Econs

Economics is the study of the ways individuals and society decide to use scare/limited resources to satisfy their unlimited needs and wants

Micro

Focuses on the decisions of individual, households, firms and industry

Ceteris Paribus - all other things constant [everything else stays the same except for the change]

Economic Problem - limited resources to satisfy unlimited needs and wants

Opportunity Cost - next best alternative forgone

Questions when Decision making:

1. What to produce?

2. How to produce?

3. How much to produce?

4. Whom to produce for?

PPF - possible combinations of goods/services that can be produced

• Consumer Good: immediate goods

• Capital Good: investments to increase economy

Assumptions of PPF:

1. Resources are fixed

2. Economy is operating at max capacity and resources are utilised efficiently

3. Technology is fixed

4. There are only 2 types of goods

Points on PPF:

• If inside PPF the economy isn’t maximised and resources aren’t being allocated effectively

• If outside PPF it is an impossible point as resources are already maximised with current resources so there isn’t a possibility to reach that point without a change

• If on curve economy is maximised

Market

A market is where buyers and sellers exchange goods & services & resources

Classification of Competition:

1. no. of firms

2. degree of similarity in product

3. ease of entry and exit

4. no. of buyers and sellers

Competitive: Interaction between buyers and sellers where sellers are the price takers e.g. pasta

Non-Competitive: Little to no competition where sellers are price makers e.g. watercorp

Demand: Buying intentions of consumers where they are willing and able to buy at a particular price at the time

Law of demand: as price increases, demand decreases, vice versa

• Inverse relationship

  1. Income effect: price ↑, demand ↓ because of ↓ in purchasing power

  2. Substitution effect: price of one good ↑, other goods become more attractive

• Price Factors (Movement)

  1. increase in price: contraction

  2. decrease in price: expansion

• Non-Price Factors (Shifts) [increase and decrease]

  1. Level of disposable income - income increases, demand increases

  2. Price of related goods - substitute goods at lower price people buy it instead

  3. Interest rates - low rates means more spending or borrowing

  4. Number of buyers - ads, wealth and health impact buyers

  5. Taste/Trends/Consumer preference - taste change, demand change

  6. Consumer expectations - expectation that price ↑ in future, demand ↑

Supply: Quantity producers are willing and able to produce at a particular price at a time

Law of Supply: as price increases supply increase, vice versa

• Proportional relationship

• Price Factors (Movement)

  1. increase in price: expansion

  2. decrease in price: contraction

• Non-Price Factors (Shifts) [increase and decrease]

  1. Input price/Cost of production - increase in cost decrease in supply

  2. Technology - improvement in tech, decrease cost, increase supply

  3. Expectations - increase in price in future = decrease in current supply

  4. No. of sellers - increase in sellers = increase in supply

Market Equilibrium: occurs when consumers and producers come together and exchange a mutually agreeable quantity at a mutually agreeable price

• Shortage - price is lower than the =

• Surplus - price is above the =

• Price Mechanism: Adam Smith, father of Economics, talked about how free markets can motivate individuals, acting in their own self-interest, to produce what is societally necessary aka the invisible hand or price mechanism.

Elasticity

Finding Elasticity Equations

The Point Method

• (ΔQ/Qi) / (ΔP/Pi)

• %ΔQ/%ΔP

The Midpoint Method

• (ΔQ/Qav) x (Pav/ΔP)

PED: Measure of how demand reacts to change in price

Price Elasticity of Demand: shift is demand for a good or service when changes happen on a variable that consumers consider apart of purchasing decision

• Businesses and the Government follow PED as it is an indicator to price

Factors affecting PED

PES: change in supply relative to change in price

Factors affecting PES

Government Taxing

• Elastic goods are unlikely to be taxed compared to inelastic goods due to revenue

• Elastic goods cause Producer Tax index - producers taking on the burden of tax

• Inelastic goods cause Consumer Tax index - consumers taking on the burden of tax

