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ECONOMICS HSC Topic 3 – Economic IssuesEconomic Growth – 2.5% below average – above OECD predictions for 2020 – GFC 1.3% economic growthUnemployment – 5% - underemployment 13% - OECD world 7 average 6%Inflation – 1.3% - OECD 7 1.9% - deflation due to low wage growthExternal stability - $AUD 0.68, TOT 107, CAD -1.5% as % of GDPDistribution of Income and wealth – 0.34 vs OECD 0.33 – Gini coefficientEcological sustainability - Paris Climate agreement Economic GrowthEconomic growth – increase in a country’s productive capacity as measured by changes on its real GDP over time (real GDP – national output of g/s adjusted for inflation)Level of economic activity/output is determined by total expenditure of consumers, firms, gov, and net exportsEquilibrium is the level of income in an economy from which there is no tendency to changeDetermining equilibrium level of national income where aggregate supply = aggregate demandAggregate supply – total volume of g and s that firms are willing to produce in a periodAS = Y =O =E (AS = C+S for 3 sector model)Aggregate demand – total amount all sectors are willing to spend (in 3 sector model this is consumption spending and investment spending)AD = C + IAD = AS at the equilibrium level of national YDisequilibrium If AD>AS then production (employment and income) will tend to increase to the level of AD until equilibrium is reached at a higher standard of living (opposite occurs at AS>AD) and hence economic growth occursThe leakage/injection approach to national Y determinationLevel of economic activity measured by level of leakages and injectionsEquilibrium when S = IWhen injections > Leakages economic activity increasesComponents of Aggregate Demand 5-sector model – aggregate demand refers to the sum of expenditure on domestic output by households, firms, the gov, and overseas sectorKeynesian economics – consumption functionConsumption is the utilising of g/s for the satisfaction of needs and wantsKeynes – everyone must consume a minimum of goods in order to survive even if income is zeroDis-saving – borrow or use of savingsY = C+SAutonomous consumption – part of total consumption which occrs even when income is 0Induced consumption is part of consumption that occurs as income risesConsumption function – C = C* + cYC = total consumptionC*= autonomous consumptioncY = induced consumptionMarginal Propensity to consumer (MPC) - C = C* + MP (change is C divided by change in Y [income])Savings Function – S = -C* + sYS = total savings-C* = dissolvingS = marginal propensity to saveInvestment Function – I = I*Investment spending is autonomousI = total investmentI* = autonomous investmentGovernment expenditure – G = G*Like investment it is autonomousNet foreign demand - Y = Y*AutonomousImports are a leakage as they are domestic demand for foreign products – import expenditure has autonomous and induced componentsM = M* + mYM = total import expenditureM* = autonomous import expenditureM = marginal propensity to consumeEquilibrium level of national income in the 3 sector model (AD = AS or C + I = Y)INSERT DIAGRAMSimple Expenditure MultiplesChanges in any or all autonomous components will caise a change in the equilibrium level of income. The simple expenditure multiplier refers to the extent to which an initial change in autonomous expenditure is multiplied to give a larger change in the equilibrium level of national incomeMultiplier (K) = 1/(1-MPC) or 1/MPSInfluences on consumptionLevel of household disposable incomeConsumer confidence – influenced by level of taxation, interest rate, and general state of economySources of economic growthConsumption spending by households (C) – level of household disposable income and consumer confidence – influenced by general state of the economy, level of taxation, wages, and interest ratesInvestment spending by firms (I) – influenced by business profits, interest rates, taxation, and business expectations about the state of the economyGovernment spending (G) – influenced by taxation revenue collected, gov budget priorities, and state of the economyNet exports (X-M) – income from export of g/s minus expenditure on imports – net export negative detracts from economic growthRate of technological change leads to improvements in labour and capital productivity. Other drivers of growth include population growth, and increased labour force participation rates. 