Introduction to Economics

Economics attempts to address the economic problem. This is: Our wants our unlimited Resources are scarce Hence all wants cannot be satisfied therefore we must prioritise what wants we wish to fulfil. All people need to obtain goods and services in daily life. Goods such as food, shelter and water are considered needs. All others are wants, they can be categorised into collective and individual where collective refers to a community.

Key Economic Issues

When producing goods and services, the economy must ask a few questions. 1. What to produced? a. [Influenced by] Consumers b. Government c. Business 2. How much to produce? a. Dependent on the demand for a product 3. How to produce? a. Decide on the most efficient use of resource to satisfy the most wants. 4. How to distribute it? a. In most markets, the amount depends on your level of income An economy has to decide whether to distribute the goods in an equitable or inequitable fashion. This is a difficult question as often the most efficient methods are not the most equitable. In most mixed-market economies goods are distributed on your level of income. Australia is a mixed market economy. In this economy the government (to ensure a more equitable balance of distribution) provides some goods for free and some for a cost. Opportunity cost is the real cost of satisfying a want. The cost is not the money you pay but the alternative we must forego. This applies to consumers, business and government; an example is where the opportunity cost of buying KFC is the food you could have bought at McDonalds.

Production Possibility Frontier

The production possibility frontier shows various combinations of two alternative products when all the factors of production are used to their full capacity. The frontier is based on several assumptions - The economy produces only two goods or services - The quantity of the resources remains unchanged - Production can be switched instantaneously.

The red line represents the original curve. Let the x and y-axis be separate goods and or services. - The dotted orange line - improvement in technology in the good or service on the x-axis. - The triangle an increase in the Factors of Production - The circle Inefficiencies in production - The red line maximum output at the present moment From this graph, one could assume it would be rational to produce the x-axis good/service and import the y-axis good/service.

Factors of Production
There are 4 factors of production [FOP] - Land Land includes all the resources provided by nature that are used in the production process. It refers to items such as soil, water, forests etc. Land can also be referred to as natural resources. - Capital Capital is the produced means of production [i.e. machinery]. This means that capital goods are not produced for immediate consumption. A community as a whole owns Infrastructure (or social overhead capital), it includes goods such as roads, railways, bridges etc.). Capital equipment can greatly increase the productivity of other resources, which is how much output they can produce per factor of production per unit of time. Using capital goods can increase the level of production from the existing workforce, allowing the satisfying more wants than previously possible. Therefore the amount of capital can have an important role in the earning capacity of a country. - Labour Labour is the human effort, both physical and mental, in production. The supply of the labour force can change over time and that is based over a number of factors. This can be due to the size of the labour pool being modulated by factors such as age, population and education. - Enterprise Enterprise involves the organising of other factors of production for the purpose of producing goods and services; it is what ties the production process together. The right decisions mean a successful business, the wrong decisions result in failure of a firm. The four factors of production are all in limited supply highlighting the problem of scarcity in economies: - There are limits in the amount of natural resources available for production - The labour pool is restricted by population size, skills of the labour market and the willingness to work - Supplies of capital are limited to the extent by which the government and the private sector are willing to invest - The supply of entrepreneurial skill is limited to size by the population and other socio-economic factors (similar to labour)

Choice in Economics
Consumers make choices which are dependant upon the consumers wish to purchase goods and services. Businesses make choice based upon belief, experiences and predictions. Their consumption of goods and services is based upon the ability to sell their product. They must assess their business activity in order to make a profit. Governments make decisions base on the needs of citizens, general economic management and for re-election. Similarly the economy has to make a choice between producing capital goods and consumer goods. Capital goods are items that will be used for the production of other goods [such as tools]. Consumer goods are items for immediate satisfaction of an individuals and communitys needs and wants. Hence the economy must evaluate the opportunity cost between the two options. If they opt capital over consumer, they can produce more consumer goods later, and vice-versa.

The x and y-axis represent consumer and capital goods.

Economic Factors Underlying Choices

The ultimate decisions made by consumers, businesses and governments have to do with their long term and short-term choice, i.e. the future implications of choice. Individuals Whatever the level of income is for the individual, they all must make a decision about how much of that income they will save and how much will they spend. This will be influenced by their level of income, as well as other factors such as their age and expectations about their future incomes. Plans in relation to education, work, family and retirement also play a substantial role in influencing economic decision-making. Business firms face choices in many aspects of its operation, i.e. pricing of products. A firm may chose to increase the price of their product hoping to have an increase in profit whilst not decreasing its sales. Their pricing of the products depends to what type of market the firm is aiming to sell at, (i.e. a mass or niche market). The underlying assumption about firms is that they seek to minimise costs and maximise profits, however in order to maintain company image, ethical issues must be considered such as environmental impact of production. Government governments can have a significant influence on what occurs in a market (in terms of the choices made by businesses and individuals). This may be by making some choices more expensive or

less expensive for others. An example of this is the cigarette tax, which attempts to discourage people from smoking. Governments have the power to sanction certain products, such as drugs and firearms, and encourage people to buy other products or services by providing subsidies, i.e. Medicare.

