LAST CHANCE REVISION - TOPIC 3Economics revision topic from the course of Sir Mirza Taha .pptx

Economics revision topic from the course of Sir Mirza Taha

1. Topic 3: Economic Issues Economic Growth Unemployment Inflation External Stability Distribution of Income and Wealth Environmental Sustainability

2. Economic growth Economic growth refers to an increase in country’s productivity capacity as measured by changes in its real GDP over time. It is a quantitative measure. The Australian Bureau of Statistics estimates the level of GDP in Australia every three months, i.e. for every quarter of the year, in the publication called Australian National Accounts: National Income, Expenditure and Product . The ABS uses information about household and business incomes, expenditure on goods and services, and production by firms to get the most accurate measure of GDP.

3. The ABS measures economic growth the following ways: Income approach (GDP I)  - Measures income generated by the economy: compensation of employees (wages and salaries, and employers' social contributions); gross operating surplus (profits); gross mixed income (income from unincorporated businesses); and taxes less subsidies. Expenditure approach (GDP E)  - Measures final expenditures on goods and services (i.e. those goods and services which are not processed any further), adding on the contributions of changes in inventories and the value of exports, and deducting the value of imports. Production approach (GDP P)  - Calculates the sum of the value of goods and services produced by each industry (its output at basic prices, which implicitly includes taxes less subsidies on production) and deducts the cost of goods and services used up by the industry in the productive process (intermediate consumption), which leaves the value added by the industry. In the production approach, taxes less subsidies on products are separately identified and are not included in the output of industries at basic prices.  Average approach – an average is taken of the Income, Expenditure and Production approaches.

4. Aggregate Demand and Aggregate Supply Aggregate demand is the total amount of goods and services demanded in the economy at a given overall price level and in a given time period. It is represented by the aggregate-demand curve, which describes the relationship between price levels and the quantity of output that firms are willing to provide. Normally there is a negative relationship between aggregate demand and the price level. It includes consumption; investment; government spending; and net export spending (export spending minus import spending). Aggregate supply is the total supply of goods and services produced within an economy at a given overall price level in a given time period. It is represented by the aggregate-supply curve, which describes the relationship between price levels and the quantity of output that firms are willing to provide. Normally, there is a positive relationship between aggregate supply and the price level. Rising prices are usually signals for businesses to expand production to meet a higher level of aggregate demand. Also known as "total output". Part of national income is collected by the government through taxation, and the rest is either spent on consumption or is saved.

5. 1) Calculate AD AND Y for an economy when Government spending is $40m Taxation is $50m - Exports are $30m Imports are $20m Consumer spending is $400m Investment is $300m Savings are $50m 2) Calculate savings when Y = 50m , C = 30m, T = 5m

6. Aggregate Demand and its components Changes in the level of economic growth in the short to medium term are driven largely by changes in the level of aggregate demand. Changes in the level of aggregate demand are influenced by fluctuations in the level of leakages and injections.

7. Influences on Consumption and Saving The most important factor influencing the level of consumption is income itself. People with higher incomes tend to consume more. Economies with higher incomes tend to consume more. If a person’s income rises over time, their consumption tends to rise too. In ascertaining how consumption influences economic activity, economists concern is with the proportion of total income that is spent on consumption (APC) , and the proportion of total income that is saved (APS) . The three greatest influences on the proportion of consumption from a given level of income are consumer expectations, the level of interest rates and the distribution of income.

8. Influences on Investment The main factors influencing business investment are the cost of capital equipment and business expectations. The cost, or relative cost, of capital equipment is influenced by the following factors: Changes in interest rates . A fall in interest rates would make it cheaper to borrow funds for the purchase of capital equipment, and a rise in interest rates would raise borrowing costs. Interest rates also represent an opportunity cost for firms who own their capital. A change in government policies relating to investment allowances and tax concessions on capital goods. Any change in the price or productivity of labour (labour being a substitute for capital in the production process) would affect the relative cost of capital compared with labour.

9. Business expectations about future prospects, a factor sometimes described as entrepreneurial or ‘animal spirits’, influence the level of investment. The factors that affect expectations are: Any change in expected demand for their products . If entrepreneurs expected a future increase in demand, they would be more inclined to purchase new capital equipment to boost production and satisfy that demand. Any change in the general economic outlook . If the outlook for the economy was one of strong economic growth and growing prosperity, entrepreneurs would be more inclined to invest in capital equipment because they would feel that the risks associated with expanding their business were declining. Inflation leads to uncertainty about future prices and future costs of production and this is likely to lead to reduced investment in productive capital equipment.

10. Influences on government spending and taxation One of the main goals of government spending and taxation policies is to maintain a strong and stable rate of economic growth . Governments may increase their level of spending and/or reduce the level of taxation to increase aggregate demand and boost growth. Alternatively, governments may reduce their level of spending and/or increase the level of taxation to reduce aggregate demand and growth.

11. Influences on exports and imports Changes in export sales and demand for imports can have an impact on the level of aggregate demand and economic activity. If export revenue is equal to import spending, net exports (export revenue minus import spending, i.e. the trade balance) neither adds nor subtracts from aggregate demand. Because Australia’s trade balance is usually in deficit , net exports usually makes a small negative contribution to aggregate demand. Volume of exports and imports are also influenced by exchanged rates and the level of domestic and international incomes.

12. STOP AND TEST Outline the influences on consumer and business spending which may have an impact on Aggregate Demand – 4 marks Point (Define AD) Outline (Give characteristics) TWO CONSUMER influences (Choose from interest rates, expectations, distribution of income). - Outline TWO INVESTMENT (interest rates, cost of capital, expectations)

13. The equilibrium level of national income National income is the total value a country’s final output of all new goods and services produced in one year. This level of economic activity or Output (O) is determined by total expenditure (E) of consumers, firms, governments and net exports. Equilibrium income (Y) is the level of income in which there is no tendency for change. Equilibrium national income is achieved when Y = E = O.

14. The simple multiplier Changes in any or all of the autonomous components of AD will cause a change in the equilibrium level of income through the effect of the multiplier. The multiplier is the greater than proportional increase in national income resulting from an increase in aggregate demand

15. Calculate K if MPC = 0.6 Calculate the change in income with spending rose by $35m

16. The larger the MPS, the smaller will be the value of the multiplier. If individuals save proportionately more of their extra income, they will spend less and therefore generate less additional income. It follows that the factor by which we must multiply our initial increase in aggregate demand must also be less. The reverse will also be true – the smaller the MPS, the larger the value of the multiplier.

