economics sac 2

material living standards

the real purchasing power of income reflected in the quantity and quality of goods and services an individual can access, measured by real GDP per capita and income levels

non-material living standards

quality of life factors that cant be purchased directly with income

health and life expectancy, environmental quality, work-life balance, leisure time, stress levels, community safety, social cohesion

conflicting relationship between material living standards and non-material living standards

• Environmental: An increase in material living standards can often result in climate change, greenhouse gases, extreme weather events, rising sea levels and wars over natural resources

• Health and social: Rising incomes, desk type work styles and increased digital devices usage has improvements in material living standards but can negatively impact non-material living standards

• Material: The government may introduce policies designed to promote non-material living standards but could potentially lower material living standards (e.g. limiting work hours to improve work-life balance may undermine national production and incomes)

compatible relationship between material and non-material living standards

• Cultural enrichment: international travel and cultural experiences can increase material and non-material living standards

• Longer life expectancy: higher incomes can be used to extend life expectancy and reduce daily suffering

• Possibility to reduce environmental damage: higher incomes may be used to combat environmental damage and reduce pollution

• More leisure time: higher incomes enable individuals to reduce working hours and stress

factors influencing material living standards

• Levels of national production and income per person: measured by the annual rise in Gross Domestic Product (GDP) per capita (person)

• An increase in level of national production will increase national income and consumption per head

• However, national production and incomes must grow at a faster rate than population for people to enjoy higher material living standards

circular flow model

the role of each sector

• Household sector: all individual members of Australia’s population who supply their resources in exchange for money/income to demand finished goods and services (C)

• Business sector: all trading businesses who demand resources that are then converted into goods and services for supply

• Financial sector: financial institutions who borrow the savings of households (S) to re-lend to customers who use it to finance investments (I)

• Government sector: the government collects revenue from taxation (T) and use this money to provide public goods and services (G)

• Overseas sector: Australians import goods and services (M) from overseas and export to people living overseas (X)

the 4 flows

• Flow 1 — resources supplied to businesses: individuals of the household sector supply natural, labour and capital resources to businesses for production purposes

• Flow 2 — income returned to owners of resources: businesses pay income to households as a reward for providing the resources. This can come in the form of wages for labour, rent for land or interest/dividends to capital providers

• Flow 3 — aggregate demand (AD = C + I + G + (X-M)): the total value of all types of spending (demand) on Australian made goods and services by households and other sectors. Involves consumption spending and leakages + injections

• Flow 4 — aggregate supply (real GDP): the total value of goods and services produced/supplied by the business sector (real GDP)

leakages and injections

• Leakages occur when income leaves the economy. This decreases the level of economic activity occurring

  • Savings, taxes and imports

• Injections occur when income is introduced into the economy. Economic activity rises as a result

  • Investment spending, government spending and exports

  • Note: consumption is not an injection

the business cycle

nature of the business cycle

shows fluctuations in economic activity over time, economists observe that economic activity moves in a ‘cycle’ or pattern

the 4 phases of the business cycle

expansionary/recovery phase, peak phase, slowdown/contraction phase, trough phase

expansionary/recovery phase

• slow economic growth at first then gains pace

  • GDP increases from low levels, cyclical unemployment decreases and inflation increases

peak (sometimes boom) phase

• economy is usually experiencing strong rates of economic growth

  • Peak: GDP at its highest, unemployment at its lowest and inflation at its highest

  • Boom: economic growth is excessive and unsustainable (operating outside of the PPF), increased inflationary pressures, demand for labour rises and shortages develop which increases wages that further add to inflationary pressures

slowdown/contraction phase

• normally follows a peak/boom where GDP growth rate slows/may even fall below trend

  • GDP slower or decreases, unemployment increases and inflation decreases

Trough (sometimes recession if prolonged) phase

• the level of economic activity reaches its minimum point in the cycle, which may turn into a recession (2 consecutive quarters of negative economic growth). A prolonged recession is referred to as a depression

  • GDP at its lowest/negative, unemployment at its highest and inflation at its lowest/negative

aggregate demand

the total spending on new final domestically made goods and services at each price level

AD = C + I + G + (X - M)

AD curve

• Diagram: AD curve sloping downward, price level on y-axis, real GDP on x-axis

• At lower prices, more goods/services are demanded

aggregate supply

the total real value of goods and services that producers are willing and able to supply at each price level, depends on productive capacity — quantity and quality of factors of production

AS curve

• Diagram: AS curve upward sloping, becoming steeper as economy approaches capacity

• Higher prices motivate greater production at capacity, output can’t increase further

