Economics Chapter 6 - Economic Activity

Living standards

The aggregate welfare of people in a country

Material living standards

Living standards as measured by access to goods and services

Non-material living standards

The aspects of a person's quality of life that cannot be measured by monetary factors.

NMLS examples

- Access to clean air, water and natural resources

- Access to health and education services

- Congestion and pollution

- Depletion of resources

- Job satisfaction

- Equality

Relationship between MLS and economic activity/growth

There is a positive correlation between the two, as when earnings and income increase, so does expenditure and consumption, which leads to additional satisfaction

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 over time

GDP

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

Real GDP

GDP adjusted for inflation. The main statistical measure of production used to measure economic growth.

Nominal GDP

GDP measured in current prices, i.e. the real 'dollar value' of production

Real GDP per capita

Real GDP divided by the total population

Economic Activity

The production, income and expenditure that takes place across an economy

The 5 sector flow model of income

ADD IN

Leakages

Income earned by economic agents that is redirected away from expenditure on Australian production. Includes savings, taxes and imports.

Injections

Spending that is not generated by households and helps to offset leakages. Includes investment demand, government demand and export demand

Savings and investment

Saved money will go to banks, who will lend it to economic agents, who will spend it, sometimes on investment.

The 4 flows of the 5-sectors circular flow model of income

Flow 1: FOP provided to business sector

Flow 2: Income given to households for providing FOP

Flow 3: Aggregate demand

Flow 4: Production of goods and services (real GDP)

5 sectors of the economy

Household, business, financial, government, external

Aggregate Demand

Total expenditure on a country's own goods and services

Aggregate demand equation

AD = C+I+G+X-M

Elements of the aggregate demand equation

Consumption expenditure (Expenditures by households and non-profits)

Private investment expenditure (Purchase of equipment, plants, buildings, vehicles, inventories or stock)

Government expenditure

Net exports (X-M)

Interest Rates

The cost of borrowing money and the rate of return from lending money. Low levels stimulate investment, high stimulate saving.

3 macroeconomic goals pursued by the Federal Government

Strong and stable economic growth of 3-3.5%

Full employment (without jeopardising low and stable inflation) of 4.25% unemployment

Low and stable inflation between 2-3%

Restrictive vs expansive macroeconomic policies

Restrictive:

Budgetary - Increase tax and reduce gov spending

Monetary - Increase interest rates

Expansive:

Budgetary - Reduce tax and increase gov spending

Monetary - Decrease interest rates

International competitiveness

Degree of competition between nations; a rise in Australia's means we are producing at a lower price or higher quality relative to other countries. Factors that decrease international competitiveness restrain AD and real GDP

Aggregate supply

The total volume of goods and services available for sale in an economy at a given time. Represents ability to meet AD

Productive capacity

The potential output of an economy if it produced at maximum efficiency

Productive capacity links to AS and AD

An improvement to an economy's supply potential (e.g. AS) will boost productive capacity and enable economic activity to occur without causing inflation.

Conversely, slower growth in productive capacity weighs directly on growth in wages, incomes, and therefore household spending

Inflation

A general increase in average prices over time

When does inflation occur?

When AS levels are limited due to excessive demand on productive resources, meaning that growth in AD cannot be fully satisfied and inflation will occur (as demand>supply)

Chain volume measure of GDP

An estimate of real GDP in the economy, using prices from the previous period and applying them to current period volumes

Why is strong economic growth pursued by the Australian government?

Because higher values of production, income and expenditure help to raise material living standards

Economic development

Improvements in the economic wellbeing of a nation, including material and non-material factors. Economic growth tends to accelerate economic development.

Costs of excessive, non-sustainable economic growth

- Contribution to the boom-bust cycle being more volatile and extreme

- Contributes to congestion, pollution and resource depletion

- Affluenza

- Widening inequality

Affluenza

The idea that the addictive pursuit of more and more goods and services is damaging to the mental health of the individual, as their wants cannot be satisfied

Limitations of using real GDP to measure material living standards

- Excludes non-marketed products like home-based production, black market goods and charity events

- Doesn't measure change in product quality

- Values are estimates

- Inaccuracies when converting nominal to real GDP

- Doesn't represent purchasing power of incomes

Limitations of using real GDP to measure non-material living standards

- Doesn't distinguish between transactions that improve or detract from our welfare

- Doesn't account for negative externalities and resource depletion

- Doesn't account for leisure time that may be lost from higher GDP

Measuring What Matters Framework

Alternative measure of living standards that identifies wellbeing themes of: health, security, sustainability, cohesion and prosperity

HDI

The Human Development Index is an alternative measure of economic development that looks at living standards/economics, health and longevity and education.