17. Put simply, an injection into the economy (in the form of government expenditure, increased investments, etc) will have a multiplied impact on national income due to flow on effects E.g. Lower interest rates 🡪 increases business investment 🡪 provides increased income for individuals 🡪 leads to increased consumption 🡪 economic growth However, the injection will not continue to increase national Y forever - each time the injection moves around the economy, its impact on national Y gets smaller because some of the income is saved The simple multiplier measures the number of times the final increase in national income exceeds the initial injection

18. STOP AND TEST DESCRIBE THE MULTIPLER EFFECT - 2 MARKS

19. EXEMPLAR

20. Effects of Economic Growth (I, F, G) Economic growth provides a number of benefits for the economy: increases in real income per capita/standard of living for those employed resources. employment growth may occur, particularly if the existing employed resources cannot meet the increased demand for goods and services despite their productivity increases. higher investment as increased demand for goods and services will eliminate any excess productive capacity. Investment is a particularly important component of aggregate demand as it adds to the nation’s stock of real capital and so provides scope for further economic growth – ‘acceleration effect’ government budget benefits, through both a reduction in its expenditure on unemployment benefits and increased taxation revenue – ‘growth dividend’

21. Economic growth provides a number of benefits for the economy: higher levels of economic growth encourages higher levels of saving from increases in income Higher rates of productivity growth and technological progress, arising from more efficient resource use Increased exports, which can be used to finance imports, lower prices, improved living standards Protection of the environment, as some resources can be reallocated to reduce pollution, climate change, protect threatened habitats Additional leisure time for workers as real incomes rise Can economic growth be bad? Effects of Economic Growth (I, F, G)

22. A number of costs may be associated with economic growth : structural unemployment may result from any structural change accompanying economic growth . inequality in income distribution becomes greater if the benefits of economic growth are not shared equally. deterioration in environmental quality, through pollution of the natural environment or depletion of non-renewable resources as a result of excessive growth. other economic objectives may suffer, such as external stability and low inflation. Overemphasis on materialism and consumerism in society Demand pull and cost push inflation as resources become scarce due to increased demand for goods and services Effects of Economic Growth (I, F, G)

23. STOP AND TEST EXPLAIN THE CAUSES OF AUSTRALIA’S FLUCTUATING ECONOMIC GROWTH RATES AND THE NEGATIVE CONSEQUENCES OF STRONG ECONOMIC GROWTH ON THE AUSTRALIAN ECONOMY - 6 MARKS Band 6 - use contemporary information like covid 19

24. STOP AND TEST Identify the role of aggregate supply in economic growth and suggest ONE method in which government an increase aggregate supply - marks

25. Trends in the Business Cycle Level of Economic Activity Time Trend Line Business Cycle A – No Govt. Intervention Market economies experience fluctuations in the level of economic activity over time - the business cycle for many years, ‘laissez-faire’ government meant no govt. attempt to control economic activity and swings in the business cycle resulted in numerous booms and recessions. Peak or Boom Trough or Recession Upswing Downswing

26. Trends in the Business Cycle Level of Economic Activity Time Trend Line Business Cycle A – No Govt. Intervention Business Cycle B – with Govt. Intervention acceptance of Keynesian theory, meant governments now had a role in controlling economic activity to minimise swings in the business cycle, particularly to reduce unemployment and control inflation. use of demand macro management policies, such as fiscal & monetary policies as counter-cyclical policies reduced swings in the business cycle.

27. Trends in the Business Cycle The business cycle is fluctuations in the level of economic activity over time and: since 1992, the Australian economy entered a phase of uninterrupted economic growth, albeit with different growth rates, for the rest of the decade and continued economic growth has prevailed into this decade – 27 years 2020 ????????????

28. Policies to promote economic growth Macroeconomic policies Monetary policy Fiscal policy Microeconomic policies

29. Government policies to improve efficiency Governments will implement microeconomic reforms and structural change to reduce capacity constraints and improve allocative , technical and dynamic efficiency. Reforms may include: Reduction in international trade barriers Reduction in international financial flow regulations Changes to tax structures Domestic competition policy reforms Financial and labour market reforms Microeconomic policies

30. Economic Issues - Unemployment

31. Why is unemployment an economic issue?

32. Why is unemployment an economic issue? Labour is a factor of production Factors of production affect GDP If labour is under-utilised then an economy is not producing as much as it should be, affecting its economic growth

33. The labour force The labour force consists of: Persons >15 who are working (at least 1 hour pw of paid work or 1 hour unpaid in a family business/farm or not at work due to paid leave, strike, shift, workers compensation) + unemployed but actively seeking work NOT included in the labour force: Children <15 years old Full-time, non-working students People who perform domestic duties Unemployed people NOT actively seeking work Retirees

34. The labour force participation rate Measures the % of the population, aged 15 and over, in the labour force Can be either employed or unemployed

35. The labour force participation rate Measured as: Example: Working age population = 18,000 Labour force = 15,000

36. Trends in participation rates

37. Unemployment rate Reflects the number of people who are out of work but are willing, able and actively seeking work . Actively seeking work Regularly checking advertisements for jobs Willing to respond to job ads, apply for jobs and attend interviews Registering with employment agency

38. Unemployment rate Measured as: Example: Working age population = 18,000 Labour force = 15,000 Number of persons unemployed = 3,000

39. Unemployment rate TOTAL POPULATION WORKING AGE POPULATION Under 15 Retirees Unemployed and not actively looking for work Domestic work F/T non-working students Anyone over 15 UNEMPLOYED (But actively seeking work) EMPLOYED (Working) LABOUR FORCE

40. Influences on the labour force Size of the population – net migration, natural rates of increase Level of net migration and skills base Age distribution of population Age of retirement School retention rate Number of people in full-time post-secondary education Number of married females Levels of unemployment Government policies e.g. paid child care

41. Trends in unemployment Australia’s unemployment rate has been impacted by: 1990s recession Structural change e.g. declining industries GFC Mining boom Changes in social views of jobs e.g. part-time, casual, maternity leave Covid 19

