Economics Units 1&2

Economic activity

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

Transaction

Exchange of money for something in return

Economy

Exists wherever production, expenditure and consumption take place

Positive economics

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

Normative economics

Economic statements or claims based on opinion or value judgements

Relative scarcity

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

Microeconomics

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

Macroeconomics

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

Economics

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

3 types of transactions that occur in an economy

Production - Process of making a good or service

Income - Money given to those involved in production

Expenditure - Spending of income on goods or services

3 types of agents in an economy

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

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

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

Economic agent

Any individual, group or body that participate in the economy and are involved in economic decisions

Needs

The basic goods and services that are necessary for our survival

Wants

Something we desire to have to improve our satisfaction or quality of life, but that is not necessary for our survival.

Resources

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

4 types of FOP

Land/natural, labour, capital, entrepreneurship

Land/natural resources

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

Labour

Mental and physical effort by humans in the production process

Capital

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

Entrepreneurship

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

Opportunity cost

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

PPC

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

Locations of a point on the PPC and their meanings

On - Show productive efficiency

Inside - Show inefficient production or underutilised resources

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

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

1. The amount and quality of resources available to them

2. How efficiently these resources can be employed

Productive capacity

The maximum ability of an economy to produce goods and/or services

Assumptions of the PPC

1. Only two goods or services being produced

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

3. All resources are fully and efficiently employed

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

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

Efficiency

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

Productive/technical efficiency

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

Allocative efficiency

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

3 basic economic questions

What to produce?

How to produce? - capital or resource intensive?

For whom to produce?

Australia's economy

Predominantly market capitalist economy, with government intervention that makes it a mixed economy

Market failures

Inherent in unregulated markets, and include:

- under-production of essential goods and services

- over-production of undesirable goods and services

Consumer sovereignty

the power of consumers to decide what gets produced

Market-capitalist economy

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

How does a market-capitalist economy answer the 3 basic economic questions?

What and how much - Determined by consumer needs and wants

How - Determined by profit-motivated behaviour of producers

For whom - Determined by wealth of individuals or groups determines who has access to those goods, i.e. those with economic power

How does a mixed economy answer the 3 basic economic questions?

What and how much - Determined by consumer want and needs as well as government restrictions (e.g. taxes on dirty energy)

How - Determined by profit-motivated behaviour of producers, as well as government regulations (e.g. minimum wage)

For whom - Determined by market as well as government interventions (e.g. income tax, public housing)

Planned socialist economy

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

Planned capitalist economy

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

Market Socialist economy

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

Circular flow diagram explanation

The values of production, income and expenditure flow from one to the other over time. Means they equal out over time. Assumes absence of government.

The 3-sector 4-flow model of a mixed economy

3 sectors - business, household and government

4 flows:

- FOP provided to business sector

- Income returned to household sector for providing FOP

- Expenditure on goods and services by households and government

- Production of goods and services (real GDP)

Economic growth

Increases productive potential of an economy. Economies grow by increasing quantity or quality of FOP.

How to increase productive capacity

- Increased employment

- More capital created

- New technology developed

The three sector circular ow model for a mixed economy image

Why does economic activity take place?

To positively affect living standards. There is typically a positive correlation between economic growth and living standards

Material living standards

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

Non-material living standards

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

Examples of non-material living standards

- Access to healthcare and education

- Job satisfaction levels

- Depletion of resources

- Pollution

- Freedom of expression

- Stress levels

- Equality levels

Trade-off

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

Micro vs macroeconomic trade-off examples

Micro - Spending vs saving, work vs leisure

Macro - Economic growth vs environment, efficiency vs equity

Cost-benefit analysis

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

Equation for a benefit-cost ratio

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

What are the 3 types of productivity?

Labour: Output per hour

Capital: Output per hour

Multi-factor: Output per labour and machine hour

What 4 things are needed to achieve technical efficiency?

1. Natural resources converted into goods and services without waste

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

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

4. No workers waiting idly for spare parts

What 3 things are needed to achieve allocative efficiency?

Technical, dynamic and inter-temporal efficiency

Private vs public sector agents

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

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

Traditional economic viewpoint of consumer behaviour

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

Rationality

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

Self-interest

Seeking maximum financial benefit for oneself

Utility maximisation

Seeking the maximum satisfaction possible from our economic decisions

Law of diminishing marginal utility

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

Incentives

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

How can the government influence the behaviour of consumers and workers?

Job keeper/seeker subsidies

Advertisements or advertising regulations

Fines and taxes

Production subsidies for desirably products (e.g. development, tech, climate stuff)

Positive Externalities of Consumption

When consumption of a good or service benefits a 3rd party or bystander. Negative externalities confer harm for 3rd parties

Subsidies

Cash payments directly to producers or consumers to incentivise certain behaviour

Regulation

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

Indirect taxes

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

Direct taxes

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

Tax rebates

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

Moral Hazard

Creates perverse incentives, for example ensured people may be more likely to be more reckless as they are not incentivised to protect their assets as they do not bear the burden of repair costs

Enterprise agreement

Agreement about pay and conditions made at workplace/enterprise level. Often includes productivity clauses to incentivise hard work

Traditional economic viewpoint of producer behaviour

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

Recession

Negative GDP increase for 6+ months

Traditional economic viewpoint of government behaviour

Aims to maximise living standards

Business cycle

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

Phases of the business cycle

Expansions (upswings, upturns)

Peaks (possibly booms)

Contractions (downswings, downturns)

Troughs (possibly recessions)

Aggregate Demand

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

Economic stabilisation

Efforts made by government and its agencies to decrease intensity of an economy's fluctuations in the business cycle

Aggregate Demand Policies

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

Macroeconomic goals pursued by the federal government

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

2. Full employment (4.25% unemployment rate)

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

When these are achieved, domestic economic stability is achieved.

Budgetary policies

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

Monetary policies

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

Restrictive vs Expansionary Macroeconomic Policies

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

Aggregate supply policies

Seek to improve the willingness and ability of businesses to supply goods and services, increasing the total amount available for sale and boosting the economy's productive capacity. Used in a long time frame to support macroeconomic goals

Examples of aggregate supply policies

- Improvements to education and training

- subsidising childcare to increase labour force participation

- tax concessions for research and development expenditure

Dynamic efficiency

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

Inter-temporal efficiency

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

Living standards

The aggregate welfare of people in a country

Material living standards

Living standards as measured by access to goods and services

Non-material living standards

The aspects of a person's quality of life that cannot be measured by monetary factors.

NMLS examples

- Access to clean air, water and natural resources

- Access to health and education services

- Congestion and pollution

- Depletion of resources

- Job satisfaction

- Equality

Relationship between MLS and economic activity/growth

There is a positive correlation between the two, as when earnings and income increase, so does expenditure and consumption, which leads to additional satisfaction

Economic growth

An increase in the amount or level of national production that has occurred over time, most commonly measured by changes in the level of real GDP over time

GDP

The final market value of all goods and services produced in an economy over a given period of time. The same as the total 'value added' during each stage of the production process and is calculated every quarter by the ABS

Real GDP

GDP adjusted for inflation. The main statistical measure of production used to measure economic growth.

Nominal GDP

GDP measured in current prices, i.e. the real 'dollar value' of production

Real GDP per capita

Real GDP divided by the total population

Economic Activity

The production, income and expenditure that takes place across an economy

The 5 sector flow model of income

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