How Economies Operate

Humans mostly carry out the production of goods and services. The assumption is that production is carried out for profit. This means in the production of goods and services businesses seek to minimise the FOPs used and maximise products. Since supply is limited, businesses face an opportunity cost when deciding what to produce. The market will tend to dictate the price of a good or service. The government can influence this by laws and taxes/subsidies. One of the main functions of the economy is to decide how to distribute the goods. The market doesnt attempt to distribute the goods and services evenly. Rather those with sufficient income may purchase the good or service, this is called the price mechanism. The price mechanism encourages a. Improvement of skills b. More competitive workforce In Australia there is a substantial number of people whose income from labour is deemed insufficient. To provide fairness, these people receive payments from the Federal Government called transfer payments (a means of re-distributing wealth from the rich to the poor). This allows disadvantaged people to obtain goods and services. Individuals and businesses generally use money as the medium of exchanging goods and services. This makes it easier for people to conduct transactions; the existence of money allows people to highlight their contribution into the production process.

The business cycle

Every economy has periods where the GDP (Gross domestic produce the total value of goods and services produced in a year) grows or shrinks. This graph over time is called the business cycle. Last time GDP fell in Australia was 4th Quarter, 2008. The general trend is overall positive GDP growth, however some countries, this is not the case.

The business cycle represents the cyclical pattern of growth in market economies. N.B. Mistake in diagram, it is not a recession, it is a downturn.

Types of Inflation
During the business cycle, we undergo periods of inflation, which are caused by inflationary pressures. This phenomenon causes a fall in the buying power of the consumer dollar. This is because the price of goods and services rise due to pressures generated by activity in the economy. There are 3 main types of inflation: 1. Cost-push Inflation: this occurs when the price of production for goods and services rise that results in additional cost in production is passed onto the consumer. This can be caused by higher wages for employees, which increases the cost of the good or service. 2. Demand-pull Inflation: this type of inflation occurs when the cost of goods and services rise due to consumer demand. This is due to the price mechanism that discriminates. When demand > supply then businesses will raise the price to discriminate between consumers. 3. Imported Inflation: this type of inflation occurs when the Australian dollar drops, increasing the costs of imported goods and services. This means an increase in the costs of goods and services (which are imported directly for the consumer).

Characteristics of the Business Cycle

Over time, economies usually experience an overall trend in the growth of their output (GDP). However economies are subject to periods of strong growth followed by an economic slowdown, in which the level of economic activity falls. The economy may then stay weak before recovering and achieving a faster level of economic growth. This is the premise for most economies in the world, although economies do not match the model of the business cycle exactly, the cyclical nature is evident in most economies. The cyclical nature of the business cycle has the potential to cause problems in society, below are the features of each stage in the economic cycle: 1. Expansion/Upswing a. Lower unemployment b. Increased inflationary pressures c. Increased GDP d. Possible cash rate increase

e. Budget likely to go into surplus f. Consumer spending increase and increase in borrowing g. Bubbles may appear in the market h. Consumer confidence is strong 2. Peak/Boom a. Unemployment low b. Inflationary pressures strong c. Cash rates high d. Consumer spending and consumer confidence is high e. Business looks to expand production f. Budget most likely in surplus g. GDP increases 3. Downturn a. Unemployment rising b. Government increases expenditure c. Decreased inflationary pressures d. Cash rates drop e. Decreased consumer spending f. GDP reduction g. Consumer confidence drop h. Business investment drops 4. Trough/Recession a. Unemployment high b. GDP negative for 2 consecutive quarter (technical recession) c. Possible deflation d. Foreclosures of business e. Cash rates low f. Possible quantative easing1 g. Consumer and business confidence low h. Possible civil unrest i. Government budget deficit j. Investment low
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Quantative Easing is a government monetary policy designed to increase the money supply by buying securities from the market. This allows financial institutions to be flooded with capital, in an effort to increase lending and liquidity in the market. However if this is not managed properly it can lead to inflation. This technique is used when cash rates are very low. Quantative easing includes printing money that is dangerous. The Australian Economy utilises automatic stabilizers in order to avoid erratic fluctuating of the business cycle, known as the boom-bust cycle. Automatic stabilizers use tax and transfer payments to regulate the economy. In a boom, employment levels are rising and also salary is rising, this means consumer spending would increase and the economy would grow. However due to the progressive tax system, more people will have to pay greater amounts of tax (due to greater income), resulting in less money to spend and the economy slows down. In a recession less people will be paying tax at lower rates. Untaxed payments from transfer payments allow consumer activity to increase causing the economy to speed up (i.e. more money is being injected into the economy).