42. Most recent statistics The seasonally adjusted unemployment rate fell to 3.5 per cent in June 2022, according to data released today by the Australian Bureau of Statistics (ABS). Bjorn Jarvis, head of labour statistics at the ABS, said: "With employment increasing by 88,000 people and unemployment falling by 54,000, the unemployment rate fell by 0.4 percentage points, to 3.5 per cent. “This is the lowest unemployment rate since August 1974, when it was 2.7 per cent and the survey was quarterly.” The unemployment rate continued to fall for men and women (both down 0.4 percentage points). "The 3.4 per cent unemployment rate for women was the lowest since February 1974 and the 3.6 per cent rate for men was the lowest since May 1976,” Mr Jarvis said. “The large fall in the unemployment rate this month reflects more people than usual entering employment and also lower than usual numbers of employed people becoming unemployed. Together these flows reflect an increasingly tight labour market, with high demand for engaging and retaining workers, as well as ongoing labour shortages.” The fall in unemployment through the pandemic has coincided with large increases in job vacancies (480,000 in May 2022). As a result, there was almost the same number of unemployed people in June 2022 (494,000 people) as vacant jobs. “This equates to around one unemployed person per vacant job (1.0), compared with three times as many people before the start of the pandemic (3.1)”, Mr Jarvis said.

43. Trends in unemployment Okun’s Law Explains the relationship between unemployment and economic growth To reduce unemployment, the annual rate of economic growth must exceed the sum of % growth in productivity + increase in size of labour force in any one year Based on assumption that output is linked to employment E.g. Australia needs economic growth rates of around 3.5% to reduce unemployment

44. SUMMARY OF UNEMPLOYMENT TRENDS The current unemployment rate is really low at around 4.2% while underemployment increased to 6.7%. The participation rate (the number of people who are currently part of a workforce) increased to 66.2%, which is consistent with pre-pandemic levels. An interesting point is that youth unemployment has decreased dramatically to 9% . Reasons for this include that there’s been a fiscal push from the government to re-skill young people and boost employability prospects. Another reason could be that corporations have struggled recently since they rely heavily on skilled labour, which has become hard to find since skilled migration has decreased. As a result, they’re turning to young people for skilled labour.

45. Types of unemployment Cyclical Structural Frictional Seasonal Underemployment Hidden Long Term Unemployment Hardcore

46. ‹#› Frictional Unemployment Frictional Unemployment - always some unemployment due to workers voluntarily changing employment.

47. ‹#› Frictional Unemployment Frictional unemployment – may reflect acquisition of more skills and training. Duration of unemployment depends on knowledge of labour market and efficiency of job seeking.

48. ‹#› Cyclical Unemployment Cyclical Unemployment or demand-deficient unemployment occurs in the downswing and recession phases of the trade cycle. It is basically due to substantial reductions in aggregate demand or total spending in the economy.

49. ‹#› Cyclical Unemployment Boom Recession Up Turn Down Turn Time Aggregate Demand

50. ‹#› Cyclical Unemployment The reduction in demand for goods and services leads to a reduction in total output and ultimately results in a reduction in demand for the labour that produce those goods and services. Cyclical unemployment is considered serious by governments of the world who are charged with correcting flagging aggregate demand via appropriate economic policy.

51. ‹#› Structural / Technological Unemployment Structural / Technological Unemployment refers to changes in the structure of the economy over time due to technology changes and changes in the pattern and nature of consumer spending.

52. ‹#› Structural / Technological Unemployment Technological change usually means that the demand for some types of workers increases, while others find their skills are no longer relevant.

53. ‹#› Structural / Technological Unemployment Bank tellers under threat from automatic teller machines (ATM), the replacement of horse and carriage by the motor vehicle causing unemployment for blacksmiths are both examples of structural unemployment.

54. ‹#› Structural / Technological Unemployment Changes in consumer demand, will result in job losses in some occupations and gain in others. As compact discs replace records, for example, workers in records factories become redundant.

55. ‹#› Structural / Technological Unemployment Structural unemployment due to mechanization and more recently computisation has probably been significant in recent decades.

56. ‹#› Structural / Technological Unemployment It should be noted that technological changes although responsible for the demise of jobs have created many new and exciting employment prospects, for example, computer programmer.

57. STOP AND TEST Distinguish between cyclical and structural unemployment - 2 marks

58. exemplar

59. ‹#› Seasonal Unemployment Seasonal Unemployment affects occupations such as fruit pickers, fishermen and shearers. Where the nature of their work means that employment may not be available for the whole year.

60. ‹#› Seasonal Unemployment Continuous work for such workers would be highly unusual, especially for those not prepared to travel great distances.

61. ‹#› Hard Core Unemployment / The Unemployable Those who cannot get a job because of their lack of physical or mental ability or their attitude to work.

62. ‹#› Hidden Unemployment Those people who have given up ‘actively seeking work’ due to frustration, loss of self esteem or despair – are more commonly referred to as discouraged workers or the hidden unemployed.

63. STOP AND TEST YOURSELF Differentiate between cyclical, structural and frictional unemployment. In your response, explain the causes of each 6 marks

64. Policies to reduce unemployment

65. Overview Controlling unemployment is one of the most difficult tasks of economic management that a government can have. Long term changes in unemployment take time to achieve and maintaining low levels of unemployment is difficult because of external influences.

66. In Australia in 2009 the government faced the issue of rising unemployment during the GFC. Because of this the government at the time had to make policy decisions on firstly controlling the short term issue of the increase in unemployment but also how they could achieve low unemployment in the long run.

67. Even in times when there is no crisis, the government must be making policy decisions that reduce long term structural unemployment. This is usually achieved through a combination of labour market policies, such as investing in training and other wider economic reform.

68. The choice of policy will depend on ‘what’ the government believes is responsible for the current unemployment increase. The most important tool for governments is macroeconomic policy aimed at sustainable growth and recession control. This is because unemployment can spike very quickly during a recession but takes many years for employment to recover.

69. For example in the GFC many governments directly intervened in their respective economies in order to stimulate economic activity and make up for the sharp fall in aggregate demand. This shift towards expansionary fiscal policy was done in order to reduce the impact of downturn. Treasury estimates suggest that the stimulus reduced unemployment by 1.5%.

