ECONOMICS

AREA OF STUDY TWO- M ANAGING EMPLOYEES

Types of Living Standards and The Factors Which Affect Them

LIVING STANDARDS

DEFINE
- Living standards is a concept used to the quality of life a person receives , generally in terms of an economy's xl level of wellbeing
the average person owns.
- This is influenced and made up of two components
 material living standards
 non-material living standards.

MATERIAL LIVING STANDARDS

DEFINE [3]

- Material living standards are the level of economic wellbeing that individuals experience as reflected through their ability to consume
 given the quantity of tangible goods and services available for each person to access
 That is measurable through national statistics
- in this sense being able to consume is seen as an increase in material living standards as these material wants and needs are able
to be satisfied to a greater degree.
- In a general sense the factors are the points of argument to be used when assessing living standards include:
 Purchasing power
 Availability of goods and services

FACTORS THAT INFLUENCE MLS [4]

LIST
 levels of national production and income per head
 ways in which goods, services and incomes are distributed and divided
 rates of unemployment
 rates of inflation affecting purchasing power

GROWING NATIONAL PRODUCTION AND INCOME PER HEAD – ACESS TO GOODS AND SERVICES

- emphasis is put on lifting the national production compared between one year and the next
 given that the size of the economy continues to grow, and that each person will need to consume goods and services,
- this is measured and monitored by the annual rise in gross domestic product (GDP) per capita (per person)
 meaning there is a higher level of production of goods and services than the year before
 as higher production levels generally come about through the increase of national income and expenditure.
- increased production is important where it provides an income stream for households
 which consequently allows for increased purchasing power that provides quality goods and services in increased amounts
- This in turn enhances living standards since increased supply allows for more persons to benefit off them.
- Although, for this idealistic situation to occur, production must operate at a rate faster than the population growth
 so that individuals are able to enjoy higher MLS.
- increasing GDP per capita is reliant on other factors such as
 improved efficiency in terms of the consumption of resources
 access to increased quantities of costs of production
 machinery in terms of technical efficiency.

DISTRIBUTION OF GOODS, SERVICES AND INCOMES

- MLS are strongly affected by the way goods, services and incomes are shared and distributed between people.
- an uneven pattern of distribution would indicate that a small minority of people may consume a majority of goods and services
 which would cause most people to live in poverty with a considerably and relatively low MLS.
- To optimise the benefits of big economy, these must be shared around
 so that a majority of people are able to enjoy a better material wellbeing as achieved through government policies
 to reduce the levels of inequality by promoting a more symmetrical or even pattern of distribution.
 [example] the richest 20% of people due to increased purchasing power would consume a majority of goods and services at
approximately 60% would cause most people to live in poverty.
- such policies may include:
 progressive taxes (where the tax rate increased in accordance with income earned)
 welfare benefits
 subsidised services

GENERAL RISE IN PRICES PAID FOR GOODS AND SERVICES OR THE INFLATION RATE
- the rate of inflation, involving a sustained increase in the general level of price for goods and services over time
 - Reduces purchasing power and consequentially MLS
 to which cause rises in price
 that inhibits the ability to properly consume commodities as they assume more disposable income.

JOBLESS OR UNEMPLOYMENT RATES

- terminated or unemployed individuals generally have lower incomes due to a loss of income stream and therefore less purchasing
power.
- this would lessen their level of consumption and ability to access goods and services where high levels of unemployment collectively
reduce society's MLS.

NON-MATERIAL LIVING STANDARDS

DEFINE
- measures a wider range of factors that affect a person’s wellbeing/quality of life
 unconnected to material possession or purchasing power
 difficult to quantify and measure as they are subjective or depend on individualistic personal values
 Including: [4]
 levels of happiness
 job satisfaction
 environmental health
 crime.

FACTORS THAT INFLUENCE NMLS

LIST
 happiness, physical and mental health (especially stress)
 Environmental quality
 a long-life expectancy
 high literacy rates
 crime rates

ENVIRONMENTAL QUALITY
- Many industries are inextricably linked with the environment, for example mineral commodities, timber and fishing.
- If these natural resources are degraded in terms of quality or quantity, these industries will suffer, reducing production and hence
national material standards of living
- Pollution and climate change make the environment less pleasant, which damages non-material standards of living.
 Affects happiness, physical and mental health
HAPPINESS, PHYSICAL AND MENTAL (MLS + NMLS)
- On a personal level, physical and mental health problems are expensive and upsetting, hence reducing both material and non-
material living standards
- On a macroeconomic level, it is more expensive to provide public healthcare if the population is unhealthy, meaning this money
cannot be spent elsewhere and material living standards are decreased.
- They are also decreased because unhealthy workers are less productive, meaning higher prices and lower production levels

LIFE EXPECTANCY
- The longer the length of life, means higher material standards of living
- Additionally, living longer is associated with better health, safety, and working conditions which are all indicators of high non-material
standards of living

CRIME RATES
- People feel safer in a country with lower crime rates, hence non-material living standards would be higher.
- Furthermore, less money needs to be spent on law enforcement, so material living standards are higher

LITERACY RATES
- In a country with higher literacy rates, workers will be more skilled and hence more productive.
- They can utilise more sophisticated business techniques and are hence more efficient, whereby leading to higher material living
standards
- The ability to read also gives an individual a better sense of adequacy and personal achievement.
- They can access written knowledge, hence allowing them to be entertained and mentally challenged where non material standards
of living are hence increased through higher literacy rates.

ACCESS TO GOODS AND SERVICES

- Determined through the utilisation of real GDP
- Is a misleading determinant of non-material living standards as in an extensive access to products, individuals may be too
materialistic and in turn diminishes feelings of content
- Additionally, they may spend their money on goods and services with negative externalities

THE RELATIONSHIP BETWEEN MLS AND NMLS NON-MATERIAL LIVING STANDARDS

 DEFINE
- material and non-material living standards cannot be isolated and looked at individually as they interact with and therefore impact one another
there are two types of relationships that may exist between material and non-material living standards.
 conflicting relationships
 compatible relationships

CONFLICTING RELATIONSHIPS

DEFINE
- This refers to the inverse consequences that occur in a trade-off where progress in one area undermines the other, resulting in both beneficial
and adverse consequences
- Generally, this will benefit MLS however deteriorate NMLS.
 [example] increases in Australia’s levels of national production and income per head (benefits MLS) although negatively
impacts the ability of future generations in their respective output and ability to consume (deteriorates NMLS)

ENVIRONMENTAL TRADEOFF – PRODUCTION RESOURCES v ENVIRONMENT

- materialistic values and greed for consumption utilise natural resources to produce goods and services for purchase.
- this will raise material wellbeing however producing these commodities will negatively impact the environment through pollution, climate
change and war tensions (competition over scarce resources)

HEALTH AND SOCIAL TRADEOFF – WORKING v LIVELIHOOD

- increases in material living standards require more supply which makes access to commodities both accessible because of more quantity and
increased purchasing power.
- however due to this increased need for work, leisure time has eroded, stress levels may elevate and cause aggravation, tension and less
devotion to home life.
 [example] the rise of fast food due to increased access to its prevalence and ability to be purchased online, has also been
linked to adverse medical consequences and has been contributed to the decline of life expectancy of today’s generation to
be lower than that of the previous.

MATERIAL TRADEOFF – PURCHASING POWER v LIVELIHOOD

- the government may introduce policies designed to promote NMLS through tighter government environmental controls (such as excise tax or
schemes).
- limiting working hours to raise leisure time and home-work life balance.
- these measures would undermine national production and incomes, lowering MLS.

COMPATIBLE RELATIONSHIPS

DEFINE
- this refers to the parallel of consequences inducing a result in which progress in one area of wellbeing promotes the other

HIGHER INCOMES
- allows for more international travel and cultural enrichment
- can be used to extend life expectancy and reduce daily suffering from pain and curable ailments
- can be directed to combatting environmental damage and reducing pollution
- enables individuals to reduce their working hours and stress

MEASURING AUSTRALIA’S PROGRESS (MAP)

- As the standard of living is a broad concept involving society’s general wellbeing, one attempt able to determine whether living standards are
progressing, or regressing is called 'measuring Australia's progress (map)'.
- This is prepared by the Australian bureau of statistics (ABS), whose role is to investigate four main domains or categories
 economy
 society
 governance
 environment
- each domain owns its own respective goals or values, where these aspects have an indicator associated with them.

Economic Activity

NATURE OF ECONOMIC ACTIVITY

DEFINE
- economic activity refers to the actions of individuals, firms and governments that aid in generating goods and services, employment and
incomes.

PURPOSE
- Mainly the process of converting scarce resources into goods and services
 its main purpose therefore satisfies society’s problem or relative scarcity
 through which it helps satisfy their seemingly endless needs and wants to improve living standards.
- economists use the concept of the level of economic activity to describe the general pace or speed at which productive activity is occurring at a
national level.

HOW IT IS DETERMINED.
- From a microeconomic viewpoint, the level of economic activity in each individual industry is determined largely by changes in relative prices
and profits in specific markets, both here in Australia and overseas.

NATURE OF ECONOMIC ACTIVITY

OVERVIEW
- At both present and future periods, the level of economic activity is able to greatly influence both
 Australian material (the annual quantity of goods and services consumed per person)
 non-material (the quality of a person's daily life) living standards

EFFECTS ON CURRENT MLS

- federal government policies are able to regulate and influence economic activity in order to actively pursue its core domestic aims of
 a sustainable rat of economic growth
 full employment
  low inflation rates
- Furthermore, economic activity is able to directly affect current MLS where:
 it affects the quantity and quality of goods and services produced and available to the population in order to help satisfy its
needs and wants
 it influences employment opportunities, and consequently the number of jobs available and unemployment rate
 it determines our average incomes, prices, purchasing power and consumption levels per person.

EFFECTS ON FUTURE MLS AND NMLS

- although higher levels of economic activity can allow the current general to enjoy better material prosperity
 there is a worrying realisation that extra production requires the extraction of common goods and depletion of scarce non-
renewable natural resources
 such as minerals, water, clean air, forests and oceans.
 This reduces access by future generations limiting their overall living standards.
- this is due to the conflicting relationship between time periods, evidenced by negative externalities impacting the environment
 climate change
 urban congestion
 family tensions
 able to be resolved through temporal efficiency.

MEASURING THE LEVEL OF ECONOMIC ACTIVITY

DEFINE
- Naturally, economists are interested in regularly measuring changes in Australia’s economic activity that assists in assessing how the economy
is performing.
- However, accurately measuring a nation’s economic activity is a huge, difficult and somewhat inaccurate process.
- there are a variety of ways to attempt accurately measuring a nation's economic activity.

GROSS DOMESTIC PRODUCT (GDP)

DEFINE
- Gross Domestic Product or GDP as measured at current prices, quantifies the total amount of production as reflective of the total market value
($) of finished goods and services that have been produced by a country over a period of time

CPI
- Consumer price index or CPI is a measure that examines the weighted average of prices of a basket of consumer goods and services.

HOW MANY TIMES IS IT MEASURED?

- the Australian bureau of statistics measures GDP either annually or on a quarterly basis (at three-monthly intervals).

WHY ITS MORE APPROPRIATE THAN CPI

- Generally, GDP is considered to be an appropriate inflation measure in comparison to the consumer price index (cpi) because it isn't based on
a fixed basket of goods.

HOW IS GDP ESTIMATED

- the value of GDP may be estimated through
 the spending approach, where the total value of spending on Australian-made goods and services is summed
 the incomes approach, where the total value of all incomes generated from the production of goods and services is summed

REAL GDP

WHY IS REAL GDP PREFERRED?

- However, as the growth or everchanging prices of commodities between one year due to inflation affects the current value of national product
that makes it inaccurate to compare one year's production with another, where the prices paid were different.
- Therefore, economists remove the effects of price change from GDP, so as to get a more accurate idea of changes to production in the
economy where it would be much more accurate to measure economic activity through real GDP.
- real GDP per capita is the preferred measure of economic activity as it statistically removes the effect of fluctuating prices, able to provide an
aggregate measure.

DEFINE
- Real gross domestic product or real GDP/Chain volume GDP is an inflation-adjusted measure that reflects the total market value of all goods
and services that have been produced in an economy over a given year, that is obtained by using previous prices and current volumes to
determine total production value.

WHY IS IT INACCURATE
- As evident in 2018–19 where Australia’s chain volume GDP was estimated at $1 851 516 million, while real GDP is a fairly good estimate of
the value of national output, it is worth noting that chain volume GDP is inaccurate for three main reasons:
 Excluded production.
 Chain volume GDP does not include the value of all goods and services produced as it ignores non-market
activity that occurs
 This includes:
  Cash and black-market economies
 Volunteer work
 Unaccounted household production
 This is because it is too difficult to accurately calculate the value of these activities.
 Some estimates suggest that the actual value of non-market production may amount to 10-20% of economic
activity, meaning that GDP seriously underestimates national production levels
 Guesstimates and imputed values.

 the value of some items included in chain volume GDP must be imputed or guesstimated, involving uncertain
levels of statistical error.

 the net rental value of owner-occupied dwellings

 value of government-produced goods and services
 farm output consumed on a farm

 Adjustments made to remove the effects of price changes.

 as prices for goods and services produced and included in GDP fluctuate between rising and falling, the value
of GDP needs to be adjusted to compensate using a special chain price index.
 this index tries to statistically remove the exaggeration to the value of GDP caused by generally rising prices or
the underestimated caused by generally falling prices.
 however, ultimately this index is prone to potentially inaccurate process.

