Economics Units 1&2 Exam Checklist

Economic activity

Any action that involves the production, distribution, and consumption of goods and services.

Economy

Exists wherever production, expenditure and consumption take place

Positive economics

Fact-based economic statements that can be proven to be either true or false using evidence

Normative economics

Economic statements or claims based on opinion or value judgements

Relative scarcity

The core economic problem faced by all economies - that we have unlimited wants and needs but limited resources and means through which to fulfil them

Microeconomics

The study of economic behaviours of individual consumers and businesses. Looks at how decisions are made about resource allocation, pricing and supply & demand

Macroeconomics

The study of the broader economy, including national and global issues like inflation, unemployment, economic growth and government policies

Economics

The study of why and how individuals or groups make decisions about the transactions they will undertake on a daily basis.

3 types of agents in an economy

Consumers - Make decisions about the type and quantity of goods to consume to gain satisfaction from spending

Producers - Make decisions about how best to combine resources to satisfy consumer wants and make the most profit

Income earners - (workers and entrepreneurs) Make decisions about how best to use labour and skills to derive the maximum possible benefit

Resources

Also called factors of production; the things used to produce goods and services

4 types of FOP

Land/natural, labour, capital, entrepreneurship

Land/Natural resources

Resources that occur in nature. Are consumed in their raw form or used to create more elaborate products

Labour

Mental and physical effort by humans in the production process

Capital

Resources made by combining labour and natural resources, usually with the intention of making more goods and services in the future, and they generally increase production efficiency

Entrepreneurship

Skills of individuals who combine resources to produce goods and services. They take financial risks to establish enterprises (businesses) and create wealth for nations. Essentially business owners.

Opportunity cost

Cost of the next best alternative use of money, time, or resources when one choice is made rather than another

Production possibility Curve

An economic tool that represents the production alternatives available to an economy producing only two good or services if all resources are being used efficiently

Locations of a point on the PPC and their meanings

On - Show productive efficiency

Inside - Show inefficient production or underutilised resources

Outside - Cannot be achieved yet, but with increased PRODUCTIVE CAPACITY

What two general factors limit a producer's productive capacity?

1. The amount and quality of resources available to them

2. How efficiently these resources can be employed

Productive capacity

The maximum ability of an economy to produce goods and/or services when producing at maximum efficiency

Assumptions of the PPF

1. Only two goods or services being produced

2. All FOP can be used in production for either resource

3. All resources are fully and efficiently employed

Is the best choice available to an economy (as shown on a PPC) a normative or positive consideration?

Normative, as it is a manner of opinion an which good/service is more valuable

Efficiency

Extent to which effort or resources are well used for their intended task or purpose

Productive/technical efficiency

Situation where a nation's resources are producing the maximum amount possible at the lowest cost and resource use. Best quality, lowest opportunity cost. Includes all points along the PPC

Allocative efficiency

(The most efficient allocation of resources) Situation where all a nation's resources are allocated to produce the best goods and service combination such that national welfare and living standards are maximised (i.e. goods and services are those wanted by society and ones that are in society's best interests). Only one point on PPC.

Market failures

Inherent in unregulated markets, and include:

- under-production of essential goods and services

- over-production of undesirable goods and services

Consumer sovereignty

the power of consumers to decide what gets produced

Market-capitalist economy

Resource allocation based on consumer and producer decisions, and resources are owned by private individuals and firms. Market and money determine everything

Mixed economy

An economy in which private enterprise exists in combination with a considerable amount of government regulation and promotion.

Planned socialist economy

Government is primarily responsible for resource allocation. Based on socialist principals of common good, health and wealth, and equality. Resources owned by government on people's behalf, and no individual can excessively benefit from good and service production

Planned capitalist economy

Governments direct private owners of productive assets to produce certain things. Planned output is often used during wartime. FOP ownership remains with individuals.

Market socialist economy

Government owns most resources (socialism) but markets and business owners determine what is produced (market system). E.g. businesses owned by government but their operations left to independent management who try to maximise profits

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

How to increase productive capacity

- Increased employment

- More capital created

- New technology developed

Material living standards

Measured by real GDP per capita. An increase in GDP/increase in economic activity (economic growth) raises income, employment and ability for expenditure and material prosperity.

Non-material living standards

Factors that influence our well-being beyond our ability to purchase things. Some are non-material benefits of economic growth (e.g. satisfaction from being employed, reduced stress from increased wealth), while some are non-material costs of economic growth (e.g. congestion, pollution, depletion of resources)

Examples of non-material living standards

- Access to healthcare and education

- Job satisfaction levels

- Depletion of resources

- Pollution

- Freedom of expression

- Stress levels

- Equality levels

Trade-off

To gain something of value with our time and money, we forgo the opportunity to do a range of other things with it. Typically between current (short run) and future (long run) consumption.

