Topic 3: Economic Issues

Economic Growth

An increase in the volume of goods and services that an economy produces over a given period of time

Economic Growth is measured by the

annaul rate of change in real Gross Domestic Product (GDP)

Change in real Gross Domestic Product (GDP)

Percentage increase in the value of goods and services produced in an economy over a period of time, usually one year, adjusted for the rate of inflation

Nominal GDP

Not adjusted for price changes

Economic Growth formula =

real GDP (current year) - real GDP (previous year)

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real GDP (previous year)

Keynesian economic theory suggests that

people wouldn’t necessarily spend their income just because goods were produced and businesses paid their workers for production. expectations play a role.

Aggregate demand

AD: total level of expenditure in an economy over a given period of time.

AD =

Consumption, investment, government spending and net export spending (X-M)

Aggregate Supply:

Y: the total level of income in an economy over a given period of time. Part of national income is collected through tax, the rest is spent on consumption/saved

Y =

C+S+T

Equlibrium occurs when:

• Y=AD

• Leakages=Injections

• S+T+M=I+G+X

If injections are greater than leakages,

economic growth

Significance of Consumption and saving:

Consumption by households usually forms at least half of expenditure (or aggregate demand) in the economy. Consumption boosts = economic activity

Influence of Income on Consumption?

More income = more consumption (think of M)

APC

Average propensity to consume: the proportion of total income that is spent on consumption

APS

Average propensity to save: the proportion of total income that is not spent, but saved for future consumption

Three factors influencing APC:

1. Consumer expectations → expecting rise in inflation, more spending now.

2. Level of interest rates → high interest rates, discouraging spending

3. Distribution of income → more equitable distribution, more consumption

Significance of investment on economy?

Most volatile component of demand/aggregate expenditure → historically contributing 10-15%

Main factors influencing investment:

Cost of capital equipment:

• Changes in interest rate → fall would make it cheaper to borrow funds for purchase of capital investment

• Change in government policy → government allowed firms in COVID-19 to reduce tax liability and make capital cheaper by allowing deduction of full cost of all asset purchases.

• Change in price/productivity of labour → if cost of labour is increased + tech cheaper

Business Expectations:

• Change in expected demand → expecting future increases, more production to satisfy demand

• Change in global economic outlook → EG expected to increase → entrepreneurs more likely to invest in equipment

• Inflation → reduced investment in productive capital equipment

Significance of government spending on economy:

Federal government spending makes up around 20-25% of aggregate demand and expenditure, tax is about 20-25% of aggregate supply or income

Influences on exports/imports:

• Weaker exchange rate → domestic industries more competitive

  • Strong exchange rate → more imports, reducing domestic aggregate demand

Multiplier Process:

Initial increases in injections (i.e government handout) will have a multiplied effect on national income. Not forever → some component will be saved (a leakage). However, it will stimulate demand and cause more growth.

Multiplier effect

The greater-than-proportional increase in national income resulting from an increase in aggregate demand

Multiplier

The number of times the final increase in national income exceeds the initial increase in expenditure that caused it

MPC + MPS

=1

MPC:

Marginal propensity to consume: The proportion of each extra dollar of income that is spent on consumer products

MPS:

Marginal propensity to save: the proportion of each extra dollar of income that is saved

Size of the multiplier is determined by the MPS and can be calculated as:

k=1/MPS or k=1/1-MPC

Governments use the multiplier process

because an initial increase in government spending can result in a much larger increase in economic activity as money circulates through the circular flow of income

Aggregate supply is determined by

the quality and quantity of the factors of production (CELL).

Increase in aggregate supply=

Increase in EG

Factors increasing aggregate supply:

• Population growth

• Discovery of new resources

• Workers acquiring new skills

• Increased capital

• Adoption of new technology

• Measures to improve efficiency

• Government policies

The effects of economic growth:

• Living standards

• Employment

• Inflation

• External Stability

• Income distribution (may not always benefit everyone)

• Environmental impacts

Eight factors that influences Australia’s business cycle in the recent years:

1. Global economic conditions (demand for X)

2. Terms of trade booms from 1005-2011 and 2017-2022

3. Macroeconomic policy has largely maintained a sustainable rate of economic growth - generates employment growth and maintains external balance without pushing inflation above target range (2-3%)

4. During economic downturns, the RBA acted quickly to reduce interest rates and support aggregate demand. → COVID: reduced the cash rate to 0.10%

5. Fiscal policy used to stabilise growth → handouts from budget

6. Highest sustained population growth.

7. Larger increases in asset prices like real estate and shares since the early 2000s have increased the wealth of households → wealth effect → more spending

8. Slowdown in productivity growth

Pre-emptive monetary policy:

When interest rates are adjusted in anticipation of a change in growth and inflation

The “three p’s” for economic growth →

Productivity, Participation and population

Fiscal policy is

the use of the Commonwealth Government’s Budget to influence the level of aggregate demand and hence EG.