OTHER INDICATORS
- Lagging indicators
 lagging indicators of economic activity tell the reader only at what level activity was occurring at some time ago.
 therefore, these statistics do not indicate as to how the economy is faring in present.
 GDP falls into this lagging indicator category as by the time the quarterly statistics are released by the ABS, three months or
so have typically elapsed. other lagging indicators are:
 unemployment rates
 inflation rates
- Coincident indicators
 coincident indicators are recorded in accordance with actual changes in the level of economic activity
 published regularly at shorter intervals and thus tell them present occurrences
- Leading indicators
 Leading indicators seek to predict where the economy may be heading in the near future.
 This serves as a forecast in the levels of change expected in the economy before it actually occurs.
 not completely reliable
 Indicators in this category include
 new housing approvals
 monthly indexes of consumer and business confidence

PATTERNS
- When examining statistical indicators, economists are on the lookout for patterns in the data.
- These could involve:
 long-term (general) - 10 or 20 years
 short-medium term cycles - 1 to 3 years
 seasonal patterns - occurs at the same time every year

Business Cycle

BUSINESS CYCLE DIAGRAM

DEFINE
- Australia's level of economic activity or production is not steady.
- it moves up and down in a fluctuating wave-like or cyclical pattern in rates of economic growth created by various phases the level of domestic
activity (measured by GDP) passes through over a period of time.
- this pattern of activity is referred to as the business cycle diagram as a model used by economists
to illustrate the changing paces of economic activity
 as reflected through peaks and troughs

PHASES
- the cycle will pass through various phases
 Period of expansion
 Peak (inflationary boom)
 Contraction
  Trough (perhaps a recession)
 Ideal to achieve level of domestic economic stability

DESCRIPTIONS
- peaks and troughs represent the upper and lower turning points in the trade cycle.
 Severe contraction leads to deep trough in production and hence cuts employment
 Strong expansion leads to high peaks in production and inflation
- the strength, severity and duration of the 'contractions' and 'expansions' may vary considerably.
 strength - deep v shallow
 peak - high v low

KEY FEATURES
- There are two important features of the business cycle diagram.
 there is short- to medium-term cyclical swings in the level of economic activity or GDP
 there is the upward-sloping, long-term trend in the level of economic activity or GDP

IDEAL LEVEL OF ECONOMIC ACTIVITY IS CALLED DOMESTIC ECONOMIC

DEFINE
- although this ideal level isn't actually perceived as apart of the four phases of the business cycle, sometimes an economy can experience ideal
conditions called domestic economic stability.
- this economic bliss is located midway between the peak or boom and trough or recession where economic activity is neither too strong causing
an inflationary boom nor too weak, causing recession with high unemployment.
- promoting domestic economic activity is seen as an important domestic macroeconomic goal for the Australian government as simultaneously
this achieves strong, sustainable rates of economic growth where
 economic growth is around 3%
 low employment of 4.5-5%
 low inflation at 2-3%

STAGFLATION

DEFINE
- the economy may occasionally experience stagflation which is the opposite of domestic economic stability
- Here, the economy simultaneously experiences a fairly stagnant level across all aspects of economic activity involving production, combined
with both high (cost) inflation and (structural) unemployment.
- this instance cannot be illustrated on the business cycle diagram as the diagram assumes that the problems of high inflation and
unemployment are opposite situations that cannot coexist.
- Economists believe solution is to stimulate spending while introducing supply-side measures to lift efficiency and to contain wages and other
production costs
- This occurred during 1970–77 when:
 although there was a very slow rate of GDP growth at 6%
 a high unemployment rate of 6%
 there was also high inflation averaging 15% a year.

SHORT TERM PHASES IN THE BUSINESS CYCLE

DEFINE
- In the short-term, the actual level of economic activity often travels
 from a peak
 through a slowdown or contraction
 past domestic stability
 to a trough
 an expansion (or recovery)
 and then back to a peak.
- this pattern forms one complete economic cycle that is then usually repeated.
- cycles are of different lengths although typically last three to eight years or longer.

EXPANSION OR RECOVERY PHASE

- Starting at lower levels of GDP there is an expansion in economic activity, that is often slow initially and gains pace
- After a time lag, typically:
 employment grows
 cyclical unemployment falls
 inflation slowly starts to accelerate.
- Thus with more people employed, the government starts injecting less in the form of welfare payments and is in turn taking more leakages in
the form of personal income tax.
-
- Characterised by:
 a rising curve
 benefits society
 prices begin to rise
- In Australia, for example, this happened during
 2009 – 2010
 2010 – 2011
 2016 – 2017
 2017 – 2018

PEAK (SOMETIMES BOOM) PHASE

- after real GDP grows at its fastest rate through a period of expansion, economic activity will reach a cyclical peak or upper turning point where
GDP begins to slow.
 (if a peak is at a rate of real GDP growth that is so high it is unsustainable, it is a boom)
 Furthermore, if there is little unused productive capacity and a nation is located outside its PPF, an inflationary boom may
occur where consumer prices rise by more than 3%.
- Demand also leads to high production levels and higher derived demand for labour, engendering a fall of unemployment to its lowest level
- Characterised by:
 the top of curve
 most economic activity and therefore highest prices
 society is at its ‘peak’
- Australia experienced a peak (but not a boom), for instance, in 2011–12.
 SLOWDOWN OR CONTRACTION PHASE
- Slowdowns or contractions moves the economy into a downturn in the level of economic activity normally follow a peak or possible boom.
- The growth rate in GDP slows, moving below the long-term trend, or, in severe cases, national production may even fall.
- After the high confidence period of a peak, reckless borrowing may have occurred which eventually needs to be repaid.
 As such people now save more and businesses invest less in the conservation of expenses

- inflation eases
 as businesses discount their prices to clear their surplus of unwanted and unsold stocks of goods.
- Furthermore, cyclic unemployment rates rise due to a loss of business confidence which may force closure or redundancy
 particularly through slowing economic activity as businesses cut costs in conserving expenses for wages
- Characterised by a downward climb, and society is returning
- During 2015–16 AND 2018–19 for example
 Australia’s rate of GDP growth was slower and below the average long-term trend.

TROUGH (SOMETIMES RECESSION)

- The trough represents where economic activity is at its lowest point on the business cycle of economic activity
 With the least economic activity
- This involves a minor slowdown where there is little or no growth in the size of the economy and unemployment is higher than normal at above
5%.
- if the value of national output falls as indicated by a drop in the value of GDP during at least two consecutive quarters or a six-month period,
this is known as a recession.
 Here there is a mild downturn in economic activity caused by the slowing of aggregate
demand through
 Reduced sales
 Above average levels of cyclical unemployment
 Slow rate of economic growth
 Experienced in Australia during
 1990 – 1992

- In trough periods there are low levels of consumer and business confidence and hence low demand.
 This brings about low inflationary pressures and high unemployment
- Longer and even more severe troughs are termed depressions, where inflation is negative or ‘deflation’ there is deflation).
 This is a large economic downturn caused by significant fall in level of aggregate demand
 Large cutbacks in production
 High levels of unemployment
 Falling prices
 Occurred during
 1889 – 1893
 1929 – 1933

LONG – TERM TRENDS IN ECONOMIC ACTIVITY

DEFINE
- the average long-term trend line for economic activity or GDP is measured over many years, depicted as the overarching line of which the
phases travel across.

UPWARD SLOPE OR STEEPNESS

GUIDE
- the steepness of the trend line is an indication of the average speed at which the value of national production has grown over a number of
years.

FLATTER TREND LINE

- Indicates that on average there has been only a relatively slow rate of growth in size of the economy’s output
  Here, aggregate supply or combined total output of all goods and services produced by has
grown more slowly over time
 By way of example, Australia can sustain an average rise in the value of its chain volume
GDP of only 3% a year, or a little more.
 This makes for a flatter average trend line
STEEPER LINE TREND
- Indicates that over time, on average aggregate supply has grown at a quicker pace
- As evident through china’s average rise at approximately 6-8% per annum

AUSTRALIA'S RECENT BUSINESS CYCLE

OUTLINE
- Australia's business cycle has experienced faster and slower rates of economic activity as evidenced through Australia’s trends in quarterly
percentage change in chain volume GDP between 2002-03 and 2018-19.
 This depicts wave-like pattern where GDP growth rates are much faster in some quarters than in others
 Illustrates high peaks of economic activity in 2003-04, 2006-07 to 2007-08
 Australia avoided a recession, however, came very close during the global financial crisis (GFC) and subsequent
slowdown in 2008-09
 following the recovery from the GFC in 2011-12,
 there was a slowdown in Australia's pace of economic activity between 2013-19
 (growth rates in GDP were below the long-term quarterly average of 0-7 to 0.8% a year)

Circular Flow Model

OVERVIEW
DEFINE
- The five-sector circular flow model is able to illustrate the nature, causes and effects of economic activity that in turn describes how money,
resources and final products move around the economy.
- this model simplifies what the Australian economy looks like and how its various parts interact to influence the macroeconomic levels of GDP,
employment, incomes and material living standards.
FIVE SECTORS AND THEIR ROLES
HOUSEHOLD SECTOR

DEFINE
- Comprises of all 25 million+ members that make up the Australian population, as opposed to individual houses specifically

FUNCTION
- The aim of households is to sell and supply their resources to firms and then use the money or income received to demand or buy finished
goods and services from businesses in order to satisfy their needs and wants.
BUSINESS SECTOR

DEFINE
- Made up of over 2 million actively trading firms
- Both businesses and households act as buyers and sellers

FUNCTION
- These businesses demand or purchase inputs or resources from households which they then convert into finished goods and services.
- In turn, businesses supply or sell these goods and services to the household sector

FINANCIAL SECTOR

DEFINE
- Made up of many types of financial institutions including banks, finance companies and the stock exchange.

FUNCTION
- These organisations borrow the savings of households and then re-lend these to credit worthy customers who use this money to finance
investments (I)
 Values of S and I in the financial sector will not necessarily be of equal value

GOVERNMENT SECTOR

FUNCTION
- Workers pay some of their income to the government in the form of tax, of which governments collect as revenue
 where this money is used to fund government spending (G) and other outlays
 that provide public goods and services including hospitals, roads, defence and schools.
- Governments therefore use this revenue to purchase products that help the economy or to transfer to some disadvantaged households who
will then use it for government spending.
- in the short term, T and G will not necessarily be of equal value

OVERSEAS SECTOR

FUNCTION
- each year Australians import goods and services from abroad to satisfy the nation's wants (M) where in return Australians sell exports to those
living overseas (X) to meet their own respective wants.
 The wants between M and X will not necessarily be of equal value in the short term

THE FOUR FLOWS

DEFINE
- there are four main flows or streams that connect the main household and business sectors.
- these flows are interdependent of one another, in which one flow affects the other and also equal when measured in money terms over a
period of time.
- a flow related to the demand side will correlate to another on the supply side.
 FLOW 1 – AVAILABLE SUPLY OF RESOURCES
- Household sector supplies natural, labour and capital resources to producers
- The business sector later converts these into finished goods and services.

FLOW 2 – TOTAL INCOMES OR THE DEMAND FOR RESOURCES

- This represents the demand for payments of incomes as reflected through the business sector paying households in return for their resources.
(basically, business pay income to household)
- logically, the value of incomes paid to households is equal to the money value of resources sold or purchased

FLOW 3 – TOTAL EXPENDITURE OR AGGREGATE DEMAND (AD)

- This represents what the sectors will do upon receiving income and how they dispose of it in different ways
 in which typically households demand G/S through expenditure and consumption

Households
- spent on the private consumption of goods and services (C)
 such as food and entertainment
- income spent as C re-enters the circular flow as part of AD

Financial sector
- some income is directed into household financial savings in the finance sector
 of which, savings (S) acts as a leakage because it lowers the level of C
- However, financial sector may inject some S back into the model by lending them to business firms to finance their operations
 through private investment spending (I) – stocks
 which helps to lifts the level of AD

Government sector
- households are devoted to paying government taxes (T)
 that are classified as a leakage because it lowers the level of AD or C
- Despite this, some or all of the money taken out through taxation may re-enter the circular flow as it is used to pay for government
consumption and investment spending (G)
- G is therefore injected back as AD, designed to provide the community with collective goods and services such as:
 public schools
 hospitals
 roads

Overseas sector
- household income leaks out of the Australian economy through spending on imports of goods and services (M)
 this is because money is then given to other economies
- this leakage is partially or fully offset by overseas spending on the nation's exports (X)
 is regarded as an injection as it adds to the level of AD

FLOW 4 – FLOW OF FINAL GOODS AND SERVICES SUPPLIED (GDP)

- In return for their expenditure, producers provide households with finished products as reflected through the total value ($) of goods and
services produced or supplied by the business sector.
- This represents aggregate supply and in turn the overall Australian economic activity (measured by GDP)
 Especially in the short to medium term, the level of economic activity or GDP is dictated by the value of AD (flow 3)
 In the longer term, the supply of resources available (flow 1) is important since it has a critical effect on the economy’s
productive capacity or potential level of GDP.
- the overall level of economic activity is determined by both aggregate demand and aggregate supply factors

DIFFERENCES BETWEEN LEAKAGES AND INJECTIONS

LEAKAGES
- Income that withdraws from the flows
 Rise in leakages relative to injections slows AD
 Made up of S + T + M
INJECTIONS
- Introduction of income into flow
 Rise in injections relative to leakages boosts AD
 Made up of I + G + X

USING MODEL TO EXPLAIN CHANGES IN ECONOMIC ACTIVITY

2 INFLUENCES ON THE SIZE OF GDP

- There are two main influences on the size of GDP

1. The level of aggregate demand
2. The level of aggregate supply

AGGREGATE DEMAND

DEFINITION
- Aggregate demand is the combined or total amount of demand for all finished goods and services produced in an economy
 expressed as the total value of money exchanged for those goods and services at a specific price point in time.
 by households, governments and net overseas transactions on Australian-made goods and services.
- Affects the value of GDP and national income
- Acts as a determinant of Australia's shorter term or cyclical level of economic activity.

EFFECTS OF LEACKAGES/INJECTIONS
- a rise in leakages relative to injections = AD falls
- a rise in injections relative to leakages = AD rises

WHAT DOES THE MODEL SHOW ABOUT AGGREGATE DEMAND?