3 P’s – productivity, population growth, and participation ‘drive growth’Australia – imports ICT and capitol equipment used in mining/manufacturing/agricultureMajor contributions to AUs economic growth – Consumption = 58.7% of expenditure on 2016-17Investment = 19.6% of GDP 2016-17Gov spending = 24.2% GDP 2016-17Effects of economic growth Benefits –Higher real per capita incomes and living standards achieved from productivity and resource use – higher real income = greater purchasing power = raise standard of living Higher levels of savings – lower debt and servicing costProductivity growth and technological progress – efficient use of resourcesEmployment creation – new entrants to the workforce – decrease unemploymentIncreased taxation revenue – additional social and economic infrastructureNew business investment – ‘acceleration effect’ on net investmentExport income to finance importsProtection of environment – eco growth allows resources to be used for environmentAdditional leisure time – increased consumption3531870-80962500Benefits must be balanced against the costs of structural change – number of problems can arise:Damaged caused to natural environment – more natural resources are needed to sustain higher rates of eco growthStructural unemploymentOveremphasis on materialism and consumption – loss of traditional valuesWidening inequality of distribution of income Demand pull and cost push inflation as resources became scarce in reaction to increased g/s demand – price stabilityIncrease in the CAD as import demand increasesIncreases in aggregate supply and economic growthThe economies productive capacity refers to the quantity and quality of resources needed to sustain growth3 potential efficiency gains from microeconomic reform policies and market induced structural change are:Technical or productive efficiency – maximum output at the minimal average cost. Technical optimumAllocative efficiency to reflect marginal cost of production and consumer preferencesDynamic efficiency refers to firms adapting to changing economic circumstances. Cost reducing technology to meet changing consumer preferencesTrends in the Australian business cycleA recession in economic activity is defined as 2 consecutive quarters ay negative economic growthAustralia’s last recession was in 1990/91Gov’s use counter cyclical or stabilisation policies to ‘smooth out’ fluctuationsPolicies to promote economic growthAustralia has averaged economic growth between 3% and 4% in teal terms as a result of effective macroeconomic policyMonetary policy – changes in official cash rate by RBAFiscal policy – changes in taxation and gov expenditure in the annual federa budgetMicroeconomic policies – used in the long term to address specific structural problemsCuts to protectionReforms to competition policyLabour market reforms (enterprise bargaining)Taxation reform – indirect taxesUNEMPLOYMENTMeasuring level of unemployment1990-91 (after Recession)Peaked at 11.2%2007-08Historic low of 4.2%2008-09Rising to 5.8%2010-11Lower to 5.2%2014-15Rose to 6.1%2017-185.4%Definitions:Unemployment-measured as % of Aus. labour force classified as unemployedTo be classified as unemployed a person must satisfy a number of criteria:Regularly checking advertisements from different sources for available jobs.Being willing to respond to job advertisements, apply for jobs with employees and attend interviewsRegister with an employment agency linked to job services Australia.???????????????????????Total number. unemployed? ? ? ? ? ? ? ? ? ??x ? 100?Unemployment Rate =? Labour force(employed+unemployed) ? ? ? ? 1?Australian labour force-all persons of working age (i.e. between 15-64 years old) who either employed full time, part time/casual, or unemployed, but actively looking for work?The labour force is calculated by using:Total Australian Labour Force = Employed (full time + part time) + Unemployed?Labour force participation rate-%? of pop. aged 15 or over, in the labour force, that are either employed or unemployed.?Size of Australia’s labour force?size of the populationPopulation Growth Rate (%) = Natural Increase (%) + Net Migration (%)?level of net migration – adds to skills base and size of labour forceage distribution of the population – the more people in the 15 years to 64 years age group the larger the pool of potential workersparticipation rate of the working age population – an economy might have a large working age population but a very small labour force if the majority of the population isn’t working??????????????????Work Force ? ? ? ? ? ??x ? 100?Participation Rate = Working Age Population ? ? ? ? 1?2003-04Lowered of 63.5%2007-09Rising to 65.3%2012-13Rose to 65.2%2015-16Lowered to 64.8%Recent Trends:1992-93: unemployment rate peaked at 10.7 %– largely due to severe Australian and global recession + structural change caused by microeconomic reforms of previous decadeFollowing early 1990s, steady decrease in the unemployment rate – largely due to sustainable economic growth rate averaged 3% pa over mid 1990’s – late 2000s?Early 2008 unemployment reached historic low of 3.9%, lowest in WA and QLD due to commodities boom.ADVANCED ECONOMIC ANALYSIS:?Economists suggest average unemployment rate between 4-5% during Australia’s 17 years of consecutive economic growth hides real story in Australian labour market.ABS calculates number of underemployed people as the labour force utilisation rate. If this rate is added to the unemployment rate, 13.8 %of the labour force in 2010 is under+unemployed.?It’s difficult to measure hidden unemployment but conservative estimates estimate total figure of official unemployed, underemployed and hidden unemployed at around 15% of the labour force in 2010.?GFC