Australia has recorded more than 24 years uninterrupted annual growth, with low
inflation and low
unemployment. The high growth rates of 2003-2007 are a result of the mining investment boom, responding to high
terms of trade and
Chinese and Asian demand for commodities (especially iron ore and coal). Whilst
one quarter of negative GDP growth occurred during the GFC, recession was avoided as a result of the Rudd stimulus package (
fiscal policy), lowered interest rates (looser monetary policy) and the impact of recovering Asian demand for commodities which supported a continuation of the mining investment boom. The high terms of trade and high currency has impaired non resource sectors, with GDP growth being driven by mining investment expenditures (half of which are spent on imported capital goods and services). Note that the one quarter of negative GDP growth in March 2011, and lower growth rates in the Dec 2011 and June 2011 quarters were a result of extensive flooding in Queensland that negatively impacted econonic activity and coal mining production and export. Since the peak of the mining investment boom in 2013, monetary policy loosened (now at record lows), whilst fiscal policy was mildly contractionary and therfore pro cyclical. Whilsty some rebalancing to housing construction has occurred, growth remains weak as does non mining business investment.
The Labour Years Episode 5 - the last recession 1hr 55 min
Quarterly GDP Growth (2007-2013). Australia
Note the absence of recession (2 consecutive quarters of negative growth) in Australia for more than 20 years. In recent history, one quarter of negative growth occurred during the GFC in March 2008, and the March quarter 2011 which arose because of the economic impact of floods in Queensland both on the general level of economic activity, and especially adverse impact on coal mining production with flooded mines.
Historically, from 1960 until 2012, Australia GDP Annual Growth Rate averaged 3.50 Percent reaching an all time high of 9 Percent in June of 1964 and a record low of -3.40 Percent in June of 1983.
In recent history, recessions were experienced in 1983, and 1991. Following the 1991 recession, Australia has had an unbroken run of over 20 years without a recession.
The 1991 recession was part of a global recession following growth through asset price rises, high levels of debt, and then the impact of high interest rates used to combat the inflationary pressures.
The 1983 recession followed a global recession in 1981, resulting in a significant drop in commodities prices. The Australian recession was exacerbated by both a serious drought, which reduced farm output by about one-quarter in 1982/3, and tradeunion-
inspired significant rises in real wages which preceded it. The unemployment rate, which had been 5¾ per cent in 1981, rose sharply to 10 per cent in 1983.
Coming out of the recession, the economy grew strongly for the remainder of the decade. A ‘Prices and Incomes Accord’ between the then Australian
government and the trade union movement generated gradually declining real unit labour costs over this period, with the result that the economic upswing was accompanied by rapid employment growth and an unemployment rate which fell from 10 per cent in 1983 to 6 per cent in 1989.
Unemployment in Australia declined during the mining construction boom prior to the GFC, and then rose following the GFC. The increase in unemployment would have been much larger if not for the fiscal policy and monetary policy responses to the GFC. Recently unemployment has been increasing as a result of lower economic growth (below 3%) as a result of significan reduction in mining investment.
This shows the significant, long term decline in unemployment levels since the last recession (1991), which in the 2000s has been caused by globalisation and the industrialisation of China. The impacts of the GFC, and softening of the global economy, can be seen in the unemployment trends post 2008.
Note also the 2 percentage point increase in the participation rate (labour force / total population), and that prior to the GFC, despite an increase in the participation rate, unemployment continued to decrease.
Note that unemployment rises quickly (in the recession in 1983 and 1991), and then comes down slowly as growth recovers. For example, following the 1983 recession it took 7 years for the uneployment rate to return to the former level.
In recent history, there was a gradual decline in unemployment towards full employment as a result of the mining investment boom, interupted by the GFC. Since passing the peak of the mining investment boom, unemployment has been increasing in Australia.
Since 1993 the RBA has used the cash rate to target inflation betwwen 2-3%, which has been succesful in managing inflation. However, in times of crisis (for example the GFC) monetary policy is not the primary tool to manage the economy as lower interest rates do not increase aggregate demand (and inflation) in circumstances of poor business and consumer confidence. Inflationary pressures were experienced in the economy during the first stage of the mining investment boom (pre GFC), and then when the mining investment boom resumed following the GFC. With contractionary fiscal policy since 2011, inflationary pressures caused by skill and resource shortages eased, and the RBA had scope to reduce interest rates without compromising the inflation target. With passing the peak of the mining investment boom in 2013, monetary policy loosened to encourage economic activity and increase inflation to within the band. This resulted in lowering the cash rate to record low levels.
Australia's inflation rate is often higher than our trading partners, adversely impacting international competitiveness. Inflation averaged 6% in the 1970s, and 10% in the 1980s.
During the 1970s and 1980s inflation averaged between 6.0% and 10.0%. However, from 1992 to 2001 the average level had declined to just over 2.0%. During 2000/01 the inflation rate averaged 6.0% overall, was mainly due to the one-off introduction of the GST which increased prices.
Australia's inflation rate is often higher than our trading partners, adversely impacting international competitiveness. Inflation averaged 6% in the 1970s, and 10% in the 1980s.
During the 1970s and 1980s inflation averaged between 6.0% and 10.0%. However, from 1992 to 2001 the average level had declined to just over 2.0%. During 2000/01 the inflation rate averaged 6.0% overall, was mainly due to the one-off introduction of the GST which increased prices.