The Circular Flow of Income

The circular flow of money is based on the premise that:

Leakages = Injections Economy is stable, in a state of equilibrium Leakages > Injections Economy shrinks Leakages < Injections Economy grows Injections Exports (X) Investment (I) Government Expenditure (G) GDP Growth = E + I + G + (X-M) Leakages Imports (M) Saving (S) Tax (T)

Currently the Australian Economy is looking to expand following large flows of investment into the circular flow following the mining boom. Individuals (Households) this sector consists of all individuals in an economy and is concerned with their level of income, and the amount they wish to save and spend. Individual return (income) for the labour they provide to firms, can be spent on goods and services can be saved, taxed or used to purchase imports. Businesses (Firms) this sector consists of all businesses engaged in the production and sale of goods and services (exclusive of financial institutions). They rely on individuals for FOPs, and in return provide goods and services to the individual.

Financial Institutions this sector consists of all institutions, which are engaged in the borrowing or lending of money. The financial sector (sometimes known as the capital market) accepts savings from the individual and lends them out to businesses for investment purposes. Savings are seen as a leakage out of the circular flow, to counteract this notion, there are also investments. The result of increased investment often leads to the increased production of capital goods, leading to increased demand for resources which leads to increased incomes and in return an increased demand for goods and services. Governments the Government plays two major roles in terms of the circular flow of income, they tax the income from individual and businesses and in return use this revenue to undertake government expenditures. Since tax is a leakage, increasing tax would reduce the level of economic activity, this is how the government can influence the level of economic activity. Conversely government expenditure represents an injection and can increase economic activity. International/Overseas this sector covers all transactions that an economy has with the rest of the world. Imports act as a leakage as the money is going away and been given to foreign business. Exports count as an injection as this mean foreign money is being injected into the economy as they purchase the economies goods and services.

Governments in an Economy
The Market Economy
In a pure market economy, firms and individuals make all major economic decisions. Under this system, most economic resources are owned by the private sector and people are able to seek wealth without the government intervening or affecting business activity. This is known as a capitalist or laissez-fair system. The laissez-fair market economy is often contrasted to a centrally planned economy. Under this system government financial planners plan out the economy and there is very little scope for businesses and individuals to influence the economy. Public ownership of factors production allows the government to allocate resources as it sees fit, in the past this was followed by Russia, China and other countries, but is no longer pursued by any major economy. A market is a network of buyers and sellers whom seek to exchange a particular product at a certain price. In markets for goods and services (known as a product market), the buyers are the consumers and they constitute the demand for the products. The sellers are the businesses whose output decisions make up the supply of the product. Price becomes a very important factor, as consumers wish to buy at the lowest price possible in order to satisfy the most wants, and firms want to get the highest possible profit. The price mechanism determines the price for each good ands service based on supply and demand (in a market economy). The principal is that the higher the demand and the lower the supply, the more expensive the good or service as the price mechanism attempts to exclude those who cannot afford the good or service. Changes in supply and demand in the product market will also influence supply and demand in the factor market, which is the market for factors of production. When demand becomes higher in areas of the economy, more factors of production will be re-allocated in order to match demand (however

manufacturers need to offer money to attract FOPs to come and produce their product/service, for example higher wages to labour, this is an example of the price mechanism in Factor markets).