• DWL (dead weight loss) is causes by tax as it is a loss of max efficiency which was avoidable

• TS (total surplus) is decreased with tax as CS [consumer surplus] and/or PS [producer surplus] decrease

• Governments tax to increase revenue

Price discrimination

• Businesses change their prices for different times/groups for customers

• Women haircuts > Men haircuts

• Uber at night > Uber at day

Market Efficiency

1. Producing goods/services that are desirable to consumers at lowest cost

2. Not possible to make someone better off without making someone worse off

3. Utilising scarce resources to make best possible decisions

4. All information is included in price so market isn’t overvalued or undervalued

Marginal Benefit: Max price consumers willing to pay for an additional good

• decreases as more goods are added as enjoyment/benefit decreases

• Can also be known as the price in demand curve

Marginal Cost: Min amount producer willing to sell for additional cost for + unit

• Increases as more units are made

• MC > Price producers will stop supplying

Consumer Surplus: Max amount consumer willing to pay vs what they pay

• CS > CE (consumer expenditure) increase in consumer welfare

• Max - actual

Producer Surplus: Min amount producers are willing to accept vs what they receive

• $ ↑, PS ↑

• PS > Cost of Production, ↑ economic welfare

Total Surplus: Measure of economic efficiency

• TS = TPS + TCS

• TPS = ½ (Actual - min) x Q

• TCS = ½ (Max - actual) x Q

Deadweight Loss: avoidable decrease in TS, preventing production of optimal output

• If market has DWL it is failing

Government Policies in Reducing Efficiency

Government reduces market efficiency to trade off for social benefit, equity and much more

• Market Restrictions

  • Limits supply

  • Taxi licenses

    → reduce congestion and pollution

• Price Control

  • Price Ceiling

    → Maximum price below equilibrium to protect consumers

    → Medicine

    → Rent

  • Price Floor

    → Minimum price above equilibrium to protect suppliers from sellers

    → Milk

• Taxes

  • Raise revenue for government to improve efficiency of economy

  • Tax is added to supply such as cigarettes

  • GST

• Subsidies

  • A cash payment from government to business to encourage the production of goods an services (grant to firms)

    → shift to right as it reduces cost of production

  • Reduce pressure to improve efficiency in future

Market Failure

Occurs when resources aren’t allocated efficiently (TS isn’t maximised)

Government intervention:

• Improve efficiency

• Influence the nature of price

• Respond to fluctuation in economic growth

Types of Market Failure

• Market Power

  • only seller

  • price setters

  • product differentiation

  • Government intervention

    → ACCC prohibits price fixing and collusions [consumer law]

    → collusions reduce competition and increase profit

    → legislate, regulate

• Externality

  • when there are costs or benefits imposed on a third party that is not involved with the economic transaction

  • Private cost: cost incurred by producer and consumer

  • Social cost: cost on third party external to price mechanism

  • Private benefit: benefits reaped by producer and consumer

  • Social benefit: benefit society has, external to price mechanism

  • Within the 2 different types of externality it further splits into consumption and production externalities

  • Negative Externality

    → Production or consumption of a good or service that indirectly causes harm to third party e.g. smoking or pollution

    → Causes overconsumption and overproduction impacting peoples health through secondhand smoke and it harms the environment with ↑ CO2

    → PC<SC

    → Government intervenes with 2 types of policies:

    • Market Based

      → Taxing CO2

      → Taxing Cigarettes by certain percent each year

    • Command and Control

      → Regulating what age, demographic and groups can use product

      → Banning where product can be used

  • Positive Externality

    → Production or consumption of a good or service that indirectly benefits a third party e.g. beekeepers or vaccines

    → There is underconsumption and underproduction as the market is unable to see the benefits to third parties such as herd immunity and pollination

    → PB<SB

    → Government intervenes with 2 types of polices:

    • Market based

      → Subsidising the cost of production to producers to increase production

    • Command and Control

      → Making it mandatory for certain ages, demographics and people to have it

      → Prioritising the licenses needed

• Characteristics of goods

  • Rival Goods: by using good/service it effects other people using good or service

  • Excludable Goods: good can only be used by person who bought

  • Public Goods

    → Non-rival, non-excludable

    → Parks

    → private firms refuse to pay for these goods as they can’t be monetised and there is no profit from it

    → Governments pay for these goods as they benefit society

    → Problem with it is there are free riders who don’t contribute to the good but take advantage of it

  • Private Goods

    → Excludable, Rival

    → Household goods

    → People go buy things at the shop which cannot be used by others as they own the item

    → By buying the item it reduces the stock for others

  • Club Goods

    → Excludable, non-rival

    → Netflix

    → People buy good that others can’t use as it is theirs

    → By someone purchasing good it does not impact another purchasing good as their isn’t a set supply

    → Government can allow companies to set price above marginal cost levels

  • Common Resources

    → Rival, non-excludable

    → Ocean - fishing

    → Tragedy of the commons

    → Fish are free to get from the ocean but people become greedy and take more it will deplete the population of fish meaning others can’t take the same amount

    → Governments restrict the time, area and amount of fish people can take to protect the species and make sure there will be some in the future

    → There are people who disregard these laws made and it negatively impacts others

Macro

Focuses on total economic activity and performance on a whole

What it includes:

• GDP [gross domestic production] - target rate of 3.5%

• Price Stability

  • Measured with CPI

  • Inflation should rise by 2-3% each year

• Unemployment rate - 4-5%

• Equitable income distribution

  • Measured using Gini coefficient in Lorenz curve

• Efficient resource allocation

  • Maximising output to achieve allocative/production efficiency

Aggregate Demand

• Total amount spent in economy over a particular time period

Aggregate Supply

• Total value of final goods+services produced over a period

Participants in economy

• Households

• Firms

• Government

Circular Flow of Income

Basic Circular Flow Assumptions:

• households spend all income

• all output is sold

• no savings

• no government or overseas sectors

Circular Flow Assumptions:

• Financial Sector

  • businesses can only invest and borrow while households can only save

  • investments are capital goods

  • banks attract surplus funds from savers by offering interest rates and make funds to borrowers at high rates

• Government Sector

  • gov employs approx. 20% of workforce

  • taxes improve social welfare

• Overseas Sector

  • drives economic growth around world

  • exports - purchase of goods and services from other countries

• 2 Flows

  • Real Flow - movement of physical resources from HH to firms

  • Money Flow - flow of [E , S , I , T , G , X , M]

• Markets

  • Factor/resource - Resources sold by HH to firms

  • Product - goods + services sold by firms to HH

  • Financial - lenders/savers/borrowers meet at bank

  • Overseas - trade

• Economic activity measured

  • Aggregate Output - value of real flow leaving firms

  • Aggregate Income - value of money flow entering HH

  • Aggregate Spending - value of money flow entering firms {C+I+G+(X-M)}

• Equilibrium

  • Level of economic activity is stable

  • TL = TI [S+T+M = I+G+X]

  • No change in activity

• Disequilibrium

  • Income and expenditure is impacted by L and I

  • TL > TI , AI decreases, C decreases, economy slows

  • TI > TL , AI increases, C increases, economy increases

  • Impact

    • TL > TI output will decrease, employment will decrease, less jobs being occupied causes economy to fall as less is being bought as income has decreased, this causes a contraction in the economy

    • TI > TL employment will increase, output will increase, more jobs being occupied causes a boost in the economy as more people are having a higher income which causes more to be consumed which causes an expansion in the economy

  • Adjustments

    • increase in injection leads to an increase to adjustments reaching increase in income I > L

    • increase in leakages leads to adjustments decreasing income L > I

    • creates a new equilibrium

    • equilibrium is a theoretical concept [ Y = C + S ] because income can only be used for spending or saving