By agreement with the government, the RBA targets an inflation range of 2-3% by using Direct Market Operations to target a certain cash rate (the rate in the short term money market) which influences cost of funds for banks. Prior to the GFC, during the first part of the mining construction boom, the RBA was tigthening monetary policy (increasing interest rates) to control inflation. Responding to the GFC, monetary policy was dramatically loosened to encourage growth, and then rates were raised as inflationary pressures returned as the mining construction boom contiuned. With contractionary fiscal policy from 2010/2011, the stance of monetary policy changed, as rates were loosened to encourage growth. In this way, contractionary fiscal policy provided space for interest rate reductions without increasing inflation outside the targetted range.
By agreement with the government, the RBA targets an inflation range of 2-3% by using Direct Market Operations to target a certain cash rate (the rate in the short term money market) which influences cost of funds for banks.
To address high inflation in the 1991 recession, very high interest rates were used to drive down inflation. Prior to the GFC, during the first part of the mining construction boom, the RBA was tigthening monetary policy (increasing interest rates) to control inflation. Responding to the GFC, monetary policy was dramatically loosened to encourage growth, and then rates were raised as inflationary pressures returned as the mining construction boom contiuned. With contractionary fiscal policy from 2010/2011, the stance of monetary policy changed, as rates were loosened to encourage growth. In this way, contractionary fiscal policy provided space for interest rate reductions without increasing inflation outside the targetted range.
By agreement with the government, the RBA targets an inflation range of 2-3% by using Direct Market Operations to target a certain cash rate (the rate in the short term money market) which influences cost of funds for banks.
To address high inflation in the 1991 recession, very high interest rates were used to drive down inflation. Prior to the GFC, during the first part of the mining construction boom, the RBA was tigthening monetary policy (increasing interest rates) to control inflation. Responding to the GFC, monetary policy was dramatically loosened to encourage growth, and then rates were raised as inflationary pressures returned as the mining construction boom contiuned. With contractionary fiscal policy from 2010/2011, the stance of monetary policy changed, as rates were loosened to encourage growth. In this way, contractionary fiscal policy provided space for interest rate reductions without increasing inflation outside the targetted range.
BOGS (2003-2012). Australia
BOGS (1990-2012). Australia
Cth Government Debt as % GDP (2003-2014). Australia
Cth Government Debt as % GDP (1990-2014). Australia
Net Foreign Liabilities. Australia
Structure of the Australian economy (sector % shares of GDP)
The structure of the Australian economy has undergone significant changes over the last 4 decades, with services being the dominant sector, and a long term decline in manufacturing as a share of GDP following the reduction in protection in 1973, followed by trade liberalisation by the Hawke/Keating government. In recent years, the mining investment boom has resulted in significant appreciation of the Australian dollar, placing further pressure on Australian manufacturing, agriculture, and services industries including inbound tourism and education services. Construction services have increased during the mining construction boom, and mining as a contributor to GDP will increase as capacity from mining investment enters production. Other structural changes in the Australian economy include the change in Australia's household saving rate (moving to 10%), and population shifts towards the boom states of WA and Qld. Note the share of GDP and employment of mining, although also note that mining impacts a range of other industries (importantly construction), and has a multiplied impact on GDP.
The Economic Problem
The economic problem is that as individuals, and as a society, we have unlimited wants and
limited resources.
This means that choices must be made, and economics is the study of the possible choices, and the impacts of those choices on various members of society, and on the economy as a whole.
Video resources
Wants and needs
Wants are desires. Needs are things like food and shelter. Wants are unlimited - which means we must chose between them as we have limited resources.
You must know the terms:
- individual wants (like an ipod, ie wanted by an individual) and
- collective wants (like a park or library, ie desired by a community for community use).
Wants vary with levels of income, and our wants change over time during our lives. Consider the wants of a youth versus the wants of a 75 year old: in what ways are they different?
Video resources
Issues
The four key economic issues, that
every economy must address:
- What to produce (with limited resources, you cannot produce everything. You will learn that consumers determine what is produced.)
- How much to produce (balance is important to avoid waste, and business determine the quantity that they can produce most effectively.)
- How to produce (what resources to allocate to production and what process to use)
- How to distribute production (who gets the income and the wealth from production: note, this is NOT about how production is physically distributed ie trucks.).
Video resources
Rewards to Factors of Production
Factors of production are resources used in the production of goods and services.
You must know the rewards that accrue to (paid to use) each of the four factors of production:
- Land: rent
- Labour: wages
- Capital: interest. Note that capital is produced means of production, like a shovel - a capital good.
- Enterprise: profit
Importantly, the market where you buy these factors of production, ie the market for labour, the market for land etc, are called
factor markets. This is an important concepts for both year 11 and year 12.
Video resources
Production possibility frontier
The production possibility frontier, typically drawn as a curve on a graph, is a representation of a simple model of the economy where you can only produce two types of goods. The number of goods potentially produced for a given time (using ALL resoureces) is on each axis, and the line shows the series of combinations of output. For example, if you can produce only cars, or ipods - the PPF shows you the combinations of those that you can produce using all of your finite resources.
You must be able to define, and draw and apply the PPF, and explain what happens to the PPF in certain circumstances where are all in the simulator below. Those circumstances are if technology of production improves, if total resources available increase, and if an economy decides not to utilise all resources (ie produce at a point beneath PPF). Each of those situations are addressed in the simulator.
 |
Video resources for the production possibility frontier and opportunity cost.
|
| |
Video resources for Factors of Production.
|
Opportunity cost
An opportunity cost is the alternate use of resources forgone as a result of making a choice.