caused unemployment to rise, but only rose to a peak of 5.8% in 2009, much lower than forecast and much lower than the OECD average of 8.8%.A corresponding spike in underemployment emerged, suggesting the reason for this relatively low unemployment rate was a reduction in hours rather than jobs by employers.?Youth unemployment rose from 8.1 %in early 2008 to 12.2 %in min-2009Unemployment during the GFC was spread disproportionately by region – areas in the north shore had unemployment rates of less than 3% (2008) while areas in Western Sydney had unemployment rates well above 10 per cent.The Types of UnemploymentCyclical UnemploymentCaused by a reduction in economic activity/aggregate demandEmployees laid off due to a reduction in the demand for labourCyclical changes in domestic and international economic activity may lead to changes in the demand for labour. Since the demand for labour is derived from the demand for final output, any decline in aggregate demand may lead to a rise in cyclical unemployment.Structural UnemploymentResults from a mismatch in employee skills and job vacancies offered by employersTakes time for workers to acquire new skills to fill in these vacanciesAnother factor is microeconomic reforms e.g tariff cuts2010-2014: High AUD eroded international labour market competitivenessFrictional UnemploymentWhen people move between jobs or experience changing economic circumstancesCaused by the search times needed for employees to find jobs and for firms to find employeesOften an imperfect flow of information between employers and employeesSeasonal UnemploymentOccurs in specific industries that are influenced by seasonal changes e.g HarvestingUnderemployment423233226737800Refers to people working part time or casually who want to work more hours or switch to full time work2015-16: 8.5%Hidden/Disguised UnemploymentPeople who have given up looking for work or receive income support from a spouse etcLong Term UnemploymentPeople who have been unemployed for more than 52 weeksHard core unemployment: People who experience extremely long periods of unemploymentRegional UnemploymentWhen a major industry in a regional area reduces demand for labour, causing unemploymentCauses of UnemploymentMajor cause of cyclical unemployment is a deficiency in aggregate demand (AD = C + I + G + X – M) INCLUDEPICTURE "" \* MERGEFORMATINET Keynes argued that the equilibrium level of national income in an economy may not necessarily coincide with the full employment level of income, denoted by Yf in Figure 8.3.?38936491400If total spending was insufficient to guarantee full employment of the economy’s resources, a deflationary gap or unemployment gap of ab would arise, causing cyclical unemployment to increase in the economy- INCLUDEPICTURE "" \* MERGEFORMATINET In Figure 8.4, the economy’s price level is measured on the vertical axis and real GDP on the horizontal axis. Aggregate demand (AD) slopes downwards to the right as more output is demanded at lower price levels, whereas the aggregate supply curve slopes upwards to the right until it reaches the full employment level of GDP at real GDP1, where supply or capacity constraints are encountered and the aggregate supply curve becomes vertical.?If the initial equilibrium level of income is at real GDP1 where AD equals AS, there is full employment of the economy’s resources. If AD shifts to the left to AD1, a new equilibrium level of real GDP is established below full employment at real GDP2. A deflationary gap or unemployment gap of ab results, causing unemployment to rise in the economy.389382027241500An important factor that may cause unemployment is the role of wage expectations in pushing up the price of labour relative to capital. Rapid rises in real wage costs will reduce the demand for labour and provide employers with the incentive to substitute capital for labour, causing a rise in what is known as voluntary unemployment or wage induced unemployment.The Non-Accelerating Inflation Rate of UnemploymentThe unemployment rate at full employment is called the natural rate of unemployment.?The natural rate of unemployment fluctuates because of changes in the levels of frictional and structural unemployment in the labour market. Some workers will be unemployed because they are in between jobs, and others because they lack the skills necessary for the jobs available. INCLUDEPICTURE "" \* MERGEFORMATINET 38836965648000Figure 8.6 illustrates the concept of the natural rate of unemployment. The real wage rate is measured on the vertical axis and the quantity of labour on the horizontal axis. The demand for labour (DL) is a negative function of the real wage rate and the supply of labour (SL) is a positive function of the real wage rate. The labour force is denoted by the vertical line LF. Full employment is where equilibrium (E) occurs in the labour market at real wage W and labour quantity QL. The distance EU (QN - QL) is equivalent to the natural rate of unemployment. Some workers are unemployed (due to frictional and structural factors) because they are