Australian Microeconomics & Macroeconomics: Key Concepts and Policies

Three Basic Economic Questions

1. What (and how much) to produce? Answered by consumer demand (consumer sovereignty) in a market economy. 2. How to produce? Decided by producers and the private ownership of production means. 3. For whom to produce? Determined by the price mechanism; goods go to those with the ability to pay.

Australia's Economic System

A market capitalist economy where production is mainly owned by the private sector, but with some government involvement in areas like healthcare and education.

Relative Scarcity

Unlimited needs and wants versus limited resources. This forces choices to be made.

Opportunity Cost

The value of the next best alternative that is forgone when a choice is made.

Efficiency

The optimal use of resources to achieve the best outcomes.

Allocative Efficiency

Resources are used to produce goods and services that provide the maximum possible benefits for consumers and the nation.

Technical Efficiency

Producing the maximum possible output from a given set of resources, at the lowest cost.

Price Elasticity of Demand (PED)

Measures how responsive the quantity demanded of a product is to a change in its price.

Factors influencing PED

The degree of necessity, availability of substitutes, the proportion of income the item takes, and the time since the price change.

Price Elasticity of Supply (PES)

Measures how responsive the quantity supplied of a product is to a change in its price.

Factors influencing PES

Storability of the product, resource mobility, unused industry capacity, and the time period.

Market Failure

Occurs when the market allocates resources inefficiently, failing to maximise societal wellbeing.

Externalities

When a third party not involved in a transaction is affected by it. Can be positive (e.g., vaccinations, R&D) or negative (e.g., pollution, smoking).

Public Goods

These are non-excludable (suppliers cannot stop non-payers from consuming them) and non-rivalrous (one person's consumption doesn't reduce availability for others). They often lead to the 'free-rider problem'.

Asymmetric Information

When one party in a transaction (consumer or producer) has more information than the other.

Common Access Resources

Resources that are non-excludable but rivalrous (e.g., fish in the ocean), which can lead to overuse.

Government Intervention

Actions taken by the government to correct market failures.

Price Ceiling

A maximum price set by the government. An unintended consequence can be an under-allocation of resources (shortages).

Price Floor

A minimum price set by the government (e.g., minimum wage). An unintended consequence can be an over-allocation of resources (surpluses, like unemployment).

Strong and Sustainable Economic Growth

The highest possible growth rate (target 3-3.5%) without causing unacceptable inflation or environmental damage.

Full Employment

The lowest unemployment rate possible (around 4-5%, the NAIRU) without causing inflation to accelerate.

Price Stability

Keeping consumer price inflation low and stable, with an RBA target of 2-3% on average over the medium term.

The Business Cycle

Describes the fluctuations in economic activity.

Expansion

Rising production, income, employment, and inflation.

Contraction

Falling production, income, employment, and inflation.

Aggregate Demand (AD)

The total expenditure on goods and services produced in an economy. AD = C + I + G + (X - M).

AD Factors

Interest rates, consumer/business confidence, exchange rates, overseas economic growth, and disposable income.

Aggregate Supply (AS)

The total volume of goods and services that firms are willing and able to produce.

AS Factors

Quantity and quality of factors of production, production costs, technology, and productivity growth.

Budgetary (Fiscal) Policy

The government's use of the budget to influence the economy.

Expansionary Stance

A budget deficit (G > T) is used to stimulate AD during a downturn.

Contractionary Stance

A budget surplus (T > G) is used to slow AD during a boom.

Financing a Deficit

Can be done by borrowing from the RBA, overseas, or the private sector.

Crowding Out

Increased government borrowing raises interest rates and reduces private investment.

Monetary Policy

Operated by the RBA to achieve price stability and full employment.

Cash Rate

The interest rate in the overnight money market.

Tightening Stance

The RBA increases the cash rate to slow AD and inflation.

Loosening Stance

The RBA decreases the cash rate to stimulate AD and growth.

Transmission Mechanisms

How cash rate changes affect the economy, including the savings and investment channel and the exchange rate channel.

Aggregate Supply Policies

Government actions designed to reduce production costs and improve supply conditions for businesses.

Examples of Aggregate Supply Policies

Skilled immigration programs and trade liberalisation (removing protectionist policies like tariffs).

Goal of Aggregate Supply Policies

To allow for stronger economic growth without causing inflationary pressures.

Balance of Payments

A record of all transactions between Australia and other countries, consisting of the Current Account (CA) and the Capital and Financial Account (CAFA).

Current Account (CA)

Records transactions for goods, services, primary incomes (e.g., wages, dividends), and secondary incomes (one-way transfers).

Capital and Financial Account (CAFA)

Records transactions for assets, including direct and portfolio investment.

Rule of Balance of Payments

The CA and CAFA must always balance to zero.

Terms of Trade (TOT)

A ratio of the average price of exports to the average price of imports. (TOT Index = Export Prices / Import Prices x 100).

Exchange Rate

The value of one country's currency compared to another's.

Lower AUD Impact

Increases international competitiveness, making exports cheaper for foreigners.

Higher AUD Impact

Decreases international competitiveness, making exports more expensive.

International Competitiveness

A country's ability to compete in global markets, influenced by factors like productivity, production costs, and the exchange rate.