Economics Unit 3 and 4

exchange rate

the value of the currency of a nation expressed in terms of the currency of another nation

internal balance

the state of the economy where there is full employment and acceptable levels of inflation

open economy

a nation that trades with other nations

CFM

GDP formula

economic problem

problem of deciding how to satisfy unlimited wants with limited resources

factor endowment

the supply of the factors of production (land, labour, capital, enterprise) that exist in a country

human capital

experience, knowledge, and skills of individuals in which a nation must invest in if they are to advance

widening gap

increasing economic difference between poor and economically advanced nations

economies of scale

cost of efficiencies that are derived by producing a large volume of standardised products

productivity

output per unit of input per unit of time

floating exchange rate

the value of a currency fluctuates in response to supply and demand initiated by a combination of market forces

• currency appreciation

• currency depreciation

fixed exchange rate

where the government attempts to maintain the value of its currency (PEGGING)

• currency revaluation

• currency devaluation

currency appreciation

increase in the value of a currency relative to other currencies under a floating exchange regime

currency depreciation

a decrease in the value of a currency relative to other currencies under a floating exchange regime

currency devaluation

deliberate downward adjustment to the value of a countries currency relative to others under a fixed exchange rate

currency revaluation

deliberate upward adjustment to the value of a countries currency relative to another currency, under a fixed exchange rate

factors changing demand for currency

factors causing changes to supply of currency

absolute advantage

ability of a country to produce commodities more efficiently than other countries. Developed by Adam Smith in 1776 that argues countries should specialise in producing what they are relatively more efficient at and trade for what that country can produce more efficiently. This specialisation lets each country to produce more than they would otherwise if they tried to produce all goods and services

assumptions of absolute advantage

• only two countries

• each country has equal quantity of resources, but not the same quality

• only two commodities are being made

• resources are perfectly mobile

  • if trade occurs, there is no transfer of costs

limitations of absolute advantage

• what if a country has no absolute advantage

  • what if a country has an absolute advantage in producing both goods

comparative advantage

 First developed in 1817, the theory is based on the ability of a nation to produce a commodity at a lower opportunity cost of production than another country. It argues that countries can benefit from trading with each other by focusing on making the things they are best at making, while buying things they are not as good at making from other countries 

Specialisation (focusing on strengths) = efficiency 

opportunity cost

the forgone benefit that would have been derived from an option other than the one that was chosen 

trade off

exchange something of value, especially as part of a compromise

opportunity cost formula

cost/gain

trade deficit

imports out way exports

trade surplus

exports out way imports

advantages of trade surplus

higher exports means a greater demand, increasing consumption of international goods and increase in economic growth

disadvantage of trade surplus

decrease in domestic investment and growth as export demands increases

causes currency appreciation - increases inflation and interest rates

disadvantages of trade deficit

depreciating, the cost of AUD purchase decreases

import prices are more expensive

international consumption decreases and so does GDP

trade weight index

Average exchange rate between a basket of currencies. This minimises effects of fluctuations, and eliminates the idea of fixing the exchange rate

globalisation

the spread of the flow of financial products, goods, techology, information, and jobs across national borders and cultures

trade intensity

a measure of economic integration based on the ratio of trade to output

how do governments trade trade

balance of payment

balance of payments

record of a countries international economics transactions. It provides information from which the relationship between the domestic and external sectors of the economy can be derived and analysed

balance of payments consists of

current account

the capital and financial account (KAFA)

current account

records day to day specific transactions specified the value of the flow of goods, services and income between AU residents and the rest of the world

• NON REVERSIBLE TRANSACTIONS

three components of current account

trade balance - difference between value of exports and imports of gs and services

primary income balance - rent, profit, interest, dividends

secondary income - remiitance from foreign workers, foreign aids

capital and financial account

concerned with financial assets and liabilities (not income and expenses) that flow in and out of Australia. It includes money flows relating to international borrowing, lending, and purchase of assets 

• They are reversible transactions e.g., investors can withdraw their money from an investment project

capital aspect of KAFA

 it records two main types of transactions involving capital 

• Involves non-financial, non-produced assets; this type of asset includes intangible assets (e.g., brand names) as well as rights to use land or water (for mining and fishing)

financial aspect of KAFA

 refers to the Australian investment that covers claims on or liabilities to non-residents concerning financial assets. The financial account components include direct investment, portfolio investment, and reverse assets broken down by sector 

two types of foreign investments

1- direct investment

2- portfolio indirect

foreign direct investment

any capital invested in an enterprise that gives the investment significant influence over the operation of the enterprise. It is when a company invests in a business in India for example, owning more than 10% of its stake. 

foreign indirect investment

is when a company invests in a foreign business by buying its shares/stocks, which can’t cross over 10% stakes.

benefits of foreign investment

• Increases economic activity, employment, and income 

• Expands productive capacity of industries and resources

• Provides foreign exchange for purchase of imports that add to quality of life

• Introduces new technology and management that helps AUS industries to operate more efficiently 

