Economics 3/4 Preparation

Economic Resources

Natural, Capital, Labour and Entrepreneurial resources

Opportunity Cost

Refers to the best alternative that could be produced which is forgone

Allocative Efficiency

A type of efficiency measured by how well resources are being allocated in the economy.

Technical Efficiency

When it is possible to increase outputs without increasing inputs.

Dynamic Efficiency

Refers to how quickly an economy can reallocate resources to achieve allocative efficiency

Inter-Temporal Efficiency

Refers to the right balance between resources used for current and future consumption.

Market Equilibrium

Is the price where the quantity demanded is equal to the quantity supplied.

Characteristics of Competitive Markets

• Large number of buyers and sellers

• Freedom of entry and exit in the market by sellers

• Buyers and sellers possess perfect information about products.

Demand

Demand is the willingness of consumers to purchase a good or service for a price

Income Effect

When a price of a good or service decreases consumers are likely to buy more of the product as it takes up a smaller proportion of their income

Substitution Effect

When a price of a good or service increases, consumers are likely to buy the substitute as its now cheaper compared to the original (and vice versa)

Supply

Is the willingness of suppliers to sell a good or service at a price.

Profit Motive

The motivation of firms to operate in order to maximize their profits

Price Elasticity Of Demand (PED)

Refers to the responsiveness of the total quantity demanded of a product to a change in the price of the product

High Price Elasticity of Demand (PED)

Product with many substitutes such as pens

Low Price Elasticity of Demand (PED)

Necessity such as fuel

Price Elasticity of Supply (PES)

Refers to the responsiveness of the total quantity supplied of a product to a change in the price of that product.

High Price Elasticity of Supply (PES)

Durable goods such as pens

Low Price Elasticity of Supply (PED)

Perishable goods such as fruit

Market Failure

Is when an unregulated market is unable to allocate resources efficiently, or where resources are allocated in such a way that national living standards or welfare is not maximized

Market Failure is likely to occur when:

• The right combination of goods and services aren't produced

• Sustainability may be compromised

Four sources of market failure

• Public goods

• Externalities

• Common Access Resources

• Asymmetric Information

Externalities

Refers to costs or benefits associated with the production or consumption of goods and services that are passed onto 3rd parties.

Common access resource (CAR)

Public goods such as fish in the ocean, air and forests. These goods are not owned by anyone and therefore available to anyone even if they haven’t paid to use them

Asymmetric Information

Where one party has greater information than the other. This distorts the allocation of resources and represents market failure as there will be an under or over allocation of resources.

Public goods

A good or service that are both non-excludable and non-rivalrous in consumption.

A person who does not pay for it cannot be excluded from consuming it and one person’s enjoyment doesn’t lessen another’s.

For example - defense force/police

Private Goods

Refers to goods or services that are opposite in nature to public goods as they are both excludable and rival in consumption

For example - If a person purchases a smoothie, then each mouthful results in less being available for someone else.

Free-rider

Refers to a person who receives benefits from a public good but does not pay for it. Instead, relying on others to pay for it, providing an incentives for suppliers to offer it in the market.

The role of relative prices in markets on the allocation of resources

The forces of demand and supply determine relative prices of goods and services, which then determines the way our productive resources are allocated in our economy.

The role of free and competitive markets in promoting an efficient allocation of resources and improved living standards

How well we use our resources will influence the quality and quantity of goods and services that an economy can produce hence how effectively resources are used to improve living standards. The degree of competition will influence how resources are used.

Government Intervention - Subsidies

Subsidies usually take the form of a direct cash payment from the government. The government provides enough income to the supplier so they can offer the product for free to the public.

Government Intervention - Regulation

Government can also use regulation to alter consumer/producer behavior and hence how resources are allocated.

For example - In relation to common access resources, the government imposes duck hunting regulations in order to protect ducks by imposing duck hunting seasons and catch sizes.

One Example of Unintentional Consequences of Government Intervention. —————

Over Regulation

Can reduce profits and increase losses, resulting in fewer resources being allocated in a way that does not maximize living standards. Reducing productive efficiency.

