Economics U4 AOS 2

Aggregate supply

• Long/formal def

• Short/useful def

Aggregate supply is the total volume of all goods and services produced and supplied by a nation over a period of time 

• Most useful version: AS is about the ability and willingness of firms to produce goods and services 

• AS policies

• Give brief listing on how these policies increase resources/cheaper resources/make firms more efficient

• AS policies increase ____

• AS policies: government policies designed to increase AS by giving firms more, better or cheaper resources or by making the economy more efficient

• Productive capacity

Note

• Stagflation - what usually causes it?

• Capacity constraints

• Supply shock

Stagflation: a period of high inflation but low or negative growth (and unemployment) 

• Often due to a supply shock --> where increased production costs – increase selling prices (cost inflation) – reduces AD (slow growth) 

• It occurred in the 1970s in Australia and other countries in part as a result of the supply shock caused by increased oil prices 

 

Capacity constraints are factors that restrict an economy from growing 

• e.g. skills shortages in the labour force or infrastructure bottlenecks 

 

A supply shock is a short-term supply shock to the economy or a sector of it that causes a sudden decrease in supply of a resource 

• e.g. sudden increase in the price of oil on world markets or a flood that destroys crops 

Compare AD and AS policies:

• AD policies are used to reduce fluctuations in the business cycle, however do not affect the long-term average growth rate --> they do not make the economy more efficient + do not increase productive capacity

• Whereas AS policies increase efficiency and are used to increase Australia's long-term growth (via increasing productive capacity)

• Technical/productive efficiency

• ASP can increase this type of efficiency by: 

Technical/productive efficiency: achieved when production is operating a lowest long-run average cost and all resources are being used at maximum efficiency 

 

ASP can increase this type of efficiency by: 

• Spending on infrastructure (e.g. roads, ports) - reduces transport costs for firms --> lowers long-run average cost and resources are used efficiently 

• Free trade agreements can increase the level of competition faced by domestic firms – forcing them to be more efficient where they would try reduce costs and use resources to efficiently to remain competitive 

--> Alos FTAs allow firms gain a larger international market which helps them achieve economies of scale where they can spread fixed costs over more units - which lowers the average costs 

• Allocative efficiency

• ASP increased this type of efficiency by

Allocative efficiency exists when a nation is utilising resources to produce the combination of goods and services that best satisfies society - living standards and welfare are maximised 

e.g. ASP increased this type of efficiency by the deregulation of the taxi industry 

• This allowed the legal operation of Uber and others, allowing idle private vehicles to be utilised commercially  --> this increases supply and availability of transport services which gives consumers more choice and lower-cost options  

--> this allows resources to be allocated towards producing more of a service which consumers demand and would maximise society's satisfaction/welfare 

• Dynamic efficiency

• ASP can increase this type of efficiency by: 

Dynamic efficiency exists when an economy can quickly allocate its resources to achieve allocative efficiency 

• This occurs by producers being able to quickly respond to changes in consumer demand for different products by reallocating resources to products where demand has increased 

 

ASP can increase this type of efficiency by: 

• Reduced taxes for firms that invest in research and development  --> makes it easier for firms to invest in developing new technologies and product  

--> Improved technology makes it easier for firms to switch to producing new products when factors including consumer preferences or supply costs change 

 

• Reduced labour regulation – makes it easier to hire and fire workers  

--> when demand for a particular product increases, firms can quickly hire workers and shift labour to producing that product  

--> while demand falls in a particular industry, firms can fire workers, allowing workers to move to industries where they are more demanded -  allowing quicker reallocation of resources

• Inter-temporal efficiency

• ASP can increase this type of efficiency by

Inter-temporal efficiency exists where there is the optimal allocation of resources between their use for current consumption and investment to increase future consumption 

 

ASP can increase this type of efficiency by: 

• Carbon tax increases production costs – where firms would be less willing to and able to supply and pass on the higher prices to consumers via higher selling prices --> reduces the consumption/demand of products that produce greenhouse gases (especially if the tax raised is used to subsidise carbon neutral alternatives) - they may shift to cleaner alternatives 

--> This helps reduce  global warming which reduces environmental damage and protects resources for future generations 

Explain/list how AS policies increase/improve these AS factors: 

• Quantity of resources 

• Quality of resources 

• Production costs 

• Productivity 

• Quantity of resources 

  • More skilled immigration increases labour resources 

  • Childcare subsidies --> lowers childcare costs, making it more affordable --> allows more parents to enter/return to the workforce, increasing size of the LF 

