployment.

What is contractionary fiscal policy?

Reducing government spending or increasing taxes to lower aggregate demand and reduce inflationary pressure.

How does a tax cut affect aggregate demand?

A tax cut increases disposable income, which increases consumption. Since consumption is part of AD, aggregate demand rises.

What are automatic stabilisers?

• Built-in features of the budget that automatically smooth the business cycle, such as higher welfare payments and lower tax revenue during a downturn.

What is discretionary fiscal policy?

Deliberate government changes to spending or taxation through new policy or legislation to influence the economy.

What is investment in AD?

Spending by firms on productive capital such as machinery, factories, tools and inventories used to produce future goods and services.

What happens to real GDP and employment when AD increases?

In the short run, firms increase production, real GDP rises, employment rises and cyclical unemployment falls. However, inflationary pressure may increase.

What is aggregate supply?

The total quantity of goods and services that all firms in an economy plan to produce and sell at a given price level over a period.

What factors increase long-run aggregate supply?

Higher productivity, improved labour skills, better infrastructure, technology, more capital and lower production costs.

What is microeconomic reform?

Government policy that deregulates or restructures industries and markets to increase competition, efficiency, productivity and international competitiveness.

How does microeconomic reform affect AS and growth?

Successful reform increases productive capacity, shifting AS right. This raises potential output and supports long-run economic growth.

What is inflation?

• A sustained increase in the general price level of goods and services over time, which reduces the purchasing power of money.

What is the difference between demand-pull and cost-push inflation?

• Demand-pull inflation occurs when AD grows faster than productive capacity; cost-push inflation occurs when production costs rise and shift AS left.

What is the RBA’s cash rate?

The interest rate target for overnight loans between banks. The RBA changes it to influence borrowing, saving, spending, investment, AD and inflation.

What is the monetary policy transmission mechanism?

Cash rate change → market interest rates → borrowing/saving behaviour → consumption and investment → AD → economic activity → inflation and employment.

What is unemployment and how is the rate calculated?

• Unemployment occurs when a person is willing and able to work but cannot find paid work. The unemployment rate is unemployed people as a percentage of the labour force

How does an appreciation of the Australian dollar affect trade and AD?

Exports become more expensive and imports cheaper, so net exports fall. This reduces AD, slowing growth and employment, but helps reduce imported inflation.

What is the balance of payments and current account?

The balance of payments records all transactions between Australian residents and the rest of the world. The current account records trade in goods and services, primary income and secondary income flows.