For example, if you choose to make 1 more shirt and that takes the resources away from making 2 socks, the opportunity cost of the shirt is 2 socks. The concept of opportunity cost applies to decisions by consumers, decisions by businesses, and decisions by government. The denominator is the number of the goods for the item you are calculting the opportunity cost of.
Opportunity Cost is NOT measured in dollars. Be careful. It is the volume of the other good that you have forgone, or given up, by making your choice.
Types of goods
There are two distinct types of goods that you must know in economics:
- Consumer goods and services are items produced for the immediate satisfaction of individual and community needs and wants. An example would be an iPhone. Consumers goods are bought and sold in consumer markets.
- Capital goods are items that have not been produced for immediate consumption but will be used for the production of other goods. Capital goods are things like machinery used in production processes. Capital goods are bought and sold in factor markets.
You need to know definitions of these items, and be able to provide an example.
Impact of decisions on the future
Choices today have an impact tomorrow, for individuals, businesses, and governments.
For an economy, consider a PPF of a choice between making
capital goods (like machinery) or
consumer goods (like iPods). If you produce only iPods then in future the PPF will move in because you will not have a stock of machinery to make things - the machinery will become worn out.
So, decisions today affect production in the future - and may shift the production possibility curve in if only consumer goods are produced.
These decisions equally impact:
- individuals (choice between education cost and consumer goods),
- business (make product A or product B) and
- government (money into education or health).
Note this pattern of thinking that will often occur in your HSC economics studies all the way through to year 12 - consider the impact on individuals, business, and government of a particular economic choice.
Choices
Choices are made by each of Individuals, business and government in allocating their resources. For every choice, there will be an impact now and later.
- Individuals make a choice between saving, or consuming their income. Spend on education today, for example, will have a payoff later.
- Businesses have a choice between making more ipods, or more computers - a choice has to be made about what they will produce with their limited resources.
- Governments have to choose between health, education, defence etc with limited resources.
 |
Video resources for the Economic Problem.
|
GDP
Gross Domestic Product (GDP) is the total market value of all final goods and services produced in an economy over a period of time.
Note the last part, many students forget and lose marks.
The nominal value of GDP can be adjusted by inflation (ie to account for the impact of an increase in prices) to obtain what is known as Real GDP.
Circular flow model of income
The circular flow model of income is a simplified model of how the economy works. It is not real - it is a model, like a model car, that enables us to understand the broad interactions at work.
There are five sectors in the model, households, firms, financial institutions, government, and the overseas sector.
You must be able to draw and explain the model, and do maths in relation to injections (investment, governent spending and exports) and leakages (saving, taxes and imports). If injections are greater than leakages, the level of economic activity will rise. If leakages are greater than injections, the level of economic activity will fall.
Business Cycle
The business cycle is the periodic but irregular fluctuations in the level of economic growth (GDP growth) in an economy. The fluctuation may be due to domestic factors (like floods), or global factors (like the GFC). A business cycle is not a regular, predictable, or repeating phenomenon - however, booms are always followed by busts. Its timing is random and, to a large degree, unpredictable.
A business cycle is identified as a sequence of four phases:
- Contraction: A slowdown in the pace of economic activity
- Trough:The lower turning point of a business cycle, where a contraction turns into an expansion
- Expansion: A speedup in the pace of economic activity
- Peak: The upper turning of a business cycle
The effect of a boom is increasing production, consumption, quality of life, income and inflation, and decreasing unemployment.
A
recession is two consecutive quarters of negative GDP growth. There is no special terminology for two consecutive quarters of positive economic growth.
Distribution of income
Returns are provided to the factors of production, which is an incentive to work, to invest, to provide capital etc.
However, the returns to those things are not equal in an economy. Some jobs are higher paid, some people are unemployed, others have significant wealth which can be invested as capital to then receive the additional return of profit.
To address this, the government has a role in redistributing income, which involves requiring taxes to be paid, and then using that money to assist those who are at the lower end of the socio economic spectrum. The level of equality of distribution of income, and wealth, in an economy can be measured using the Gini index, which you will meet in the HSC course.
Market economy
The role of government in economies is a choice for each society.
In North Korea, the economy is a planned economy - the choices of what is produced, by who etc is tightly planned and controlled by the government. At the other end of the spectrum, a pure market economy is one in which all decisions are made by individuals and firms in the market, and the government does not interfere.
Australia is a
mixed economy in which both the government and the market play a role, however not as significant as in a planned economy.
There are five features of a market economy you must know:
- the market system: buyers and sellers trading in product markets (like ipods) and factor markets (like labour)
- private ownership of property: necessary for incentives and self interest
- consumer sovereignty: consumers determine what is produced, and the quantity produced
- freedom of enterprise: necessary for entrepreneurial activity
- competition: which allows the market to work efficiently
Equilibrium in the circular flow
When leakages or injections are larger than each other, the circular flow will change, and keep adjusting till it settles to a new level. You can think of this like the level of water in the circular flow rising and falling.
When it settles, the sum of leakages will equal the sum of injections, and no further change will happen. This is called equilibrium in the circular flow model of income.
This is a key and important concept for economics all the way through to the HSC and byeond.
| |
Video resources for GDP and business cycle.
|
| |
Video resources for Circular Flow.
|
| |
Video resources for Economic Systems
|
Types of goods
There are two distinct types of goods that you must know in economics:
- Consumer goods and services are items produced for the immediate satisfaction of individual and community needs and wants.
