Economics UNIT 3 AOS 2

Material Living Standards

Affected by one’s income/wealth regarding the ability to consume finished goods and services (e.g. purchasing power)

• Tangible + Represented through quantitative data

Non-material Living Standards

Factors that influence one quality of life (E.g. crime rates)

• Non-tangible + Represented through qualitative data

How to measure changes to material living standards overtime

• Inflation: When prices rise quickly, people cannot afford to consume as many goods/services (reducing purchasing power)

• Unemployment rates: People without jobs have lower incomes and less purchasing power which lowers their access to goods and services

GDP

Total volume of finished goods and services produced by a country at a given time

Real GDP

Total value/volume of finished goods and services produced by a country at a given time adjusted to current inflation

Does not account for…

• Population size 

• Income inequality 

• Non-material living standards 

• Black market 

• Non-marketable goods (E.g. Mum cooking meal)

+ Measured by including imputed value

Real GDP per capita

Total value/volume of finished goods and services produced by a country at a given time adjusted to current inflation and divided by the population of the nation

• Does not take into account income inequality (some may produce more than others)

• Shows the average

Conflicting relationship between material and non-material living standards

• Increases in GDP might be due to increased work hours, reducing leisure time 

• Increases in GDP would require more uses of land resources causing exploitation/degradation

Compatible relationship between material and non-material living standards

• Increases with GDP is associated with more international travel, allowing for more multicultural enrichment 

• Longer life expectancy

Five Sector Circular Flow Model of Income

AD = C + I + G1+ G2 + (X - M)

C = Flows of private consumption (E.g. Buying a car)

I = Investment Spending (E.g. Stocks)

G1 = Government consumption/current

G2 = Government investment/capital

X = Exports (E.g Iron Ore)

M = Importing spending (E.g. German cars)

Referring to the circular flow model, explain the effect on economic activity of a rise in the level of interest rates

Will see the reward for saving increase, which is a leakage from the circular flow income model. As leakages rise, injections decrease, cerberus paribus, this will see spending on Australian made goods and services fall, which will see businesses respond by cutting back production of goods and services. Fewer resources will be demanded by businesses, increasing unemployment, also seeing income fall. As businesses see less demand for products, prices may also fall to encourage sales.

Referring to the circular flow model, explain the effect on economic activity of an increase in the budget deficit compared to last year

Means that the injection in the form of government spending is rising relative to the level of taxation which, cerberus paribus, will [IMPACT ON FLOW 3] increase spending on Australian made goods and services. Businesses will require more resources, seeing the rate of unemployment fall, which subsequently sees income paid rise. High spending might see shortages develop which might encourage businesses to increase prices, raising inflation. 

Business Cycle

Economic activity over-time, as caused by changes in spending on Australian made goods and services comprised of a number of phases including a contraction which is characterised by falling rates of economic growth, falling inflation and rising unemployment

Why does it fluctuate?

• Changes in economic growth 

• Changes in inflation 

• Changes in unemployment

Macroeconomic characteristics of a peak

• Economic growth is at its highest 

• Inflation is at its highest 

• Unemployment is at its lowest

Macroeconomic characteristics of a trough

• Economic growth is at its lowest

• Inflation is at its lowest

• Unemployment is at its highest

Macroeconomic characteristics of a expansion/recovery

• Economic growth is rising

• Inflation is at its rising 

• Unemployment is falling

Macroeconomic characteristics of a contraction/downturn

• Economic growth is falling 

• Inflation is at its falling 

• Unemployment is rising

Macroeconomic characteristics of stagflation

• Slow/Negative economic growth 

• High unemployment 

• High inflation

When does a trough become a recession?