If the government wants to increase the level of EG they can

reduce taxation, increase expenditure or do both (increase level of injections to leakages)

Fiscal policy is more effective in

stimulating growth in a downturn than slowing down an economy (think jobkeeper and jobseeker)

Monetary Policy

influences the level of interest rates, which influences the level of aggregate demand and level of EG

If the RBA wants to stimulate growth

interest rates can be reduced to encourage consumer and business spending

Microeconomic policies aim to

increase the economy’s sustainable growth rate by increasing aggregate supply.

Microeconomic policy reduces

the extent to which higher growth becomes constrained by inflationary and CA problems

Labour market policies encourage

economic growth through increasing AS, but by improving labour productivity

Labour market policies aim to

help workers produce more through higher education attainment and upskilling. i.e nurses.

High levels of unemployment are a problem because:

It leads to less production, slower economic growth, lower taxation revenue and higher social welfare payments

Long term social costs include

Increased inequality, poverty, family problems, crime and social division

Labour Force consists of

All the employed and unemployed persons in the country at any given time.

• Persons aged 15 and over who are currently employed for at least one hour per week of paid work → includes those on paid leave, stood down for less than four weeks, on strike, on workers’ compensation or receiving payment whilst undertaking full time study

• self employed persons working for at least one hour per week in their own/family business

• unemployed persons aged 15 and over, who are available for work and actively seeking work

The persons not included in the labour force are:

• Children under 15 years of age

• full time, non working students 15+

• people who perform full time domestic duties

• unemployed persons who are not willing to actively apply for jobs and attend job interviews or who are not available to start work

• people who have retired from the labour force

The size of the labour force in 2023:

14.5 million

Labour force participation rate refers to

the percentage of the population aged 15 and over in the labour force, either employed or unemployed

People may decide to not participate in the workforce for many reasons including:

1. studying

2. undertaking carer responsibilities

3. volunteering full time

4. other income sources

5. feel they are unlikely to find work

The labour force participation rate can be defined as

the percentage of the working age population - 15 years and over - who are in the labour force, either working/actively seeking work

Labour force participation rate %

labour force

---

working age population (15+)

Unemployment refers to

a situation where individuals want a job but are unable to find a job, and as a result labour resources in an economy are not utilised

Unemployment statistics reflect the number of

people out of work but actively seeking work.

To be classified as actively seeking work, a person must:

• regularly checking advertisements from different sources for available jobs

• willing to respond to job advertisements, apply for jobs with employers and attend interviews

• registering with an employment agency linked to Workforce Australia

How often does the ABS survey the labour force?

Monthly

Unemployment rate %=

number of persons unemployed

---

total labour force

Problems with the method used to measure unemployment:

• Classifying people as either employed/unemployed means official statistics don’t take into account the number of hours people work → some people are UNDEREMPLOYED & if you took one job and divided the hours by three, you would have three jobs

• By classifying people as either in the labour force or not → unemployment statistics don’t include people who haven’t been able to find work/left the labour force → hidden unemployed, “discouraged jobseekers”

Australia’s unemployment trend:

1960s-70s: very low unemployment

Mid 1970s: unemployment began increasing

1990s: level of unemployment peaked → 10.7% recorded in 1992-93 was the highest level since the Great Depression. Main reason: severe Australian recession + global economy. Low demand.

• Was also worsened by structural change and microeconomic reform → lost jobs in declining industries, shift in skill requirement. New technologies and production techniques changed the structure of businesses → unemployment a major structural issue

Gradual downward trend in unemployment 1993-2008

2008: GFC triggered worldwide recession → unemployment only rose by 2%

2010: unemployment was close to 5%

2010s: unemployment stayed mostly in the range of 5-6%.