70. Macroeconomic Reform In Australia the government aims to reduce structural unemployment (largest contributing factor for unemployment). Macro policies aim to increase economic growth through growth and job creation. The policies implemented in Australia include

71. Tariff reduction Deregulation National competition policy Privatisation Tax reform Labour market reform

72. Labour market policies The government has a range of policy tools they may implement. They range from education and training to wage subsidies. Under the Howard government, labour market reform centred around encouraging greater demand for labour in the market by trying to make the labour market more flexible.

73. The End Game All economy policy is aimed at reaching ‘full’ employment. Of course we know that full employment is a fairy-tale. However, a lower threshold has been decided upon as favourable and that is zero cyclical unemployment. This is referred to as NAIRU

74. Stop and test Explain one government policy that could be used to reduce structural unemployment and one government policy that could be used to reduce cyclical unemployment - 4 marks Make sure you explain HOW it would address it rather than just identify a useful policy

75. EXEMPLAR

76. NAIRU Is non-accelerating inflation rate of unemployment. This means that at some point there will be no cyclical unemployment, economy is at full employment. Even at full employment there will always be some positive level of unemployment comprised of frictional, seasonal, structural and hard-core. (called natural rate of unemployment)

77. Once NAIRU is achieved (elimination of cyclical unemployment) additional economic growth will see firms compete for suitably trained workers and cause wage increases. These wage increase will add to inflationary pressure and not cause any significant reduction in unemployment.

78. NAIRU suggests that policy to reduce unemployment will be worthwhile up to a point, but, any further reduction in unemployment will only create inflation. Estimating NAIRU is difficult, because it tries to remove cyclical influences, even though employment and the economy as a whole is heavily influenced by cycles.

79. This relationship between unemployment and inflation is known as the Phillips Curve. In Australia the NAIRU in 2016 was estimated to be 5.3%. The lower the NAIRU the greater the capacity for the economy to grow without affecting inflation. During the Resource Boom, prior to the GFC Australia unemployment rate fell below NAIRU.

80. However, it did not have any significant effect of inflation, which led many economists to surmise that in fact Australia's NAIRU is significantly lower.

81. EFFECTS OF UNEMPLOYMENT

82. STOP AND TEST DISCUSS THE SOCIAL AND ECONOMIC EFFECTS OF UNEMPLOYMENT - 6 MARKS DON’T FORGET TO DEFINE KEY TERMS!

83. Inflation

84. Measurement Inflation is a sustained increase in the general level of prices in an economy. The best-known and most widely used measure of inflation in Australia is the percentage change in the Consumer Price Index (CPI) . The CPI summarises the movement in the prices of a basket of goods and services, weighted according to their significance for the average Australian household. The basket of goods and services used to calculate the CPI does not include all goods and services available in the economy, but it covers a wide selection that reflects average household spending patterns.

85. Headline inflation Headline inflation is the quarterly change in CPI that is recorded each month. Each item in CPI is weighted in terms of importance in household spending ABS uses an ‘acquisition’ based approach in measuring prices - this removes the effect of rising interest rates The CPI measure of inflation is monitored by the RBA for achieving its inflation target of 2-3%.

86. Underlying inflation An underlying rate of inflation measures the inflationary pressures in the economy that are predominantly due to market forces, i.e. changes in prices that reflect only the supply and demand conditions in the economy. Underlying inflation (aka ‘core inflation’) removes the effects of one-off or volatile price movements. As a result, measures of underlying inflation tend to be less variable than headline inflation. Both Treasury and the RBA have their own calculation of the underlying inflation rate

87. Stop and test yourself Distinguish between the headline rate of inflation and the underlying rate of inflation - 2 marks BAND 6 TIP: DISTINGUISH MEANS YOU NEED TO USE CORRECT LANGUAGE TO ILLUSTRATE DIFFERENCE

88. exemplar

89. Inflation today Media article

90. Causes of inflation Demand pull inflation When aggregate demand (or spending) exceeds the productive capacity of the economy, prices rise as output cannot expand any further in the short term. Consumers force prices up by bidding against each other for the limited goods and services available. The main causes of demand pull inflation are excessive growth in any of the major components of aggregate demand (AD = C +I+G+X-M)

91. Demand pull inflation using the Keynesian Income-Expenditure model An inflationary gap occurs when the full employment level of income is less than the equilibrium level. As AD exceeds the full employment level of the economy’s income, an inflationary gap of cd would arise, leading to a rise in inflation, a higher price level and a fall in consumer’s purchasing power.

92. Cost-push inflation Cost-push inflation is caused by an increase in the costs of the factors of production. When production costs rise, firms attempt to pass them on to consumers by raising the prices of their products. Major sources of cost-push inflationary pressures in the Australian economy include oil prices and wages. When wages increase faster than productivity growth, the cost of labour for each unit of output increases.

93. Stagflation Stagflation occurs when the rate of inflation and the rate of unemployment rise simultaneously. When there is a decrease in AS, then there is a fall in GDP, and an increase in inflation. This fall in real GDP may lead to an increase in the unemployment rate – therefore, a serious outbreak of (cost-push) inflation may lead to stagflation. In the 1970s, Australia, along with a number of other Western nations, suffered from stagflation. This was largely caused by the rapid increase in world oil prices during the OPEC oil crisis, a range of capacity constraints, poor monetary policy regimes and the slowdown in the world economy after the ‘golden era’.

94. Imported inflation This type of inflation is transferred to Australia through international transactions. The most obvious cause of imported inflation is rising import prices. An increase in the price of imported goods will increase the inflation rate in exactly the same way as would an increase in the price of domestically produced goods. Typically true of oil prices and the price of petrol A depreciation of the Australian dollar will also increase the domestic price of imports and will lead to inflation. The extent to which increases in overseas prices or a fall in the dollar will lead to consumers paying higher prices for imports will depend on market conditions.

95. Inflationary expectations If individuals in the economy expect higher inflation in the future, they may act in a way that causes an increase in inflation. There are two ways in which high inflationary expectations can bring about higher inflation: If the prices of goods and services are expected to increase in the economy, consumers will attempt to purchase products before prices increase. If employees expect inflation to increase, they will take this into account when negotiating their wage increases. The economy can experience ‘cost push’ and ‘demand pull’ inflation at the same time through a wage-price spiral .