Australian Market Economy

Australia is a modified market economy in which the government has the ability to influence the market. It has the following characteristics: 1. Private ownership: This means that businesses have the right to acquire, use and dispose of assets 2. Government regulation on some goods and services, they also impose restrictions on all business (i.e. OHS + Fairwork Australia) 3. Freedom of Enterprise: Business can be set up, modified or closed down 4. Competition: Despite the existence of natural monopolies2, goods and services have more than 1 option in most cases, allowing for competition 5. Price Mechanism: Businesses can set prices of many goods and services independently.
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Natural monopolies are automatic dominances created by the virtue of a business size or the nature of the market they supply (i.e. Domestic Airlines). Governments intervene in the market economy in order to provide: - Resource allocation o Provide important things that otherwise would not be provided o Restrict the production of harmful goods through regulation - Income distribution o Creates a fairer society and attempts to restore income equality - Economic Stability o Smooth out sharp fluctuations in the economic society (in Australia via Reserve Bank and Fiscal Policy (Budget)) o Ensure stability in the economy and in the financial system As a result the Federal Government plays a large role in the economy in a number of ways that impact on the market: 1. Regulates imports through tariffs and restrictions 2. Places regulations on industries 3. Tax regulation that impact on consumer/business activity. Such as PAYG (pay as you go) and FBT (fringe benefits tax) 4. Transfer payments to low income earners 5. Incentives/subsidies to businesses and consumers to engage in certain activities (i.e. buy solar panels) 6. Government infrastructure creates demand on FOPs for public goods such as roads 7. Governments can create trade agreements with nations that allow Australian products to compete 8. Government can create demands in certain areas by specific budgetary measures A mixed market economy also attempts to answer and solve the economic problems, by specifically addressing the four major questions: - What to produce The government has the power of what to produce in many ways. For example the government can become a producer itself. It can provide collective goods and services such as schools, roads and bridges. It can compete with private enterprise as seen through ABC and radio stations. It can encourage the production of certain goods and services through subsidies and tax incentives. It also has the power to prohibit the distribution of certain goods and services.

- How much to produce The government also has the power to limit how many goods and services are produced. This can be seen in the taxi industry where the state governments (in Australia) restrict the number of taxi licenses, which are handed out each year. They can also encourage a greater provision of a good or service; these are often referred to as merit goods and it can be seen through the governments encouraging of education. - How to produce Government can influence the cost of factors of production and how those factors are used in the production process. For example, under labour, there are laws out-lining the minimum wage for workers. There are also laws which regulate the ways firms operate which means that capital may not be able to be used in the cheapest way (i.e. using a chainsaw without gloves or any safety equipment). - How to distribute it The government also affects the distribution process in the economy. For example higher income earners (in Australia) have to pay higher taxes (progressive tax system) which means that they will not be able to afford as many goods or services. Governments may also impose restrictions on the factor market as seen by imposing a minimum wage on labour, changing the way it is distributed amongst firms (i.e. a firm may not be able to afford the minimum wage).

Comparing an Economy with Australia (Indonesia)

Over the recent years Australias relationships with countries in the Asia region have become very important, this is because of a number of underlying reasons - Australias trading relationships are mainly with Asian economies, over half of Australias exports are destined for Japan, China and South Korea - Australias relatively strong performance through the global downturn of the late 2000s which battered the economies of Europe and North America highlighted how Australias economic fortunes are linked with Asian economies - Rising living standards in Asia and the shift towards market-orientated economies in the Asia region in recent decades make for more meaningful comparisons and economic analysis Below is a quick analysis between Australia and Indonesia pertaining to key bits of economic data (2010), use this for extended response comparison question: Factor Australia Indonesia GDP ($US Billion) 1,237 707 HDI 0.977 0.600 Life Expectancy 81.9 71.5 Mean Expected Years of 12.0 5.7 Schooling Population 22 342 000 237 641 326 Gini Index 33.5 37.0 CO2 (Tonnes per capita) 17 2 Public Spending: Health and 10% 4% Education (% of GDP) GDP/Capita ($US) 57 400 2 900 Unemployment Rate (%) 5.0 6.9 When comparing economies from an economics point of view, it is important to examine the economies across five areas: economic growth, quality of life, employment and unemployment, distribution of income, environmental sustainability and role of government.

