Commerce

The Nature of Economics

The nature of economics is the study concerned with consuming goods and services that help regular functioning.

Key terms:

Business cycle: the cyclical fluctuations in the general level of economic activity
Depression: a severe contraction in the level of economic activity resulting in many business failures, high and sustained levels of unemployment and sometimes falling prices.
Recession: a relatively mild contraction in the level of economic activity in many business failures, high and sustained levels of unemployment and sometimes falling prices.
Contraction: when an economy loses steam
Expansion: when thers is economic growth
Boom: the peak of economic growth
Economic growth: the national output of an economy

The business cycle

The business cycle is a period of high and low economic activity. After a period of prosperity, business activity gradually slows down until a recession and depression are reached. Eventually, business picks up again until prosperity is restored.
The level of the economy moves up and down, Meaning total production, incomes, spending and employment rise and fall. The fluctuations are caused by the level of total spending by consumers (consumption), business spending (investment) and government spending within the economy.

Business cycle graph

Inflation

Inflation is a general increase in prices and the fall in the purchasing value of money
The cause of inflation occurs due to the demand for goods and services and exceeds what businesses can supply. As a result, the supply of goods and services gets disrupted

Recession

Recessions are caused by a lack of spending, not the inability of the economy to produce goods and services.
The amount produced depends on how much the business thinks consumers, other businesses and governments will buy, which is influenced by the level of economic confidence.
If products aren't bought, businesses may cut production, resulting in job losses and reduced spending. A widespread, prolonged recession is called a depression.
Income and production are at their lowest level.
Unemployment is at its highest level in the business cycle.
Wages and salaries either fall or grow very slowly

Boom

The upside of the business cycle is growth and prosperity, production, spending and employment rise.
There is a limit. When this happens, additional spending pushes up prices. Inflation, a general rise in prices, now becomes a major economic problem and eventually brings an end to the continued growth.

Impacts of contractions and expansions in the business cycle

Contraction

Total output = falling levels of production
Consumer spending = Decreased consumer spending
inflation = rate of inflation may fall
Wage rates = Wage rates generally fall
Interest rates = interest rates eventually fall
Unemployment = level of unemployment rises

Expansion

Total output = increasing levels of production
Consumer spending = increased consumer spending
inflation = rates of inflation may rise
Wages rates = wages rates generally rise
Interest rates = interest rates eventually rise
unemployment = level of unemployment fall

The circular flow of income ( the five sectors)

What is the economy?

The economy is the state of a country in terms of the production and consumption of goods and services and the supply of money.
Macroeconomics=the study of the economy as a whole.

Economic relationships

On a daily level within the economy individuals and businesses rely on each other to supply their wants and needs that they can not supply for themselves. Therefore this reflects the idea of interdependence in the economy.
Some individuals can have a certain expertise in a particular area therefore they become the experts within the economy showing the idea of specialisation.

What is the circular flow of income?

The circular flow of income shows the connections between the five different sectors of an economy:

Consumers, businesses, financial institutions, the government and the overseas sector.

It also shows where money is being injected into the economy and where money is being lacking from the economy. These injections and leakages help economists calculate changes in the level of economic activity within an economy.

Difference between leakage and injection

Leakage:

Is the introduction of income into the circular flow from sources outside houses and businesses, such as additions to investment, government expenditure and exports

Injections:

It occurs when there is a withdrawal of money from the economy that results in a reduction of the national income (money not being utilised anywhere in the economy)

Sectors of the economy

The consume and Business sector (2 sectors)

The household sector of an economy is made up of consumers, who hold economic resources such as land, labour, capital and enterprise.
In a simple two-sector economic model, the other sector of the economy is the firms sector.

People sell their resources to firms (businesses) in exchange for an income.
Firms then use the resources of households to produce goods and services. This is known as Production.

Households will then use their income to buy various goods and services. This is known as consumption.
Consumers and businesses are interdependent on each other- businesses can't survive without consumers and consumers rely on businesses (demanding to safety needs+wants)

Financial (third sector)

Refers to financial institutions- banks then act as intermediaries between the savers and borrowers in an economy
They receive the savings of individuals and businesses and then this money to others who need to borrow money
A choice of savings or investments is an important factor within the economy. Saving (S) refers to putting money away for later use and is a leakage used to expand and grow a business
This means investments are an injection into the circular flow of income.