Negative economic growth for 2 consecutive quarters or more

Macroeconomic characteristics of domestic economic stability

• Sustainable economic growth

• Full employment

• Low and stable inflation

Explain the effect of a business cycle expansion on the rate of economic growth and on the rate of inflation. (4 marks)

• The business cycle refers to fluctuations in economic activity over-time 

• A rise in injections relative to leakages in the 5 sector circular flow model of income will see increased spending on Australian made goods and services and therefore an expansion in economic activity 

• This is characterised by increase in the total volume of finished goods and services produced, increased economic growth, as businesses respond to rising sales and attempt to clear the shortage 

• In addition, the rate of change in the general price of goods and services, the inflation rate, will increase as businesses attempt to meet demand and must increase price to clear the shortage

Aggregate demand

Total spending on Australian made goods and services over a given time period

AD = C + I + G1+ G2 + (X - M)

Private consumption (C)

Includes household expenditure designed to help satisfy our immediate needs and wants for goods and services (Represents almost 60% of AD)

Private investment (I)

Involves capital spending by firms on products used to make other goods and services, often designed to grow businesses (Represents less than 22% of AD)

Government Consumption/Current (G1)

Public expenditure on the goods and services to help satisfy the community’s immediate needs and wants (Represents around 17% of AD)

Government Investment/Capital (G2)

Includes government capital/investment expenditure on equipment needed for the provision of public social and economic infrastructure (Represents around 3% of AD)

Net Exports (X-M)

Balance/Difference between foreign spending on Australia’s goods and services minus our spending on imports of goods and services (Represents around 8%-24% of AD)

Aggregate demand side conditions

Disposable Income

Changes the level of household consumption (C) after direct tax

Interest rates

Changes the level of consumption (C) in credit sensitive goods and services and investment spending (I) on the purchase of new equipment and expansion of businesses

Appreciation/Depreciation of AUD

Changes exports (X) and imports (M)

Stronger/Weaker aggregate demand side conditions

Stronger aggregate demand side conditions

Increase in inflation (Shortages of goods and services) Increase economic growth (GDP growth increases as production increases) Decrease in unemployment (Increasing production requires more labour resource)

Weaker aggregate demand side conditions

Decrease in inflation (Surplus of goods and services) Decrease in economic growth (GDP growth decreases as production decreases) Increase unemployment (Decreasing production requires less labour resource)

Aggregate Supply

Total level of production of goods and services by Australian businesses, and reflects the nation’s productive capacity and the willingness and ability of Australian businesses to produce

Productive capacity

The physical limits on the value of the nation’s output of goods and services. Its level reflects the quantity and the quality of resources available

Stronger/Weaker aggregate supply side conditions

Stronger aggregate supply side conditions

Increases the production of goods and services as productive capacity increases  As businesses see higher profit margins, they are able to profitability lower prices, decreasing inflation  Unemployment would decrease as structural unemployment decreases and the cost of production decreases providing better international competitiveness  Economic growth would increase as the volume of goods and services produced increases as there is more businesses able to produce them due to less closures and more openings

Weaker aggregate supply side conditions

Decreases the production of goods and services as productive capacity decreases  As businesses see lower profit margins, they are unable to profitability lower prices,  inflation increasing Unemployment would increase as structural unemployment increases and the cost of production increases providing worse international competitiveness  Economic growth would decrease as the volume of goods and services produced decreases as there is less businesses able to produce them due to more closures and less openings

Aggregate Supply Curve

Aggregate supply side conditions

Cost of production

The cost of resources used to produce goods/services, affecting the per unit production cost

Productivity

Level of outputs per unit of inputs

Technological changes

AI or machinery replacing expensive and injury prone labour resources

Appreciation/Depreciation of AUD

Changes within the price of domestic currency (AUD) relative to other currencies, changing the cost of capital goods resources/equipment overseas

Refer to…

Affecting profitability + closures and openings + ability to produce goods/services + productive capacity

Economic growth

An increase in the volume of goods and services produced in an economy overtime

Goal of strong and sustainable economic growth

The fastest rate of economic growth, measured by changes in real GDP, that is consistent with both the government’s other economic and environmental goals

Percentage range of growth considered sustainable/improve living standards

• Sustainable changes

• Around 3% to improve living standards = Strong rate high enough to improve living standards overtime, while sustainable as it would not result in inflationary pressures nor degrade the environment

• Where economic growth is not too high preventing both the increase in demand and cost inflationary pressures 

Nominal GDP growth

The total volume of finished goods and services produced by Australian businesses as measured by current prices

• Not adjusted to inflation

• Does not reflect goods and services produced and living standards due to inflation being included

Chain volume GDP/Real GDP

The volume of goods and services produced by Australian businesses measured at a constant price