96. Other causes of inflation Government policies may directly influence the level of inflation in several ways. By increasing indirect taxes, the government can have an impact on the general level of prices. Other measures that may influence prices include deregulating an industry, changing tariff rates, imposing price controls or price monitoring and increasing charges for goods or services provided by the Australian Government. Excessive increases in the money supply can also lead to an increase in inflation. When the increase in the money supply outstrips the growth rate of the economy, an increased volume of money chases the same amount of goods and services and prices are likely to rise. Therefore, increasing the money supply without an increase in real production simply causes inflation (sometimes called ‘monetary inflation’).

97. STOP AND TEST YOURSELF Explain TWO factors that could cause an increase in inflation - 4 marks BAND 6 TIP - FOLLOW DIRECTIVE EXPLAIN: CAUSE AND EFFECT IE CAUSE OF INFLATION AND EFFECT IT HAS

98. Effects of inflation Economic Growth Inflation is the main constraint on economic growth High inflation distorts economic decision making – producers and consumers change their spending and investment decisions in order to minimize the effect of inflation on themselves, e.g. buying assets – misallocation of resources Low inflation has a beneficial effect on the level of economic growth because it removes the distortion to investment and savings decisions which high inflation causes.

99. High inflation discourages business investment because it makes producers uncertain about future prices and costs, and therefore future profit levels. Low inflation has a positive impact on business investment, restoring the incentive to invest in long term productive assets rather than short term speculative investments, which a high inflation environment encourages. High inflation may lead to speculative investment in financial assets rather than economic investment in expanding productive capacity and technological progress.

100. Wages The level of inflation is a major influence on nominal wage demands. During periods of higher inflation, employees will seek larger wage increases in order to be compensated for the erosion in the purchasing power of their nominal wages. This can lead to the emergence of a wage-price inflationary spiral that is very difficult to break, where wage increases lead to higher prices, which lead to higher wage demands and so on.

101. Income distribution High inflation rates tend to have a negative impact on the distribution of income because lower-income earners often find that their incomes do not rise as quickly as prices. Lower-income earners may face higher interest rates on their borrowings if inflation rises. High rates of inflation hurt those individuals who are on fixed incomes or whose incomes are not indexed to (or rise as fast as) the rate of inflation. Higher inflation rates can also erode the value of existing savings so that individuals who do not have a means of protecting their savings from the impact of inflation will see their net wealth decline.

102. Unemployment Levels of unemployment and inflation are closely related in the short term. Higher inflation results in slower economic growth and higher unemployment. Firms face rising labour costs and in turn may reduce the size of their workforce. Firms substitute capital for labour because of rising wage inflation. Phillips curve demonstrates the inverse relationship between inflation and unemployment

103. International competitiveness High inflation results in increased prices for Australia’s exports, reducing international competitiveness and the quantity of exports. As the price of domestic goods increase, consumers will also be more likely to switch to import substitutes, worsening the trade deficit. Low inflation should improve Australia’s international competitiveness, making it more attractive for other countries to purchase Australian goods and services, as well as making local goods more competitive with imports. This should lead to an expansion of exports and the replacement of imports by domestic substitutes, thus improving the trade deficit.

104. Exchange Rates In the short term, high inflation may result in an appreciation of the exchange rate, as speculators expect the RBA to raise interest rates, attracting greater financial flows. However, high inflation generally causes the currency to depreciate over time. Sustained low inflation may foster greater international confidence in the Australian economy, strengthening the value of the dollar.

105. Interest rates Higher inflation results in higher interest rates, central bank tries to reduce demand pressures. Savers will find that the real value of their savings will decline if nominal interest rates do not keep pace with inflation.

106. Positive effects of inflation The main benefit of a low positive level of inflation is that it reduces the likelihood of the economy experiencing falling prices, or deflation . Deflation gives consumers an incentive to delay purchases, which can cause a fall in consumer spending and an economic downturn. Deflation can also make borrowing money less attractive because the amount to be repaid is rising in real terms, not falling. Rising prices of assets(shares and real estate) – asset inflation from a speculative boom. Speculators can gain from asset price inflation if they sell their financial or real assets at inflated prices. However, asset price inflation can lead to a distortion in resource allocation (investment in speculative assets rather than productive assets).

107. Stop and test yourself Discuss the impacts that high inflation could have on the economy - 6 marks BAND 6 TIP - WHAT DOES DISCUSS MEAN?

108. Exemplar

109. REVISION Outline 2 ways to measure inflation List the 4 CAUSES of inflation Outline 3 trends of inflation (last 15 years) HOMEWORK: ASSESS THE IMPACT OF CHANGES IN THE GLOBAL ECONOMY ON AUSTRALIA’S ECONOMIC GROWTH AND INFLATION

110. Policies to sustain low inflation Monetary policy Has played the major role in Australia’s low inflation record since the early 1990s. In the short to medium term, monetary policy is the major tool used to reduce inflation and it attempts to sustain growth at a level that does not create excessive inflationary pressures. If inflation starts rising, the Reserve Bank will implement contractionary monetary policy. This has the effect of dampening consumer and investment spending, resulting in a lower level of economic activity and therefore lower inflation. Results in a decline in the growth of AD and demand pull inflation.

111. Fiscal policy Contractionary fiscal policy involves and increase in the structural surplus or a result in the structural deficit of the budget outcome. Reduction in the net injection of funds from the government sector – reduction in demand pull inflationary pressures. Reduction in government expenditure and/or increase in the level of taxation.

112. Microeconomic policies Can increase competitive pressures, making it harder for firms to raise prices. Examples of microeconomic policies include: Reduced protection has lowered the price of imports through increased competition for domestic producers. Tax reforms to remove indirect taxes such as sales tax which distorted prices. Workplace bargaining through enterprise agreements based on productivity improvements. Investment in infrastructure such as roads, railways and ports to reduce capacity constraints that create bottlenecks, that increase production costs and add to inflationary pressures.

113. STOP AND TEST Explain how government policies can manage the issue of inflation HOMEWORK: 2009 HSC (Q27) Analyse the federal government’s macroeconomic policy mix to address inflation and unemployment in the Australian economy - 20 marks

114. Economic Issues External Stability https://www.ubs.com/au/en/hsceconomics/elearning/economic_issues.html

115. External Stability External stability is about the  financial relationship between Australia and the rest of the world , and in particular, the stability of our currency. External stability is achieved when export income is sufficient to finance import expenditure. If Australia is unable to meet its financial obligations (i.e. debt servicing costs on overseas debt in the form of interest payments), financial markets will lose confidence in the Australian economy, resulting in a depreciation of the Australian dollar and an unwillingness for further lending from overseas. Should the dollar drop in these circumstances, with the valuation effect it further worsens the interest payments required on foreign denominated debt, resulting in an even higher debt load, an even worse CAD, and further worsening of investor confidence.