Positive Externalities in Production

Occurs when a firm produces a good or service that provides benefits to another economic agent not involved in the transaction

For example - An employee receives training from a business leaves the business, joins another firm where the other firm stands to reap the rewards of the investment.

Positive Externalities in Consumption

Occurs when the consumption of a good or service improves the wellbeing of a third party.

For example - An individual’s high education would provide society with the benefits of more educated workers, high production and low crime.

Negative Externalities in Production

Occurs when production activities undertaken by suppliers impose costs on third parties. This might be in the form of reduced living standards

For example - A factory dumps waste materials into a river. Their activities impose a cost on the fish market as the waste kills fish making it unsafe for consumption.

Negative Externalities in Consumption

Occurs when the consumption of goods or services impose external costs on third parties.

For example - Consuming a cigarette in public results in toxins being passed from consumer to third party, thus decreasing living standards.

Material Living Standards

Material Living Standards relate to the physical enjoyment that people derive from the use of goods and services that provided in the economy. For e.g - The car we drive, the food we eat.

Non-material Living Standards

Refers to the range of factors that affect our quality of life. For e.g - Air quality, mental health, exposure to crime

Factors Affecting Living Standards

Environmental quality will impact our immediate enjoyment of life via the ability to enjoy clean waterways, fresh air.High levels of physical and mental health will have the potential to make us more productive, increasing our income earning and therefore access to goods and services

Five-sector Circular Flow Model of Income ——————————

Flow 1

Factors of Production Flow from households to Business Households provide resources to businessBusinesses use these resources to create products

Flow 2

Businesses pay income to those who provide the factors of income The provision of labor ensures households receive wages, salaries, commission and royalties. Provision of land leads to rents being paidProvision of capital the households may receive dividends, interest and profits.

Leakages

Money that is diverted away from consumption

Savings

Redirected through the financial sector of the economy. This is usually held by banks

Taxes

The payment of tax represents a reduction in the capacity of households to purchase goods and services

Imports

The money is leaving the economy through the external sector and boosts economic activity in other nations

Injections

An increase in funds flowing back into the core of the economy.

Investment

Funds which are saved in the financial sector. This allows for loans to be used to finance the purchase of new capital and land

Government

Use of tax revenue to fund government initiatives and transfer payments

Exports

Purchase of goods by a foreign nation/organization/household

Flow 4

Production of goods and services which leads to the creation of GDP

The Business Cycle

Refers to the economic activity in a nation within a period of time

Peak

During a peak, the economy is usually experiencing strong rates of economic growth.

• Consumer and business confidence is high

• Encouraged to spend and save less and willingness to take on new debt

• Leakages will be falling relative to injections

Boom

If a peak is considered to be a boom, then the rate of economic growth generally becomes excessive and unsustainable .

• Inflationary pressures increase in response to AD moving beyond productive capacity

• Businesses will increase prices in response to shortages

• Labour market tightens which results in increase wages result in more inflation

Downturn

Refers to a contraction in economic activity due to

• Excessive rates of inflation and capacity constraints

• Increasing the volume of production becomes increasingly difficult

Trough

A period of very low rates of growth in production or the lowest point in the business cycle. This may or may not turn out to be a recession

• Fewer factors of production,

• High rate of unemployment and

• Leakages will be high relative to injections

Recovery

A return to normal levels of economic activity Consumption, investment and Net Exports will all start to pick up overtime

• Lower inflation

• declining interest rates and

• falling wage pressures result in the eventual rebound on the economy

Strong and Sustainable Economic Growth

Means that the growth rate must be strong enough to create ongoing employment and incomes for Australians while avoiding excessive inflation, that our material living standards increase overtime.

Elements of strong sustainable economic growth

The goal is to achieve the highest rate of growth in real GDP, which is consistent with employment growth, without running into excessive inflationary/environment/external pressures.

Strong and Sustainable economic growth rate

Considered to be within the range of 3-3.5% per annum

Gross Domestic Product (GDP)

Refers to the final market value of all goods and services produced in the Australian economy

How is GDP measured?