Government (Fourth sector)

The government sector refers to local, state and federal governments and has two significant roles in the circular flow of income:

Taxation (leakage): the government collects taxes from individuals and businesses when they earn an income or profit
Government expenditure (injection): this is when governments spend money raised through taxation on things such as infrastructure, welfare payments, education, and health

Overseas (fifth sector)

The role of trade in helping an economy grow. Trade consists of exports and imports.

Exports (X) refers to Australian businesses selling their goods or services to overseas individuals, businesses or governments. These are as an injection into the circular flow of income.
Imports (M) refers to the buying of overseas goods and services by Australians. These are a leakage from the circular flow of income.

How do economists measure this?

The circular flow of income is used by economists to measure changes in the level of economic activity; that shows if it is growing or shrinking. This is done by adding up the injections into the economy and comparing them to the leakage out of the economy.

When injections are greater than the leakages, economic growth occurs and the economy will expand
When leakages are greater than injections, an economy will experience economic decline

It is the government's role to try to manage and maintain a balance within their nation's economy by altering flows of money and influencing decisions within sectors.

Equilibrium

What is an Equilibrium?

The point at which demand and supply intersect is called market equilibrium
The price mechanism of the intersection of the forces of demand and supply that determines the price of a good or service

Why do the prices of products always change?

Change in demand

A change in any factor other than price will cause a shift in the entire demand curve and change the equilibrium price and quantity.

Graph of equilibrium

Movement in the demand curve

If demand shifts outwards from D1 to D2- we see a rise in both price and quantity
Total spending by consumers will rise

Movements in the supply curve

If supply shifts outwards from S to S1 - we will see a rise in price and a fall in quantity

Equilibrium in the circular flow

The economy is in equilibrium when:

Leakage=injections

The economy is expanding when:

leakages<injections
Injections > leakages

The economy is contracting when:

leakages>injections
Injections<leakages

To find out if the equilibrium, expanding or contracting

You would use this formula S+T+M= I+G+X

Example:

S=100, T=150, M=200, G= 80, X=170, I =200

S+T+M=I+G+X

100+150+200= 200+80+170

450=450 (Equilibrium)

The nature of markets

What is a market

A market exists in any situation where buyers and sellers come together to exchange goods and services.

So as long as there is a buyer and a seller that exchanges products there is a market
We can also say whenever there is a buyer there is a demand and when there is a seller there is a supply

The type of markets

Retail

The sale of goods and services by a business to the consumers

For example: consumers are the buyers/ demands and the stores are the sellers/ suppliers

Labour

The buying and selling of labour.

People want to sell their labour and businesses want to buy labour
The price paid by the employer as a buyer of labour is known as a wage or salary.
buyers/demand is the employers and the seller/ supply is the employees

Financial market

Financial markets are the intermediaries between the savers and the borrowers in an economy.

Goods and services have prices, and so does money. Just like a business that sells products for money, you can ‘sell’ (save) your money for money (interest). Just like how you might buy a product using money, you can buy (borrow) money for money (interest).
Buyers/Demand is the borrowers and the seller/supply is the savers

Stock market

The stock market is a relationship between buyers and sellers of units of ownership in a company.
Similar to other markets, the value of shares goes up and down depending on the company's performance, affecting demand and supply for these shares.

A company's value increases with strong performance, boosting demand and prices. Poor performance leads to selling, raising supply and lowering prices. The ASX lists only Australian shares.
Buyer/Demand is the investors, and the seller/supply is the shareholders

Supply and demand

Law of demand

As the price of a good or service increases, consumer demand for that good or service will decrease.
There is thus an INVERSE relationship between price and quantity demanded.
There are 3 laws

Substitution: describing how consumers switch to cheaper alternatives when the price of a good or service increases, leading to a decrease in demand for the original product
Income ( if income is good people will buy, for businesses this will mean if prices are expensive = less purchase, but if they are cheap/affordable = more purchases)
Law of diminishing marginal unity: This law states that, as a person consumes more of a good, the extra satisfaction they get from each additional unit decreases.

Graph of Demand

Shifters in Demand

Shifts of demand (a new relationship between price and quantity)

Preferences- taste, popularity etc.
Number of buyers
Prices of related goods – substitutes and complement
Expections (e.g. if you think the price is going up/down people will buy more – e.g covid times )
Income

Factors affecting demand

The price of the good itself
The price of other goods
Expected future prices
Changes in consumer tastes and preferences
The level of income
The size of the population and its age distribution

Law of Supply

As the price of a good or service increases, willingness to sell good or service will increase
There is thus a relationship between price and quantity demanded.
Supply is the quantity of a good/service that businesses are willing and able to offer at a given price, at a given point in time

Shifters of supply

Price of resources
Government involvement
Number of sellers
Expectations

Factors affecting supply

The price of the goods itself
Wages
Cost of production
Productivity
Technology
self

Graph for supply

Note for the Demand and supply graph

When the demand or supply increase it goes to the right
When the demand or supply decreases it goes to the left

Government Interventions

Why should the government intervene?