  • Greater access to gov land increases natural resources 

 

• Quality of resources 

  • Training and education programs improve quality of labour by making them more skilled and productive 

  • Subsidies for R&D can help create better capital resources 

 

• Production costs 

  • Reducing tariffs on imports reduces costs of resources due to greater access to cheaper resources overseas 

  • Reducing company tax 

 

• Productivity 

  • Market reform such as privatising gov firms (the electricity companies) or removing regulations (e.g. taxis) which increase competition – which promotes firms to be more efficient by increasing productivity 

  • Reducing tariffs/entering free trade agreements increases competition and hence productivity as firms would aim to be more efficient in order to compete 

AS policies - LIPS 

AS policies reduce cost inflation (e.g. via reduction in tariffs, subsidies) 

AS policies - SSEG

• Increases strong and sustainable growth as they increase productive capacity firms become more efficient produce more which increases real GDP growth 

• Particularly sustainable growth as shifts the AS curve to the right which both increases real GDP and reduces inflation – it’s growth is based on improved efficiency rather than increased demand (inflation) or CAD (unsustainable foreign debt) 

AS policies - FE

• Increases PR via policies that make it easier/more attractive for people to enter the workforce (e.g. incentivising older Australians to work via reducing their income tax rate/delaying access to pension) 

• Increases size of the workforce (e.g. via immigration) 

• AS policies on skill and training policies which improve workers' skills which increases dynamic efficiency of the workforce and reduces structural UE as workers are better skilled to fill available jobs 

 

--> Note that AS policies may not reduce UE in the short-term 

e.g. 

When tariffs are reduced, imported cars become cheaper and more competitive. 

→ Australian car producers face greater competition 
→ Some less-efficient Australian firms may shrink or close 
→ Workers in those industries may lose their jobs 
→ Unemployment can temporarily increase. 

 

--> However in the long-term they reduce UE as the increased production would result in UE falling 

e.g. 

Those workers and other resources can move into industries where Australia has a comparative advantage and can produce more efficiently. 

Lower tariffs also mean businesses can access cheaper imported inputs and machinery, reducing their production costs. 

→ Firms can produce goods and services at lower costs 
→ They can expand production 
→ More workers are needed → demand for labour increases 

• International competitiveness

• AS policies & international competitiveness 

• A country's international competitiveness measures how well it can compete in international markets in terms of the price and quality of its goods and services 

• AS policies improve international competitiveness via improving productivity and lowering production costs

AS policies and LS 

MLS 

• AS policies → higher productivity / lower production costs → increased production → higher real GDP → increased employment and real incomes → greater ability to purchase goods and services → higher material living standards 

 

NMLS 

• Reduced UE – greater job security, lower financial stress, sense of purpose 

• Improved productivity and efficiency – access to better healthcare, education, public infrastructure – links to greater life expectancy and happiness 

 

However note that AS policies can also reduce NMLS via increased production which results in greater pollution and increased stress 

• Investment in infrastructure is what type of gov spending?

Explain how infrastructure investment increases AS via:

→ productivity

→ production costs

→ quantity of resources

• Explain how AS policies increase quality of resources

Gov capital spending (G2)

• Increase in productivity firms can transport raw materials and finished goods more quickly –where the same truck and driver can make more deliveries in a day, increasing output per hour and therefore productivity. 

• Lower production costs - lowers freight and delivery costs per unit → firms spend less on fuel and labour because journeys are shorter and more efficient (also energy, communication costs) 

• Increases quantity of resources → better road networks allow workers to commute from a wider area/further or work at home giving firms access to a larger labour force  

Not a roads example but  

• Increases quality of resources --> newer, faster and more reliable capital resources replace congested or ageing capital (e.g.  fibre replacing copper networks enabling firms to use cloud computing which processes data more quickly and supports remote working) 

North-east Link Freeway 

In the 2024/25 Federal Budget an extra $3.25 billion was committed to the North-East Link freeway which connects the Eastern Freeway to the M80 Ring Road 

• This will reduce travel to time for businesses moving goods and so reduce both labour and capital costs and increase overall efficiency. 

•  It can also improve the allocation of labour resources to firms as workers will be able to commute further to work at a firm where their productivity and income is maximised.  

Quantum Computer 

In the 2024/25 Federal Budget $470 million was committed to build in partnership with PSIQuantum the world's first commercially useful quantum computer. 