• Adjusted to inflation

• Does reflect goods and services produced and living standards due to inflation not being included

Calculating GDP (Real GDP/Chain Volume GDP

Change/Original x 100 = Growth (%)

Real GDP2 - Real GDP1/Real GDP1 x 100 = Real Growth Rate (%)

Quarterly GDP Figure

Adding up the total value of finished goods and services produced in an economy over a three month period (quarter)

Annualised Growth Figure

Multiplying the specific quarterly growth GDP by 4

Short term causes

The level of spending on Australia made goods and services influenced by aggregate demand factors

Long term causes

The level of production of finished goods and services influenced by productive capacity and aggregate supply

Consequences of economic growth being too high

Inflation: Relationship is direct to inflation if it is caused by increased spending and there is no spare capacity as businesses are unable to increase production to meet increased demand, increasing prices to clear shortages (demand inflation) Relationship is indirect if favourable aggregate supply conditions increase productive capacity  Material Living Standards: Reduces purchasing power, reducing access to goods and services  Non-material Living Standards: Increased stress and less leisure time as people must work more to pay bills and mortgages

External Pressures:  Productive capacity is being reached, increasing inflation  Domestic prices rise, imported goods become relatively cheaper, making them more attractive to consumers Australian exports become more expensive in global markets, reducing international competitiveness  Increase in imports relative to exports would cause the trade balance to decrease (trade deficit) AUD depreciates as supply for AUD would increase relative to other currencies, reducing purchasing power  Cheaper for other countries to purchase Australian made goods and services, increasing exports  Exports increasing relative to imports would cause the country to reach productive capacity, increasing inflation High inflation (Increase economic growth) → Export/Imports → Trade balance → Depreciation → Exports → Inflation

Environmental Degradation:  Relationship is direct to economic growth   Natural/Land resources are used in the production of goods and services, and when economic growth is too high, this can cause the overuse of natural resources  Increases market failure including negative externalities and the overexploitation of common access resources  Material Living Standards: Reducing common access resources would cause individuals to have less access to those goods and services  Non-material Living Standards: Environmental quality falls from increase greenhouse gas emissions

Consequences of economic growth being too low

Unemployment:

• Caused by LOW economic growth (contractions/trough) - weak spending on Australian made goods and services 

• Material Living Standards: Those without jobs would receive welfare payments which are less than minimum wage, reducing their access to goods and services

• Non-material Living Standards: Reduces their self-esteem as they lose their purpose and worth and they lose social connections from their job

Describe the trend shown in the above graph (2 marks)

1. Identify the trend 

2. Provide data in the graph (Date + Figure) to support the trend

Explain how productivity growth may affect the achievement of the Australian Government’s domestic macroeconomic goal of strong and sustainable economic growth and living standards. (6 marks)

1. Define goal 

2. Factor provided: Productivity 

3. Living standards (Material/Non-material)

   The goal of strong and sustainable economic growth refers to the fastest rate of economic growth, as measured by changes in real GDP, that is consistent with the government's other economic and environmental goals. 

   Productivity growth refers to an increase in the ratio of outputs per unit of inputs, and will see businesses increase their profitability, all else being equal. This will see businesses become more profitable as per unit production costs fall, with more new business openings and fewer closures, increasing the willingness and ability of businesses to produce goods and services, as well as productive capacity. Australian businesses will therefore be able to increase their production of goods and services, resulting in stronger economic growth, while that growth might be more sustainable as businesses might be able to reduce selling prices while maintaining profit margins, seeing a faster potential rate of economic growth before inflationary pressures are met.  

   As lower selling prices allow consumers to access more goods and services with a given income, purchasing power will rise, increasing material living standards. At the same time, more profitable businesses with lower costs of production will mean structural unemployment falls, seeing newly employed workers having better social connections and a sense of worth, improving non-material living standards.

   
   

Describe how the change in the unemployment rate since January 2023 may have affected the achievement of the goal of strong and sustainable economic growth (5 marks)

1. Define Goal 

2. AS/AD Factor 

3. Stronger or Weaker Economic Growth 

4. Sustainability 

5. Data

   Aggregate Demand response (option 1)  

   DEFINE GOAL: 

   Strong and sustainable economic growth is the fastest rate of economic growth, measured by changes in real GDP, consistent with the government's economic and environmental goals.   