Adding the total value from goods and services produced.

Quarterly Growth

Annual Growth

Total Production

Environmental Degradation

If economic growth is too high it runs the risk of environmental degradation to the extent that it contributes to the depletion of natural resources, or damaging the environment

If Economic Growth is Too Low

If Economic Growth is too low relative to productivity growth then it will lead to a reduction in demand for labour, high levels of unemployment

Aggregate Demand

Total Expenditure on Australian made goods and services (AD=C+I+G1+G2+X-M)

Private Consumption Expenditure (C)

Refers to the total value of all expenditures on individual and collective consumption. For e.g - semi-durables such as cars or furniture or services

Private Investment Expenditure

Refers to the purchase of new equipment and plant, buildings and vehicles

G1

Represents the purchase of goods and services consumed during the current budget period. That have no ongoing benefits for the futureFor example, defense equipment such as submarines.

G2

Represents the purchase of capital assets that will have ongoing benefits into the future.For example, defense equipment such as submarines.

X

Refers to spending on exports, by foreign clients

M

Refers to spending on imports for foreign made goods, by Australian clients.

Importance of Aggregate Demand (too narrow)

AD influences the level of economic activity because it provides the incentives for firms to increase production levels, thus generating income growth for the country

Factors that may affect the level of aggregate demand in the Economy -------------

Disposable Income

More Disposable income is likely to result in increase in consumption expenditure, therefore resulting in a rise in AD

Interest Rates

Increase in interest rates is likely to reduce demand for goods and services, decreasing Consumption and Private Investment

Exchange Rate

A higher exchange rate will reduce inflation.

Consumer confidence

Consumer confidence refers to consumer's perception of their economic wellbeing in the future. When consumer confidence is high it provides upward pressure on consumption. (Vice versa)

Economic Growth overseas

Is likely to increase the demand for Aussie exports such as raw materials. This increases demand for X, lifts AD and economic activity.

Aggregate Supply

Refers to the total volume of goods and services that Australian businesses produce over a given period.

Factors that may affect the level of aggregate supply in the Economy --------------

Advances in Technology

Improved internet speeds, smarter robotics or more efficient machinery will result in an increase in the quality of both capital and labor, this increases factors of production.

Exchange rates

A higher exchange rate will reduce inflation

Cost of production

This can include costs such as labor for businesses, for example wages. As well as superannuation.

Climatic Events

Events like droughts, floods or bushfires have an impact on supply and cost of raw materials such as wheat. This increases the costs of production for businesses

Full Employment

Refers to level of unemployment that exists when the government meets its objectives of economic growth.

NAIRU

Non-Accelerating Inflation Rate of Unemployment refers to the attainment of the lowest unemployment rate possible before inflation begins to accelerate. (approx 4.25% U/E)

Employed

Refers to someone:

• Aged over 15 years

• Working a minimum of one hour per week

• Currently working

Unemployed

Refers to some Aged over 15 yearsWithout a job (not working minimum one hour per weekActively looking for work Current rate 3.5%

Hidden Unemployed

Refers to people who are not members of the labor force, and are not actively seeking employment because they're discouraged about their employment prospects.

Long-Term Unemployed

Refers to a person who must be unemployed for a long period of time.

Underemployed

Are those individuals that are classified as employed, but who prefer to work more hours. Usually they're working on a part-time or casual basis.

Frictional Unemployment

Refers to a person who is currently moving from one job to another. For example, during a downturn some people may take some more time to find a new job

Cyclical Unemployment

Occurs when the economy is not operating at its full capacity due to a deficiency of aggregate demand. Usually as a result of fluctuations in the business cycle

Structural Unemployment

Results in a mismatch between skills that unemployed persons have and the skills firms require. The government aims to reduce this by setting measures such as expenditure on education

For example, much of the work in the farming industry is becoming mechanized, meaning fewer farmers are necessary, and many lose work.

Participation Rate

Refers to the percentage of the total working population who are members of the labor force