•  A quantum computer can increase productivity in areas where current computation is unable to solve problems within a reasonable period including improving supply chains (fastest/cheapest ways to move goods), drug development and accurate weather forecasting. 

Airport Rail Link 

The Victorian and Commonwealth governments are each committing funds towards a rail link to Melbourne Airport – where the 2025-26 Federal Budget allocated $2 billion to upgrade Sunshine Station to support this rail link 

• This will enable quicker travel between Melbourne and other cities and also reduce congestion on the Tullamarine freeway and so reduce transportation time and costs for business and increase labour and capital productivity 

Outline the 3 types of sustainable in SSEG

• Sustainable without inflation --> growth that doesn't breach the RBA's 2-3% band 

• Environmentally sustainable --> e.g. public transport shifts trips out of cars, resulting in less cars on the road and hence less emissions and congestion (this could include the SRL and rail electrification) 

• Sustainable across generations --> the asset can be used for a long-time where future generations can get the benefit (however if debt-funded, they also have to repay the debt – so make sure to state the trade-off) 

Investment in infrastructure on the achievement of LIPS

Short-term: 

• Adds to AD --> which if already near capacity, raises demand inflation and hence works against the goal 

 

Long-term: 

• Increases productivity – lowers production costs and hence lowers cost inflation and hence works for the goal 

Investment in infrastructure on the achievement of SSEG

Short-term: 

• Raises real GDP due to increased AD (from G2 injection) - while this can promote strong growth, it is demand-driven and hence not sustainable on its own 

 

Long-term: 

• Raises productivity and hence growth in GDP + also sustainable as it lowers cost inflation/increases AS 

Investment in infrastructure on the achievement of FE

Short-term: 

• Directly creates construction and engineering jobs 

• Note that it may draw workers away from other projects (capacity constraint) 

 

Long-term: 

• Derived demand for labour rises as firms expand (due to reduced production costs and higher productivity where they produce more)--> this lowers structural UE 

How infrastructure will help living standards 

MLS  

• Higher productivity raises real GDP 

• Lower prices for products with high transport content + more housing supply lowers housing costs – increases purchasing power + consumption 

• Increased jobs and higher real incomes 
   

NMLS 

• Shorter commutes mean more leisure and family time 

• Lower emissions and less congestion (due to increases use of public transport and less vehicles on roads) - better air quality 

• Better and greater access to health, education and services as improved transport can help people access these services quicker and easily + build more schools/hospitals + upgrade existing facilities 

 

However note that when being built, infrastructure can have some cons including: 

• Construction noise e.g. from machinery, drilling, trucks 

• Disruption e.g. temporarily blocking roads, traffic congestion 

• Displacement e.g. some projects may require land that is currently occupied by homes or firms – so some people may need to relocate 

Strengths - AS policies

• AS policies raise long-run GDP whereas AS policies only reduce fluctuations in the cycle 

• Achieves both strong growth and low inflation together 

• Can be targeted at a specific issue, industry or region 

• Includes positive externalities including lower emissions, safer roads 

• Politically easier to implement as their benefits are broadly distributed and often do not create a group of people to lose income/faced with a disadvantage unlike some AD policies (e.g. infrastructure benefits firms and households whereas tax increases cause taxpayers to lose disposable income) 

Weaknesses - AS policies

• Expensive to implement where it is mostly funded by tax (resulting in households having less disposable income to spend, thus lowering AD) or budget deficits (where crowding out can occur which raises interest rates and lowers investment + raises future taxes to decrease deficit) 

• Long implementation (time for gov to put policy to action --> takes years to plan, approve, construct them) 

• Long impact lags (time for policy to affect the economy) (e.g. SRL East would not lift AS until 2035) 

• There's an opportunity cost – where money could have gone to another sector/area 

• Gov may make decisions based on political interests rather than what's the most efficient for the economy --> leading to government failure where resources are allocated inefficiently as resources may be directed towards a biased industry and not towards their most productive use 

• Explain what training and education is

• How does training and education increase AS

• Example

This involves the gov spending on schools, universities, TAFE, apprenticeships and student support 

• This raises labour productivity and the quality of the labour force as they are more skilled thus lowering production costs and increasing AS 

• This also reduces structural UE by matching skills to vacancies 

• Explain what R&D is

• How does R&D increase AS

• Example

Involves grants (giving money) to universities and research bodies + tax concessions (reduction or exemption in the amount of tax paid) to firms to do their own research 

• R&D grants encourage firms to invest more in creating new products and more efficient processes which increases capital productivity, dynamic efficiency and productive capacity which increases AS

• Subsidies

• Explain how it increases AS

• Example

• T or F? Subsidies always lead to an efficient allocation of resources

Cash payments or other assistance to producers to lower their costs or raise their output 

• By lowering production costs directly it increases AS 

• Also childcare subsidies increase the PR, increasing quantity of labour resources and thus AS 

 

Example 

• The 2025-26 Australian budget allocated $5 billion towards building a universal early childhood education and care system. 