   AD EFFECT: 

   An increase in the unemployment rate from 3.6% in January 2023 to 4% in January 2025 will see disposable income, gross income less income tax, fall as fewer people are working and more rely on welfare payments. This will decrease private consumption spending and spending on Australian made goods and services.  

   IMPACT ON STRONG GROWTH: 

   As businesses observe unplanned increases in inventory, they may decrease the production of goods and services which might decrease the growth in real GDP below the December 2024 year ended figure of 1.3%, meaning growth is weaker.  

   IMPACT ON SUSTAINABLE GROWTH: 

   However on the other hand, if businesses observe significant falls in sales, surpluses of inventory might cause them to offer sales or at least not increase prices, possibly resulting in disinflation. As the December 2024 year ended inflation figure was 2.4%, this fall in prices might be sustainable, however if it falls below the 2% lower bound it could reflect overly weak economic growth.  

   Aggregate Supply response (option 2)  

   DEFINE GOAL: 

   Strong and sustainable economic growth is the fastest rate of economic growth, measured by changes in real GDP, consistent with the government's economic and environmental goals.  

   AS EFFECT: 

   An increase in the unemployment rate from 3.6% in January 2023 to 4% in January 2025 may see wage costs fall as surplus labour resources may see wages bid down, decreasing costs of production. This in turn may see Australian businesses more profitable, seeing more openings and fewer closures and increasing willingness and ability to produce goods and services.  

   IMPACT ON STRONG GROWTH: 

   As productive capacity rises, this might increase the rate of Real GDP growth above the December 2024 year ended figure of 1.3%, meaning non-inflationary growth is stronger.  IMPACT ON SUSTAINABLE GROWTH:

   As businesses are able to more profitably produce goods and services they may also be able to reduce their selling prices while maintaining profit margins, possibly resulting in disinflation below the. December 2024 year ended inflation figure of 2.4%, meaning this growth is more sustainable.

   
   

Employed

Those who are aged 15 and over and works at least one hour per week where they have worked that week or on sick leave/holiday/strike

Unemployed

Those who are aged 15 and over, actively looking for work and unable to find it, while they are able and willing to work in the week of the survey

Goal of full employment

Lowest rate of unemployment consistently with low inflation and other economic goals and there is no cyclical unemployment caused by weak aggregate demand conditions at the non-accelerating inflation rate of unemployment (NAIRU)

Hidden unemployment

Those people who would otherwise like to work, however have stopped looking for employment (Includes discourage people due to repeated failures to find work)

• E.g. Those with criminal records/severe mental health issues

Frictional unemployment

Type of natural unemployment and refers to these individuals who have finished one job and are unemployed before they start a new job

Disguised/Underemployment

Those who are working at least one hour per week and are therefore classified as employed, however they would like to work more hours than they currently are

Relationship between the business cycle and the incidence of under-employment

High levels of economic activity → Derived demand for labor to use → Giving current under-employed individuals more hours of work → Reducing under-employment. 

As economic activity decreases → Derived demand for labour to fall → Providing current employed workers with less work hours then they would like → increasing under-employment.

Labour force

Those who are aged 15 or over and willing and able to work

Labour force participation rate

The proportion of those aged 15 or over and who are in the labour force

Unemployment rate calculated

Underutilisation rate calculated

Cyclical unemployment

Unemployment caused by weak aggregate demand side conditions

Natural unemployment

Occurs independently of the business cycle, some may always occur, and in that sense is not able to be ‘fixed’

• Structural

• Frictional 

• Seasonal 

• Hardcore

Structural unemployment

Unemployment caused by changing aggregate supply side conditions that alter the way goods and services are produced, as well as the types of goods and services produced

Caused by…

• New technology: 

Changes the way in which goods and services are produced, including labour saving devices

• Mismatch between skills of the unemployed:

Existing workforce has skills that are redundant 

• Outsourcing: 

When businesses transfer some business functions overseas due to high costs in Australia

• Business restructuring

Frictional unemployment

Individuals who have finished one job and are unemployed before they start a new job