- Capital goods are items that have not been produced for immediate consumption but will be used for the production of other goods. Capital goods are things like machinery.
You need to know definitions of these items, and be able to provide an example.
Impact of decisions on the future
Choices today have an impact tomorrow, for individuals, businesses, and governments.
For an economy, you consider a PPF of a choice between making capital goods (like machinery) or consumer goods (like ipods). If you produce only ipods then in future the PPF will move in because you will not have a stock of machinery to make things.
So, decisions today affect production in the future - and may shift the production possibility curve in if only consumer goods are produced. These decisions equally impact individuals (choice between education cost and consumer goods), business (make product A or product B) and government (money into education or health).
Choices
Choices are made by each of Individuals, business and government in allocating their resources.
- Individuals make a choice between saving, or consuming. Spend on education, for example, will have a payoff later.
- Businesses have a choice between making more ipods, or more computers - a choice has to be made.
- Governments have to choose between health, education, defence etc with limited resources
| |
Video resources for the The Economic Problem.
|
GDP
Gross Domestic Product (GDP) is the total market value of all final goods and services produced in an economy over a period of time.
Note the last part,
many students forget and lose marks.
Circular flow model of income
The circular flow model of income is a simplified model of how the economy works. It is not real - it is a model, like a model car, that enables us to understand the broad interactions at work. There are five sectors in the model, households, firms, financial institutions, government, and the overseas sector.
You must be able to draw and explain the model, and do maths in relation to injections and leakages. If injections are greater than leakages, the level of economic activity will rise. If leakages are greater than leakages, the level of economic activity will fall.
Business Cycle
The business cycle is the periodic but irregular up-and-down movements in economic activity, measured by fluctuations in real GDP and other macroeconomic variables. A business cycle is not a regular, predictable, or repeating phenomenon like the swing of the pendulum of a clock. Its timing is random and, to a large degrees, unpredictable.
A business cycle is identified as a sequence of four phases:
- Contraction: A slowdown in the pace of economic activity
- Trough:The lower turning point of a business cycle, where a contraction turns into an expansion
- Expansion: A speedup in the pace of economic activity
- Peak: The upper turning of a business cycle
A recession is two consecutive quarters of negative GDP growth. There is no special terminology for two consecutive quarters of positive economic growth.
Distribution of income
Returns are provided to the factors of production, which is an incentive to work, to invest, to provide capital etc. However, the returns to those things are not equal in an economy. Some jobs are higher paid, some people are unemployed, others have significant wealth which can be invested as capital to then receive the additional return of profit.
To address this, the government has a role in redistributing income, which involves requiring taxes to be paid, and then using that money to assist those who are at the lower end of the socio economic spectrum. The level of equality of distribution of income, and wealth, in an economy can be measured using the Gini index, which you will meet in the HSC course.
Market economy
The role of government in economies is a choice for each society. In North Korea, the economy is a planned economy - the choices of what is produced, by who etc is tightly planned and controlled by the government. At the other end of the spectrum, a pure market economy is one in which all decisions are made by individuals and firms in the market, and the government does not interfere. Australia is a
mixed economy in which the government and the market both play a role, however not as significant as in a planned economy.
There are five features of a market economy you must know:
- the market system: buyers and sellers trading in markets
- private ownership of property: necessary for incentives and self interest
- consumer sovereignty: consumers determine what is produced, and the quantity produced
- freedom of enterprise: necessary for entrepreneurial activity
- competition: which allows the market to work efficiently
Equilibrium in the circular flow
When leakages or injections are larger than each other, the circular flow will change, and keep adjusting till it settles to a new level.
When it settles, the sum of leakages will equal the sum of injections, and no further change will happen. This is called equilibrium in the circular flow model of income.
| |
Video resources for GDP and circular flow
|
| |
Video resources for supply demand and price mechanism
|
Consumer Sovereignty
Consumer sovereignty is an economic term for the concept that, in a free market, consumers determine the goods that are produced; this makes them "sovereign" over production in an economy. The theory of consumer sovereignty says that, while businesses and companies can produce anything they choose, if consumers do not want or need a product, it will not sell. If a product is not sold, it will not continue to be produced.
Therefore, buyers ultimately decide what is produced.
Note, however, that consumer sovereignty is not absolute, and is affected by:
- marketing: this can create demand in consumers that would not otherwise have existed
- misleading or deceptive conduct: firms can engage in this activity to mislead consumers into making purchases, altering the balance of power between them
- planned obsolescence: firms can design and produce products that only last a short time, or introduce new products with new desirable features regularly. Apple are masters at this to encourage purchases of new versions of iPads and iPhones
- anti competitive behaviour: firms can agree amongst themselves and set prices (collusion) which alters the balance of power with consumers where they all agree to maintain a certain price
| |
Video resources for propensity to consume and save
|
Propensity to consume and save
Consumers receive income (denoted Y), which they can either consume (C) or save (S).
This can be expressed Y = C + S.
This is an important relationship that is also used in the HSC course.
When reviewing the behaviour of a consumer, ratios can be calculated to study the extent to which they consume, or save, their income. These ratios are either
average propensity to consume and save (ie C/Y and S/Y), or
marginal propensity to consume or save, which is a change in S divided by a change in Y, and a change in C divided by a change in Y. Marginal is looking at what the consumer does with one extra dollar of income (called a marginal dollar).