AD/AS equilibrium

• Diagram: combined AD/AS showing equilibrium price level and real GDP

• Key: changes in AD or AS shift curves and change equilibrium outcomes

AD conditions

private consumption, investment, government consumption, government investment, exports, imports

private consumption (C)

The total value of all expenditure on goods and services by households

• Largest component, accounts for about 60% of total AD

• Targeting this component has the most significant impact on AD

• Spending on goods and services with short term economic benefits

• Examples: food, transport, rent, clothing, entertainment

investment (I)

Investment expenditure by individuals and businesses on buildings and equipment with the purpose of producing other goods and services, designed to grow the businesses

• The most volatile AD component — highly responsive to economic events

• Less than about 22& of AD

• Spending on goods and services with long term/ongoing economic benefits

• Examples: Manufactured materials, machinery, buildings, computers, farm vehicles

government consumption (G1)

Government spending on the provision of public goods and services to satisfy society’s immediate needs and wants

• Comprises of about 16% of total AD

• Spending on goods and services with short term economic benefits

• Examples: public sector wages, healthcare services, education services, defence operations

government investment (G2)

Government investment on capital or investment expenditure on equipment needed for public or economic infrastructure, expanding productive capacity and efficiency of resources

• Spending on goods and services with long term/ongoing economic benefits

• Only about 3% of AD

• Examples: building schools, hospitals, roads, railways, telecommunication networks

exports (X)

Exports are Australian goods and services purchased by foreign households, businesses, governments and organisations

• They are an ‘injection’ of funds into the domestic economy and thus increase AD

• Examples: iron ore, coal, beef, wheat, wool

imports (M)

Imports (M)

Imports are foreign made goods and services bought by Australian household, businesses, governments and organisations

• They are a ‘leakage’ of funds from our domestic economy and thus decrease AD

• 18-24% of AD each and the net impact is about 4% either way

• Examples: cars, refined petroleum, electrical and electronic equipment, machinery

Net exports = X - M

factors that affect the level of AD

• The AD curve can shift based on prevailing conditions in the economy

1. Disposable income

2. Interest rates (ability to borrow)

3. Business and consumer confidence

4. Exchange rates

5. Overseas economic growth

changes in disposable income

• Total income minus taxes

• An increase in the level of disposable income will cause more to be demanded at any given price

• This could occur because of income tax cuts, increases in the minimum wage, increased transfer payments (i.e. money not earned, for example centrelink welfare payments)

changes in interest rates/borrowing power

• The ability to borrow is affected by both the cost of borrowing (interest rates) and the willingness of financial institutions to release funds

• High interest rates in recent years have decreased the demand for borrowed funds

consumer confidence

• If consumer confidence is high, consumers have a more optimistic view of the state of the economy and therefore will have a greater propensity to spend (C)

• In times of uncertainty, consumer confidence tends to drop

business confidence

• If business confidence is high, businesses have a more optimistic view of the state of the economy and therefore will have a greater propensity to invest (I)

• In times of uncertainty business confidence tends to drop (such as when a bank collapses or there is a pandemic)

the exchange rate

• The exchange rate is the value of 1 currency in comparison to another

• If AUD becomes relatively stronger, AD will fall due to exports becoming more expensive for foreigners and consumer spending on imports increases as foreign goods become cheaper

rates of growth overseas

• Events that impact the economy of major trading partners often impact Australia’s level of AD

• Better conditions overseas tend to mean more demand for exports as overseas customers will be more willing and able to buy them

  • Increased overseas economic growth results in increases to average incomes for those overseas, thus increasing demand for Australian goods and services as exports

How should you structure a response linking AD factors to goals?

1. Factor (demonstrate understanding of the factor) 

2. AD components (AD = C + I + G + (X – M)) 

3. Link spending to production 

4. Impact on the goal

AD curve

• The total annual value of spending on Australian made goods and services is represented by the AD formula

• The AD curve has a negative slope, as the overall quantity demanded decreases when there is a rise in the general price levels

reasons for a downward sloping AD curve

Purchasing power effect

• Higher prices will reduce purchasing power of savings and incomes, which will contract how much people can afford to buy

Interest rate effect

• Higher price will also increase interest rates, making borrowing money more expensive which will contract how much people can afford to buy

Import substitution effect

• Domestic price rises (inflation) encourages Australians to purchase cheaper imports of goods and services, decreasing spending on domestically produced goods and services

shifts of the AD curve

Changes in aggregate demand factors such as a change in consumer confidence, household disposable income etc. can alter the level of aggregate demand curve