• E.g. Construction workers, where after finishing a project they must wait and find a new project to be employed and start

Seasonal unemployment

Loss of a job that occurs at the same time each year due to recurring seasonal factors

• E.g. fruit pickers when the fruit is not in season

Hardcore unemployment

Those who might not have the work ethic to hold down a job, or might otherwise be seen as too difficult to employ due to criminal records or disability

Discuss the effect of a business cycle expansion on the rate of unemployment (4 marks)

1. Define key terms 

2. One perspective (2 Marks)

3. Another perspective (2 Marks)

   ON THE ONE HAND

   The business cycle refers to the fluctuation in economic activity over time, where an expansion in the business cycle may be caused by an increase in injections relative to leakages in the circular flow of income model which will see increased spending on Australian made goods and services. As businesses observe higher sales they may increase the production of goods and services, increasing the derived demand for labour, decreasing the rate of cyclical unemployment as more people over 15 years of age who are willing and able to work are employed.  

   ON THE OTHER HAND

   However if the underemployment rate is high, meaning there is a large proportion of the labour force working but wanting more hours, businesses might increase production of goods and services by offering their existing workers more hours, rather than hiring new workers from the pool of unemployed. This would see the rate of underemployment fall, but not necessarily see the rate of unemployment fall.  

   ALTERNATIVE ON THE OTHER HAND  

   However if the rate of unemployment is already very low, meaning there is little to no spare capacity in the labour force, businesses might not be able to increase production as unemployed workers are not available to hire in the short term. This might only result in price increases as businesses clear shortages by increasing prices rather than increasing production. This will see the unemployment rate remain the same.

Consequences if unemployment is too high

GDP Growth: Inverse relationship  Unemployment rate is too high → Underutilised labour resources + Australia is not operating at its productive capacity  = Decreasing GDP growth  Opposite occurs for low unemployment

Tax Revenue:  Inverse relationship  Unemployment rate is too high → Fewer people are paying income taxes + Less spending on goods and services (Less GST collections) = Loss of tax revenue  Material living standards - Less public goods and merit goods  Non-material living standards - Life expectancy falls due to less access to healthcare

Inflation:  Demand inflation: Unemployment is low → Household income rises + Higher spending on Australian goods and services → Demand exceeds productive capacity → Shortages occur, causing businesses to raise prices (Affected by AD) Cost inflation: When unemployment is too low → Businesses have greater cost of production as wages increase to attract/retain employees → Businesses must raise prices to maintain profit (Affected by AS)

Inflation

The situation where the prices of most goods and services are rising overtime

• Purchasing power falls 

• Material living standards fall if income does not increase more than inflation rate

Purchasing power

The amount of goods and services that a unit of currency can but at a given time

Goal of low and stable inflation (Price stability)

When the rate of inflation, as measured by changes in the Consumer Price Index (CPI) is between 2 to 3 per cent per annum, on average, overtime

• Target is not 0% as there would be slow/low economic growth and high cyclical unemployment 

• Target is not greater than 3% as prices are too high

• Improves/Maintains material living standards as people are able to afford the same quantity of goods and services 

• Improves non-material living standards as there is less financial stress and increased confidence in the economy

Disinflation

The situation where the rate of inflation is positive, but is slowing, where the prices of most goods and services are rising, but at a slower rate than the prior period

Deflation

The situation where the prices of most goods and services are falling overtime and the rate of inflation is negative

Consumer Price Index (CPI)

Quarterly measure of inflation that takes into account the retail price of around 100,000 local foreign made goods and services that represent a high proportion of the expenditure of metropolitan households living in capital cities

• Measured by ABS (Australian Bureau of Statistics) 

• Uses the Australian capital cities prices 

• Items are weighted according to relative importance to household expenditure, where frequently purchased or more expensive items are weighted more than those that are not

Regimen used to calculate CPI

100,000 items of (foreign/domestic produced goods/services) which is regularly update

How to calculate inflation rate from CPI

Annualised = x4 to quarterly inflation rate

Underlying rate of inflation

The general increase in the price of goods and services that removes the effects of volatile or one off events

• More reflective and persistent/generalised source of inflationary pressures in the economy 