Aggregate Expenditure

AE = C + I + G + (X - M) = GDP

• Total spending in economy

Aggregate Demand

• We study the change in level and why they vary so economic activity can be explained snd managed

• Total amount spent in economy over a particular time period

Consumption: Total spending on goods and services by HH

• Composition in AE is 55%

• 3 Types of Goods and Services

  • Durable {15% composition}

    • used for 3+ years e.g. washing machine

  • Non-durable {35% composition}

    • short period of time e.g. milk

  • Services {55% composition}

    • can’t touch product e.g. insurance

• 5 Factors Affecting C

  • Disposable income

    • increase in disposable income leads to increase in consumption as people are more willing to more make purchases as there is less financial burden

  • Cost of Credit and Availability of Credit

    • increase in interest rates means a decrease in consumption as people are saving more and less borrowing is occurring

  • Stock of Personal Wealth

    • assets on hand [e.g. house] increase, people spend less frugally

  • Expectations

    • expected increase in income people are more willing to spend more increasing consumption

  • Government Policy

    • Fiscal Policy

    • if government want so increase EG they use expansionary fiscal policy by decreasing taxes to increase spending

Income: Income available to an individual after payment of tax

Government Expenditure: Total spending on goods and services by government at local, state and federal levels

• Composition in AE is 25%

• Government injects around $400 bn every year to overcome the impact COVID had

• 2 Types of Gov Spending

  • G1: day to day spending that has to happen e.g. schools, healthcare

  • G2: expenditure to stabilise the business cycle e.g. investment

• Decided Upon by Budget

  • Structural Expenditure

    • allocative expenditure, providing public resources to transfer to households to provide social security e.g. schools

  • Cyclical Expenditure

    • changes with the business cycles

• 2 Factors Affecting Gov Spending

  • Where we are in the business cycle

    • economy in trough, expansionary fiscal policy, increase in eg

    • economy in boom, contractionary fiscal policy, decrease in eg

  • Political Ideology

    • Labour: increases government spending

    • Liberal: decrease government spending

    • Depends on different party in power

Net Exports: Income earned by exports minus the imports spending

• Composition in AE is -3% to 5%

• Trade Balance

• Either deficit or surplus

• Currently Surplus [E>M]

• 4 Factors Affecting Net Exports

  • Where we are in the business cycle

    • upswing/boom, increase in Y, M elastic, trade deficit

    • downswing/trough, decrease in Y, M inelastic, trade surplus

  • The business cycle for business partners

    • trading partners increase, exports increase, trade surplus

    • vise versa

  • Exchange Rate

    • dollar value increases, X decreases, M increase, trade deficit

    • vise versa [deprecates]

  • Terms of Trade

    • ratio of export price to import price

    • TOT increase, trade balance improves

Private Investment Expenditure: Purchase of capital/investment by firms to increase ability to produce output

• Composition in AE is 16% to 25%

• Planned Investment

  • Spending on producer or capital goods that are used by businesses to produce final goods and services

    • Fixed investment: equipment, buildings, construction

    • Residential fixed investment: new housing

    • Working Capital: stocks and inventory

  • Refers to change in capital stock

  • When businesses change the level of planned investment all other equal things AE and AD changes creating a new equilibrium

• 5 Factors Affecting Investment

  • Degree of Uncertainty

    • as it increases firms are less likely to invest [political, overseas, change in tastes]

  • Real rate of Interest

    • Real Rate of Interest excludes inflation and shows firms the real value of money that needs to be paid back based on the base year it can be found [nominal rate of interest - inflation]

    • increase in real rate of interest, investment becomes expensive and less profitable meaning there will be a decrease in investment

  • Business Expectations/Confidence

    • confidence in economy increases, investments increases

  • Profit Levels of the Business

    • increase in profit, increase in investment

  • Government Policies such as Fiscal Policy

    • changes in taxes and gov spending can incentivise firms how to invest

    • decrease in taxes leads to increase in investment

Economic Growth

Increasing the capacity of an economy to satisfy the growing needs and wants of the population