July 2020: Pandemic + lockdown → highest ever unemployment at 7.4%

2021: employment rate recovered

mid-2023 unemployment at 3.5%.

COVID-19 impact on Employment:

Underemployment reached a record high 13.7% in 2020, before falling back to lower levels (mid-2023 it was 6.4%)

Okun’s Law

Explores the relationshio between unemployment and economic growth → to reduce unemployment, the annual rate of economic growth must exceed the sum of percentage growth in productivity PLUS the increase in the size of the labour force in one year.

Okun’s Law in the short term means

higher rates of productivity growth make it more difficult to reduce the rate of unemployment (ie 1990s saw higher productivity).

conversely, lower productivity growth is a lower rate of unemployment (2000s).

Okun’s law in the long run

→ a higher level of productivity growth should lead to stronger economic growth and more job creation, but in the shorter term more jobs are likely to be created (less productivity, need more people to produce more)

Structural issues with the workforce:

• Aging population → lower fertility rates and longer life expectancy

• Technological change

Structural Unemployment occurs because

of structural changes within the economy caused by technology or the pattern of demand for goods and services. Skills don’t match jobs available. Most of Australia’s long-term unemployed is structurally unemployed

Cyclical Unemployment occurs because

of a downturn in the level of economic activity and falls during times of strong economic growth. Falling demand → fewer opportunities

Frictional Unemployment

Represents the people who are temporarily unemployed as they change jobs - finished one but haven’t started a new one. It’s inevitable but can be fixed if job matching services are more efficient.

Seasonal Unemployment

Occurs at predictable and regular times throughout the year because of the seasonal nature of some kids of work (i.e Santa at shopping centres). ABS publishes seasonally adjusted statistics too

Hidden unemployment

Includes people who can be considered unemployed but don’t fit the ABS definition of unemployment and are not reflected in unemployment statistics.

People who:

• have been discouraged from seeking work and are no longer actively looking for work.

Known as the ‘hidden employed’ because they aren’t seeking a job and aren’t considered unemployed

Underemployment refers to

people who work for less than full time (35 hours a week) but would like to work longer hours.

They aren’t classified as unemployed, but are forming a growing part of the unemployment problem → June 2023: 935,000 Australians were underemployed

Long Term unemployment refers to

the number of long-term unemployed - referring to those who have been out of work for 12 months or longer, usually a result of structural unemployment

Some reasons for long-term unemployment turning into permanent unemployment:

• New arrivals into the unemployment pool are re-absorbed into the workforce especially if they have skills more up to date and attractive for employers

• the long term unemployed usually suffers from structural unemployment and do not possess the skills demanded in the labour market

• they lose their confidence

• they lost contact with the world of paid work → do not learn about the new skills and developments in the labour market

  • potential employers look less favourably upon people who have been out of work for a long time

Hard-core unemployment

People who are out of work for so long employers consider them unemployable because of their personal circumstances:

• mental illness, physical disability, drug abuse and anti-social behaviour.

Often people who are deemed unable to undertake work, even on a part time basis are placed on disability support pension → not counted in unofficial unemployment statistics

NAIRU

Non-accelerating inflation rate of unemployment refers to the level of unemployment at which there is no cyclical unemployment, where the economy is at full employment

The theory behind the NAIRU

is that some level of unemployment is inevitable in the economy, and efforts to reduce unemployment below this “natural” level will be counterproductive

The NAIRU is comprised of

frictional, seasonal, structural and hardcore unemployment

When unemployment is above the NAIRU

spare capacity in labour market → policymakers should stimulate economic growth with the aim of reducing unemployment

when employment is at or below the NAIRU

an increase in economic growth will increase wage pressures because there are insufficient numbers of unemployed people to fill those job vacancies (given they need to have the right skills and available to work)

The concept of NAIRU

suggests policies to encourage economic growth and reduce unemployment will be worthwhile up to a point, but beyond that, these policies will only create inflation

NAIRU may be reduced by

increasing retraining and reskilling programs to aid the structurally unemployed

NAIRU is hard to measure

because it aims to remove cyclical influences → unemployment and inflation are highly influenced by cyclical factors. However, estimates have trended downwards

Why is it suggested NAIRU is lower than previously thought?