Economic Growth and Quality of Life By international standards, Australia has a very small population but commands a large GDP. This is because Australia has had a recent mining boom allowing Australia to become very important on the international market. The Asian economic region has been the worlds fastest growing economic region since the Second World War. The Asian Tiger Economies of South Korea, Singapore, Hong Kong and Taiwan pursued growth strategies that relied on competitive labour costs and growing export markets, particularly for manufactured goods, to achieve rapid industrialisation, which was achieved over a few decades, contrasting with the centuries long industrialisation in some European countries. Recent decades have seen a third major phase in economic development in Asia. Developing Asian economies including China, Indonesia and India have experienced the fastest average annual economic growth of 7.5% over the last three decades. Australias economic outlook and performance has been very different to the rest of Asia since it achieved strong industrialisation and high living standards prior to WWII. Australias average annual economic growth of 3.2% over the past three decades is slower than most economies in Asia (but faster than developed nations). Australia has achieved relatively stable economic growth for the past 30 years. GDP per capita is a measure of living standards that takes all financial value of all goods and serviced produced by a country within a year and then divided by population. Australia has a very high GDP per capita and this is highlighted through exceptional living conditions. The quality of life enjoyed by Australians is among the highest in the world. The Human Development Index is a popular but narrow measure of quality of life that takes into account income, life expectancy, adult literacy and educational levels. Australia has a high degree of cultural diversity with a quarter of the population born overseas. Australians enjoy political freedom that compare favourably towards other Asian countries like Indonesia, where the government is, at times, unstable. Employment and Unemployment Employment patterns in Australia are similar to most other developed nations, with the majority of people employed in tertiary industry, such as real estate and business services. Industries like manufacturing and construction still continue to provide many jobs; however there has been a stark decline in jobs in the agrarian industries. Many Asian economies that are still industrialising still have large agricultural sectors, like Indonesia where 41% are employed in fishing and farming industries, and has much smaller sectors in the tertiary industry, focussing on primary. Coming decades are to see rapid urbanisation as people move away from such employment to work in industry and the services sector in the cities. Distribution of Income Distribution of income is very important as there might be large scales of income inequality (refer to Lorenz Curve later on in notes). Agriculturally developing economies can also have a very unequal distribution of income because of divisions between rural and urban populations and the concentration of land ownership amongst the wealthier groups in society. Without government intervention the process of industrialisation can worsen this inequity as business owners can exploit the lower earners in society for FOPs. Mixed economies with a greater role of government in redistributing income to poorer groups tend to be more equal. The Gini Index was created to measure this inequality, and the lower the number is, the more equal the nations distribution of wealth. Environmental Sustainability

Over the recent decades, preserving the environment has become a key part of decision-making in modern economies. Despite Australia having large national reserves, less water and air pollution, and more efficient industrial processes. For an industrialised country Australias environmental sustainability is quite poor: 1. Australia has a very poor history of preserving biodiversity despite being one of the six most bio diverse nations on the planet. In the past 200 years, 27 mammals have become extinct 2. Australia does not make good use of its water resources, as measured by water productivity US dollars of economic output per cubic metre of water used. Australia was at $22/cubic metre compared to Japan at $59/cubic metre but it is still significantly higher than developing Asian countries like Indonesia 3. Australia has a very high dependency rate on fossil fuels for its energy use. 93% of electricity produced in Australia comes from fossil fuels like coal. In other Asian countries, fossil fuels typically accounts for 85% of electricity produced As a result Australia emits double any Asian countries amount of CO2 into the air per capita. However different countries face unique problems when it comes to Environmental sustainability. For example Indonesia is a significant contributor to climate change because of its large deforestation industry. Role of the Government Over the last three decades, divisions between planned economies and market economies within Asia have decreased. Governments of planned economies such as China have started to release government control to allow supply and demand to play a greater role. Over the same period, market economies such as Indonesia, governments have been using a range of interventions to promote the development of competitive export sectors and rapid industrialisation. Market forces, especially in key sectors like agriculture, mining, construction and manufacturing, have always governed Australias economy. However being a mixed market economy, there has always been a role for government in certain service industries such as telecommunications and aviation. But even these sectors, recent decades have seen a reduced role for the government through deregulation and privatisation in specific sectors. Higher levels of government spending generally indicate a greater role of the government in the economy. Australias government expenditure was 37% of GDP, which is higher than Indonesias, which was approximately 23% (Developing Asia). Australians pay more tax but receive more benefits and services from their government than other industries. Australias social welfare system provides a level of assistance much greater than that in most Asian countries. The purpose of Welfare in Australia is to ensure a minimum standard of living for people who are unable to work or are looking for work. Welfare benefits include unemployment benefits, the age pension, disability support payments etc.

Consumers in an Economy
In a modified market economy, the economic decisions of what to produce, how to produce, and how to distribute are either partly or wholly down to the consumer. This is called consumer sovereignty and can be modified by: 1. Government intervention they have the power to ban certain goods and services so that it is no longer available to be produced or purchased by the consumer. This is evident through firearms and drugs which are prohibited by the Australian government