You need to know the factors that impact a consumer's decision to spend or save:
- age (saving and spending vary greatly with age of the consumer)
- income level (lower incomes have a higher propensity to consume, and higher incomes have lower APC)
- culture (Chinese save more of their incomes than the West as they remember hard times)
- personality and spending plans (some people are spendthrifts, others plan for things like cars)
- expectations of the future (if you expect the future to be bad, you will save more now)
- tax policies (if savings like superanuation are taxed lower, then consumers are more likely to save now)
- availability of credit (if loans are hard to get, then consumption will go down - ie higher interest rates makes buying a new car with a loan too expensive and consumers do not purchase)
Factors influencing individual consumer choice
When we consider a particular consumer, and their consumption decision, there are six key influences you must know:
- income: higher income tends to mean more consumption, of more expensive (luxury) items
- the price of the good: a consumer will consider how much the movie ticket is before buying
- the price of substitute goods: if the price of DVDs is $1 and a movie ticket $40, then consumers will shift to DVDs. That is, the price of substitute goods can affect the consumer's decision
- the price of complement goods: if the price of an xbox game (a complement good to a console) is $500, then consumers will choose to buy less xbox consoles
- consumer tastes and preferences: fancy buying a walkman? a film camera? tastes and preferences have a large impact on consumer decisions
- advertising: how did you find out about the iPad or the Angus burger? Advertising can have a large impact on consumer decisions.
| |
Video resources for factors affecting consumption
|
Factors affecting demand
There are six factors that affect demand that you must know. The first results in expansion or contraction of demand, and the others results in increase or decrease (ie shift of the demand curve):
- the price of the good or service: if the price goes up, consumers will want less (unless they are a necessity) This causes a shift ALONG the curve called expansion and contraction of demand
NOW the things that increase/decrease demand ie shift the curve:
- the price of other goods or services: the cost of substitutes (PS4, xbox console) and complements (xbox games) will affect how many xbox consoles consumers want to purchase
- expected future prices: if the price of xbox consoles is expected to rise, consumers will buy more today
- changes in tastes and prefereces: demand for nintendo DS's have collapsed following the iPad release.
- income level: higher incomes tend to see more consumption, and greater demand for luxury items
- population demographics: the age and rate of change of the population will impact demand for everything from nappies to nursing homes
Law of demand
The law of demand is about the behaviour of consumers, in particular their purchasing behaviour as the price of a product rises.
The law of demand provides that consumers people will buy more at lower prices, and will buy less at higher prices, other things remaining the same. It is often expressed using a graph, on axes of price and quantity, with a line which slopes from top left to bottom right.
This is a key part of your economics studies.
You should practice drawing demand curves until instinctively you know that the demand curve slopes down and to the right.
Law of supply
The law of supply is about the behaviour of producers, in particular their supply behaviour as the price of a product rises.
The law of supply provides that producers will supply more at higher prices, and will supply less at lower prices, other things remaining the same. It is often expressed using a graph, on axes of price and quantity, with a line which slopes from bottom left to top right.
Income redistributon
Governments intervene in the market to achieve an income distribution that is more equitable (more fair) than would occur without intervention in the market.
For example, where there are no laws in relation to employment terms and conditions, including minimum wages or annual leave, then the forces of supply and demand would operate in the labour market to achieve an equilibrium price and quantity of labour demanded and labour supplied. However, the equilibrium point may have a price significantly below that which the society considers appropriate for a minimum wage. In this situation, the government intervenes to set minimum terms and conditions of employments which will operate to increase the amount that the lowest paid workers receive, however, will result in a higher level of unemployment.
On the other hand, governments intervene in the market by requiring the payments of taxes, and set the taxation laws so that those with higher incomes pay a higher average rate of tax. This is called progressive taxes. These taxes are then redistributed in the form of social welfare payments to lower income citizens within the society in order to achieve the desired distribution of income.
In Australia, the distribution of income is more fair than the distribution of wealth.
Public goods
Suppliers will supply goods that they can charge for, and make a suitable profit from supplying to purchasers.
There are some goods that private sector suppliers will not supply as they are not able to effectively charge for them due to their characteristics. These are called
public goods. This is an important distinction, and one that is highly examinable both in year 11 and HSC assessments.
Public goods have two distinct features - they are
non excludable and
non rival in consumption.
- Non excludable means that the goods cannot be confined to those who have paid for it
- Non rival in consumption means that the consumption of one individual does not reduce the availability of goods to others
Because of these two attributes, the private sector will not supply these types of goods because they are not able to make a profit from attempting to sell these types of goods to purchasers. However, public goods are important for a society to have, and so the government intervenes in the market, levies taxes on citizens, and then uses those funds to supply the public goods to the society. Examples of public goods would include ABC radio, street lighting, and national defence such as the army and navy.
Be careful however, public schools are NOT public goods because they do not meet the criteria of non excludable and non rival. Just because a good is provided by the public sector does not make it a public good for the purposes of economics (and economics assessment).
Merit goods
Merit goods are goods and services which the market does not produce in sufficient quantities because individuals do not place sufficient value on them.
For example, public education. Note that this is a merit good, not a public good, as those terms are defined in economics.
The government intervenes in the market and provides public education (ie public schools) because consumers (the public) do not sufficiently value education and would not pay for it if the government did not provide it.