OVERVIEW
- The short-term fluctuating cyclical levels of economic activity/GDP (flow 4) are largely caused and therefore dictated by increases or decreases
in the level of Aggregate Demand
 As exemplified through flow 3
- the model also demonstrates that changes in AD can be caused by the changes in the total value of leakages relative to injections

RISING ECONOMIC ACTIVITY

- a period of expansion in GDP is generally caused by a stronger growth in AD
 This reflects lower leakages and / or higher injections
 When businesses see AD or sales rise and the levels of unstocks fall,
 this may lead to widespread shortages of goods and services
 cause rising prices or inflation (in an effort to reserve stock and capitalise off
demand)
 they lift their output (as long as there is some unused or spare productive capacity
available)
 this causes GDP to overall rise due to increased demand for resources
 by extension creating more jobs and growing national incomes.
SLOWING ECONOMIC ACTIVITY
- a period of slowdown in GDP is largely the result of a weaker growth in AD
 this reflects higher leakages and / or lower injections
 When businesses see a drop in spending and sales,
 This may lead to unplanned rises in stocks
 They often discount prices and cut their output in an attempt to clear surplus
 Causes overall GDP to slow where this fall in demand
 results in unemployment rises
 national income to decline
 typical characteristics of a recession

AGGREGATE SUPPLY

DEFINE
- The overall level of production of all of a nation’s goods and services
 Available to a market
 That are collectively produced or supplied at given general levels of prices
 By the nation’s businesses
 Measured over a period of time
- Influences the potential long-term level of economic activity
- firms are generally more willing and able to expand their collective supply or national production
 in response to a general rise in prices or an increase in total spending
 provided that there is some spare capacity or available resources in the economy.

WHAT DOES THE MODEL SHOW ABOUT AGGREGATE SUPPLY?

OVERVIEW
- the circular flow model also refers to
 the available supply of resources provided by households, exemplified by flow 1
 the total aggregate supply of finished goods and services by businesses referred to as GDP, as per flow 4.
- While aggregate supply can respond to changes in aggregate demand in the short term, in the long term, the potential national level of output
supplied is largely governed by the quantity and efficiency of resources available for use by businesses.
- aggregate supply at its potential or maximum level can be illustrated as the points located outside of the PPF.
 This means that
 aggregate supply / the total output of an economy / potential GDP can keep growing
  only if businesses have access to a greater volume of resources or use
existing resources more efficiently
 aggregate supply will be lower if there is reduced access to these resources or if
businesses begin to close down instead of expanding.

Aggregate Demand

AGGREGATE DEMAND

DEFINITION (SAME AS USING MODEL TO EXPLAIN CHANGES IN ECONOMIC ACTIVITY)

- Aggregate demand is the combined or total amount of demand for all finished goods and services produced in an economy
 expressed as the total value of money exchanged for those goods and services at a specific price point in time.
 by households, governments and net overseas transactions on Australian-made goods and services.
- Affects the value of GDP and national income
- Acts as a determinant of Australia's shorter term or cyclical level of economic activity.

CONTEXT: KEYNESIAN THEORY

- Before the 1930s, little significance was attached to the role of total spending/aggregate demand
- Changed in 1936 through which British economist John Maynard Keynes pointed out the short-term instability in AD and its components are
mainly responsible for the cyclical ups and downs in the level of economic activity.
- This period marked the start of macroeconomics as an area of study
- However, confidence in this theory was undermined when it was unable to deal with the problem of stagflation (stagnant production, high
unemployment and rapid inflation) as experiences in the 1970s.

FORMULA
- The value of AD is made up of C + I + G + (X - M)
- AD = (C + I) + (G1 + G2) + (X - M)
 (C+I) = private
 (G1+G2) = public overseas
 (X + M) = overseas net exports
 C = private consumption spending by households
 I = private investment spending by businesses
 G1 = public consumption spending by governments
 G2 = public investment spending by governments
 X = exports purchased from abroad
 M = imports purchased by local residents

WHY IS M REMOVED
 C = consumption by households
 M = imports purchased by local residents
- AD is a measure of demand for G/S produced in Australia, but when consumption expenditure is counted (C), it includes the value of imported
items.
- So, for a more accurate idea of demand for Australian products, m is subtracted.

COMPONENTS OF AGGREGATE DEMAND

PRIVATE CONSUMPTION/HOUSEHOLD CONSUMPTION SPENDING (C)

- Includes household expenditure designed to satisfy immediate needs and wants
- While this component is normally relatively stable, its rate of growth can vary contributing to economic instability
- It represents almost 60% of AD and hence is the largest component
- Affected by:
 Consumer confidence
 Disposable income
 Interest rates on credit
 Household savings and debts

PRIVATE INVESTMENT/BUSINESS INVESTMENT SPENDING (I)

- Private investments represents the value of new capital demanded by businesses, where this is reflected by capital spending on products used
to make other goods and services, often designed to grow businesses
- While this type of spending contributes to increases to aggregate demand, it also
 helps to raise nation's productive capacity to make possible the production of other goods and services
 as well as helps improves the efficiency of labour and capital resources
- It is the most volatile and unstable component
- Represents 15% to 20% of AD (Less than 22)
- Affected by:
 Business confidence
 Interest rates on credit
 Business stocks of unsold goods

GOVERNMENT INVESTMENT SPENDING (G)

DEFINE
- This includes all the money spent by the government and consists of two parts involving:
 Government consumption or expenditure (G1)
 Government investment or capital expenditure (G2)
- Is usually worth around 20%
- Affected by:
 Domestic economic conditions
 Election promises and political conditions
 Budgetary policy setting and public sector debt

GOVERNMENT CONSUMPTION OR EXPENDITURE (G1)

- Involves current public expenditure by the government on goods and services to
 maintain daily processes
 satisfy the community’s immediate needs and wants
- It incorporates spending on:
 Government departments
 Defence
 Daily running costs such as stationary or telephone
- Does not include welfare outlays, because these are not actually spent by the government, but rather by welfare benefit recipients
- In recent years, G1 has averaged around 17% of AD

GOVERNMENT INVESTMENT OR CAPITAL EXPENDITURE (G2)

- This involves government investment or capital expenditure on equipment needed for the provision of public social and economic infrastructure
- This involves spending on
 Schools
 Hospitals
 Roads
 Railways
 Telecommunication networks
 Water supply
- used to help expand Australia's productive capacity and improve the efficiency of other resources
- This spending represents only about 3% of AD.

NET EXPORTS (X-M)

- represents the balance or difference between foreign spending

 on Australia's exports by residents on foreign goods and services
 on overseas imports by foreign citizens on Australian goods and services
- The net impact on the external sector on AD is usually plus or minus about 4%, however this net figure behaves erratically
- collectively net exports represent 18-24% of AD
- Affected by
 Value of Australian dollar exchange rate
 Overseas and domestic economic conditions and confidence
 Terms of trade and global commodities

NET INCREASE IN UNSOLD BUSINESS STOCKS

- are a component however aren't calculated because they are relatively minor in AD
- represents money that has been spent by firms to make items that have not been sold in the current period of time

REASONS FOR THE VOLATILITY OF AGGREGATE DEMAND

- Even over quite short periods of time between one year and the next, the components or parts making up Australia’s AD are quite unstable
and prone to fluctuation
 resulting in levels of economic activity that shows volatility where it speeds up and slows down.
- This is evident within the erratic shifts of government investment expenditure (G2) from 2016-17 at 14%, and 2018-19 at 2%
 Stronger macroeconomic demand side-factors that increase AD and domestic economic activity
 Sets off a chain of events culminating in economic prosperity and an increase in material living
standards as long as inflation remains low
Weaker macroeconomic demand side factors that decrease AS and domestic economic activity
 Sets of chain of events culminating in a fall in economic prosperity along with the deterioration of
material living standards

MACROECONOMIC FACTORS THAT MAY INFLUENCE THE LEVEL OF AGGREGATE DEMAND

HOUSEHOLD OR CONSUMER CONFIDENCE

- consumer confidence or sentiment refers to the general household expectations about;

 their future income
 employment prospects
 inflation
- Effects C and M
- Consumer confidence affects the future decisions of households about whether to spend on local or foreign-made goods and services, or
conserve their income.
- weaker confidence, or greater pessimism, lifts household savings however compresses consumption, slowing AD and economic activity
- stronger confidence does the reverse

HOUSEHOLD DISPOSABLE INCOME

- Household disposable income is the money available for spending by individuals following receiving government welfare transfers and
payment of personal tax.
- Effects C and M
- This is an aggregate demand factor because it affects the level of household Consumption (C) of local and foreign-made goods and services,
influencing decisions as to whether to save or spend
- A more rapid rise in disposable income usually causes an acceleration in consumption (C) and imports (M).
- However, a slower growth in disposable income weakens AD, and slows GDP and economic activity.

RATE OF POPULATION GROWTH

- A country’s population growth rate is influenced by both

 the net natural increase in population (births - deaths)
 net migration (immigration - emigration).
- Impacts C, I and G
- This is an aggregate demand factor since it will especially alter expenditure on Consumption (C), Government Expenditure (G) and Imports (M)
- faster rate of population growth typically lifts AD
- slower rate tends to reduce AD and economic activity

BUSINESS CONFIDENCE
- Business confidence or expectations refers to whether firms are generally feeling optimistic or pessimistic about their level of future sales and
profits
- Business confidence is an aggregate demand factor because it impacts the level of business investment spending (I) on new plant and
equipment.
- If firms are optimistic and expect higher future sales and profits, expands their productive capacity and in turn accelerates AD and economic
activity
- pessimism does the reverse

INTEREST RATES

- interest rates are the cost of borrowing money (credit) where these are dictated by the Reserve Bank of Australia (RBA) as part of their
monetary policy stance.
- this policy is designed to affect the growth in credit-sensitive consumption (C) and investment (I) spending on the expansion of businesses
- As a consequence, interest rates are seen as an aggregate demand factor affecting
 GDP
 Employment
 income levels.
- A rise in interest rates slows consumption and investment, weakening AD and domestic economic activity
- a reduction in interest rates tends to eventually accelerating AD and GDP growth

BUDGETARY OR FISCAL POLICY STANCE

- the budgetary policy, or fiscal policy, stance relates to changes in expected government receipts and outlays for the year.
- This can affect AD by influencing levels of household consumption (C), Government Expenditure (G), Exports (X) and Imports (M).
- This is dependent on whether the government runs a
 budget surplus where tax and other receipts exceed outlays
 budget deficit where outlays exceed its receipts
 as dependant on macroeconomic conditions (whether economic activity is weak or strong)

PUBLIC AND PRIVATE INDEBTNESS

- Some Australian households, businesses and governments need to borrow money to finance their spending because their current levels of
savings are too low
- Such credit causes a rise in indebtedness in both the private and public sector.
- tolerance and affordability of rising debt is an aggregate demand factor that can affect the ability of households and businesses to consume
- ultimately affects consumption (C), investment (I) and government (G) spending, and hence the growth in AD and level of domestic economic
activity.

ECONOMIC ACTIVITY OVERSEAS

- Economic activity overseas among Australian trading partners involves the general pace of production in countries including:
 Japan
 the United States
 New Zealand
 China
 whether these nations are experiencing a period of boom or recession.
- This is an aggregate demand factor that alters the level of overseas spending on export goods and services (X), and may possibly influence
levels of foreign import (I).
- downturn in overseas activity means weaker export (X) sales and AD in Australia, thereby slowing domestic economic activity.
- the reverse applies if activity abroad rises

TERMS OF TRADE

- the terms of trade measures the ratio of average prices the world is prepared to pay for Australian exports against the price Australians pay for
imports.
- It is regarded as an aggregate demand factor because the average prices that Australia receives or pays in international transactions
- affects the value of Australian exports or injections against the value of imports or leakages
- It is measured by means of an index that uses a base year as the basis of comparisons for following years.
 trade index = (export price index / import price index) x 100
- the following index demonstrates that
 a rise in the terms of trade index tends to increase injections (X) relative to leakages (M), boosting AD and
economic activity
 a fall has the reverse effect

EXCHANGE RATE FOR THE AUSTRALIAN DOLLAR

- international transactions between countries requires that currencies are able to be swapped or exchanged.
- The exchange rate is the price at which the Australian dollar is swapped for other currencies.
- Changes in the dollar's average value can be gauged through the trade weighted index (TWI)
- the exchange rate affects the price or attractiveness of exports relative to imports, in turn affecting the value of Australia's exports relative to
the value of imports
- a depreciation (fall in value) of the Australian dollar tends to boost the value of X (injections) and reduces Ms (leakages, increasing AD and
economic activity
- an appreciation (rise in value) in value slows net exports (X-M) and hence economic activity

COVID-19 PANDEMIC
- The COVID-19 virus spread around the world in early 2020
 bringing on a severe contraction in AD
 due to rising unemployment
 lower incomes
 reduced household and business confidence.

HOW CHANGES IN AGGREGATE DEMAND FACTORS CAN AFFECT THE ECONOMY

OVERVIEW
- By affecting the components making up AD, changing macroeconomic aggregate demand factors can cause total spending to either rise or
fall.
- In so doing, this alters the short-term cyclical level
 GDP
 economic activity
 inflation
 employment
 incomes
 material living standards.

SIGNIFICANCE OF GENERALLY STRONGER AGGREGATE DEMAND-SIDE FACTORS

SIGNIFICANCE OF GENERALLY WEAKER AGGREGATE DEMAND-SIDE FACTORS

Aggregate Supply

AGGREGATE SUPPLY

DEFINE (SAME AS USING MODEL TO EXPLAIN CHANGES IN ECONOMIC ACTIVITY)

- The overall level of production of all of a nation’s goods and services
 Available to a market
 That are collectively produced or supplied at given general levels of prices
 By the nation’s businesses
 Measured over a period of time
- Influences the potential long-term level of economic activity

NATURE/CONDITIONS OF AGGREGATE SUPPLY

- firms are generally more willing and able to expand their collective supply or national production
  in response to a general rise in prices or an increase in total spending
 provided that there is some spare capacity or available resources in the economy.
- Beyond this point, where no unused capacity exists (there are no unemployed resources) and a nation is on its production possibility frontier
(PPF)
 aggregate supply cannot grow further
 unless there are changes involving better macroeconomic supply conditions
 that make businesses even more willing and able to lift their production levels.

OVERVIEW (WHAT THINGS ARE LIMITED BY)

- Ultimately or in the long-term, the size and growth of Australia’s GDP are limited by the levels of aggregate supply (AS) and a country’s
productive capacity.
- The nation’s potential supply or production level (economic activity) is especially limited by the quantity (volume) and efficiency (productivity) of
its available resources.