• Key initiatives include $3.6 billion to for wage increases for up to 200,000 early childhood educators and teachers and $1 billion to create 160 new or expanded services in underserved areas.  

• This would increase PR as childcare is more affordable for parents allowing them to enter the workforce 

False.

Note that subsides can be lead to an inefficient allocation of resources where they help firms that are inefficient or uncompetitive: 

For example: 

1. The government gives a car company a subsidy. 

2. The subsidy lowers the firm's costs of production. 

3. This allows the firm to keep producing even if it would otherwise make losses. 

4. Without the subsidy, the firm might have had to improve productivity, reduce costs, or shut down. 

5. Therefore, government money is being used to keep an inefficient firm operating. 

6. This can cause resources to be misallocated because workers, capital and other resources remain in an industry that may not be the most productive use of them. 

Does lowering the income tax rate increase AS? Explain why/why not + use an actual example (income tax reduction example)

• Lowering the tax rate would increase financial reward from working – households keeping more of each extra dollar earned raises the incentive to work more hours or re-enter the workforce  

• This would increase labour supply and wage cost pressure on firms ease --> increases AS

• Immigration

• What percentage of Aus were born overseas

Immigration is the permanent settlement of people from overseas in Australia 

• Around 32% of Aus were born overseas 

Migration Vs Net migration 

• Migration is the number of people coming into Aus 

• Net migration is the number of people coming in minus the number of people going out (including both permanent and temporary migrants but not holiday makers) 

Permanent Vs Temporary migration

• Permanent migration is people coming here to stay permanently/for good 

• Temporary migration is people on short term work visas who must leave at the end of their visa 

• Permanent migration is a mixture of what categories?

• Also outline what proportion of migration each category takes up

• Skilled migration program: involves the immigration of independent migrants who are selected on the basis of their nominated occupation, age, skills, qualifications, English language, employability (make up roughly 2/3rds) 

• Family migration program: involves the immigration of migrants who are selected based on a relationship  to a sponsor in Aus (partners, fiancés, children and parents) (makes up roughly 1/3^rd) 

• Refugee and humanitarian migration program: involves the immigration of migrants who are generally refugees – in which they migrate for safety reasons

In the 2026/27 budget, how many permanent migrants are expected to come and how much of these are skilled migrants?

Note

• In addition to immigration, Aus allows people to come and work here on temporary skill in demand visas, allowing them to stay up to 2 (sometimes 4) years 

• There are also temporary visa for non-skilled workers 

• New Zealanders can come and live in Aus if they want

What was Aus net overseas migration (NOM) for:

• 2025/26

• 2026/27

Explain why migration, particularly skilled migration, would increase productivity

• As 2/3rds of permanent migrants are chosen based on having needed skills – they are on average more skilled than existing Aus --> thus they make the LF more productive 

• Plus they can also teach existing Aus workers skills which can further increase productivity 

• As they are chosen to fill skill gaps, they fill in jobs that Australians do not have the skills for or which their skills are inadequate – this allows projects to go ahead that otherwise would not and hence make existing Aus more productive 

--> This would benefit existing Australians as: 

• Construction workers can continue working on the project 

• Workers could eventually work in the new facility (e.g. healthcare workers in a newly built hospital) 

• Economy produces more products 

Explain the problem with an ageing population

An ageing population occurs when the proportion of older people in society increases while the proportion of working-age people decreases 

An ageing population means that there will be fewer working age Australians to support the increasing number of elderly people who often require high levels of government spending in areas such as the aged pension; health care and aged care accommodation

Explain how migration increases PR and link to how this helps reduce the effect of Aus ageing population

Immigration tends to increase participation rate (the percentage of population is 15 and above that are in LF)  as it adds more people to the LF as many migrants are skilled entering Aus to work 

• Immigration slows down the rate at which the population is ageing as many migrants are of working age and are average younger than existing Australians (their median age is around 26 years compared to 38 years for existing Australians) which increases the proportion of working-age people 

• Immigration helps reduce the effects of an ageing population by increasing ratio of workers to retirees  

--> more tax being paid which makes the gov more able to fund benefits and services to retirees including the aged pension, health expenses and aged care 

--> this helps prevent the budget from producing ever increasing deficits 

Explain how migration increasing the population increases AS

Where in addition to adding to labour resources, this increases the domestic market of consumers, allowing firms to operate at a larger more efficient scale (gaining economies of scale) which reduce their average costs of production, thereby increasing aggregate supply.