2. Advertising exerts a powerful influence over the spending patterns of consumers, most strategies aim to manipulate the behaviour of consumers. It attempts to convince the consumer to either buy their product or to preferentially choose their product over another. Manipulative or deceptive marketing practices (i.e. bait and switch) diminish consumer sovereignty 3. Peer pressure or general trends of consumer spending pressurise the consumer into buying a product that would be accepted by greater society 4. Planned obsolescence (where a company has already a superior product planned, like Apple with its iPhones). This manipulates on the consumers desire to stay in trends with latest fashion and products, therefore they are encouraged to purchase the latest products 5. Monopoly or oligopolistic3 behaviour may leave consumer with little choice. Sometimes known as anti-competitive behaviour. For example, a business may manufacture electronic devices that only the companys brand of accessories such as power supply cords or batteries are compatible with. 6. Misleading or deceptive conduct can lead consumers to pay for items they do not really want to buy. This is common with weight loss schemes and baldness treatments. 3 Oligopolistic behaviour refers to different business agreeing not to compete with each other (sometimes happens in industries such as petrol).

Consumer Spending
Households can make two decisions pertaining to their income, either to save or spend it. Therefore the equation for all income is Y=C+S Income = Consumption + Saving If the proportion of spending to saving is a zero sum equation (C + S = 1), and that a change in either consumption or spending will influence the other. If the proportion spent of Y is 90%, i.e. (0.9), the average propensity to consume is C/Y = 0.9. Average propensity to consume (APC) and Average propensity to save (APS) are written as decimals. As a general trend: Low Y APC higher, APS lower High Y APC lower, APS higher As income rises, the assumption is that or every extra unit of income the consumer earns, there is an increase in savings and a decrease in consumption. This is caused by the amount of disposable income one has. The consumption function is a graphical representation between the relationship between income and consumption for an individual or an economy. It is usually sloping upward with a gradient less than one and with a positive y-intercept.

Marginal propensity to save (MPS) and Marginal propensity to consume (MPC) are also written in decimals. It is calculated by taking the additional income, and seeing what proportion is being spent, and what is being saved (i.e. $50 increase, $10 spent, $40 saved, therefore MPS 0.8). There are a variety of factors that influence a consumers decision to spend or to save: - Cultural factors some cultures tend to save more of their income. Present generation spend more than the previous generation - Personality factors some people are more cautious and prefer to have savings in case of any future need - Expectations of the future people who expect their income to rise in the future would be less likely to worry about saving now - Any specific future-spending plan individuals might tend to save more if they have a purchase (most likely expensive) planned in the future, i.e. car. - Tax Policies the tax system can influence ones spending patters by making it more attractive to save, for example superannuation is exempt from tax - Availability of credit spending is likely to be higher if credit is readily available as there is a new source of income.

Factors influencing Consumers

1. Price generally speaking, the lower the price, the higher the demand. If there is a competing product, price is an important factor, i.e. butter and magarine 2. Income the higher a consumers income is, the more goods and services they can purchase. For different income groups, types of products change and pattern of spending changes 3. Sociocultural factors these includes a range of factors including: religion, cultural background, ethics, morals, gender, peer pressure and geography 4. Advertising aims to make people more aware of a product or to preferentially purchase their product 5. General economic conditions if consumers are confident they tend to buy more goods and services 6. Disposable income how much a consumer has to spend after recurrent spending (regular expenses such as mortgage, taxes etc.)

7. Price of complementary goods some goods cannot operate without other goods (i.e. car needs petrol)

Sources of Income
Many sources of income derive from the market demand for factors of production. The income from each FOP is: - Labour Wages salaries, commissions, royalties, stipend, bonus - Capital Interest payments made on capital and payments made on the loan - Land Rent rent from commercial and domestic use, natural resource tax (royalties for land) - Enterprise Profit profit taken by individual owners and dividends Income in Australia may not be necessarily derived from an earning on a FOP, these incomes include: 1. Transfer Payments a. Unemployment benefits b. Rebates (health care etc.) c. Pensions d. Tax write offs for low income earners e. Student payments 2. Windfall [These payments are untaxed in Australia] a. Lotteries b. Prizes c. Wills d. Inheritance Sources of Household Income 1. Wages and Salary 59% 2. Businesses profits and Investment 17% 3. Property Income 10% 4. Government Benefits 9% 5. Other 5% 2. Assistance to families with children 26% 3. Assistance to people with disabilities 18% 4. Assistance to veterans and dependents 6% 5. Assistance to the unemployed and sick 6% 6. Aboriginal advancement programs 1% 7. Other welfare programs 1%