116. DEFINE THE ECONOMIC OBJECTIVE OF EXTERNAL STRABILITY - 2 MARKS

117. Australia’s CAD Current Account Deficit/GDP Ratio = CAD/GDP x 100/1 CAD Currently -3.6% of GDP & BOGS -0.4% of GDP.

118. Australia’s CAD Since the 1980s the CAD has generally moved in a range of around 3 to 6% of GDP.

119. Causes of the CAD Overtime there have been different explanations for Australia’s persistent current account deficit. Cyclical factors – Exchange rate, terms of trade, domestic economic growth and the international business cycle affect both the BOGS and NPI. Structural factors – Narrow export base, lack of international competitiveness & the savings and investment gap are explanations for the CAD.

120. Causes of the CAD Growth in foreign borrowings(public and private) during the 1980s. Foreign debt replaced foreign equity investment as the main source of foreign capital in the 1980s, raising the size of the net income deficit. During the 1990s there was a switch to reliance on foreign equity borrowings. The collapse in TOT early in 2014 resulted in falling commodity prices, which reduced Australia’s export earnings and raised the cost of imports. This caused a depreciation of the $AUD and persistent deficit on the BOGS.

121. Causes of the CAD The deteriorating state of the global economy. Widespread slowdown in global growth and regional growth has led to large increase in the goods deficit. The slower rate of growth predicted for the Chinese economy (30% of export income) could reduce export performance even further in the future. The lowering of protective barriers(tariffs/quotas) in the 1980s/90s, coupled with the growth of domestic demand, lead to increased import volumes. Depreciating $AUS, particularly to against the US dollar, has led to increased debt servicing costs.

122. Causes of the CAD Savings/investment gap (structural) National savings = Private saving(households+firms) + public savings(govt) The CAD is associated with domestic savings being unable to finance all of domestic investment, requiring a reliance on foreign saving through foreign borrowing. Recent government deficits have caused the savings-investment gap to widen. The trend increase in household savings and corporate savings since 2007/8 has seen the savings-investment gap narrow. Pitchford Thesis states that as long as a CAD is the result of savings and investment decisions by the private sector which are not the result of distortions to normal market mechanisms, there is no cause for concern about an economy’s external stability. The CAD is sustainable if borrowings are invested in exports industries to induce export revenue.

123. Causes of the CAD International competiveness(structural) Lack of international competitiveness – particularly in manufacturing industries. Australia’s manufacturing sector has declined as a share of total output, reducing Australia’s exports of finished goods and increasing our reliance on imports. High inflation and declining international competitiveness in the 1980s reduced Australia’s export earnings relative to import expenditure, worsening the goods balance in the CAD. Dutch Disease : Lack of international competitiveness in non-commodity sectors of the economy(e.g. services) caused by the high Australian dollar(2012-2013).

124. External Stability Pitchford Thesis   The Pitchford thesis states that as long as a current account deficit is the result of savings and investment decisions by the private sector(80% of net foreign debt), then there is no cause for concern about an economy’s external stability. This means private sector firms borrow money from overseas to make profits and therefore they can afford to pay interest on their debts. Pitchford Thesis - 🠙CAD and 🠙 Net Foreign debt is not a problem as the borrowing is mainly private sector which borrow to invest in productive capacity which will 🠙 export income and is therefore sustainable. Pitchford argues if funds borrowed are invested in export industries, this would increase export income in the future. The Australian government has accepted the Pitchford Thesis and that the current account deficit is sustainable if borrowings are invested in exports.

125. External Stability Terms of trade  (export price index / import price index x 100) Prior to the commodities boom driven by China, Australia had a long term secular decline in the terms of trade which placed pressure on the CAD. General trend improvement in Australia’s TOT since 1999. Most dramatic improvement in TOT occurred between 2004 and 2009, and 2010 and 2011. In 2011 the TOT reached 130 its highest level for 140 years. Main effect of the rising TOT on Australia has been the increase in export income in the BOP due to higher prices of mineral exports. This reduced the goods deficit and led to a surplus in net goods in 2008/09, 2010/11. 2011/12 and 2013/14. The rising TOT provided significant stimulus to aggregate demand through rising incomes, increased investment and government taxation revenue.

126. External Stability Exchange rate   Movements in the value of the AUD on bilateral rates, or the TWI. The movement of the AUD is highly correlated with movements in the terms of trade, such that we have moved between US60 cents during the GFC to a high of US$1.1 in 2012. The Australian dollar appreciated against all major currencies such as the YEN, US and Euro between 2000-01 and 2007-08 and in 2010-11 as global resources lifted commodity prices resulting in a large rise in Australia’s TOT. Sustained portfolio and direct investment also increased the demand for $AUD as foreign investors purchased shares and equity in the mining sector. The high exchange rate then hollows out the non resources based economy.

127. External Stability

128. External Stability International competitiveness   Movements in the exchange rate for the $AUD against currencies of Australia’s trading partners influence international competitiveness. Australia became less internationally competitive between 2003 and 2007 and in 2010-11 because of the appreciation of the real exchange rate. Manufactured export volumes fell as did service exports such as travel, tourism and education. As a small economy with high labour rates and relative transportation costs, Australia's lack of international competitiveness results in a narrow export base with a high dependency on commodity exports for which we are a price taker. In this way our external stability is very tied up with commodity prices, the terms of trade and the international business cycle.

129. Financing successive CAD by borrowing overseas leads to a debt servicing commitment. Debt servicing costs will lead to a deterioration in the CAD  🠙 Net foreign debt 🢂🠙 interest servicing costs🢂🠙 Net income deficit 🢂 🠙 CAD Currently with low global interest rates, the cost of servicing the debt has eased. Pitchford Thesis - 🠙CAD and 🠙 Net Foreign debt is not a problem as the borrowing is mainly private sector which borrow to invest in productive capacity which will 🠙 export income and is therefore sustainable. Explain the link between the current account deficit and foreign debt in Australia.