BACKGROUND
- Jean Batiste Say (1767–1832) emphasised the importance of the aggregate supply side of the economy as the main determinant of economic
activity.
 claims that ‘supply creates its own demand’.
 means the more goods and services produced or supplied, the more income is created and the
greater the level of demand or spending

FACTORS INFLUENCING AGGREGATE SUPPLY

- There are at least four main groups of aggregate supply factors

 affecting the overall quantity of goods and services
 that Australian businesses are collectively willing and able to produce or supply
 at various price levels in our economy

INCREASED ACCESS TO LABOUR RESOURCES

- grow productive capacity and aggregate supply

OUTLINE
- increasing the size, skills and productivity of the labour force can
 enlarge a nation's productive capacity
 grow the level of aggregate supply
 help increase the sustainable pace of economic activity
- access to labour resources may be affected by:

DEMOGRAPHIC AND POPULATION AGE STRUCTURE

- the size of the population and its age distribution is able to affect the labour force
- Australia is currently undergoing an ageing population wherein there is
 A rising proportion of the population in senior, older age groups
 this causes labour shortages or bottlenecks
 limits expansion and constricts supply

PARTICIPATION RATES AND THE SIZE OF THE LABOUR FORCE

- The participation rate in the labour force is the proportion of people aged 15 and over
 who are able and willing to work.
- This proportion will affect the supply of labour
 hence access to the labour resources
 needed to grow a nation’s productive capacity.

VARIOUS GOVERNMENT AGGREGATE SUPPLY POLICIES

- There are several key government policies that can affect access to labour resources. For example: • Immigration policies.
- These include:
 Immigration policies
 Education policies.
 shape the effectiveness and level of spending on education
 impact on innovativeness and productivity of the labour force.
 Policy about welfare access
 Financial assistance with childcare.
 the affordability of having children.
 whether parents participate in work.

 Labour productivity
 Amount of leisure time and hours of work

LABOUR PRODUCTIVITY
- high labour productivity allows for a greater level of output per worker, as measured by the annual percentage change in GDP per hour
worked.

AMOUNT OF LEISURE TIME AND HOURS OF WORK

- typically, fulltime work occupies around 40 hours per week.
- over recent decades there has been a decrease in leisure and an increase in hours worked
 this increase has allowed for increased volume in labour resources available
 grows productive capacity or aggregate supply

INCREASED ACCESS TO CAPITAL RESOURCES

- grow productive capacity and aggregate supply

OUTLINE
- a nation’s capital resources is essential for increasing productive capacity and aggregate supply.
- This may be affected by many factors, including the following.
 Investment levels
 capital resources are acquired and increased
 through high levels of investment in new plant and equipment
 interest rates
 purchase of capital important for the expansion of companies/efficiency
 these resources are often expensive
 need to borrow credit from banks
 when interest rate high, this deters investment
 slows growth of capital and limits capacity/aggregate supply
 outlays/investment on technology and R&D
 increase the volume and efficiency of capital resources
 adding to productive capacity.
 Tax rates
 increases the ability to spend and invest
 low tax rates on businesses can provide incentives for higher levels of
business investment
 lower tax rates on personal incomes can encourage greater participation in
the labour force and higher productivity
 adequacy of national infrastructure
 both social (education) and economic infrastructure (roads, railways, water, power and telecommunications)
 are important where;
 it cuts business costs/improve profitability
 firms are more willing to expand their productive capacity

INCREASED ACCESS TO NATURAL RESOURCES

- grows productive capacity and aggregate supply

OUTLINE
- While the quantity of non-renewable natural resources is fixed and limited
- their ‘known’ quantity, usefulness and efficiency can sometimes be increased by the following:
 mineral exploration
 land management
 the productivity and sustainability of mining/farming practices
 can grow rural and export capacity
 combatting climate change
 climate change result in severe weather events
 reduce productive capacity (destroy natural/capital)
 policies/preventive measures are in place

LOWER BUSINESS COSTS AND BETTER PROFITABILITY

- grow productive capacity and aggregate supply

OUTLINE
- To survive and be able and willing to increase aggregate supply, businesses need to be profitable (their sales revenue must more than
outweigh their costs and taxes).
- The after-tax profits of firms are affected by aggregate supply factors as follows:
 Wage and other-on costs of employing labor
 labour costs are generally the biggest production expense for most firms
 these impact business competitiveness, profitability and survival
 productivity or efficiency
 refers to the output gained from utilising a certain quantity of inputs, affecting costs and overall profits.
 productivity can only be enhanced by improving skills, applying new technology and updating to the latest capital
equipment
 there is also efficiency in terms of the way resources are distributed and used
 interest rates and cost of credit
 the level of interest rates to be paid by businesses on their borrowed funds
 affects whether they will increase their investments that consequently grow productive capacity
 costs of materials used in manufacture
 value of the Australian dollar and the cost of imports
 changes in the exchange rate used for swapping currencies and international transactions can affect
 production costs (imported machinery and materials)
 sales and profits of local companies that export
 new technology
 cost cutting
 scale or business size
 size alter average costs per unit
 tax rates
 affect business survival, and the incentive to produce and expand
 tax rates on company profits can affect aggregate supply
 other government aggregate supply policies
 aggregate supply policies can
 lift efficiency
 lower business costs
 increase profitability
 boost productive capacity
 grow aggregate supply

 some policies may be

 reductions in the level of government tariff protection
 increases foreign competition
 encourages local firms to cut costs/use resources more efficiently.
 the payment of government subsidies and targeted industry assistance
 can boost aggregate supply (but not necessarily efficiency).
 the provision of efficient and adequate economic infrastructure
 like transport, water and power needed by firms
 can affect their production costs and profits.
 high levels of government red tape
 in setting up and running businesses
 can discourage start-ups.
 Immigration
 can grow the supply of labour
 slow wage costs
 reduce skills shortages.
 environmental policies to mitigate climate change
 can encourage the growth of low-emissions industries

HOW CHANGES IN AGGREGATE SUPPLY FACTORS CAN EFFECT THE ECONOMY

OVERVIEW
- aggregate demand decides the extent to which the economy’s available capacity is actually used.
- in the longer term it is impossible to keep on expanding the level of economic activity and production simply spending more to boost AD.
- when this point is reached, further increases in national production depend on new, more favourable aggregate supply conditions.

HOW MORE FAVOURABLE AGGREGATE SUPPLY FACTOR CAN INCREASE ECONOMIC ACTIVITY
HOW LESS FAVOURABLE AGGREGATE SUPPLY FACTOR CAN INCREASE ECONOMIC ACTIVITY
 Aggregate Demand and Supply Diagram
AGGREGATE DEMAND

- When graphed it has a negative slope

 the quantity of goods and services demanded will contract when prices rise, and
expand when prices are lower.
- This means that the overall quantity of goods and services demanded (the amount of national
output purchased each year, shown on the horizontal axis) contracts
 When there is a rise in the general price level (the national price level, shown on
the vertical axis
- Alternatively, lower prices cause an expansion in the quantity of national production demanded.
- There are at least three reasons for this negative sloping aggregate demand line:
 Purchasing power effect
 Generally higher prices throughout the economy eat into the
purchasing power of people’s nominal level of incomes
 Contracting how much they can afford to buy.
 Import substitution effect.
 Domestic inflation encourages Australians to buy cheaper or
more competitive imports of goods and services
 Contracting spending on domestically produced goods and
services.
AGGREGATE SUPPLY

- When graphed, it has a positive slope, consisting of a horizontal section and a vertical
section joined by an intermediate section or ‘elbow’
- The horizontal section of the AS line represents the low levels of national output, where
there is plenty of unused productive capacity.
 At this level of national production, firms would find it very easy to increase
their production levels in response to little or no rise in the general level of
prices.
- The vertical section represents the economy operating at full capacity
 No unused productive capacity
 real national production is at its physical limit because all resources are fully
employed.
 On this section of the curve even large price rises will not lead to an extension
of supply or increase to national production, as extra resources are not
available to firms required to lift GDP.
 Unless more favourable aggregate supply conditions develop
- The intermediate section of the ‘elbow’ indicates the gradual onset of full employment of
labour and other resources
 at which excess capacity is taken up
 the economy moves from a position of under-utilisation of resources to one of
full employment of all productive resources
 moving upwards there is bigger rises in average prices needed to make extra

EQUILIBRIUM LEVEL OF ECONOMIC ACTIVITY

- The equilibrium level of economic activity is the point at which the AD curve and the AS curve intersect
 and represents a general equilibrium achieved nationally across all markets.
THE AD-AS DIAGRAM
- National economic conditions are volatile and change to reflect the levels of AD and AS.
- The cause of changes in all these economic conditions can now be illustrated on our complete AD–AS diagram.
- The AD-AS diagram shows the interaction between the aggregate demand and aggregate supply
 shows the effects changes in each can affect a country’s general economic conditions.
- The AD-AS diagram can be used to illustrate economic conditions such as an inflationary boom, a recession, or conditions of domestic
economic stability.

DEFICIENT AD AND RECESSION

- If generally weaker aggregate demand conditions prevail for Australia

 and total expenditure is deficient at only AD0
 This causes a recession
 (as happened between 2018–19 and 2019–20)
- this has three important macroeconomic effects:
 Slower GDP growth.
 The actual equilibrium level of economic activity
(measured on the horizontal axis by real GDP) will
decrease to GDP0
 Causing a recession
  Higher cyclical unemployment.
 Low or falling production means there is less demand for resources including labour, causing the level of cyclical
unemployment to rise.
 Causing a recession
 Lower demand inflation.
 Weaker spending and hence higher levels of unsold stocks
 lead to price discounting by sellers (to help clear these stocks)
 hence a slower inflation rate of only P0
 Causing a recession
- Effect of a serious recession in China/United States (on Australia’s terms of trade)
 Means the pace of economic activity overseas is slowing
 Would be a weak demand side condition
 This, combined with a drop in terms of trade, would lead to a fall in the demand for Australia’s exports.
 This will cause a decrease in AD1 to AD0.

EXCESSIVE AD AND BOOM

- An inflationary boom occurs where stronger demand-side

conditions causes expenditure (aggregate demand) to rise
excessively to AD2.
 as happened during 2007–08
- The new equilibrium located high up on the AS line causes
domestic macroeconomic conditions to change through
 Maximum GDP growth
 Excessively strong spending growth
would cause economic activity and
national production to rise to its
highest point at GDP2.
 Thus, stretching national production
beyond its limit (GDP2), increases
demand for resources including
labour
 As a result, cyclical unemployment
would fall to very low levels and
cause labour shortages.
 Rapid demand inflation
 Because of excessive and
unsustainable levels of spending,
An
this causes an inflationary boom
 where production would not be able
to keep up and so the economy
would overheat.
 Widespread shortages of goods
and services would develop,
causing rising prices and demand
inflation.
 This is seen on the diagram by the
hike in the price level to P2 .
 Living standards would suffer due

IDEAL AD AND DOMESTIC ECONOMIC STABILITY

- The economy is originally experiencing domestic economic stability at E1 where the aggregate demand line causes expenditure to be at (AD1)
 that in turn intersects the aggregate supply line
- This has three main domestic impacts:
 A strong and sustainable rate of economic growth.
 With spending at AD1, equilibrium would occur at near maximum production (GDP1).
 Here, economic activity is neither too hot leading to inflation, nor too cold causing recession.
 Full employment.
 When there is a strong and sustainable rate of economic growth (GDP1)
 there would be a rise in the demand for resources including labour
 leading to relatively low unemployment rates (called full employment).
  Economy experiences Low inflation and prices.
 When the pace of economic activity is neither too strong nor too weak, there would be no widespread shortages or
surplus of goods and services
 so, it is likely that inflation or general prices would be quite low and stable (P1).
 Here, conditions are such that short-run material living standards should be maximised.

MORE FAVOURABLE AGGREGATE SUPPLY CONDITIONS

- Favourable conditions that increase AS means an improvement in domestic economic stability, prosperity and material living standards
- This involves making producers more willing and able to increase their production, lifting the productive capacity from AS1 to AS2
- the whole AS curve shifts outwards and to the right of the original line.
- Benefits:
 Stronger and more sustainable rate of economic growth.
 The new equilibrium (E2 ) and an increase in AS (the shift from AS1 to AS2 )
 means a rise in national output (the shift from GDP1 to GDP2 ).
 Although real GDP is higher, this is economically sustainable because the level of prices or inflation is actually lower.
 Slower cost inflation.
 more favourable supply conditions are often associated with lower production costs or better profits for businesses.
 If production costs are lower, firms can cut prices to make their products even more competitive.
 This causes the general level of prices in the economy to fall (the shift from P1 to P2 ), lowering cost inflation
pressures.
 Lower structural unemployment and more jobs.
 More favourable aggregate supply conditions often lower costs and prices
 thus, making local businesses more competitive and profitable.
 This can mean that fewer firms close down and others expand more rapidly, in the long term reducing structural
unemployment and creating more jobs.

LESS FAVOURABLE AGGREGATE SUPPLY CONDITIONS

- Less favourable aggregate supply conditions make producers less willing and able to increase productive capacity
- Supply would decrease from AS1 to AS0, causing the problem of stagflation and a general deterioration in macroeconomic economic
conditions in three ways:
 Lower or stagnant levels of GDP.
 fall in aggregate supply would cause real production levels to stagnate or decrease (the shift from GDP1 to GDP0).
 Rising cost inflation
 Unfavourable conditions decreasing aggregate supply can be rising production costs/falling business profits
 These conditions usually force most firms to lift their prices, accelerating cost inflation (the shift from P1 to P0).
 Rising structural unemployment.
 weak or negative economic growth
 causes rising production costs and falling profits
 some firms will close down, and workers will lose their jobs.
 Structural unemployment will then rise.

The Goal of Low Inflation (Price Stability)

INFLATION

DEFINE

- Refers to a sustained increase in the general level of price for a good or service over time
- And the fall in the purchasing value of money.

IMPORTANCE

low inflation helps to create general conditions that align with other government goals (and consequently improved living standards)
LOW INFLATION PLAN
EFFECTS
- inflation occurs when there is a sustained increase in the general level of prices over time
 as opposed to the reverse situation of deflation where prices are generally falling.
- during times of inflation, commodities become more expensive
 consuming large proportions of income
 where in this sense, agents lose purchasing power.
- Most people see inflation as something to be avoided.

RBA’S PLAN

- for this reason, the Reserve Bank of Australia (RBA) has set a goal of low inflation

 achieved when general consumer prices for goods and services are increasing fairly slowly

 within the current target range of 2-3% a year average

 over the duration of an economic cycle

 as measured by the Consumer Price Index (CPI)

 at a rate that is consistent with achieving other government macroeconomic goals.