GDP in the Circular Flow of Income

• Market value of output = spending = income received = wages = profit

• Resources match money so we can track what is going on (equal and opposite)

  • all output is sold at market price (market value = spending)

  • total spending = total income

  • total output = total spending = total income (measure of value of GDP)

GDP

• Market value of all final goods and services produced within a period of time in an economy

• includes stock regardless if sold or not as it is produced

• AE = GDP = C + I + G + (X - M)

  • C: HH [including rent]

  • I: inventories

  • G: transfer of money between groups

  • (X - M): net value of exports - import

• Benchmark to compare country size and productivity

• Can add up all the total output of all businesses to measure

• O: 84% of GDP is services and manufacturing is declining

• Y: allows us to see if living standards are increasing as it shows GDP per Person

  • also shows where the money is going

  • 2 sides to transaction

  • capital gain/losses are not counted

PPF

• Moving along curve shows opportunity cost as an increase production of consumer goods, decrease in capital goods [vice versa]

• Shift outwards demonstrates economic growth as there is a increase in potential output e.g. increase in resources or technology

APF [Aggregate Production Frontier]

• The relationship between input and GDP

• Total production in economy

• Shows efficiency of economy by measuring the output per input

• Increasing the input does not increase the output per input, it moves along the curve

• When efficiency increases output increases per input and the APF model moves upwards e.g. technology has improved

• Proportional relationship between output and input [other factors are constant]

• Determines max quantities

• Changes in production are subject to the law of marginal returns

• Law of Diminishing Returns

  • an additional amount of a single factor of production will result in a decreasing marginal output of production [other factors are constant]

• Capital widening when the efficiency is maintaining an increase in economic activity aka consumer spending

• Capital deepening when efficiency increase, economic growth increases due to an increase in supply

Limitations of GDP

1. Prices are not the value

   • GDP is the market value but things are constantly sold below the value so GDP is greater than what it actually should be

2. Non-market activities [HH] production not included

   • GDP only measures what market goods and services that are sold which excludes HH work like laundry ect.

3. Shadow economy is missing

   • Excludes off the book work like babysitting and excludes illegal activities such as the black market

4. Environmental Damage

   • Pollution is ignored and natural resources have no value

5. Leisure doesn’t count

   • Increase in work, increase in money, decrease in quality of life as leisure decreases

6. GDP ignores distribution

   • Views income as the same for everyone ignoring some are better and worse off

Measure of Living Standards

• GDP per person measures average income of a country, increase incomes, increases investing to education, healthcare, etc

Real and Nominal GDP

• Nominal is GDP in todays prices (total production at market value)

  • Inflation makes GDP increase even when the actual production hasn’t changed and same amount is produced

• Real is GDP is constant prices

  • Inflation is excluded

  • GDP due to change in output [isolates economic growth]

  • Measures change in production

  • When we use 1 year price to calculate it is called the base year

• Economists adjust nominal GDP for price changes to obtain a measure of real GDP, they ‘deflate’ nominal GDP using price index

• Equations

  • Real GDP (YR 2+) = NGDP 2 x (CPI 1 / CPI 2)

  • %ΔGDP = [(GDP2 - GDP1) / GDP1] x 100

  • Real Rate % = %ΔGDP - CPI%

  • %ΔNGDP = %ΔRGDP + %Δincome

  • GDP per Capita = RGDP/population = $ per person

Factors Contributing to Economic Growth

• Potential rate of economic growth over time is determined by the stock of natural, human and capital resources used to produce [qualitative and quantitive]

• Depends on willingness to buy goods/services

• Illustrated with APF

Benefits of Growth

• Material living standards increase

  • higher goods and services

  • higher income

  • higher employment

  • creates further growth via multiplier k

• Fiscal dividend

  • rise in output

  • income and spending increases, tax payments used to improve public and merit goods and services