Doughnut economics

Framework that balances economic development within a doughnut, between a social foundation and the planet's ecological ceiling in a safe and just space for humanity

GPI

The Genuine Progress Indicator is an alternative measure of economic development, that takes a well-rounded view on an economy's wellbeing by subtracting environmental and social costs of economic actions from GDP

The business cycle

The movement in economic activity and economic growth over time fluctuates in a wave-like pattern highlighted by periods of relatively high and relatively low economic growth.

Expansions vs contractions

Expansion is a period of increasing economic growth, while contraction is a period of decreasing economic growth

Peaks/Booms

A peak is a period of high economic growth, while a boom is a period of very high rates of growth, that is typically very unsustainable

Troughs/Recessions

A trough is a period of low economic growth, while a recession is defined as two successive quarters of negative economic growth

What happens in an economy during a peak/boom?

- Strong economic growth

- Consumer and business confidence high, reducing savings and increasing consumption

- Labour demand increases (unemployment low)

- Leakages fall, AD very high

IF BOOM:

- Inflationary pressures (especially if producing near PPF) push up interest rates

- Imports increase

What happens in an economy during a contraction/downturn?

- Boom capacity constraints (plus inflation and interest rates) lead to overvalued assets, leading to market 'correction'

- Private consumption and investment fall as more save, AD falls

- Injections fall, slowing growth

- Employment, confidence and inflation fall

What happens in an economy during a trough/recession?

- Fewer FOP needed, so unemployment is high

- Reduced inflation due to spare capacity and supply

- AD low

What happens in an economy during an expansion/upturn?

- Sparked by low inflation, interest rates and labour costs

- Consumptions, investment and net leakages increase (injections rise)

- Growth in production, employment, income and expenditure (AD rises)

Economic shock

Unexpected demand- or supply-side events that impact an economy

Leading indicators

Indicators of economic activity that are forward-looking and provide insight into future trends or changes in economic activity.

Examples:

- Consumer confidence indexes indicate future spending patterns

- Business sentiment indicators indicate spending/hiring intentions

- Volume of planning/building permits

- Job vacancy rates

Coincident indicators

Indicators of economic activity that provide and indication of what is simultaneously occurring in the economy

Examples:

- Sales volumes

- Hours worked

- Business inventory levels

- Payroll figures

- Interest and exchange rates

Lagging indicators

Indicators of economic activity that are backward-looking because of the time lags associated with the occurrence of the event and the collection of data associated with that event.

Examples:

- Actual rate of growth of GDP or GNE

- Employment/unemployment levels

- Inflation rates

- Capacity utilisation

Are statistics like GDP growth, unemployment and inflation rates always lagging indicators?

No, as statistical agencies strive to reduce the time lag between occurrence of the event and the reporting of it, meaning these indicators can in some circumstances be regarded as coincident indicators.

Capacity constraints

Factors that prevent or constrain an economy from producing more goods and services, such as skill shortages or infrastructure bottlenecks. Typically occurs when economy is at productive capacity.

AS factors

- Quantity of factors of production

- Quality of factors of production

- Costs of production

- Technological change

- Productivity growth (^, causes increased supply)

- Exchange rates (AUD ^, import cost lowers, cheaper production)

- Climatic conditions

- Supply shocks

- Gov regulations/aggregate supply policies

Aggregate supply policies

Policies that stimulate AS, including labour market deregulation, promoting stronger competition and lowering tax rates and tariffs (forces firms to use resources more efficiently to keep international competitiveness up), and government infrastructure

AD factors

--> disposable income

--> interest rates

--> consumer confidence

--> business confidence

--> the exchange rate (AUD^, international competitiveness down, lower AD)

--> rates of economic growth overseas (^ increases demand for Aus goods)

2 ways that lower interest rates stimulate AD

- Savings lowers and borrowing increases, increasing AD

- Lower loan costs leads to more income available after paying for essentials (discretionary income), increasing AD

Productivity

The total volume of production compared to the total inputs used to achieve that production level. Describes our efficiency, and most common measure is labour productivity (production/hours worked)

How does a rise in productivity growth affect economic growth?

Average cost of production is reduced, increasing supply incentive and lowering inflation. This encourages greater consumption, and in exports due to higher international competitiveness, increasing AD + economic growth.

How does negative productivity growth affect economic growth?

Causes inflation of unit labour costs (cost of labour per unit of output), and therefore has negative supply side effects on inflation and economic growth.