Government Interventions include how the government uses taxation, spending and borrowing to influence the economy → to have an impact on a market

Prevention of Environmental Degradation

Preventing environmental degradation is vital for our economy and well-being, as we rely on it for air, food, water, and production.
Governments can attempt to reduce environmental degradation by imposing regulations that restrict people from things that cause environmental damage.

Enforcing legislation (law)

Conservation of Natural Resources

The overuse of natutal resources is both an environmental and economic issue
The challenge faced by governments is the trade-off between the short-term exploration of natural resources for economic gain and the long term needs of both society and the economy
For long-term economic growth, the environment needs to be sustainably managed

Price Ceilings and price floors

Price controls by the government

Laws enchanted by the government to regulate prices are called price controls. Price controls come in two favours. A price ceiling keeps a price from rising above a certain level. A price floor keeps a price from falling below a certain level.

Price ceilings

If the government does not like the equilibrium price point in the market because it is too HIGH, it may want to change it
They impose a maximum price that can be charge for a good/ service
For example:

Rent control- where the government limits what landlords can charge for rent in an attempt to make housing more affordable
Natural disasters (where clean water becomes a scarce commodity)- governments may implement a price cap on bottled water

The graph for the price ceiling

P0 and Q0 represent the market price of a water bottle at $20, where 200 units are demanded. The government sets a price ceiling to prevent supplier exploitation at $10. At this price, demand rises to 300 bottles, but suppliers are only willing to sell 100, creating a shortage with excess demand.

Price floors

If the government does not like the equilibrium price point in the market because it is too slow, they may want to change it
The government will impose a minimum price that must be charged for a good/service
It MUST be higher than the equilibrium price
For example:

Often governments do price floors for wages in the labour market
Wheat-wage farmers get paid for wheat is worthwhile

Graph for the price floor

The equilibrium of this market allows for 300 jobs at $10/hr.
The government might believe this is too low and intervene to raise the minimum wage to $13/hr instead.
This now means there is a surplus (or excess) of supply. At $13/hr, 400 people are willing to work (supply), whereas there are only 200 buyers/employers/demand paying for $13/hr.
This means there’s a surplus in supply (400-200).

Price cap

A "price cap" refers to a maximum limit or ceiling on the price of something, often used in regulated industries or contracts to control costs and mitigate risks.

Tax and subsidy

Tax

What is tax and how does it work?

A tax is a mandatory financial charge imposed by a government on individuals or businesses to fund public services and infrastructure.

Government imposes tax
Businesses and individuals pay tax
The government uses tax revenue

Supply curve shifts to the left → increase in cost of supply

The gap between the vertical lines is the size of the tax

Sugar tax

Sugar tax (excise tax) that government has imposed on sugary drinks to reduce sugar consumption to encourage society in better health choices.

How does it work

Manufacturers produce sugary drinks → must pay tax based on sugar content
Higher sugar = higher tax → tax is applied per ‘g’/’L’ of drink
Manufacturers may increase prices → costs imposed to consumers
The government collects tax revenue → used for healthcare, obesity programs, public services etc.
Consumers may choose healthier options → encourage companies to reformulate drinks with less sugar (most brands did except Coca Cola)

Subsidy

A subsidy is a financial benefit given by the government to individuals, businesses or industries
Forms of cash payments, tax cuts or lower prices on goods and services

How does it work? (Let’s use an education degree as an example)

Government provides financial support → given to businesses, farmers or consumers (in this case uni students studying education - In AUS we are lucky to have HECS-HELP)
Lowers production costs → businesses can produce goods/services at a more affordable price → unis providing the degree at a lower price compared to a Law degree
Reduces prices for consumers → makes essential goods and services affordable
Encourages production and economic growth → helps industries grow or compete globally

How does subsidy look on a D+S graph?

A subsidy affects D+S graph by shifting supply curve to the right (increase in supply).

This happens because production becomes cheaper allowing businesses to produce more at the same time

For example:

A government may subsidise farmers by giving them money to produce wheat. This lowers the cost of wheat, making bread cheaper for consumers and have an ample supply of bread.

Effects:

Initial equilibrium
Supply curve shifts to the right → reduce production costs and businesses supply more
New equilibrium → increased quantity and lower prices