How does migration affect real wage growth?

Immigration reduces real wage growth in the short-term because: 

• Immigration increases supply of labour – reduces upward pressure on wages as firms don't need to raise wages as much to hire workers, hiring workers is more easy 

 

Immigration increases real wage growth in long-term because: 

• It increases productivity – skilled migrants fill skill shortages + remove bottlenecks --> helping firms to expand and increase output where firms earn more revenue and can afford to pay higher wages as workers are more valuable

Immigration and SSEG 

Immigration makes easier to achieve SSEG as it increases AS which increases GDP growth  

• However immigration without adequate investment in infrastructure and increased housing may become unsustainable from an environmental perspective as it increases congestion and increases housing costs 

Immigration and LASI/LIPS 

• While immigration adds to AD – as it largely consists of skilled migration, it's supply side benefits typically outweigh the increase in demand thus reducing demand inflation (as increased AS reduces the likelihood of AD outstripping AS) 

• It also reduces cost inflation by increasing productivity and hence lowers production costs 

Immigration and FE 

Immigration will tend to reduce UE in long-run as increases AS, increasing derived demand for labour + migrants also add to AD which further increases production and derived demand for labour 

Immigration & international competitiveness 

• Immigration improves international competitiveness as it increases productivity and lowers production costs – increasing AS and lowering the price of exports 

• It also makes Aus more integrated into global community, making trade easier 

Trade liberalisation

Trade liberalisation is about removing protection for Australian businesses from foreign competition by reducing tariffs, subsidies, quotas and regulatory barriers to trade/promoting free trade 

• It has been the policy of Australian governments for the past 40 years 

 

Note that 'free trade' agreements reduce trade barriers but do not eliminate them 

Protectionism

The opposite of free trade is protectionism - policy of governments to protect local businesses from international competition by methods such as: 

• Imposing tariffs – taxes imposed on imports 

• Restrictive quotas on imports – which are limits on the quantity of a particular product entering the country (e.g. US, China and EU have quotas on Aus beef) 

• Providing subsidies to local businesses – which are assistance by gov to local firms via direct payments, tax reductions etc 

• Imposing regulations that make importing more difficult (e.g. labelling laws on goods which increases compliance costs)

Explain how trade liberalisation has affected Aus economy (hint: statistics)

Aus governments have pursued policies of trade liberalisation since 1980s, where: 

• Average tariffs imposed by Aus fell from 36% in the 1960s to 3% today 

• Some tariffs dropped even more (e.g. motor vehicles from 57% to 5%) 

• It has been calculated that the reduced tariffs between 1986 and 2016 have added 5.4% to Aus real GDP 

The reduction in tariffs over the last 40 years in Aus has driven many firms out of existence as they were unable to compete, including: 

• In 1980, there were 4 car manufacturers in Aus (Holden, Ford, Mitsubishi and Toyota) - now there are none 

• Many clothing manufacturers have gone out of business or moved their production to other nations 

 

However trade liberalisation has made Aus more internationally competitive and helped increase our GDP growth 

Explain the negative effects of protectionism

• Protection makes local firms less competitive as they face less pressure to improve and hence becomes less efficient and innovative 

• Over time, overseas producers often become more efficient and lower their costs – where even with tariffs, foreign products may still be attractive where Aus firms would demand even higher tariffs for protection 

• Tariffs increase production costs where some imported goods (e.g. vehicles) become more expensive --> hence resulting in higher prices on consumers 

• Other nations may retaliate where they impose tariffs on Aus exports – which reduces the sales of Aus products overseas and hence can damage export industries (e.g. agriculture, mining) 

TL and technical efficiency

• More competition results in firms having to be more efficient where they increase productivity and use all resources to maximum efficiency 