- it is the RBA's main responsibility to keep inflation within this range.
 although, inflation should not reach zero.
 Zero inflation would be inconsistent with the achievement of other domestic economic goals, where;
 it would cause a slow level of economic activity
 this weakens economic growth
 results in high cyclical unemployment
- over the period 2007–08 to 2019–20, inflation has slowed to below the target rate.

MEASURING THE INFLATION RATE

- there are two measures of consumer inflation compiled by the Australian Bureau
of Statistics (ABS) and the RBA.
- These include:
 the headline consumer price index (CPI)
 underlying or core measures of inflation.
- Trends in these measures: figure 2.27 - annual percentage change in Australia's
headline and underlying rates of inflation.
 over the period 2007–08 to 2019–20, inflation has slowed to below the
target rate.

HEADLINE CONSUMER PRICE INDEX

DEFINE
- the headline consumer price index (CPI) measures quarterly changes in the retail prices
 of both locally and foreign-made goods and services
 that typically represent a high proportion of the expenditure of metropolitan households
 (including employees, pensioners, unemployed and employers).
- Represents how high average prices of consumer products are now compared to prices in a previous period
 Assigned an index value of 100

WHAT DOES IT CONSIST OF

The CPI consists of:
- Regimen
 the regimen refers to the range of goods and services to be included in the basket whose prices are to be measured.
 the CPI owns a range that consists of 100 000 individual items, subdivided into 11 categories, these including;
 food
 clothing and footwear
 communication
 the ABS reviews the composition of the regiment and the weighing of items from time to time,

- prices surveyed
 the quarterly price survey is conducted through a representative range of metropolitan retail outlets
 across both the private (Coles, Myer, Kmart) and public sector(local council property rates).

- weighting of items
 every item is weighted in proportion to its relative importance in overall household expenditure.
 these weights are reviewed every five years.
 things that are frequently purchased or are expensive in value have a greater bearing on index trends
 food
 housing
 transport
 items of less significance are not weighed to such significance
 education
 alcohol

- base year
 price changes over a period of time are compared against the price or cost of the regimen in a representative or base starting period
or year.
 recently, the base year for CPI was changed to 2011-12 where its value is equal to 100 index points
 in 2017-18 the CPI measurement for Australia's eight capital cities amounted to 112.4 points
 relative to 110.2 in 2016-17.
 on this basis, there was a 1.8% inflation rate between 2016-17 and 2017-18.

CALCULATION

THE UNDERLYING INFLATION RATE (CORE INFLATION RATE)

- the inflation rate can be affected by many factors, which makes the headline CPI not suited in some circumstances as it only generalises
sources of inflationary pressures in the economy
- for this reason the ABS measures the underlying inflation rate that measures of inflation rates without being skewed by one-off events which
change prices drastically in the short term.
- This is through the exclusion of volatile items to reduce the size of the headline CPI measure
 Such as
 fresh vegetables
 fruit
 fuel
 energy
- these items are excluded because their prices are affected by one-off or volatile events such as
 cyclones (Yasi, Marcia and most recently Debbie in 2017)
 droughts (1996–2010, 2014–20)
 floods (Townsville in early 2019)
 changes in government policies (the imposition of the carbon tax during 2012–14)

DIFFERENCES BETWEEN THE MEASURES OF HEADLINE AND UNDERLYING MEASURES OF INFLATION

- there are several key differences between the headline and underlying CPIs
- different sized regimens or baskets of goods and services
 headline has a bigger regimen - 100 000
 underlying has a smaller regimen - 80 000

- different statistical results

 if the prices of volatile items are rising faster than other items (due to one-off events)
 headline figure shows a higher rate than the underlying one
 in reverse, if volatile items are falling
 headline rate will be lower than the underlying rate
- different uses
 the underlying CPI provides important additional information
 as to whether to increase interest rates to help slow persistent or core inflationary pressures
 raising interest rates slow AD and will have no impact in curbing underlying inflationary pressures
 CPI can provide a guide to the changes in the cost of living for households
 the headline CPI provides a broader view of changes in living costs

LIMITATIONS OF USING CPI AS A MEASURE OF INFLATION

- the CPI data provide a guide to general retail price trends in the Australian economy
 however, it may not be totally accurate, where the published inflation rate depends on several factors
- does not represent the prices of intermediate goods and the needs and wants of rural Australia well
- prices are only those paid by metropolitan households
 only around 100 000 selected consumer goods and services that are typical of the items purchased by metropolitan households are
included in the CPI basket
 misleading for those who do not live-in capital cities
 inflation rate is only representative of the average across eight capital cities
- inappropriate weighting of items in the regimen for some households
 for some categories of households, the weighting of items in the regimen may be unreflective of the actual pattern of household
expenditure
 for example, if meat prices went up CPI will rise faster in turn
 although this figure would be misleading for vegetarian households

CAUSES AND TYPES OF INFLATION

TYPES OF INFLATION
- there are two main types of inflation, each caused by different factors;
1. demand inflation
 caused by excessively strong spending or AD in an economy
 where it reflects aggregate demand factors pushing spending
2. cost inflation
 is caused by less favourable aggregate supply factors for
businesses
 that cause a rise in their production costs
 which then amount to higher prices in an attempt to protect
business profits.

CAUSES OF DEMAND INFLATION

- Australia's rate of demand inflation accelerates and slows, reflecting changes in the
cyclical level of AD and economic activity.
- inflation rises in response to strong aggregate demand conditions when there is efficiency in productivity.
- these factors are:
 rises in consumer confidence
 strong levels of business optimism
 rises in disposable income per capita
SITUATIONS
- In a situation where spending (AD) is running ahead of national production (AS)
 in an economy near its productive capacity
 demand inflation pressures are caused by
 falling stock levels
 widespread shortages of goods and services
  the general inability of firms to significantly lift output.
 This erodes the purchasing power of incomes and hence undermines living standards.
- In reverse, demand inflation disappears when spending and economic activity slow.
 There may even be deflation if there is a recession or depression.
 Here, generally weaker aggregate demand conditions cause unplanned rises in stocks of goods due to falling sales.
 In turn, this leads to widespread price-discounting by sellers, slowing demand inflation.
 lower prices usually improve our purchasing power and material living standards.

USING THE AD–AS DIAGRAM TO SHOW THE EFFECTS OF CHANGING AGGREGATE DEMAND CONDITIONS ON INFLATION

- The development of boom or demand inflation pressures can be illustrated

on an AD–AS diagram.
- Figure 2.29 shows that persistently strong aggregate demand conditions
 eventually cause the level of expenditure on Australian-made
goods and services to become excessive
 (i.e. an increase from AD1 to AD2 )
 and rise beyond the economy’s productive capacity (at GDP2)
 causing increased inflation (a rise from P1 to P2).
- By contrast, the onset of generally weaker aggregate demand conditions
 will slow expenditure (from AD2 to AD1)
 thereby easing general shortages of goods and services
 promoting price-discounting and thus curbing demand inflation
pressures (P2 to P1).

CAUSES OF COST INFLATION

- cost inflation occurs when heavy costs are imposed on firms when producing or selling goods or services.
- these rising production costs may be attributed to:
 higher wages and salaries for staff
 rises in the on-costs of labour
 elevated charges for utilities (electricity, gas, water)
- Here, the rising costs of purchasing resources are seen by firms as less favourable aggregate supply conditions.
- This decreases profit margins
 whereby firms are forced to pass these onto consumers in the form of higher prices
 where a failure to raise prices would mean lower profits, losses or even business closures.
- In reverse, lower production costs
 allow firms to reduce their prices to compete and still make good profits
 thereby easing cost inflation pressures.

USING THE AD–AS DIAGRAM TO SHOW THE EFFECTS OF CHANGING AGGREGATE SUPPLY CONDITIONS ON INFLATION

- can also be used to illustrate the onset of cost

inflation.
- Figure 2.30 shows that the development of less
favourable aggregate supply conditions
 (perhaps involving increases in
production costs or other factors like
higher taxes on businesses that shrink
their profits)
 make businesses less willing or able to
produce.
 This decreases the level of aggregate
supply.
 There is an inward move of the AS line
from AS1 to AS2.
- The consequence of rising production costs and
the inward shift of the aggregate supply line
 is higher cost inflation
 (shown by price rises
from P1 to P2)
 along with reduced national output
 (production falls from
GDP1 to GDP2)
CONSEQUENCES OF HIGH INFLATION

RAPID INFLATION RESDISTRIBUTES INCOMES AND PURCHASING POWER MORE EVENLY

- Rapid inflation, or generally rising prices, changes the way incomes are distributed in the economy.

- This engenders different effects on various groups, where while a few people gain increased purchasing power and incomes, the living
standards of most people suffer.

- For example
 Fixed income earners such as self-funded retirees/pensioners
 whose incomes often depend on fixed amounts of interest,

 where these incomes will not be able to keep up with rising prices.
 in contrast those with upwardly flexible incomes like individuals in a strong wage-bargaining position can end up with
rising incomes and enjoy a better standard of living.
 Exporters
 become less internationally competitive so their sales, incomes and living standards fall.

 although importers will benefit off stronger sales

 Ordinary families
 will suffer in terms of living standards where rising interest payments such as on a home loan will consume a higher
proportion of family incomes where its affordability declines

 to compensate, they will reduce their consumption of other goods and services, undermining living standards

 conversely, lenders will experience a rise in income

 Some workers may be unemployed
 because inflation has caused local businesses to close due to weaker competitiveness against cheaper goods from
abroad.

 As these unemployed people move onto welfare, they face greatly reduced incomes, purchasing power and living
standards.

RAPID INFLATION CAN UNDERMINE EFFICIENCY IN RESOURCE ALLOCATION

- resource owners often allocate their resources to maximise their incomes and returns.

- when inflation occurs, the prices of shares, property and other assets tend to rise faster than the general inflation rate.
- this gives opportunity to investors to make large capital gains, boosting their incomes and living standards

- Inflation causes resources to be consumed in an inefficient manner where it is unable to be used for productive long-term uses (business
investment expansion) and is instead redirected to more speculative investments

 this slows the long-term sustainable rate of economic growth and depressing living standards

RAPID INFLATION ERODES AUSTRALIA’S INTERNATIONAL COMPETITIVENESS

- Higher inflation rates in Australia relative to those overseas tend to damage the competitiveness of locally made goods and services against
imports.
- local sales will suffer when consumers switch to cheaper imported substitutes
 The value of exports is likely to be down
 because overseas consumers prefer to source their goods and services from countries where inflation is slower.
 the demand for exports will go down
 This causes Australia’s trade balance (the difference in value between exports and imports) to become less favourable
 may lead to a rise in the current account deficit (CAD) (the country is importing more than exporting)
 the exchange rate my depreciate or fall in value, reducing purchasing power and material living standards
 In turn, a lower exchange rate reduces our purchasing power and hence material living standards.

RAPID INFLATION CAN SLOW THE RATE OF ECONOMIC GROWTH

- inflation has mixed effects on the rate of economic growth.

- scenario one – good
 inflation may reflect unsustainably rapid increases in the spending of AD
o results in widespread shortages
o may provide incentive to businesses to undertake higher investment spending so as to increase capacity
o increases the potential rate of economic growth
 scenario two - bad
o may undermine consumer and business confidence
 slows spending
 causes a recession
o often drives up domestic interest rates
 tightening of monetary policy by the RBA to help check inflation
 also undermines confidence
 slows credit-based spending (loans)
 depresses

CAN EVENTUALLY CAUSE UNEMPLOYMENT

- can lead to an increase in structural unemployment as excessive inflation undermines the international competitiveness of Australian
producers
- some firms would be unable to maintain themselves if they cannot expand their sales or market share,
 decreasing profits
 slowing business expansion
 forcing closure
- This causes higher rates of structural unemployment
 lower incomes
 depresses consumption per head
 decreases average material living standards
 less confidence
 diminishes non-material/material living standards (reduced self-esteem, happiness, health, family tension, crime
rates)

ALTERS HOUSEHOLD BUSINESS BEHAVIOUR

- Passing mention has already been made of the way that inflation rates can alter the behaviour and spending decisions of households and
businesses.
- In particular:

 Inflation causes interest rates to rise

 encourages saving
 discourages credit-based consumption and investment spending
 overall slows economic activity
 inflation tends to erode household and business confidence
 slowing consumption and investment spending
 unemployment
 eroding incomes, purchasing power and general affordability to purchase
 inflation has a wealth effect
 rising prices for assets makes the rich richer
 they spend more in the short term

SOME ANSWER?
  structure (4m) explain how a reduction in GDP per capita may influence the government and RBA's goal of low inflation

step one.

o outline the impact on either AD or AS

step two.

o whether is DEMAND INFLATION (AD) or COST INFLATION (AS) is impacted

o exerts upwards or downwards pressure?
o increase or decrease when talking about change in the rate of inflation

step three.

o link and define back to the goal of low inflation

The Goal of Strong and Sustainable Economic Growth

DEFINE
- Strong and sustainable economic growth is the second domestic macroeconomic goal for the Australian government.
- Economic growth occurs when there is an increase in the level of national production of goods and services between one year and the next.
- The rate of economic growth is measured by the annual percentage rise in real gross domestic product (chain volume GDP).
- The goal of strong and sustainable economic growth is defined as the fastest rate of growth in national production, averaging perhaps 3 per
cent per year, that is consistent with achieving other economic and environmental goals.

Broadly speaking, there are two main sources of economic growth: growth in the size of the
workforce and growth in the productivity (output per hour worked) of that workforce.

Capital formation increases investment which effects economic development in two ways.

Firstly, it increases the per capita income and enhances the purchasing power which, in turn,
creates more effective demand. Secondly, investment leads to an increase in production.

KEY ELEMENTS
- the two elements of this definition are:
A STRONG RATE OF ECONOMIC GROWTH.

DEFINE
- This is defined as the fastest rate of increase in GDP that is consistent with achieving other government economic goals.
- Although targets change and depend on the circumstances, typically the average rise in real GDP target is set around 3 per cent each year (or
possibly a little more) over the economic cycle as a realistic target.
- this speed allows for a pace of economic growth that allows for the achievement of other objectives, such as;
 low inflation
 full employment
 improved material living standards.