130. Foreign debt is the amount borrowed from non-residents by residents of Australia. It includes securities such as bonds, as well as loans, advances, deposits, debentures and overdrafts. Foreign debt is a subset of the financial obligations that make up Australia’s foreign investment position. It is distinguished from other forms of foreign investment capital inflow such as equity investment (foreign ownership) by the obligation to pay interest and/or repay capital. The method most commonly used is to express net interest payments as a percentage of export earnings (goods and services credits), or the debt service ratio. Explain the link between the current account deficit and foreign debt in Australia.

131. Australia’s level of net foreign debt in June 2014 was $865 billion. From June 1984 to June 2014, the dollar value of Australia’s net foreign debt increased at an annual average rate of 11.6 per cent. As a proportion of GDP, the size of Australia’s net foreign debt has increased considerably more than threefold from 15.2 per cent in June 1984 to 54.6 per cent in June 2014. In 2013–14 a total of $23 billion was paid in net interest overseas. The net interest paid adds directly to the current account deficit as a debit on the net primary income. As with foreign debt, it is useful to obtain a measure of the relative size of interest on foreign debt. This emphasises the international liquidity aspects of interest payments since exports provide a source of foreign exchange income that can be applied to interest payments. Australia’s debt service ratio increased through the latter half of the 1980s to peak at 21.0 per cent in 1989–90. It later fell to 7.9 per cent in 2002-03 before rising again to 12.3 per cent in 2007–08. It subsequently fell once more and in 2013–14 Australia’s debt service ratio was 7.0 per cent. In other words, in 2013–14 the equivalent of 7.0 per cent of the value of goods and services exported was required to pay the interest liability on Australia’s net foreign debt. Explain the link between the current account deficit and foreign debt in Australia.

132. DISTRIBUTION OF WEALTH & INCOME Favela Street in Sao Paulo by Urban Photography

133. In this topic you will learn to: Examine economic issues investigate recent trends in the distribution of income in Australia and identify the impact of specific economic policies on this distribution analyse the economic and social costs of inequality in the distribution of income Apply economic skills interpret a Lorenz curve and a Gini coefficient for the distribution of income in an economy

134. Why look at this? You will learn about: Distribution of income and wealth • measurement – Lorenz curve and Gini coefficient • sources of income as a percentage of household income • taxation, transfer payments and other assistance • sources of wealth • dimensions and trends, according to gender, age, occupation, ethnic background and family structure • economic and social costs and benefits of inequality Read and watch more here, including past HSC questions: https://www.lumenhsceconomics.com/income--wealth.html

135. INCOME LEVELS • OCCUPATION • WEALTH • EDUCATION • GEOGRAPHY What are the predictors? There are a number of factors that can influence the distribution of income and wealth. Income levels Av h/h after-tax income for top 20% is $4,166 per week middle 20% ($1,884 per week) and nearly 6 times that of the lowest 20% ($753 per week). Occupation ABS uses: Managers; Professionals; Technicians and trades workers; Community and personal service workers; Clerical and administrative workers; Sales workers; Machinery operators and drivers; and Labourers. Wealth Average household wealth has now surpassed $1m, but it is very unequally distributed with the highest 20% having more than 90 times the lowest 20% Education In 2020, over two-thirds of Australians aged 20-64 years (69% or 10.4 million people) had a non-school qualification (a certificate, diploma or degree). Geography The Australian Capital Territory continues to record the highest median total income, but the second slowest growth rate since 2011-12.

136. STOP AND TEST YOURSELF Distinguish between the terms income and wealth (2 marks)

137. Measurement – Lorenz curve and Gini coefficient

138. Lorenz curve This is a graphical representation of the distribution of wealth and income in a country. Gini coefficient When all people have the same level of income, the Gini coefficient 🡪 0. When one person receives all income 🡪 1. Income inequality has remained stable in Australia while income growth has been slow. 2017-2018: Aus Gini coefficient for income inequality was 0.328, 2015-16: 0.323 DIFFERENCES BETWEEN GROUPS, NOT JUST COUNTRIES GDP and other measures can indicate overall living standards, but there are often differences between groups within a country. Economists use various measures to explain the distribution of wealth and income and highlight inequalities. How can wealth and income distribution be measured? When considering the circumstances of households, the key economic wellbeing factors that affect people’s material standard of living are income, consumption and wealth. ABS: Household Economic Wellbeing (12/07/2019) Household income in 2017–18 was $1,062 per week. (2015–16:$1,046 per week). 2017–18, household assets were worth $1.2 million while mean household debt was $183,900. This Photo by Unknown Author is licensed under CC BY-SA

139. Sources of income as a percentage of household income

140. 100 90 80 70 60 50 40 30 20 10 Sources of income Proportion of households (%), by main source of household income, 2017-2018, (ABS, 2019) ZERO OR NEGATIVE INCOME 0.4% SUPERANNUATION 5.6% EMPLOYEE INCOME 61.2% WAGES & SALARIES INVESTMENT INCOME 4.1% Interest, rent, dividends, rolyalties TOTAL PRIVATE INCOME 76.8% All sources except govt PENSIONS & ALLOWANCES 22.8% TRANSFER PAYMENTS OWN UNINCORPORATED BUSINESS INCOME 4.3% PRIVATE BUSINESS PROFITS KEY POINTS In 2017–18, the main sources of household income were: employee income (61% of households), the same as 2015–16. government pensions and allowances (23% of households), a significant decrease from 2015–16 (24%). Digging deeper: The highest 20% of households has six times the income of the lowest 20%. Source: ABS, 6523.0 Household Income and Wealth, Australia Source: Inequality in Australia 2020, UNSW & ACOSS, p. 12

141. Taxation, transfer payments and other assistance

142. Estimated Australian Government expenses on social security and welfare Source: Australian Government, Budget strategy and outlook: budget paper no. 1: 2020-21, pp. 6-10, 6-22-6-26.