• Declining inflationary and wage pressures in the previous years

  • its current best estimate is 4.25%

Causes of Unemployment given by economists

• economic growth too low to generate adequate employment growth

• jobseekers don’t have the right skills to fill job vacancies

  • jobseekers do not have adequate opportunities for education and training

• Structural change is creating a larger pool of workers whose skills are no longer in demand

• Wage rates are too high

• Too many regulations around employment, discouraging employers from hiring new employees

• Some people choose to remain unemployed, because they can recieve welfare instead

• workers in high income economies whose jobs can be performed overseas cannot compete with lower-wage economies

  • not enough is done to support those physically unable to work

Actual causes of unemployment:

• Level of economic growth → the demand for labour is a derived demand → downturn in level of AD may result in lower domestic consumption and investment spending

  • government policies (contractionary monetary/fiscal policy) designed to dampen demand

  • decrease in the demand for Australia’s exports due to a global recession, slower growth in economies of major trading partners

• Stance of macroeconomic policies → expansionary stance aims to increase economic growth and job creation. A contractionary will aim to reduce inflation, even at the cost of lower growth and higher unemployment in the short term

• Constraints on economic growth

  • Unemployment is influenced by the level of sustained economic growth achieved in an economy → significant constraints →struggle to produce enough jobs for an economy

• Rising participation rates

  • An increase in labour force participation rate → increase in unemployment in the short term. This is because more people are looking for more jobs

• Structural Change

  • Process of structural change → short term costs → loss of jobs in less efficient industries & areas undergoing structural change → offshoring

• Technological change

  • Can cause unemployment → AI forecasted to rakw 1.5 million jobs by 2030

• Productivity

  • Higher productivity growth will tend to slow employment growth in the short term because fewer employees are required per unit of output. Long term → more economic growth contributes to higher EG, and vice versa

• Inadequate levels of training & investment: structural unemployment related to mismatch of skills → reliance on skilled migrants

• Increased labour costs → unemployment may rise because of a sustained increase in labour costs (wages).

  • Employers may compete with eachother for limited pool of labour → forcing up labour costs

  • Wage breakouts may cause businesses to substitute labour for capital

  • High minimum wage (Fair Work Commission)

  • Other costs (payroll, super, compo)

Economic costs of unemployment include

• Opportunity cost: economy operating below its PPF

• Lower living standards → lower incomes, lower demand

• Decline in labour market skills for long-term unemployed - hysteresis

• Costs to government: revenue (taxation) and expenditure (welfare) → deteriorate budget

  • Lower wage growth: High unemployment → excess of labour → “downward stickiness” for wages → slower wage growth over time.

Social costs of Unemployment:

• Increased inequality → unemployment often affects lower-income workers like the young and unskilled → poverty trap as they become worse off

  • Other social costs: debt, homelessless, family tension and breakdown, crime, higher suicide risks

Unemployment for particular groups:

• ATSI: 51% unemployed

• Age related unemployment: people aged 15-19 34% unemployed

• Regional areas/specific regions may cause inequality

  • People born outside Australia → stigmas to non-English speakers (qualifications may differ)

Cyclical unemployment is largely countered by

macroeconomic policy.

• these sustain economic growth and minimise sharp downturns in the business cycle

  • expansionary fiscal policy (lower taxes/increased government spending) → stimulates economic activity and can increase output through multiplier effect (injection)

Structural unemployment can be addressed with

microeconomic reform → to increase economic growth and job creation. I.E Tariff reduction, deregulation, national competition policy

An example of a labour market policy in reducing unemployment:

→ Jobs and skills summit: $1 billion to TAFE to reskill

Microeconomic policy can influence unemployment by

• increasing enterprise bargaining (employers more flexibility in determining employment conditions) → increase productivity and give employers greater incentives to hire workers.

• stricter regulations around who can qualify for wellfare payments

Frictional Unemployment can be combatted with

Workforce Australia Online - an employment service platform that focuses on online job searching

Inflation is a sustained

increase in the general level of prices in an economy

The measure of inflation is the

percentage change in the Consumer Price Index (CPI)

The CPI summarises

the movement in the prices of a basket of goods and services, weighted according to their significance for the average Australian household

The annual inflation rate is calculated by

the percentage change in the CPI over the year

Inflation rate percentage formula:

CPI(current year)-CPI(previous year)

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CPI(previous year)

The basket of G&S used to calculate CPI

does not include all G&S, but covers a variety that reflects average household spending patterns