HIGHER PERCENTAGE OF ECONOMIC GROWTH

- a rate of economic growth that is too strong (from 4-6%)
 would cause severe economic problems
 living standards to ultimately suffer.
 the pace of national output would be pressed beyond the normal rise in productive capacity
 Supply or production would not be able to keep up with demand or expenditure.

LOWER PERCENTAGE OF ECONOMIC GROWTH

- if economic growth is too slow (1-2% a year or less)
 some government economic goals would not be possible to achieve.
 The unemployment rate would soon rise, since there would not be enough jobs and incomes to accommodate a growing labour
force.
 Higher unemployment would then lead to poverty.
 living standards would suffer

SUSTAINABILITY OF ECONOMIC GROWTH

DEFINE
- this term refers to ecological or environmental sustainability
 focusing on temporal efficiency
 wherein the rate at which Australia’s economy grows its production
 without jeopardising the living standards of future generations.
- this is because the greed for non-renewable resources creates severe long-term environmental problems,
 pollution
 global warming
 resource depletion

WHY IT IS A GOAL/IMPORTANT
- too much consumption of these scarce and finite resources disallows future generations the ability to enjoy a similar standard of living.
- for this reason, it is important to be ecologically sustainable in the long term so as to not:
 deplete non-renewable resources,
 degrade the environment
 impede on the ability of future generations to meet their needs and wants.
- In some ways, a trade-off exists between strong economic growth and future living standards.

STRUCTURE (4M)

explain how an increase in the rate of savings may influence the government's goal of strong and sustainable economic growth

- step one.
 outline the impact on either AD or AS
- step two.
 outline the impact of the change in AD or AS upon the rate of economic growth (GDP)
- step three.
 link and define back to SSEG

MEASURING THE RATE OF ECONOMIC GROWTH

CALCULATING GDP

- Economic growth occurs when there is a rise in the real value (volume) of finished goods and services produced in Australia between one year
and the next.

- the rate of economic growth is most commonly indicated by the annual percentage change in GDP.

- Economic growth occurs when there is a rise in the real value (volume) of finished goods and services produced in Australia between one year
and the next.
- these GDP figures are prepared by the ABS quarterly (at three-monthly intervals) where these four quarters are combined to produce an
annual rate of economic growth

- in recent years, the rate of economic growth has been relatively weak and below the government's 3% target.

ESTIMATES OF GDP USING 3 APPROACHES

OVERVIEW
- it is possible to see that the value of goods and services produced or GDP (flow 4) can be estimated using three different approaches.
- This is because the model assumes that the three flows
 total expenditure on production (flow 3 or AD
 total incomes paid to those selling resources (flow 2)
 total production (flow 4 or GDP)
 are all equal in value.

OUTLINE
1. GDP(E)
- GDP should be equal to the total annual market value of expenditure (AD) on final goods and services produced in Australia.
- this calculates:

C + I + (G1 + G2) + (X - M)
 private consumption spending (C)
 private investment spending (I)
 government consumption spending (G1)
 government investment spending (G2)
 any change in unsold stocks
 overseas spending on exports (X) minus spending on imports (M)

2. GDP(I)
- GDP should also be equal to the total market value of incomes paid to those selling the resources needed for production.
- Incomes here include wages, plus salaries, plus supplements, plus the gross operating surplus or profits of firms.
WAGES + OPERATING COSTS

3. GDP(P)
- GDP should be equal to the total market value of final goods and services produced each year.
- This is equal to the value added in production by all firms each year.
 refers to the total market value of sales minus the cost of all inputs purchased by firms.
- the annual value of production needs to be imputed or estimated
 because the output has not actually been marketed or sold.
- Even then, it is impossible to include all forms of production in GDP
 that would simply be too complicated
 Some things are therefore excluded from the GDP estimates
 such as the value of illegal black market
 non-traceable production (cash economy, home duties including parenting, background DIY activities)

TOTAL MARKET VALUE OF SALES - COST OF ALL INPUTS PURCHASED BY FIRMS

CALCULATING CHAIN VOLUME GDP AND ALLOWING FOR CHANGES IN PRICE LEVELS

OUTLINE
- inflation and deflation affect the total market value of goods and services produced by the nation, hence influencing the annual rate of
economic growth between one year and the next.
- These circumstances can lead to a misleading impression of the actual size of the change in the volume or real value of goods and services
produced each year measured by GDP at market or current prices.
- Inflation and deflation affect the total market value of goods and services produced by the nation, hence influencing the annual rate of
economic growth between one year and the next.
- to correct this, the ABS statistically removes these impacts that annual price changes have on the value of production, measured at current or
market prices, through utilising chain volume GDP as a measure

DEFINE
- Chain volume GDP takes account of the annual market value of expenditure on GDP and then uses special chain price indexes (a bit like the
CPI) to deflate the figures (if there has been inflation) or inflate them (if there has been price deflation).
 to expose how the real value of goods and services produced in Australia, has changed between one year and the next.
- these chain price indexes measure the average change in the prices of goods and services relevant to expenditure on GDP against the
existing prices referenced in a selected base year or reference year
 where the price index is always equal to 100 points.
- the current approach now uses a changing reference year (the year immediately before the current year)
 One consequence of this is that previous GDP figures need to be revised every year.

FIGURE 2.33 - THE STATISTICAL ADJUSTMENT PROCESS

LIMITATIONS OF USING GDP AS A MEASURE OF ECONOMIC GROWTH

DEFINE
- Data relating to GDP are only estimations of the annual value of a nation’s output.
- While the statistics can provide a general indication of changes in economic growth
 they are by no means completely reliable
  and there are great limitations
 that inhibit it's ability to accurately measure the economy and societal wellbeing.
- Several reasons for this:

GDP IS AN UNDERESTIMATION CAUSED BY THE EXCLUSION OF NON-MARKET PRODUCTION

- the value of some types of non-market production is typically excluded from the calculation of GDP figures because it is too difficult to estimate
it is value, such as:

 illegal production involved with black economy

 household and individual non-market activity (home repairs, gardening, housekeeping
 volunteer work

SOME ITEMS INCLUDED IN GDP ARE IMPUTED AND SUBJECT TO ERROR

- the value of some production that must be included in the calculation of GDP has to be estimated or imputed because it is not actually
marketed or sold in the normal way.
- this potentially reduces the accuracy of GDP as a measure of economic growth.

QUALITY CHANGES MAY NOT BE REFLECTED IN THE VALUE OF GDP

- changes in the quality of goods and services produced between years are not fully reflected in the changes in the value of chain volume GDP
- Quality may increase despite the price paid or value of production going down
 making the rate of economic growth appear less impressive than it is in reality

REMOVING THE EFFECTS OF PRICE CHANGES FROM THE VALUE OF GDP CAN INVOLVE ERROR
- GDP measured at market prices needs to be statistically adjusted to account
 for any exaggeration or underestimation
 caused by inflation or deflation.
- however, this conversion process of converting at current prices to constant prices
 makes it difficult to calculate indexes
 so that they accurately and fully reflect changes in the prices of all goods and services entering GDP.

SOME LIMITATIONS OF USING GDP AS A MEASURE OF OVERALL LIVING STANDARDS

OVERVIEW
- Some people try to use the growth in chain volume GDP to indicate changes in both
 material living standards (the quantity of goods and services consumed by each person)
 non-material living standards (the quality of life for each person).
- Chain volume GDP is not able to indicate aspects of overall wellbeing, as:

WEAKNESSES OF USING GDP TO INDICATE MATERIAL LIVING STANDARDS

- uneven distribution of national production and incomes
 not all individuals, families, regions and groups benefit equally from economic growth
 this is due to great income inequality
 this means that some people benefit more than others
- population size
 the bigger an economy is, the faster it's rate of economic growth
 this allows for the people to be better off materially
 this only occurs when the rate of growth is faster than the rate of rise in total population
 or in other terms, when average GDP per capita
- changes in hours worked and leisure time
 economic growth sometimes results when the labour force works longer hours
 this however reduces leisure time
 erodes non-material living standards

WEAKNESSES OF USING GDP TO INDICATE MATERIAL LIVING STANDARDS

- Negative externalities.
 Growing the size of GDP has created negative externalities or costs for third parties that lower society’s material and non-material
living standards.
 typically, this is:
 pollution
 environmental damage
 stress

CAUSES OF ECONOMIC GROWTH

TWO DETERMINANTS
- there are two determinants of an economy's rate of economic growth.
  the short-term cyclical rate of economic growth that reflects the strength of aggregate demand factors
 this determines the extent to which the economy's productive capacity is actually being used.
 in the longer-term, the potential sustainable rate of economic growth as determined by aggregate supply factors
 these ultimately dictate the economy's productive capacity that is made available initially

USING AD-AS TO SHOW THE INFLUENCE OF AGGREGATE DEMAND CONDITIONS ON ECO GROWTH
OVERVIEW
- The AD–AS diagram can illustrate the impact of changes in aggregate demand conditions and the level of AD on Australia’s actual rate of
economic growth.

- Australia's rate of economic growth varies cyclically in response to volatile changes in aggregate demand-side conditions that affect the level
of expenditure.

STRONG AD

- When aggregate demand conditions are generally stronger and causing spending to grow faster, business stocks fall

- To replenish shortages of these stocks and meet stronger sales and orders

 Firms will lift output

- thereby accelerating Australia’s rate of economic growth.

WEAK AD

- weaker aggregate demand conditions slow expenditure.

- The level of unsold stocks would then rise and new orders disappear.

- In this case, firms cut production and defer new investment spending,

- slowing Australia’s rate of economic growth.

FIGURE 2.35 – AGGREGATE DEMAND EFFECT ON LEVEL OF AD/CYCLICAL RATE OF ECONOMIC GROWTH

- Referring to figure 2.35, the optimum rate of economic growth occurs when AD is sufficient to cross the AS line at the elbow.

 This level of expenditure corresponds with AD1.

- However, if demand-side conditions are too weak, falling expenditure to AD0 causes firms to cut output to GDP0,

 slowing the rate of economic growth

 perhaps resulting in a recession.

- By contrast, if expenditure grows too quickly at an unsustainable rate and reaches AD2

 excessively strong aggregate demand conditions cause the economy to be stretched beyond its capacity or ability to supply.

 extra spending is not translated into increased economic growth.

 Instead, excessive expenditure only causes depleted stocks and widespread shortages
 leading to demand inflation

 seen by the rise in the general price level from P1 to P2.

THE INFLUENCE OF AGGREGATE SUPPLY CONDITIONS

- Changing aggregate supply conditions can also affect Australia’s potential and sustainable rate of economic growth.
- changing aggregate supply conditions affect Australia's potential and sustainable rate of economic growth where this may alter the
 availability of resources
 production costs
 profits
 number of business expansions or closures
 willingness of firms to produce
- These aggregate supply factors can alter the economy’s productive capacity or the sustainable speed limit at which AS or national output can
grow:
 more favourable aggregate supply conditions for business, firms become more willing and/or able to produce and expand.
 less favourable supply conditions might slow the sustainable rate of economic growth.

2.36 – FAVOURABLE AGGREGATE DEMAND GROW AS/SUSTAINABLE RATE OF ECONOMIC GROWTH

- can again be used to illustrate the effects of changing aggregate supply conditions on the long-term sustainable rate of economic growth.
- as a result of generally more favourable supply conditions, the aggregate supply line (AS) for the economy grows and moves outwards and to
the right from AS1 to AS2.
- the new equilibrium level for economic activity is now higher (GDP2 not GDP1)
 indicating increased economic growth.
- By contrast, generally less favourable aggregate supply conditions
 such as higher production costs
 rate of economic growth (GDP2 to GDP1)
 accelerate cost inflation (P1 to P2).

REASONS FOR PURSUING STRONG AND SUSTAINABLE ECONOMIC GROWTH

- there are three main reasons that underpin government need to pursue strong and sustainable economic growth.
- CAN HELP RAISE REAL INCOMES AND MATERIAL LIVING STANDARDS
 a nation can only have higher incomes if
 it produces more goods and services (more jobs)
 there is strong economic growth at a rate that is faster than the increase in population
 (for Australia, this is usually 1.5–2 per cent a year).
 causes real incomes per head
 purchasing power and consumption increases
 raises average material living standards
 sluggish rates of economic growth associated with rising unemployment levels due to less activity (no need for jobs)
 slows or even decreases real incomes per person
 cuts the quantity of goods and services consumed per capita
 decreases material living standards

- GENERALLY, CREATES MORE JOBS AND LOWERS UNEMPLOYMENT

 when the rate of economic growth is slow of negative, firms employ less labour and other resources
 to cut their production costs, consequently cutting production output / levels
 leads to
 depressed average incomes
 lower consumption of goods and services
 unemployment is kept high (demonstrated through depressions such as the 2008-10 GFC)
 strong economic growth requires businesses to increase demand for resources, including labour
 boosts jobs
 reduces cyclical unemployment
 raises average per capita incomes and consumption
 although it is important to note that new growth in technology may replace workers to aggressively cut costs and increase
efficiency
 however, workers will still be needed to maintain these and more jobs can always be created

- IMPROVES THE GOVERNMENT'S FINANCES AND ABILITY TO PROVIDE ESSENTIAL SERVICES

 solid rates of economic growth can help to strengthen the government's financial or budgetary position
 possibly resulting in smaller budget deficits or surpluses.
 occurs because average incomes rise when GDP accelerates
 government collects more budget revenue from
 personal tax
 company tax
 excise tax
 in turn this allows for government outlays on welfare, provision of infrastructure
 without adding to government's debt and interest repayments
 as a result society's collective needs are better met and living standards are improved

The Goal of Full Employment

DEFINING

Unemployment not only reduces the average income and consumption levels of individuals, it also has adverse effects on the quality of life
including family and other relationships, health and happiness.

EMPLOYMENT

- In economic terms, employment refers to when a person who is 15 years or over, who is able and willing to work, has a paid job
- This is perceived as beneficial as it means that labour resources are being used productively to lift national output and engender better
material living standards

UNEMPLPOYMENT

- unemployment occurs when people aged 15 years or over, who are ‘actively looking for work’, cannot find it.