Social Welfare Expenditure 1. Assistance to the aged 39%

Income Distribution in Australia

Income in Australia is distributed according to the market value of the FOPs (i.e. the value of your labour). This means that the more the value an individual provides, the higher the income. Like most developed economies, Australia has quite high levels of income inequality. To measure this inequality a Lorenz Curve is used: The line of perfect equality represents an economy where there is no income inequality. The Lorenz Curve measures the differences in income. It represents that small amounts of people own great portions of the economys wealth, however there are greater numbers that share lower amounts of wealth, this is prevalent in most economies. The Life Cycle of Income refers to the differences in income due to age. The first two periods of life is spent dissaving. The next 4 decades tend to have savings (in Australia there are enforced savings called superannuation). After work the individual re-enters the state of dissaving (using the income saved during their working career). Individuals and households tend to smooth their consumption, if they expect a very high level of income during this period, and very low or no income in the following period, they are likely to save up around half their income this period so as to have a reasonably constant standard of living during both periods.

Firms

(Businesses) in an Economy

The term firm refers to any enterprise that uses FOPs to produce goods or services for consumers, government or and business. The enterprise does this in the hope of returning a profit. A group of firms in producing a similar good/service are termed an industry.

The general classifications of firms in a 5-sector model are: 1. Primary extractive industries such as mining, farming, fishing etc. 2. Secondary transforming materials into finished or semi-finished goods 3. Tertiary provision of services 4. Quaternary information services 5. Quinary these are household services which are associated with hospitality

Production Decisions
When operating a firm, the business must make decisions on what to produce and how to produce them, they must consider several factors prior to making this decision; these include: - Costs of the use of FOPs to produce the good or service, the lower the costs and the risk of operating (particularly the beginning) the more likely the business owner will operate that business. - Their ability to produce that good or service, and the skills and experiences of the business operator. The more experienced the businessman the better the business will do as the entrepreneur will know the demands of the consumers, nature of production etc. - Market conditions industries where there is strong consumer demand for the product. The business owner will most likely go where rapid growth is being experienced. For example in the early 2000s many business owners made a fortune due to heavy investment flows in the mining market - Future expansion of production, markets and prices the scope that the business has in the future. For example if you try and take on Woolworths, nothing is going to happen immediately, but if you tapped into a niche market which has been under-exploited, then the possibilities are much greater. - Management expertise, beliefs and interests, the ability of the entrepreneur. Risk/Reward of FOPs FOP Natural Resources/Land

Reward New resources can be discovered improving the productivity of such resources Investment in education and training can increase the productivity of the nations workforce Businesses increase economys capital stock through investment in goods that are used in the production process The supply of entrepreneurs will increase under favourable political and economic conditions

Labour

Risk Natural resources can be diminished through exploitation, such as overfishing or deforestation A declining birth rate or an ageing of the population could decline the labour pool Over time, old capital will wear out and become obsolete. This discarded component of capital is known as depreciation An uncertain environment, such as an economic downturn, will reduce the willingness of businesses to take risks

Capital

Enterprise

Firms provide employment to countries and help reduce the unemployment rate. Healthy, growing private sectors will generate a higher rate of economic growth and a stronger revenue base to fund the services provided by governments. This is why the Queensland and the Western Australian governments are so prosperous in comparison to other states.

These decisions are relevant in terms of goals of a firm. The goals of a firm may vary depending of what they are aiming at, at different times. A firm will attempt to maximise their profits by making the largest possible profit within regulation, they do this by: 1. Minimising costs of production 2. Increasing market share increasing the size of their market 3. Satisficing behaviour this is where a company aims to make adequate profits, and they attempt to achieve other goals such as improving company image etc. This in the long term leads to greater profits. 4. Meeting shareholder expectations this can be dividends, share price, good behaviour, support of a worthy cause etc. Shareholders are often concerned with maximising short-term profits which can create strains within a business about what the goals should be 5. Increase range of products leads to diversification, also can lead to maximising growth, which has potential problems.

Efficiency and Productivity

Efficiency refers to the ability of a firm in using the least volume of FOPs to produce the most goods and services. The more efficient a firm is, the more likely it is to produce goods and services more cheaply with less waste. The term productivity relates to the quantity of what is produced to what is required to make it. There are substantial benefits to the economy when firms use resources more efficiently. In a general sense, because we are able to produce more goods and services without existing resources, our overall living standards increase (since the economy can satisfy more wants). It is this improvement in productivity which is the key to increasing living standards within a country. If one of the factors of production is increased while the others remain fixed, a point will be reached where eventually if more of that factor is added, the productivity begins to fall, this is called the law of diminishing returns. However an increase in the productivity in any Factor of Production (particularly labour) will have the following impacts: a. An increase in the volume of goods and services b. Less wastage of resources (i.e. using the waste as a resource) c. Higher incomes d. Less pollution e. Lower inflationary pressures (more is being produced for less) One of the main drivers of productivity is specialisation. In a globalised market for Factors of Production (factor market) and for products (product market) the specialisation of resources is very important. This process leads to firms becoming more productive and becoming specialists in some fields. Type Division of labour (specialisation of labour) Definition Occurs when businesses break down their production process into sub-processes allowing individuals to become specialists at one part in the production process Occurs when a large number of Example The assembly line approach to a car production, where each worker does a different part of the vehicle