• Access to cheaper imported inputs reduces production costs 

TL and allocative efficiency

• Aus imports products that other nations produce relatively cheaper or more efficiently 

• Aus firms shift resources towards industries where Aus has a comparative advantage so produce more value 

 

Comparative advantage: refers to producing products where their opportunity cost is lowest 

• Increases output 

• Less waste + more efficient resource allocation 

• Lower prices for firms and consumers 

Trade liberalisation and international competitiveness 

It helps improve international competitiveness as: 

• It forces Aus firms to compete with other nations –-> and so increases technical efficiency where they reduce prices and/or improve quality 

• It encourages firms to focus on their areas of comparative advantage where they can be more efficient and out-compete international firms – improving allocative efficiency 

• Reduces costs for Aus firms who rely on foreign imports of capital goods and intermediate goods 

• It helps firms gain access to foreign markets and so allows them to achieve economies of scale – resulting in cheaper products 

TL & SSEG

• ncourages technical and allocative efficiency thus increasing AS, allowing non-inflationary growth 

• Reduces costs of imported inputs, reducing production costs and thus increases AS 

• Firms may increase investment to improve technology and capital in order to improve productivity and be more competitive – increases AD 

• Makes it easier to export to other nations – increases net exports and hence AD 

 

CHAT SSEG – allocative efficiency and comparative advantage answer 

Trade liberalisation can contribute to SSEG by allowing countries to specialise in areas in which they have a comparative advantage. This enables resources to be allocated towards industries where they can be used most efficiently, increasing allocative efficiency. Greater allocative efficiency can increase productivity as resources are directed towards their most productive uses. Higher productivity increases the economy's productive capacity, shifting aggregate supply (AS) to the right. This allows the economy to produce a greater quantity of goods and services, increasing real GDP and therefore contributing to stronger economic growth. 

TL & FE

• By encouraging growth it creates more demand for labour (however it is possible to have 'jobless growth' where growth id driven by becoming more capital intensive) 

• TL can cause short term structural UE due to firms being unable to compete against international firms and hence close down 

TL & LIPS

• By increasing technical and allocative efficiency and so AS – it reduces the risk of demand inflation (as decreased likelihood of AD outstripping AS) 

• Reduces cost inflation due to access to cheaper capital imports and intermediate imports 

• By reducing the cost of consumer imports it directly lowers inflation 

TL & Living standards

MLS 

• Increases growth in real GDP via higher productivity & lower production costs (however not for all for instance people experiencing structural UE) 

 

NMLS 

• In response to higher MLS, people may experience higher levels of happiness, consumption of goods and services, etc 

• However an argument against higher NMLS is that many firms may move production (offshore) to nations with less strict environmental regulations as production costs are cheaper – leading to greater pollution and environmental degradation, lowering NMLS 

Bad things about TL 

• In short-term, it can cause structural UE in industries that cannot compete with overseas firms 

• Result in some industries going offshore where things can be made cheaper as they have looser environmental standards --> this can lead to Aus workers losing their jobs + lead to more pollution/waste/environmental damage 

• TL can make nations more dependent on other nations for products and materials – this can become a problem if there is a supply chain disruption (e.g. ware, pandemics, political instability) 

  e.g. 

  • During COVID, international transport was disrupted where many nations relied heavily on imports including medical equipment, masks, vaccines 

  • Fertiliser and AdBlue --> where disruptions to this supply due to gulf war has increased production costs and hence lower AS and higher selling prices 

• Global warming/climate change + effects

• How are its changes expected to affect GDP growth?

Global warming/climate change refers to the average increase in temperatures and other climate changes caused by the increase of CO2 and other greenhouse gases in the atmosphere as a result of human activity 

• e.g. burning fossil fuels 

 

It has several effects including: 

• Rising sea levels 

• Higher temperatures 

• More extreme weather events (e.g. droughts, floods, storms, bushfires)

These changes are expected to reduce GDP by between 2-10% from what it otherwise have been (note this does not mean that it is less than the present GDP, it would still be higher (most likely) but less than expected/been) 

The different ways in which climate change limits growth 

• Extreme weather events 🌊🔥(e.g. floods, bushfires, storms) 
  → damage/destroy factories, farms and infrastructure – reduces capital resources 
  → productive capacity ↓ 
  → AS ↓ → real GDP ↓  

 

• Higher temperatures ☀ 
  → workers become less productive, especially in outdoor industries 
  → productivity ↓ 
  → AS ↓ → real GDP ↓  