• RBA uses it to set interest rate policies

Headline rate of inflation

Overall rate of inflation in an economy, including all goods and services, as measured by CPI

Limitations of CPI

• Weighting of items would be different for different demographics, thus may be inaccurate in some circumstances

• Prices of items in locations that are not located in capital cities may differ, thus the regimen does not help reflect inflation in other geographic locations

Cost Inflation

• Occurs as a result of changes in the costs of production faced by firms 

• In response to changing costs of production, businesses will increase/decrease their selling prices in order to maintain profit margins

Demand Inflation

• Occurs as a result of spending on Australian made goods and services (AD) exceeding the capacity of the nation’s businesses to lift output in response 

• As the nation’s businesses reach the limits of their spare capacity, they are unable to resolve shortages by increasing production, thus must increase prices

Consequences of inflation being too high

Erode purchasing power for people on fixed incomes/allowances (unemployment benefits):  Nominal income remains the same, while cost of living increases → Real income decreases  These people afford/access less goods and services, decreasing purchasing power

Erode purchasing power for workers:  Nominal wages stay the same or grow more slowly than inflation → Real wage decreases  Workers afford/access less goods and services, decreasing purchasing power

Wage-price spiral:  The positive feedback loop between wages paid to workers, and the general price level In times, of high inflation, workers tend to demand larger pay increases to compensate for their diminished purchasing power  Increasing cost inflation via higher costs of production as wages are higher, exacerbating the already high inflation rate

Interest rates:  Direct relationship    RBA changes interest rates to change aggregate demand (spending on Australian made goods and services) to combat high/low inflation

Spending decisions by consumers:  Purchasing power reduced → Consumers priorities spending on more important goods/services rather than non-essential/luxury items Economic uncertainty, which can reduce consumer confidence, causing people to delay major purchases or increase savings

Spending decisions by businesses:  Harder for businesses to predict future costs and demand → Reduce business confidence → Delays in investments Cost of raw materials/wages and other production costs increase → Profit margins shrink → Discouraging expansion or starting new projects Weaker spending on goods/services produced → Discouraging investment and hiring

Distort price signals:  Makes it hard to tell if price changes reflect real shifts in supply and demand or it is caused by inflation Consumers may be confused and make irrational spending decisions  Businesses may misallocate resources or make inefficient production choices

Incentive to save:  Reduces the incentive to save  Erodes purchasing power, making savings less overtime  Inflation exceeds nominal interest → Real interest rates become negative  Consumers may choose to spend rather than save, as the value of savings will be lower in the future  Leading to reduced savings  Less likely to save for future needs, causing lower living standards as they would struggle to keep up with rising prices

Investments encouraged during this period:  Real assets (properties/stock/commodities such as gold) as they are not affected by inflation, which would preserve or increase the real value of investments  Whereas cash savings would erode

Return on investment spending undertaken by businesses:  Increases production costs → Reducing profitability + Increases uncertainty about future prices and demand, making it difficult to predict real returns on investments Inflation exceeds nominal returns → Real return on investment will decrease and might become negative  Higher interest rates set by the RBA to control inflation would make borrowing more expensive, reducing the incentive to invest

Consequences of inflation rate being too low

Relationship between rate of inflation and rate of unemployment and economic growth: Inverse relationship between unemployment and economic growth  Low inflation → Higher unemployment and weaker economic growth  Low inflation = Slow economy (decreased spending on Australian made goods and services) → Reduce businesses producing  Cyclical unemployment rises as the economy operates below productive capacity, requiring less labour resources

Living standards:  Material living standards: Improves as purchasing power is maintained, allowing consumers to afford the same amount of goods and services  Non-material living standards: Improves as there is less financial stress

Consumption spending: Direct relationship  Low inflation would cause consumption spending to decrease Caused by delayed consumption: During times of low inflation (or deflation) as households and businesses form the expectation that prices might drop in the future, and they would be better off purchasing items at a later date when they are cheaper Rising unemployment and lower consumer confidence could decrease spending on Australian made goods and services  Material living standards: Worsens, as access to goods and services decrease as lower demand leads to stronger economic growth and increase unemployment  Non-material living standards: Worsens as financial stress and job insecurity increases, affecting overall, wellbeing and mental health