In this case, the intervention of the government shifts the supply curve to the right for the particular good, resulting in more consumption and a lower price for the good in the society. This is because the demand curve only represents private benefits. If the demand curve properly represented the value to the society, the demand curve would move to the right.
Price elasticity of demand
We know that as price goes up, quantity demand will go down. Price Elasticity is a concept that will tell us how sensitive (how responsive) demand is to an increase in price. For example, if the price doubles, will demand halve? Will demand stay the same? Go down just a little?
Price elasticity of demand measures the degree of responsiveness of the quantity demanded of a good to a change in its price. For the purpose of the Preliminary course, you will not calculate price elasticity of demand, but classify demand as one of the following:
- elastic: which means that as the price goes up, the total amount paid by consumers (ie price x quantity) falls
- inelastic: which means that as the price goes up, the total amount paid by consumers rises
- unit elastic: which means that as the price goes up, the total amount paid by consumers stays the same
This is called measuring price elasticity using the
total outlay method.
You also need to know that a demand curve for perfect elasticity is a straight line, and for perfectly inelastic is a vertical line.
You must also know that there are five factors that affect the price elasticity of demand:
- luxury or necessity: a luxury good is more likely to be price elastic, and a necessity price inelastic
- existence of substitutes: the existence of the PS4 makes demand for xbox consoles more elastic as people can switch if the price of xbox consoles rises
- spending as a share of income: tiny spends, like a candy bar, may still be made even if the price goes up 10%, whereas if the price of a house rises 10% it will significanly impact demand. These small spends are likely to more price inelastic than large spends.
- time since price increase: as time passes, consumers can seek out alternatives, so elasticity will increase over time.
- habit forming nature of good: where consumers are addicted (ie tobacco), demand can be quite price inelastic because consumers will still buy if the price rises.
| |
Video resources for price elasticity of demand
|
Product and factor markets
There are two types of markets that you must know in economics:
- Factor markets: a market of demand and supply for the factors of production which are used in the production process. This is the market for land, labour, capital and enterprise.
- Product market: a market of demand and supply for the products which are the output of the production process. The market for ipods and cars are both product markets.
This is an important distinction that you will refer to in short answer and essay responses in year 11 and year 12.
Price Mechanism
Where there is a lot of demand for a product, sellers are only willing to sell to the highest price. In other words, the market has a price mechanism which is the interaction of the forces of supply and demand which determine two important things.
The price mechanism determines the
price at which goods will be sold, and also the
number of goods that will be sold (called the quantity). This ensures
allocative efficiency which is the economy's ability to allocate resources (goods) to satisfy the wants of consumers.
The price mechanism can be seen in both:
- product markets: markets for finished goods, like ipods and xboxes
- factor markers: markets for the factors of production, like the real estate and labour markets
Supply and demand
In the market, buyers and sellers are brought together. Buyers know how many of the product they want to buy at different price levels. Suppliers know how many products they are prepared to supply at different price levels. When these two are brought together, the market determines the price, and the quantity, that will be sold in the market.
After this point (initial equilibrium), if there is a change in demand (because of style preferences for example), or a change in supply (because production costs go up), then the demand curve, the supply curve, or both, shift (SIDEWAYS) resulting in a new equilibrium position for price and quantity for the good.
Goals of the firm
The goals of the firm are:
- Maximising profits: which is revenue less expenses
- Meeting shareholder expectations: ie how much profit is required by shareholders
- Increasing market share: the proportion of the market you have - ie Coke may have 60% of cola market
- Maximising growth: which is growth in revenue (money received for selling products)
Note that the goals of the firm may conflict, such that a
satisficing outcome, or satisfactory outcome, is chosen where some of several goals is achieved. For example, revenue growth can be achieved by lowering prices, however that may negatively impact the objective of maximising profits.
Productivity
Productivity is the amount of output (ie goods produced) per unit input.
For example, labour productivity is the amount of output produced per unit of labour input. By increasing productivity, the firm can make more profits, as more is produced with the same level of inputs. Productivity can be improved with specialisation (ie division of labour into tasks) and technology purchased with capital.
Increasing productivity is important because it:
- makes better use of scarce resources
- results in higher profits for the owners of the business
- can result in lower inflation (price increases) as it reduces costs for firms
- can result in higher wages (income) as firms are more profitable
- can result in higher exports as firms are more competitve internationally
However, increased productivity can result in an increase in unemployment as less labour is required to produce the same volume of output.
How to increase productivity?
- labour specialisation
- specialisation of location (clustering like businesses together)
- specialisation of capital (large business can afford large and specialised equipment)
| |
Video resources for productivity.
|
Economies and diseconomies of scale
INTERNAL economies and diseconomies of scale (internal = within the business' control)
As a business gets bigger, average production costs go down due to bulk buying, specialisation, better equipment etc. This is called internal economies of scale. However, as a business gets even bigger, average production costs start to go up because it gets too big to manage, too much red tape etc. This is called internal diseconomies of scale.
The volume of production at which a producer should produce is called the technical optimum, and is the bottom of the long run average cost curve. In other words, the producer should produce at the volume at which the average cost of production is the lowest.