Location of industry

The concentration of advanced

(specialisation of natural resources)

Large-scale production (specialisation of capital)

businesses that produce similar goods congregate in a similar area to reduce production costs by reducing the amount of capital to buy (they share the capital) Occurs when businesses grow so large they can use highly specialised machinery to in their production process

technology industries in the North Ryde industrial area.

A large win producer that uses specialised machines to bottle, cork and label wines

Economies of Scale
An economy of scale is when a business gains a productivity advantage by becoming large or expanding the size of their operation. By becoming an economy of scale it means that the per unit cost of producing is reduced. The main advantages of becoming an economy of scale are: - Marketing purchasing power (i.e. bulk buying and price making) - Being able to purchase specialist equipment - Able to hire specialist labour - Access to finance - Able to engage in research and development Internal economies of scale are businesses that have become bigger because of factors under their control. Actions that lead to this productivity advantage are: - Purchasing capital - Increasing factors of production - Actions which lead to the expansion of business An external economy of scale is the advantages of growing big by factors that are outside of the firms control. These include: - Better transport links - Taxation and industry assistance (from government) - Microeconomic4 Reform (changing ways that business operate) - Larger capital markets for similar businesses
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Microeconomic reform is government initiatives or policies aimed at improving performance and or the efficiency of industry or sectors of the economy. Due to growing pressure on firms and wide spread inefficiencies in the 1970s, microeconomic reform has become a key part of the framework of the Australian Economy. Businesses aim to produce at the technical optimum if they can (i.e. there is a demand for the product). This is where the internal economies of scale are the most productive. If the technical optimum is exceeded, the following issues can occur: - Lack of space - Costs to replace capital - Lack of contact between management - Loss of product quality When such factors cause the average cost per unit (costs to produce 1 product that the firm produces) to rise again, the firm becomes an internal diseconomy of scale. The curve that highlights the technical optimum and the average cost of unit as output increases is known as the Long Run Average Cost Curve.

The technical optimum (represented by the triangle) is the lowest you can push the cost/unit down. The only reason you would surpass the technical optimum is to increase market share (size of market). To move the curve down (i.e. to reduce costs further), you need to improve capital (via technology) and learn from experience (specialisation over time). Similarly to economies of scale, there are external diseconomies of scale. This means that the firm loses its productivity advantage because of external factors. Such factors include: - Government restrictions (such as Carbon Tax), increasing costs for businesses - Traffic issues because of increasing urbanisation - A limited supply of raw resources that a firm uses during production, driving costs of production up

Ethics and Investment

An increasing number of businesses are engaging in ethical practices in their activities. This is often driven by a bid to increase market share and company image amongst consumers. Such factors include: 1. Environmental safeguards or standards met it is the concept that involves minimising pollution and waste, preserving the natural environment and increasing the use of renewable energy. Businesses may change their activities to make them more environmentally sustainable in response to consumers, new regulations, and financial incentives by government or because of business ethics that value such sustainability. 2. Human rights and standards of employment practices (i.e. not using sweatshops) globalisation has led to firms being able to access a larger labour pool. Due to the nature of some economies, it may be cheaper to use certain FOPs overseas but it maybe unethical. For example Coca Cola used the African market to produce coke for some time, however after demonstrations by college students in the US, they agreed to extend health care benefits to employees in Africa who worked for Coke, many of which were suffering from HIV/AIDS and needed medical care.

3. Employment level in some areas (keeping production and jobs local) new technologies have mixed impacts on the demands of firms fro employees. As new technologies make old jobs redundant, it leads to job cuts, and some decisions (to support a particular product) may be made in order to support jobs in a particular area. 4. Price, especially of staples (bread, milk etc.) or produce not covered by regulation the advent of internet has allowed consumers to quickly check and compare the price of a good or service online, which means that firms must be careful about how they price they goods and services or suffer loss of sales. 5. Demand for safety of particular goods and services (i.e. cars) the goods must be safe to use otherwise there will be a lack of consumer confidence, and a lack of support behind the particular product.