143. STOP AND TEST YOURSELF Describe how income tax and transfer payments impact on the distribution of income? POINT EXPLAIN (DEFINE KEY TERMS) EVIDENCE (EXAMPLES OR STATISTICS) LINK BACK TO Q

144. Sources of wealth

145. Owner-occupied housing HOME: 39% 39% in the main home Sources of wealth Investment housing Superannuation Shares & bank deposits Other non-financial assets Trends AND AWAY: 12% 12% of wealth is in investment properties LONG-TERM: 21% 21% in superannuation Why? Why is this the largest component of wealth? Who? Who owns investment properties? When? When did super become so important for our wealth? What? What are these financial assets? What? What are these non-financial assets? INTERNATIONALLY In 2019 Australia had the fourth highest average wealth level per adult ($US386,000) in the world and the 11th highest number of people with $US10 million or more. IN THE BANK & BONDS: 20% CARS, ETC: 9% WEALTH HOLDINGS The wealthiest 20% hold more of their wealth in shares, financial and property investments than other groups. Source: ABS, Household Income and Wealth, Australia, 2017-2018 During the boom years from 2003 to 2009, the Gini coefficient for wealth inequality increased from 0.57 to 0.62. After the GFC it fell back to 0.59, then continued to rise to reach 0.62 in 2017.

146. Dimensions and trends, according to gender, age, occupation, ethnic background and family structure

147. Sample 6 3,124 +57% Australia 7,020 +227% Saudi Arabia 180,060 +16% United States 16,370 -8% United Kingdom 3,287 -4% Mexico 10,025 +27% Canada 70,426 +176% China Number of ultra high-net-worth (UHNW) individuals* Growth since 2015 *To be considered an UHNW individual, you must have a net worth of at least US$30m. Source: “The Top 20 Countries for the World’s Ultra Wealthy”, Visual Capitalist, March 15, 2021. Trends in the Number of UHNW individuals

148. Stop and test Discuss TWO economic and TWO social costs which can arise from inequality in the Australian economy – 6 marks

149. STOP AND TEST Investigate recent trends in the distribution of income in Australia – 6 MARKS

150. Environmental Management National and global context Regulations Market-based policies Targets International agreements

151. Environmental management policies are designed to address environmental sustainability issues such as preservation of natural environments, addressing pollution and climate change, and managing the use of renewable and non-renewable resources. Operate similarly to microeconomic policies, aiming to influence the behaviour of individual households, businesses and industries. The two main tools for policy makers are: Regulations Market-based policies

152. Define environmental policies - 1 mark

153. Exemplar

154. Regulations Environmental regulations are the traditional policy tool for achieving environmental sustainability goals. Regulations are laws or rules that govern economic behaviour. Regulations may prohibit a person from doing something that causes environmental damage, such as littering or producing polluting chemicals. In Australia, environmental regulations can be made by local, state or federal governments, or by their agencies. Some regulations impose requirements that the quality of goods meet environmental standards. Eg. the Fuel Quality Standards Act 2000 regulates the quality of fuel for Australia. The aim of the legislation is to reduce the levels of pollutants and emissions from fuels that may cause environmental and health problems.

155. Regulation can require firms and individuals to follow certain environmental procedures. Eg. the Environmental Protection and Biodiversity (EPBC) Act provides a framework for the protection and management of matters of national environmental significance.

156. STOP AND TEST Using an example, give a reason as to why regulation is an effective tool for environmental sustainability. 4 marks

157. Environmental regulations are the traditional policy tool for achieving environmental sustainability goals. Regulations are laws or rules that govern economic behaviour. Regulation is a effective tool for environmental sustainability as it builds strong procedures around actions that can and cannot take place, and removes the harming of the environment through dangerous actions. The Fuel Quality Standards Act 2000 regulates the quality of fuel for Australia. It acts as an effective tool for environmental sustainability as is aims to reduce the levels of pollutants & emissions from fuels that cause environmental & health problems.

158. Market-based policies Market-based policies are policies that involve financial incentives and disincentives ( such as subsidies and taxes) to influence the behaviour of households and businesses. Environmental costs (or benefits), known as externalities, are borne by all of society and not taken into account by producers and consumers in the market place. In the case of negative externalities this results in the equilibrium price being too low and production being too high. A market-based response to this scenario would be to levy a tax or fee on production that is approximately the same as the environmental costs associated with this economic activity.

159. Governments generally prefer taxes over subsidies when they want to influence economic behaviour because aside from discouraging environmentally damaging activities, taxes also raise government revenue that can be used for other environmental programs. Subsidies are grants provided by the government to producers with the aim of reducing costs of production and promoting environmentally beneficial activities.

160. STOP AND TEST Explain how market based policies can be used to preserve the natural environment - 4 marks POINT SENTENCE EXPLAIN - DEFINE POLICY EXAMPLE EFFECT ON ENVIRONMENT

161. exemplar

162. Targets The Australian Government uses many targets to guide its environmental policies. Eg. efforts to increase the use of renewable energy are supported by a Renewable Energy Target (RET) of sourcing 23.5 per cent of Australia’s electricity supply from renewable energy sources like solar and wind power by 2020. The Clean Energy Regulator oversees the operation of the RET scheme in accordance with the RET legislation. The Department of the Environment provides policy advice and implementation support for the scheme. https://www.environment.gov.au/climate-change/renewable-energy-target-scheme

163. STOP AND TEST Assess the effectiveness of one government target - 4 marks ASSESS????

164. International agreements Successful environmental management policies require global cooperation. Collective action is often necessary because individual nations cannot successfully address global environmental problems on their own. Individual nations are often reluctant to impose strict environmental management policies on their own economy if other nations are not willing to do the same. In many cases, international agreements are required to prevent the overuse of common international resources, an issue known as the tragedy of the commons .

165. Climate change A global agreement for climate action post-2020 was concluded at the Conference of the Parties (COP21) to the United Nations Framework Convention on Climate Change (UNFCCC) in December 2015. Key outcomes include: A global goal to hold average temperature increase to well below 2°C and pursue efforts to keep warming below 1.5°C above pre-industrial levels. All countries to set mitigation targets from 2020 and review targets every 5 years to build ambition over time, informed by a global stocktake. Robust transparency and accountability rules to provide confidence in countries’ actions and track progress towards targets. Promoting action to adapt and build resilience to climate impacts. Financial, technological and capacity building support to help developing countries implement the Agreement. The Paris Agreement provides for five yearly reviews of national targets, underpinned by a rules based system that will assess whether countries are meeting their commitments. The Australian Government announced a target for 2030 in August 2015 (26-28 per cent below 2005 levels by 2030).

166. STOP AND TEST Discuss the advantages and disadvantages of international environmental agreements in addressing environmental sustainability in the global economy - 6 marks TIP- make sure you use ECONOMIC terminology such as free rider, public goods etc

167. STOP AND TEST Describe why targets may be used for environmental management -2 marks TIP - Try and imbed a specific example in your response