EXTERNAL economies and diseconomies of scale (external = factors outside the control of the business)
External factors sometimes lower production costs. For example, where the scale of businesses means a highly populated area provides skilled labour and access to inputs and other businesses this lowers production costs. This is called external economies of scale. However, where the growth of industry causes congestion, or pollution, then production costs may increase. This is called external diseconomies of scale. Unlike the internal ones, there is no graph, and no technical optimum.
| |
Video resources for economies and diseconomies of scale
|
Factors affecting supply
Factors affecting the level of supply (that you need to know) are:
- the price of the good itself (expansion/contraction of supply which moves ALONG curve)
NOW things that increase/decrease demand ie shift curve:
- the price of other goods and services. If X price up, make more of it, less of Y.
- state of technology. If improves, supply increases as higher productivity
- changes in cost of production. If down, supply increases
- availability of resources. If down, supply decreases. Unique objects.
- climatic and seasonal. If storms, supply bananas decreasses
| |
Video resources for Supply Factors.
|
Price elasticity of suppy
Price elasticity of suppy is a measure of how responsive quantity supplied is to a change in price of the product.
For the Preliminary course, you do not need to know how to calculate price elasticity of supply, however, you need to be able to draw perfectly elastic supply (ie very responsive, ie a horizontal line) and perfectly inelastic (ie a vertical line).
Factors affecting the level of elasticity of supply:
- time lag after change: following a price change in the market, it takes producers a little time to respond and to adjust production, so elasticity will increase over time
- option to store stock: if a producer can store stock for later (rather than sell it now like fruit) then the quantity supplied will be more elastic as the producer can take from the warehouse and sell to the market.
- availability of excess production capacity: if a firm has unused capacity, it will be able to respond to a change in price (elastic) however, if it is already operating at capacity, supply will be price inelastic in the short term.
| |
Video resources for externalities.
|
Market failure
Market failure does NOT mean that the market fails to reach an equilibrium. It will always do that.
Market failure means that the position that the market reaches is sub optimal (less than the best) for the society as a whole. In other words, it fails to deliver the socially best outcome for the society. This leads to a misallocation of resources. This market failure is one of the reasons that the government intervenes in the market to address those elements.
Externalities are third party effects arising from production and consumption of goods and services for which no appropriate compensation is paid.
A negative externality is an unintended negative consequence of production or consumption that is not taken into account by the price mechanisim (for example pollution from a power station). A positive externality is an unintended positive consequence of production or consumption that is not taken into account by the price mechanism (for example increased property values around a newly built Westfield).
Why intervene
Australia is a
mixed economy, which means the government intervenes in the market, to achieve a different outcome to that which the market would achieve if left to its own devices.
The government intervenes to achieve the following:
- a more efficient allocation of resources in order to produce and provide items that will not be provided by the market - for example large infrastructure projects, defence, health etc. They also regulate the production of harmful things (ie tobacco, drugs etc)
- better competition: left to their own, large companies that are dominant in markets will compete in ways which are unfair, and will result in higher prices paid by consumers. Here the government intervenes with regulations and laws to ensure competition
- a better (fairer) distribution of income than the market would achieve. This is done through providing social welfare payments (benefits), funded by progressive income taxes (progressive means the average rate of tax increases with income).
- to smooth the effects of the business cycle: the government softens busts by increasing spending (remember circular flow of income?) and lessening booms by reducing government spending. They also ensure financial stability (remember guaranteeing deposits during the GFC?)
Regulation
In addition to specific regulations on products (ie tobacco, pharmaceuticals), the government has established specific government bodies to regulate certain economic activity:
| ACCC |
Australian Competition and Consumer Commission regulates competition, and anti competitive practices and consumer protection. about
|
| ASIC |
Australian Securities and Investments Commission regulates companies, investment products, and investment advisers. about
|
| APRA |
Australian Prudential Regulatory Authority regulates banks and insurance companies. about
|
| RBA |
Reserve Bank of Australia regulates the payment system and financial system stability. functions video
|
| Fairwork Commission |
Regulates labour awards and the labour market in Australia. about video
|
| Fairwork Ombudsman |
Advises companies and individuals in relation to labour market framework and issues. about
|
Price floors and ceilings
Sometimes the government intervenes in a market to ensure the price for the good is ABOVE the price that the price mechanism would result in. This is called setting a price floor, as the price is not allowed to drop below the floor to the market clearing price.
This can be seen in the labour market, where the government sets a minimum wage, which is above the price that the market would reach, and it does this to protect workers. However, setting a price floor will result in excess supply of the good.
Sometimes the government intervenes in a market to ensure the price for the good is BELOW the price that the price mechanism would result in. This is called setting a price ceiling, as the price is not allowed to rise above the ceiling to the market clearing price.
This can be seen in the pharmaceuticals market, where the government sets a maximum price, which is below the price that the market would reach, and it does this to protect consumers. However, setting a price ceiling will result in excess demand for the good.
Labour Policy
The labour market is the market where individuals seeking work interact with firms who seek labour. The labour market is a factor market, as labour is one of the factors of production.
There is a policy tradeoff in the labour market for governments. A totally free labour market is very efficient, with employers and employees interacting to find the market price. However, a totally efficient labour market may not be equitable - some or all workers may be disadvantaged - especially in relation to terms and conditions of employment of wages and conditions.
Generally speaking, laws to improve equity of the labour market will decrease the efficiency of the labour market.
Labour market policy is directed to balancing these competing interests, aligned with the philosophical underpinnings of the political party in power.
The labour market is a key market as labour costs are a large input cost for business in Australia. The regulation of the labour market is thus very important in both year 11 and HSC assessment.