• Provides opportunities to access new markets 

costs of foreign investment

• Leads to loss of ownership and control of industry and resources

• Increasing external debt results in high debt servicing, which increases the income component of the current account 

• Portfolio (indirect)  foreign investment tends to be short term and speculative

trade protectionism

government intervention in international trade through the imposition of trade restrictions/barriers to prevent the free entry of imports into a country or to protect the domestic economy from foreign competition 

methods of protectionism

• Tariffs 

• Subsidies 

• Quotas 

• Bureaucratic requirements: (licensing, procedures quarantine and health regulations

paradox of thrift

increased savings represent a diminishing circular flow model of income; as everyone tries to save an increasingly larger proportion of their incomes, the nation becomes poorer instead of richer 

macroeconomic objectives of sustainable growth

• full employment

• price stability

• external stability

• sustainable development

• improved living standards

  
  

multiplier effect

an economic term referring to the proportional amount of increase, or decrease, in final income that results from an injection, or withdrawal, of capital.

Real GDP

adjustment for inflation

why real over nominal GDP

• More accurate measure of growth

• Ensures that changes in GDP reflect changes in production rather than price fluctuations 

• Greater accuracy supports the effectiveness of policy decision making 

• Helps analyse long-term economic trends, and separate inflation data

monetary policy

central banks RBA actions to pursue objectives such as price stability and maximum employment

fiscal policy

governments revenue collection and spending decisions

collective goals of fiscal and monetary policy

• economic growth

• inflation control

  • social stability

structural employment

fundamental shifts in an economy

seasonal

only unavailable at specific times of the year

cyclical

during contractions in an economy

frictional

exists due to moving from one job to another

surplus

wage changes

hardcore

multiple barriers - lack of education

natural

when labour force is in perfect equilibrium

long term

unemployment for a year or more

keynesian theory

advocates using active government policy to manage aggregate demand to address or prevent economic recessions

economic life cycle

fiscal expansionary

• increased gov spending

  • decreased taxation

    
    

fiscal contractionary consist of

• decreased gov spending

  • increasing taxation

monetary expansionary consists of

• decreased interest rates

• enough money supply in ban

  • higher inflation

monetary contractionary consist of

• increased interest rates

• lower money supply

  • lower inflation (main objective of contractionary monetary policy)

contractionary fiscal

deducing aggregate demand and discourage economic growth + activity

expansionary fiscal

increase aggregate demand to stimulate economic growth

what effects SRAS curve

• Changes in labour costs (wages, income)

• Changes in the prices in factors of production (inflation)

• Technological progress (productivity and output)

• The amount of money in circulation (money supply and interest rates)

 -  more money flowing through the economy corresponds with lower interest rates

contractionary money policy

decrease supply and movement of money = reduced economic growth

two types of inflation

demand pull

cosh push

demand pull + primary driver

overall demand for goods and services exceeds economies ability to produce them thus increasing price

primary driver - increase aggregate demand

cost push inflation + primary driver

inflation when cost of production for goods and services increases, leading businesses to pass these higher costs onto consumer in form of higher prices

primary - increased production costs

policy response to cost push inflation

• increased interest rates

• reduced money supply

policy response to demand pull

• Targeted measures such as subsidies or tax relief 

• Policies to improve supply chain efficiency

economic indicator

data used to gauge the growth trends of a nations economy

leading indicator

points towards possible future events

lagging indicators

may confirm a pattern that is in progress - unemplotment

coincident indicators

occurs in real time and helps clarify the state of the economy

philips curve

inverse relationship between inflation and unemployment - trade off

interemporal economics

field of economics that studies how current decisions affect what becomes available in the future

interemporal equilibrium

equilibrium of the economy should be analysed across different time periods of time

discretionary fiscal policy

deliberate change of tax rates to manage aggregate demand and reach macroeconomic objectives

purpose of discretionary fiscal policy

• promote economic growth

• reduced unemployment

• control inflation

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progressive tax

tax that increases as taxable income increases.

direct tax

levied on individuals or entities by the government directly - income, company profits

indirect tax

collected by intermediary (marketplaces, manufactures) from the end consumer

• goods and services

• customs

  • dividends

main effects of taxation - re

1. Brings around the redistribution of income (income tax revenue)

   impacts incentives to work - increase in income will result in increase in tax therefore reducing incentive to work

   1. domestic production - tax on imports - increases demand for domestic production

      
      

laffer curve

analysis which suggests at some tax rates, income will reduce incentives to work and actually leads to lower tax revenue

3 components of macroeconomic objectives

• fiscal policy

• monetary policy

• microeconomic policy

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microeconomics

study of economic behaviour at individual unit levels - decisions by individuals, firms and governments

supply side policy reforms

improving productive capacity of an economy by enchancing the factors that contribute to productivity q

types of supply-side policy

• infrastructure investment

• education and training

• deregulation and competition policy

• taxation reforms

  • labour market reform

structural changes

shift in how systems operate

purpose of microeconomic policies

encourage the efficient operations of markets

• market failures

• promoting competition

  • creating environment to optimal resource allocation