- unemployed persons, without paid work or a job, are prevented from contributing to national production. unemployment also results in an
increase in welfare payments (which becomes their only stream of income) burdens taxpayers and distributes national incomes less evenly.

THE GOAL

- full employment is the third Australian government domestic macroeconomic goal.

 may also be referred to as the non-accelerating inflation rate of unemployment (NAIRU)
- The Australian government’s goal for full employment is to:
 eliminate cyclical unemployment caused by weak AD
 achieve the lowest rate of unemployment rate at around 4.5-5% of the labour force
 consistent with achieving low inflation and other government economic goals, as determined by the RBA
 as close as possible to the Non-Accelerating Inflation Rate of Unemployment (NAIRU)
 which is the lowest rate of unemployment possible
 without running into excessive inflationary pressures on the economy
 or undermining the achievement of other government economic objectives
  especially the goal of low inflation
- the target used to be higher (at around 5%), however it is believed that this new, lower target will allow for
 a more effective allocation of resources
 operations closer to Australia's productive capacity
 improve society's general wellbeing

LEVELS BELOW NAIRU

- if unemployment remained at around 3 per cent for long

 as during 2007–08
 there would be an acceleration of cost inflation mostly because labour shortages would cause wage levels to rise.
 Then, in order to protect their profits, many businesses would be forced to pass on these higher wage costs to customers by raising
their selling prices.

NATURAL UNEMPLOYMENT

- Although the government sets a target level of unemployment, there is an acceptance that there will always be some form of natural
unemployment
- natural unemployment may be attributed to four causes:
1. structural causes of unemployment
 situation where people cannot find jobs because their skills do not meet what is sought after by employers
 government accepts a certain level of structural unemployment as it is a natural product of an economy
 where new technology and production methods make some jobs obsolete
 rationalisation by firms such as the introduction of cost-cutting measures
2. frictional causes of unemployment
 people unemployed during their job search or change between one job and the next (e.g. builders and tradies)
 government accepts this type of unemployment as it is a natural product of an economy
 where labour is constantly reallocated to the most efficient usage
 where people are rationally seeking better opportunities
3. seasonal causes of unemployment
 unemployment that occurs at the same time each year (e.g. shearers, tourist operators and fruit pickers)
4. hard-core causes of unemployment
 refers to unemployment that arises because individuals have certain characteristics that make them unable to obtain or retain jobs.
 This can be due to mental health issues, disabilities, or substance addition problems, criminal history

MEASURING THE LABOUR FACE

THE ABS LABOUR FORCE SURVEY

- According to the Australian Bureau of Statistics (ABS), the labour force consists of all individuals who are aged 15 and over, able and willing to
work.
 This therefore defines people as employed or unemployed.
- when determining the extent to which the goal of full employment has been achieved is measured using various labour market indicators
calculated by the ABS from it's monthly labour force survey.
- this survey interviews only 0.7 per cent of Australian households, who act as a representative sample.
- labour market statistics are compiled on the following aspects:
 size and growth of the labour force
 Rate and level of employment/unemployment
 Duration of employment

ABS DEFINITIONS FOR SURVEYS

- employed persons
 working either
 fulltime (35 hours or more per week)
 part-time (more than 1 hour per week for pay, or 15 hours in a family business without pay)
 those who hold a job regardless of whether they are prevented from working
- unemployed persons
 actively seeking full- or part-time work but are unable to find it
 able and willing to take up a job in the week prior to the survey period
 are aged over 15 years
 includes those waiting to resume work after being laid off or stood down without pay
CALCULATING UN/EMPLOYMENT RATES

- can be expressed in two ways:

 figures as an actual number
 August 2020
 12 583 400 persons were employed
 921 800 persons were unemployed
 out of a total labour force of 13 505 200 persons.

 figures as a rate or percentage of the total labour force

 in August 2020
 around 93.2% of the labour force was employed
 while 6.8 per cent was unemployed.

OTHER TERMS AND MEASURES OF LABOUR MARKET CONDITIONS

- The participation rate is the proportion of all people aged 15 years and over who are either employed or unemployed, according to the
above definitions.

- The underutilisation rate is the extent to which the available labour is not working at its capacity. This is equal to the unemployment rate
plus the underemployment rate.

- duration
 refers to the average number of weeks for which a person is unemployed
- hidden unemployment
 includes people who would like to work however are discouraged from seeking jobs
- disguised unemployment
 is where individuals have jobs but are underemployed and are not working to capacity
 such as those in part-time jobs with limited hours

LIMITATIONS OF UNEMPLOYMENT STATISTICS

- the unemployment survey data may be misleading and inaccurate, where:
 definitions of un/employment are somewhat arbitrary/random and affect the result
 like why is the cut-off point for those who work more than 1 hr a week
- the statistics fail to account for the hidden unemployed
 includes those who are discouraged from seeking jobs
 hopelessness
 lack of previous success
 personal and family reasons
 as they are not 'actively looking for work' they are not regarded as members of the labour force or as unemployed
 the inclusion of these people would result in a higher level of unemployment than what is reported
 in one instance the ABS found this figure would double the unemployment rate
- changes in the participation rates and other factors can affect the results
 whereby making employment rates look better/worse
 change in participation rate
 duration of unemployment
 proportion of those in fulltime work
- survey error
 as only 0.7% of the population is surveyed across different regions, industries and occupations, the likelihood of error in the results is
higher than the case with a survey of all workers
 This may partly account for the variability in recent unemployment figures
CAUSES AND TYPES OF UNEMPLOYMENT

OVERVIEW
- Australia's unemployment rate and labour market conditions are influenced by two sets of factors.
 cyclical unemployment is caused by weaker aggregate demand factors that slow spending

 natural unemployment (especially structural unemployment) is caused by changing aggregate supply conditions that alter the way
goods and services are produced

CYCLIC UNEMPLOYMENT
OVERVIEW
The general rule is that Australia’s level of cyclical unemployment rises and falls with the overall strength of
aggregate demand conditions that affect the pace of economic activity.

WEAKER CONDITIONS
- They cause the level of spending, production and economic activity to collapse, possibly leading to
 a recession
 cyclical unemployment
- This is because falling levels of AD means that firms will notice rising stocks and fewer orders.
 Pushed to cut production
 Weakens demand for resources
 Raises levels of cyclical unemployment
 strong conditions

STRONGER CONDITIONS
- When aggregate demand conditions are generally stronger
 firms notice
 rising sales
 falling stocks
 greater orders for goods and services.
- In response, businesses try to lift their output by employing more resources, including labour.
 If extra staff can be recruited
 then the level of cyclical unemployment will fall.

FIGURE 2.43 – HOW AD CONDITIONS CAUSE HIGHER/LOWER CYCLICAL UNEMPLOYMENT

- weaker aggregate demand conditions cause expenditure on Australian-made production to fall below the economy’s productive capacity
(from AD1 to AD0 )
- then national production and employment will fall (from GDP1 to GDP0 ) causing cyclical unemployment to rise.
- In reverse, generally stronger aggregate demand conditions stimulate spending (from AD0 to AD1 ) and economic activity (seen in the
rise from GDP0 to GDP1 )
 creating full employment.
- Only if spending grows too fast (beyond AD1 ) and exceeds the economy’s capacity
 will the onset of overfull employment in the labour market cause inflation to accelerate.
NATURAL UNEMPLOYMENT

- natural unemployment may be attributed to four causes:

STRUCTURAL CAUSES OF UNEMPLOYMENT

- situation where people cannot find jobs because their skills do not meet what is sought after by employers
- It occurs because of structural change where businesses
 alter the way they go about producing goods and services
 try to cut costs or lift efficiency.

Use of New Technology

- government accepts a certain level of structural unemployment as it is a natural product of an economy
 where new technology and production methods make some jobs obsolete
- A recent report warned that by 2030
 up to 46 per cent of existing work in Australia (up to 6.5 million fulltime jobs) could be automated
 possibly creating higher levels of structural unemployment.

Mismatch of Skills among the unemployed

- When firms use new technology, they often no longer need to hire those with traditional skills.
- This creates a mismatch between the skills held by the unemployed and the skills needed to fill the advertised job vacancies.
- Skills most recently sought by employers
 computer programmers
 experts in electronics/robotics

Business Closures and Relocation Due to High Costs, Poor Profits And A Lack Of International Competition
- if production costs are too high and profits are too low businesses become uncompetitive
 forced to close down
 move overseas with cheap wages

Recent Government Aggregate Supply Policies

- typically, are cost-cutting
- efficiency promoting measures
- improves business conditions
- reduces costs
- grows profits
- encourages expansion
- boosts Australia's productive capacity

FRICTIONAL CAUSES OF UNEMPLOYMENT

- exists when people are unemployed during their job search or change between one job and the next (e.g. builders and tradies)
 government accepts this type of unemployment as it is a natural product of an economy
 where labour is constantly reallocated to the most efficient usage
 where people are rationally seeking better opportunities

SEASONAL CAUSES OF UNEMPLOYMENT

- unemployment that occurs through termination of jobs at the same time each year due to the regular change in seasons.
(e.g. shearers, tourist operators and fruit pickers)

HARD-CORE CAUSES OF UNEMPLOYMENT

- refers to unemployment that arises because individuals have certain characteristics that make them unable to obtain or retain jobs.
- This is the product of personal attitudes seen as hostile to effective employment
- This can be due to mental health issues, disabilities, or substance addition problems, criminal history

HOW AGGREGATE SUPPLY CHANGES CAN CAUSE HIGHER STRUCTURAL UNEMPLOYMENT

Involving rising production costs, lower profits and business closures

- These less favourable supply conditions shift the AS line inwards and to the left (from AS1 to AS2).
- Rising costs of production can force firms to increase their prices, resulting in cost inflation (prices rise from P1 to P2).
- Cost pressures can also reduce the competitiveness and profitability of local firms.
 As a result, some businesses will close down
 staff may lose their jobs as national output falls
 (the shift from GDP1 to GDP2)
- In reverse, better aggregate supply conditions that increase profits or capacity may cause an outward shift to the right in the AS line (from AS2
to AS1)
 because firms are more willing and able to expand production (the shift from GDP2 to GDP1).
CONSEQUENCES OF UNEMPLOYMENT

- both cyclical and natural high unemployment rates generally have negative effects.

LOWERS INCOMES, INCREASES INEQUALITY AND REDUCES MATERIAL LIVING STANDARDS

- Having achieved full employment means that most people receive relatively good incomes and are able to enjoy reasonable living standards.
 2019, those with fulltime jobs on average were paid $1 700 weekly
 2019-20, those on the adult minimum wage received $740.80 a week
 welfare benefits are only $250-$350 a week
- Similarly, changing from fulltime employment to part-time or casual work brings a corresponding reduction in disposable income.
- With less income, a person has to reduce spending and purchase fewer goods and services.
- Material living standards fall, and income inequality widens

LOWERS NON-MATERIAL WELLBEING AND THE QUALITY OF LIFE

- These factors adversely impact the quality of daily life

- typically, the unemployed are
 less happy
 more financially stressed
 poor self-worth

IS A WASTE OF RESOURCES AND CAUSES A LOSS OF GDP AND INCOMES

- Only when there is full employment will economic growth and material living standards be maximised.
- In this situation, the economy would be located on its production possibility frontier
 thus, operating at its productive capacity or physical limit.
- by contrast, higher unemployment means that some labour resources are idle and are therefore not contributing to national production or the
generation of incomes.

CAN SLOW INFLATION

- Higher unemployment tends to slow cost inflation

 Because it means that the supply exceeds the demand for labour creating a surplus that depresses wages in the labour market.
 as there is so much labour available
 employers are able to lower their wages and salaries
 in the belief that someone else would be prepared to replace their role.
- The unemployed have less disposable income, eroding confidence and slowing spending.
- Weaker spending, due to decreased income, would cause rises in unsold stocks
 Forcing suppliers to price discount their products
- Lower Unemployment rate would elicit an opposite effect
 Signal labour shortages
 businesses exceed the supply of labour
 increased wage costs
 puts pressure on firms to pass these onto consumers as higher prices to protect their profit margins
 cause cost inflation
 very low unemployment could demand inflation
 because wages and income rise more quickly
 strengthens confidence and consumption spending
 widespread shortages of goods
 inflation

WEAKENS GOVERNMENT FINANCES AND LIVING STANDARDS

- important to provide financial support for the unemployed

 through the payment of government welfare and income support.
 However, when unemployment is high this becomes very expensive and less affordable.
- This is because high unemployment means weaken the government’s finances and budgets because
 fewer people paying income taxes and spending on goods and services, reducing budget receipts
 more people qualify for welfare increase budget outlays.
 peak of the recession in 1992
  more than 950 000 unemployed people requiring welfare benefits.
 during 2012–15, the number of unemployed increased to 766 000 people.
- With rising unemployment,
 there is less tax revenue collected by the government
 yet budget outlays on welfare costs are higher.
 Therefore, less money coming in and more going out
 the budget typically moves into deficit (outlays exceed receipts)
 where the government is forced to increase its debt
 Additionally, to repair the deficit the government may need to:
 cut other areas of spending such as education or health
 raise tax rates on those with jobs
 reducing society’s general wellbeing.
- In contrast when the goal of full employment is achieved
 government’s budget position is far stronger,
 the government is in a better position to improve its provision of community services and infrastructure
 can possibly cut tax rates, improving average living standards.