 

• Droughts / changing rainfall 🌾 
  → less water and lower agricultural production 
  → supply of goods ↓ 
  → AS ↓ → real GDP ↓  

 

• Higher production costs 💰 
  → businesses face higher costs for cooling, insurance, repairs from damage of resources 
  → AS ↓ → real GDP ↓  

• Carbon tax

• How does this reduce # of emissions

Carbon tax is a tax that is applied to firms based on the amount of greenhouse gases they emit 

• This increases the production costs for activities associated with emissions and so should increase the price and reduce the quantity of emission producing products --> hence the quantity demanded of these products contract 

• Firms are then encouraged to adopt cleaner technologies and production methods to lower production costs, thus lowering emissions 

• Subsidies (in relation to GH gases) and how they help reduce emissions

Subsidies can be paid: 

• To firms in return for reducing their emissions or 

• Firms producing or consumers buying zero or low emission products (e.g. solar panels or electricity via wind farms) 

• Firms that reduce net emissions (e.g. by planting trees) 

Emissions trading scheme - describe it

• Under an Emissions Trading Scheme (ETS) the gov sets a cap on the total amount of GG that can be emitted and issues tradeable permits to firms in total equalling that cap  

--> note that firms must have permits to cover all emissions and if emits less than the permits it holds it can sell some of its permits to other firms 

• The amount of greenhouse gases allowed to be emitted would reduce every year  

 

• This method allows the forces of the market to decide where the most important place in the economy to allow emissions is 

--> where if a firm can easily reduce emissions, it has an incentive to do so as it can then sell its permits 

--> If it really hard to reduce emissions and what you do is very valuable (e.g. flights) you can buy permits 

 

This results in the effect in which: 

• Emissions go to places where they are the most valuable – where cuts in emissions are done where it is the cheapest 

Draw a supply/demand graph for the carbon pollution permits

Strengths of an ETS 

 Reduces emissions at the lowest cost 

• Firms have different costs of reducing emissions.  

• An ETS allows firms to buy and sell emissions permits.  

• Firms that can reduce emissions cheaply will reduce more and sell their extra permits.  

• Firms that find it expensive to reduce emissions can buy permits.  

• Therefore, emissions are reduced at the lowest possible cost 

→ minimises the increase in production costs and hence increase AS and GDP 

 

e.g. 

Example 

Suppose the government wants 10 tonnes of emissions reduced. 

• Firm A can reduce 1 tonne for $10  

• Firm B can reduce 1 tonne for $100  

If both firms were forced to reduce 5 tonnes each: 

• Firm A: 5 × $10 = $50  

• Firm B: 5 × $100 = $500  

• Total cost = $550  

But under an ETS, Firm A can reduce more because it is cheaper for them. 

For example: 

• Firm A reduces 8 tonnes → $80  

• Firm B reduces 2 tonnes → $200  

• Total cost = $280  

So the same 10-tonne reduction is achieved for $280 instead of $550. 

 

2. Certainty over the amount of emissions reduced 

• Government sets a maximum level (cap) of total emissions - issues a limited number of emissions permits.  

• Therefore, the government knows how much total emissions can occur.  

→ certainty over the quantity of emissions reduction. 

• In contrast, a carbon tax provides certainty over the price of emitting but not the exact quantity of emissions that will be reduced 

Weaknesses of an ETS 

• Complicated and prone to fraud 

--> An ETS requires the government to accurately measure and monitor firms' emissions and regulate the trading of permits -This can be complex and costly, and firms may under-report emissions or manipulate permits to reduce their costs 

ETS impact on AS and LS

Short-term: 

• Will reduce AS – as it would increase production costs for firms due to buying permits and investing in cleaner technologies --> make them less willing to and able to supply 

• Reduce LS – due to higher selling prices + emissions aren't automatically reduced as of yet 

 

Long-term: 

• If an ETS is properly run (and if other nations reduce their emissions too) it increases AS as it would lower amount of emissions, limiting climate change that would increase cost of production 

• It should also improve LS as it increases GDP (by limiting emissions and preserving natural resources) and NMLS (better environment) 

Impact of an ETS on intertemporal efficiency 

An ETS improves intertemporal efficiency by: 

• Encouraging businesses to reduce emissions and adopt more sustainable production methods 

• As the number of permits available decreases each year, overall emissions are gradually reduced, helping to protect environmental quality and ensuring that current economic growth does not come at the expense of future generations' living standards