Micro vs macroeconomic trade-off examples

Micro - Spending vs saving, work vs leisure

Macro - Economic growth vs environment, efficiency vs equity

Cost-benefit analysis

Used to determine the best trade-offs to make to minimise opportunity cost. Benefits and costs are listed in current dollar terms and the projection is viable if the net benefits are positive.

Equation for a cost-benefit ratio

Benefits divided by cost. If >1, indicates benefits outweigh cost, but

What 4 things are needed to achieve technical efficiency?

1. Natural resources converted into goods and services without waste

2. Producers do the best job possible combining resources into goods and services

3. Less waste and input means lower prices, so material living standards improve

4. No workers waiting idly for spare parts

What 3 things are needed to achieve allocative efficiency?

Technical, dynamic and inter-temporal efficiency

Private vs public sector agents

Private - Consumers, households, businesses, charities, trade unions

Public - Governments, gov-owned businesses (e.g. AusPost) and statutory authorities like the RBA and ACCC

Traditional economic viewpoint of consumer behaviour

Economists assume that consumers are rational and will strive to make decisions that yield the greatest net benefits/satisfaction (utility). They also assume that consumers have access to perfect information to guide their rational decisions

Rationality

Acting out of self-interest to maximise one's own utility given one's budget constraints

Utility maximisation

Seeking the maximum satisfaction possible from our economic decisions

Law of diminishing marginal utility

States that for each additional unit of a good or service consumed, less utility (satisfaction) is generated than the last. Means total utility grows less rapidly with each unit consumed, and means consumers will vary their consumption

Incentives

Encourage economic agents to make particular choices, usually by providing benefits or rewards for desired behaviour, while disincentives provide costs of penalties for undesired behaviour.

Subsidies

Cash payments directly to producers or consumers to incentivise certain behaviour

Regulation

Laws limiting producers or consumers who produce negative externalities / limiting people from consuming goods and services that produce negative externalities

Indirect taxes

Taxes imposed by the government on spending. Responsibility for payment lies with the business, who usually increases cost of good or service correspondingly (disincentivising the product)

Direct taxes

Taxes paid directly to the government tax authorities by the taxpayer, including personal income taxes, corporate income taxes, and wealth taxes. E.g. to increase labour productivity government can lower marginal tax rates on people's incomes, incentivising work.

Tax rebates

Decrease the amount that individuals have to pay when they lodge their tax returns, or incentivises businesses to invest in certain things. E.g. tax rebates increased during COVID to stimulate spending and avoid a depressive period.

Traditional economic viewpoint of producer behaviour

Producers aim to maximise profit. They want to adapt to consumer wants and needs and produce goods and services as efficiently as possible.

Recession

Negative GDP increase for 6+ months

Traditional economic viewpoint of government behaviour

Aims to maximise living standards

Business cycle

A feature of market capitalist economies, refers to the cyclical movement of economic activity over time (measured in real GDP).

Phases of the business cycle

Expansions (upswings, upturns)

Peaks (possibly booms)

Contractions (downswings, downturns)

Troughs (possibly recessions)

Aggregate demand

The total demand for final goods and services in an economy at a given time. Changes in aggregate demand are reflected in the business cycle

Aggregate demand policies

Government policies such as budgetary policy and monetary policy that are used to stimulate or restrain aggregate demand to promote the achievement of the government's macroeconomic goals.

Macroeconomic goals pursued by the federal government

1. Strong and stable economic growth (3-3.5% real GDP)

2. Full employment (4.25% unemployment rate)

3. Low and stable inflation (2-3%)

When these are achieved, domestic economic stability is achieved.

Budgetary policies

Involves the Federal Government altering the level and composition of government revenues and expenditure to stimulate or dampen aggregate demand. E.g. increasing taxes to reduce spending in a peak or decreasing taxes and increasing government spending in a trough

Monetary policies

Relates to the RBA altering the cash (interest) rate, and at times resorting to unconventional monetary policy tools to stimulate or restrain aggregate demand.

Restrictive vs Expansionary Macroeconomic Policies

Restrictive are used during peaks to restrain growth, while expansionary are used during troughs to stimulate growth.

Dynamic efficiency

Speed at which resources can be reallocated from one area of production to another. Improved by factor mobility.

Inter-temporal efficiency

When an ideal balance is met between using resources to satisfy needs and wants today, and conserving resources for the future. Mix of investment and consumption.

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

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.

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)

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.

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 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

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

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.

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'

- Injections fall, slowing growth

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

- 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

- Consumption, investment and injections rise, leading to increased production, income and expenditure, as well as increased employment, causing AD to rises

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 an 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

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 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.

Demand

The willingness and ability of buyers or consumers to purchase goods and services

Income effect

Existing consumers increasing the amount or quantity of a product purchased (i.e. increasing demand) when the price falls, as they can now afford to buy more

Substitution effect

Consumers turning away from a rival product and substitute into an existing product that has become 'relatively' cheaper