Labour Demand
The demand for labour is a
derived demand (derived from the demand for the goods the business produces), and depends upon:
- the output of the firm: which depends upon the economic cycle, conditions in the firm's industry ie consumer preferences at an industry level, and the demand for an individual firm's products. In a boom, there is an increased demand for labour by firms.
- labour productivity: the more productive labour is, the less labour will be demanded by firms - unless demand is growing faster than productivity growth. As technology is introduced to the workforce, and labour productivity improves, less workers are needed by firms to produce the same level of output - that is, labour has been replaced by capital in the form of technology in the firm.
- cost of other inputs: as technology becomes cheaper, it will be substituted for labour, thus lowering the demand for labour
- cost compared to overseas: as overseas labour becomes cheaper, it will be substituted for domestic labour where possible - ie offshoring work and manufacturing (ie the closure of Holden in Australia).
Labour Supply
The supply of labour (ie the labour supply curve) is influenced by several factors:
- pay levels: the higher the level of pay offered, the more labour will be supplied. Note that this will result in a movement along the supply curve, not a shift of the supply curve.
- working conditions: the better the working conditions, the more labour will be supplied
- education and skills: a lack of education may limit supply - ie for engineers. Putting in place higher education requirements for a role will limit the amount of supply of labour for those roles
- labour mobility: occupational mobility (ability to change between jobs) and geographical mobility (ability to change locations) both influence the quantity of labour supplied.
- participation rate: as more citizens look for work, the labour supply increases. This rate is influenced by the stage of economic cycle (booms increase participation rate), population demographics (older populations participate less), attitudes about work and also retention levels in schools.
Intergenerational report 2015: must read in relation to workforce demographics in the future.
Labour outcomes
Labour market outcomes are the wage and non wage rewards obtained by various classes of workers in the economy. Wage outcomes are not equal, and differ based on:
- occupations: average weekly earnings are very different between managers and labourers
- experience: experienced managers earn more than inexperienced managers
- geography: roles in remote or expensive locations may attract higher wages and benefits
- productivity: employers may link wage increases to productivity improvements
- profitability of firm and sector: the same role in a different company or sector may attract higher wages and benefits than one in a struggling sector
- age of the worker: income varies through a worker's lifetime, peakng between 45-55
- gender of the worker: average weekly earnings of women tend to be lesser than men, partly as a result of roles performed
Economic and social costs and benefits of labour market inequality
There are economic and social costs, and benefits, of labour outcome inequality. The benefits of inequality are:
- education: encourages workforce to build skills
- work ethic: encourages workforce to work harder and longer
- ovecomes mobility: inequality in outcomes can encourage labour to move
- risk taking: encourages taking of risks
- savings: creates potential for higher savings and building of capital
The economic and social costs of inequality:
- reduces overall utility: very uneven means the rich can only buy so many homes and cars, and many of the poor go without, reducing the total utility of the society
- can reduce economic growth: people do not work for the lower conditions, increasing unemployment, reducing production and therefore reducing GDP growth
- reduces consumption and investment: increasing inequality sees a decrease in total household consumption as average propentiy to consume is lower for higher income individuals. Reduced consumption means that businesses will then investment less as total purchasing by consumers has reduced.
- conspicuous consumption: rich may divert money to non productive, prestige items, bidding the price up for very expensive, high performance sports cars which do not contribute to the productive capacity of the society - or bid up the price for antiques
- poverty and social problems: lower incomes result in an increase in poverty, alcohol abuse, family breakdown, violence and crime
- welfare support costs: as poverty and social problems increase there is a requirement for the government to increase the level of social welfare payments, unemployment benefits, and spending on police and criminal justice system
Types of unemployment
The syllabus requires you to know how the following three measures are calculated:
- the labour force (all those with a job (at least 1 hr per week) and those looking for a job)
- the participation rate (the labour force / total over 15 years) see chart. Currently just over 65%.
- the unemployment rate (those actively seeking work / the labour force). NB that this is not a great measure, as to be counted as employed you only need to work one hour per week - so there is lots of underemployment that is not evident, AND there are the hdden unemployed who have given up on getting work and do not show up in official statistics. see chart
You must also know the definitions for the various types of unemployment:
- cyclical: unemployment that occurs because of economic cycle fluctuations (ie recessions)
- structural: unemployment caused by structural changes in the economy, resulting in a mismatch of skills and needs of business
- frictional: unemployed are those those that are between jobs, ie before they start the new role
- seasonal: unemployment driven by a change of seasons (the classic Santa Claus example in June, or students graduating university en masse in February.)
- underemployment: where people work less than full time and would like additional hours (8% of the labour force in 2015)
- hidden: those that are not actively seeking work as they are discouraged, and do not register for assistance and are therefore not counted (ABS estimates 1.3m people)
- long term: unemployed are those that have been out of work for more than 12 months. This is an increasing issue.
Casualisation of labour
Casualisation is a concept that relates to one of three shifts in employment arrangments in Australia, namely an increase in the proportion of workers that are casually employed, the increasing use of contractors by business, and outsouring by business to reduce labour costs.
Casualisation often indicates a spread of bad conditions of work such as employment insecurity, irregular hours, intermittent employment, low wages and an absence of standard employment benefits.
An increasing number of Australians are employed in a casual capacity rather than full time employment which would be a full working week. Indeed 40 per cent of workers across all fields in Australia are now paid casual rates or are on independent contracts. This is a massive change from the 9% level of five decades ago. Unions and social welfare organisaitons are concerned about what that means for employment conditions.