Cost of Growth

• Inflation risk: AD > AS

• Environmental concerns: air quality

• Damage to Social Welfare: excess consumption increases

• Income and wealth inequality

• Structural changes + structural unemployment: may become overly dependent on one sector

Source of Economic Growth

• Sustained economic growth must come from demand side and supply side

• D economic activity can increase by:

  • Fiscal Policy

  • Monetary Policy - RBA reduces interest rates to increase consumption and investment

• S economic activity can increase by:

  • Increasing use of resources

  • Finding better resources

  • Use resources more efficiently

  • Make labour more productive via capital

  • Invest in human capital

    • Increase education and training makes labour force more efficient, motivated, skilled and productive

Relation Between AD and Economic Growth

• AD and AS need to increase to achieve economic growth

• without AD

  • investments are low

  • depreciation in capital stock

  • lower levels of tax revenue

  • decrease in labour force

  • fall in international competitiveness

Inflation

Unemployment

Business Cycle

Income Distribution

Government redistributes income to support and maintain a minimum standard of living (40% of spending/budget used)

Role of Government in a Modified Market Economy

1. Provision of goods and service

• Provide without profit

• Private firms have no incentive so govt takes over providing these as they benefit people

• Street lamps, education, healthcare

2. Redistribution of Income

• The government uses progressive tax (personal income tax) to redistribute income within the country

• Income can be redistributed while wealth can't really (Inheritance cannot be taxed in Australia)

• The higher income earners take majority of the burden with the highest tax bracket being $190K and up with it claim a ≅ 45% of income

• The government then uses this for welfare such as jobseeker

3. Regulation of Business Enterprise

• ACCC - Australian consumer act, ceilings and floors

• Used to have fair competition and protect consumers (rules against anti-competition)

4. Macroeconomic Management

• Fiscal policy is used by the government to increase or decrease the flow of money in the economy by either increasing or decreasing taxes and spending

• This was introduced in the 1940s to help with the fluctuation in the business cycle

Redistributive Role

• Welfare benefits (pension/jobseeker)

• Progressive taxes

• Provision of essential goods/services

• Public housing, education, healthcare

• Reduces burden on people, leaving more for spending on discretionary goods

• Compulsory Superannuation

• Employers are required to put a % of income into a superannuation account which employees can access when they are over the age of 67.

• This improves equity and allows elders to have a decent living standard when they retire

Causes of Income Inequality

- Mobility of Labour

- Ease of movement between occupations or geographic regions

- Primary Labour Market

- Little to no likelihood of unemployment e.g. doctor

- Secondary Labour Market

- Frequent unemployment, casual employment and low/declining wages e.g. waiter

- Relative Poverty

- Situation where income/lifestyle is below minimal/average living standards

- Unemployment

- long-term or permanent loss of job e.g. bank tellers

- Underemployment

- employed less than full time or inadequate amount in respect to economic needs

Income VS Wealth

- As income increases the capacity to have greater wealth increases

• Income is the flow of funds

• Majority of households have at least one income with some households also receiving transfer payments from the government

• Once direct and indirect payments are applied HH are left with disposable income

• Direct Tax: personal income tax

• Indirect Tax: GST

• Many HH receive some form of indirect benefits e.g. education, healthcare

• Wealth is the stock of assets

• It refers to the current value of assets a HH has accumulated overtime

• This can be through savings, investment, business profits and inheritance

• Defined as the difference between HH assets and its liabilities

• Assets generally are as property, shares, savings

• Liabilities are generally loans, mortgages, debt

Distribution of Income

- Very few Aussie live in absolute poverty (basic needs)

- 20% Aussies live in relative poverty (just below minimal living standards)

Income Redistribution

- Key elements of income redistribution

- Direct Taxation - Progressive tax

- Spending Powers - Direct Transfer (40% of budget)

- Indirect Payments - Public Services

Government and the Macroeconomy