Aggregate Demand/Supply factors effect on domestic macroeconomics (2019 and 2020)

OVERVIEW OF DOMESTIC MACROECONOMICS IN THE LAST TWO YEARS

- there are two main drivers that determine domestic macroeconomic economic conditions
 thereby affecting the degree to which the Australian government’s three key domestic macroeconomic goals
 and living standards are achieved.
- In the two years to 2020, economic activity slowed down
 Resulting in less spending and therefore need for labour
- Changing aggregate demand and aggregate supply factors caused the following trends:
 The inflation rate slowed from 1.6 per cent to –0.3 per cent
 (below the bottom end of the RBA’s target range between 2–3% a year).
 The average rate of economic growth further weakened from just 1.6 to –6.3 per cent
 Australia fell into recession
 below the government’s goal of 3%
 The unemployment rate rose from 5.1 in early 2020 to reach 7.4% in June 2020
 actually over 11% if not for the government’s JobKeeper payments to eligible firms
 This is above the government’s goal of 4.0–4.5%

AGGREGATE DEMAND FACTORS RECENTLY AFFECTING AUSTRALIA’S ECONOMIC CONDITIONS

FACTORS THAT STRENGTHEN SPENDING

- Over the last two years to 2020, there were some aggregate demand factors that operated to strengthen spending on Australian-made goods
and services.
- these being;
 low interest rates
 a weaker exchange rate
 reductions in company tax

FACTORS THAT SLOW AD

NEGATIVE EFFECTS
- However, unfortunately, recent strengthened spending were partly offset, since other factors were creating headwinds that slowed AD
 resulting in the three key domestic goals not being fully achieved.
- overall, aggregate demand was weaker and economic conditions were less than ideal where:
 Demand inflation remained low
 as there was some unused productive capacity
 This is because weaker AD conditions have led to unplanned rises in stocks.
 In turn, firms responded by widespread price discounting to clear their surplus
 thereby removing demand inflation pressures.
 Cyclical rates of economic growth was positive, but were slowed and fell below trend
 The weaker growth in AD
 combined with slower orders and unplanned rises in stocks
 caused many firms to cut production.
 reducing the cyclical growth rate in Australia’s GDP.
 High cyclical unemployment and the average was above the target rate
 To avoid further unplanned rises in stocks there was a slower rise in production.
 As a result, the demand for labour rose more slowly.
 This led to higher than usual rates of cyclical unemployment
 mostly between 5–7%
 general living standards did not improve significantly for most people.

SLOW WAGES GROWTH WEAKENED CONSUMER SPENDING

- As an aggregate demand factor, the level of consumption spending (C) accounts for over 60% of all spending making up AD.
- Thus a slow rise or lack of consumption, as seen in recent years,
 greatly weakens the growth total spending and the speed of activity
 causes economic growth to be sluggish
 further depressing demand inflation
 adding to cyclical unemployment.
 MOSTLY FLAT OR WEAK CONSUMER CONFIDENCE SLOWED CONSUMPTION SPENDING
Over the last few years, Australian consumers have been relatively pessimistic about their future employment situation and income level.
 Where in recording changes in Australia’s index of consumer confidence
 Between 2014 and late 2020
 The index was below 100 points
- As a weaker aggregate demand factor where people are more reluctant to spend, this slowed the growth in private consumption spending (C)
weakening AD.
- some businesses cut production and their demand for resources
 adds to cyclical unemployment

MODEST BUSINESS CONFIDENCE HELPED TO LIFT INVESTMENT SPENDING

- Most businesses were fairly neutral about their future levels of sales and profits.
- When the business optimists outweigh the pessimists this is shown by the net balance being above zero.
- As a result, many businesses increase their borrowing of money from banks to finance higher levels of private investment spending (I).
 caused unsold stocks to fall
 boosted production
 increased demand for resources
 leads to a fall in cyclical unemployment and a rise in average incomes.
- This is unfavourable if such a trend continues where
 In 2019 and 2020, extreme business pessimism
 as an aggregate demand factor
 depresses business investment spending.
 This has slowed
 AD
 Inflation
 GDP growth
 employment.

LOW INTEREST RATES ENCOURAGED CONSUMPTION AND INVESTMENT SPENDING

- Australian interest rates have been at its lowest in recent years to late 2020.
- As a stronger aggregate demand factor
 this made it cheaper and more attractive for households and businesses
 to borrow credit and undertake private consumption (C) and investment (I) spending
- This in turn
 helps stimulate
 AD
 GDP
 Employment
 all without accelerating inflation pressures
 given the current existence of unused capacity).

GROWTH IN POPULATION CONTRIBUTED TO HIGHER SPENDING

- recently the population has been rising by about 1.6 to 1.7 a year
 mostly driven by quite high levels of net migration
- Overall, this development helped to boost aggregate demand conditions by contributing to household C expenditure and AD.

 With plenty of spare capacity

o population growth does not add to demand inflation (excluding the property market)
- This caused firms lift their production
 Stronger demand for resources by businesses result
 Causing cyclical unemployment to slowly fall

LARGE BUDGET DEFICITS STIMULATED SPENDING

- For a decade, the federal government ran large budget deficits

 where the total values of government outlays or injections exceeded revenues or leakages.
 adds to the burden of paying interest on Australia’s public sector debt.
 Thus, there was a pressing need to gradually cut the size of budget deficits and slowly return to surplus.
- Australia was on progress to return a budget surplus by the end of 2019–20.
 However, in response to the COVID-19 recession starting in March 2020
 budget went again into a large deficit due to reduced leakages and large rises in welfare/other outlays.
 This helped to stimulate spending, and economic growth
 in an attempt to reduce cyclical unemployment.
REDUCTIONS IN RATES OF COMPANY TAX HELPED TO LIFT PRIVATE INVESTMENT SPENDING

- Australian government has announced reductions in the rates of tax on the profits of small and medium-sized companies

 from 30% prior to 2016

 to 27.5% in July 2018? 2020
 eventually coming down to 25% by 2021-22
- As a stronger aggregate demand factor
 it is likely this has helped to boost business confidence
 stimulate higher levels of private investment spending (I)
 lifting
 AD
 economic activity
 employment.

RISES IN OVERSEAS ECONOMIC ACTIVITY STIMULATED SPENDING ON OUR EXPORTS

- Following the end of the GFC (Global Financial Crisis)

 world economic activity rose by an annual average of around 3–4 per cent in recent years,
- Overall, mostly positive economic growth abroad until the 2020 pandemic
 meant that more resources were needed by trading partners for consumption and production
- With the rise in global demand
 increased the value of Australia’s exports of commodities.
 Resulting in higher commodity prices
 lifting terms of trade
 adding to the value of Australia's exports or injections

AGGREGATE SUPPLY FACTORS RECENTLY AFFECTING AUSTRALIA’S ECONOMIC CONDITIONS

FACTORS THAT STRENGTHEN RATE OF GROWTH IN PRODUCTIVE CAPACITY

- Over the last two years to 2020, there were also some aggregate supply factors
 that operated to strengthen the potential rate of growth in Australia’s productive capacity
 make conditions more favourable for businesses.
- Includes:
 low interest rates
 reductions in company tax rates
 a slow growth in wage costs

FACTORS THAT SLOW CAPACITY AND AS

NEGATIVE EFFECTS
- However, unfortunately, recent strengthened rate of growth in productive capacity
 were partly offset, by some negative factors slowing capacity and AS

- these opposing forces caused less than ideal economic conditions

 to which the Australian government's three key domestic goals were not fully achieved

- where:

 Low rates of cost inflation.

 Although there were some developments pushing production costs up,

 there were also others that reduced the pressures on local firms to raise prices to protect their profits.

 This kept cost inflation down.

 Economic growth was positive, but were slower and fell below trend.
 Despite some favourable aggregate supply developments,

 there were other less favourable ones that discouraged businesses expansion,
  led to closures,

 slowed the growth in productive capacity and AS

 cut the potential rate of economic growth.

 Some structural and other types of natural unemployment.

 Recently, structural unemployment as the main type of natural unemployment

 remained quite high due to Australia’s:

 relatively weak international competitiveness

 low profits

 business closures and relocation

 general living standards for most people did not greatly improve.

WEAK PRODUCTIVITY GROWTH SLOWED THE RISE IN PRODUCTIVE CAPACITY

- Productivity or efficiency bounces around from year to year, as typically measured by the annual percentage change in GDP per hour worked.

- However, overall Australia’s average growth in labour productivity has slowed dramatically until a rebound in 2019–20 (or December 2018-
19?)
- less favourable aggregate supply factor
 as smaller rises in efficiency or output is gained from a given quantity of labour resources
- problem of lower productivity means that
 production costs rise more quickly
 accelerating cost pressures
 undermining international competitiveness
 eroding business profits
- firms become less willing to produce
 businesses may close or relocate to places where wage and other costs are lower
 as happened with Ford/Toyota

HIGH LABOUR COSTS, REDUCED INTERNATIONAL COMPETITIVENESS AND LIMITED CAPACITY

- Australia is a high-wage country

 Where the minimum wage
 as set by the Fair Work Commission
 is relatively high in terms of international standards
- however, adds to on-costs of employing labour
 including
 the superannuation guarantee charge (SGC)
 an additional cost currently amounting to 9.5% of staff wages that must be paid by firms.
 Paid annual maternity leave arrangements/other guaranteed employment conditions

 although wages are high, this is only an issue as productivity is very low in terms of international standards
o on average an Australian worker produces 20% less in comparison to a US worker
o but are paid more than double the average US rate
o adds to labour costs and cost pressures
 high costs make businesses less internationally competitive, erode business profits
 overall discourages production
 slowing economic and employment growth.

FALLING RULCS HELPED ENCOURAGE THE EXPANSION OF BUSINESS CAPACITY

In recent years, the rate of growth in real unit labour costs (RULCs) has been negative
 such as
 −0.6 in 2018–19
  –9.3 per cent in 2019–20)
- This should
 help to reduce cost inflation pressures
 improve business profitability and survival
 encourage production and expansion
 lower structural unemployment

CHEAP OIL AND COSTS OF OTHER PRODUCER GOODS ENCOURAGED BUSINESS EXPANSION

- In the last few years, the price or cost of producer goods have risen slowly.

- oil prices have generally remained low by historical levels in recent years

- This is a favourable aggregate supply factor for users of oil (e.g. Qantas, transporters).
 allowed some firms to produce at a lower cost

 keeping cost inflation in check.

- reduces costs for the purchasing of inputs
o strengthens profits
o are thus an incentive for business expansion
o greater rates of economic/employment growth

AN AGEING POPULATION AND RELATIVELY LOW PARTICIPATION RATES LIMITED PRODUCTIVE CAPACITY
- Australia has an ageing population
 medium age has risen from 33 to 37 years
 the ABS predicts/projects that this will rise to 40 years by 2040
- the proportion of Australia’s population of non-working age
 was rising nearly two times faster by June-2018 relative to that for people of working age
 is a less favourable supply-side factor that
 reduces the labour participation rate (proportion of those aged 15+ who are economically active)
 reduces supply of labour resources
- participation fell from 67.5% to 65.6 in February 2019, and 64.1% in June 2020
 which if this isn’t addressed, an aging and a reduced participation rate:
 generates labour shortages
 put upward pressure on wages
 add to cost inflation pressures
 slows productive capacity
 limiting sustainable rate of economic growth
 weakens government finances
 leaving less money for the government
 to spend on economic/social infrastructure
 needed to grow Australia’s productive capacity

CLIMATE CHANGE AND SEVERE WEATHER EVENTS SLOWED PRODUCTIVE CAPACITY

- In recent years, there has been a lot of publicity and concern about climate change
 caused partly by the release of carbon dioxide emissions into the atmosphere.
- resulted in global warming
 meaning an increase in the occurrence/intensity of severe weather events
 bushfires, floods, cyclones,
 evident within:
 2020 – persistence of drought in many regions
 reduced rural output and $100 billion in damages
 2020 – with many lives lost, due to bushfires in January–February 2020
 slowed GDP by 1 per cent.
 2019 – three years of drought in EA to 2019 slowed GDP by 0.75% ($12.5 billion)
 2019 - tropical storm and floods in QLD (January to February)
 led to agricultural losses amounting to $1 billion
 2017 - Cyclone Debbie that hit QLD resulted in:
 $1.5 billion lost from coal exports
 flooding of mines
  destruction of rail and port infrastructure
 repair required $1.5 billion
 $120 million lost from tourism
 $270 million of lost sugar cane production
- Are less favourable aggregate supply conditions
 recently limited the growth of Australia’s productive capacity
 by destroying public infrastructure and other industries such as tourism, in the affected regions.

REDUCTIONS IN COMPANY TAX RATES HELPED TO ENCOURAGE THE EXPANSION OF BUSINESS CAPACITY

- Australian businesses pay higher rates of tax on their profits compared with firms in similar countries abroad
 the current rate is 30%
- However, the Australian government has recently implemented several reductions in the rate of company tax
 seen as a more favourable aggregate supply factor
 It should help
 boost the ability, incentive and willingness to start up and expand operations
 make local firms more internationally competitive and reduce the number closing down.
 reduce structural unemployment.
- In these ways, lower company tax rates should help grow Australia’s productive capacity, AS and potential GDP
 thereby promoting domestic macroeconomic goals.

HIGHER BANKRUPTCIES AND LOWER PROFITABILITY HAVE SLOWED PRODUCTIVE CAPACITY

- According to the ABS, recently there has been a sharp downward trend in the gross operating pre-tax profits of Australian incorporated
businesses between June 2017 and June 2020/ December 2016 and December 2018

- This slower growth in profits until the June quarter 2020 was also accompanied by higher bankruptcy rates.

- As unfavourable aggregate supply factors, this:

 reduced of productive capacity

 forced business closure

 adds to structural unemployment

- However, cuts to the rate of tax on the profits made should help to offset this problem

 creating better aggregate supply conditions.

LOW INTEREST RATES FOR BUSINESSES BORROWING CREDIT HELPED TO GROW PRODUCTIVE CAPACITY

- Interest rates can be seen as an aggregate supply cost factor

 because many firms borrow money from banks to finance their operations.

- Recently during 2018 and late 2020

 interest rates charged to businesses borrowing credit from Australian banks
 fell to historic lows of between 1.8 and 0.6 per cent/dropped between 3.5% to 55%

- In turn this:
 allows businesses to keep their profits up
 reduces business closures
 creates new jobs
 encourages expansion
 increases productive capacity
 makes local firms more internationally competitive
 fostering economic growth/jobs
 LARGE BOTTLENECKS IN NATIONAL INFRASTRUCTURE LIMIT PRODUCTIVE CAPACITY

- Australia has a large stock of ageing economic infrastructure that has not kept up with population growth.
- Bottlenecks exist in some key areas such as
 Water, gas, electricity supply

 road and rail transport

- By reducing efficiency, these infrastructure shortages:

 added to business costs

 made local firms less competitive internationally, leading to closures.

 limited productive capacity

 limited sustainable rate of economic growth in

 mining

 agriculture

 manufacturing
- Recently, however, the federal government has been trying to reduce some of these bottlenecks

 The 2019-20 budget for instance

 revealed $100 billion will be dedicated to infrastructure building projects
 aims to create more favourable aggregate supply conditions