unable to find work at the equilibrium real wage rate of W.The Long Run Phillips’ Curve (LRPC) shows that there is no tradeoff between inflation and unemployment in the long run, with the economy’s NAIRU equal to the natural rate of unemployment of 6%. The NAIRU is the lowest unemployment rate which can be sustained without an increase in inflation. Reducing the NAIRU from LRPC (6%) to LRPC1 (5%) involves the use of supply side policies by the government such as labour market reforms and improvements in productivity. If these policies are successful in the short run, the SRPC would shift from SRPC to SRPC1. In the long run the LRPC would shift from LRPC to LRPC1 and lower the NAIRU from 6% to 5% at point C, without any change in the inflation rate at 3%. The Reserve Bank estimated a NAIRU of 5% to 6% in Australia in 2014 as inflation was relatively stable at 2.5% and the unemployment rate averaged around 6%.Main Groups Affected By UnemploymentYoung people (15-24 years) experience the highest rates of unemployment. For males in 2015-16 the rate was 13.3% and for females it was 11% (see Table 8.4 on page 195).?Workers between 25 and 34 years, the rate of unemployment was 5.9% in 2015.?45 and 54 years, the unemployment rate was lower at 4.1% in 2015, reflecting the strength of employer demand for more mature workers with high levels of skill, education and experience.The les educated someone is, higher levels of unemployment are more likely to be experiencedATSI people are also more likely to be unemployedMigrants also fall in this categoryEffects of unemployment·? ? ? The primary economic cost of unemployment is the opportunity cost of lost output and income. Real GDP will be lower (as it is below full employment) and national income will be reduced, along with living standards.·? ? ? Unemployment may also cause poverty traps because of welfare dependency.·? ? ? Unemployment also causes a loss of human capital as the unemployed will not be contributing their skills and experience to the workforce and will need to undergo re-training·? ? ? The longer a person is unemployed, the more difficult it is for them to secure a job because they are less preferred to new workforce entrants by employers for the jobs available.·? ? ? Other economic costs of unemployment include the increasing taxation burden placed on employed persons in the workforce to finance increased social security spending from the taxation payments they make to the government.·? ? ? Unemployment can also lead to a less equal distribution of income as the unemployed will be reliant on income support from government welfare payments, and be concentrated disproportionately in the lowest quintile of the distribution of household income.·? ? ? Social costs of unemployment are difficult to quantify but researchers have linked increasing rates and duration of unemployment to undesirable social trends ie. Crime·? ? ? If the productivity of the workforce is rising over time because of the more efficient use of capital and labour in the workplace, fewer workers will be needed to produce the same output. The American economist, Arthur Okun, formulated a relationship between economic growth, unemployment and productivity which has become known as Okun’s Law.Okun’s Law suggests that for a government to reduce unemployment, the rate of economic growth needs to exceed the growth in labour?Policies to reduce unemployment·? ? ? Stimulatory monetary policy through cuts to interest rates by the RBA·? ? ? Expansionary fiscal policy through an increase in government spending and/or cuts in taxes;·? ? ? Industrial relations policy or wages policy to contain the growth in aggregate wages; and·? ? ? Microeconomic reform policies to improve the economy’s resource allocation and productivity.·? ? ? Promoting Higher Sustainable Economic Growtho ? Use monetary policy and fiscal policy to offset cyclical downturns in the economyo ? Fiscal stimulus and easing of monetary policy have potential to stimulate aggregate demand and increase the output of goods in the economy·? ? ? Labour market reformsO more flexible, encourage more competitive work practices and higher levels of labour productivity.o ? Leads to higher levels of employment as employers have a greater incentive to hire additional workers.o ? Labour market deregulation and the movement towards decentralised wage determination, where firms and employees are able to negotiate wage increases on the basis of improved levels of productivity, has been the central component of Australia’s recent labour market reform agenda.o ? Workplace relations act 1996 – cur union powers and weak unfair dismissal laws – direct intervention into the labour market by the Howard government to reduce unemploymento ? Fair Work Act 2009 – passed to strengthen the safety net of workplace relations system – National Employment Standards and Better Off Overall test·? ? ? Education and Trainingo ? Major reason for unemployment is the lack of education, training, and skills of some workers demanded by employers for the jobs demanded by employers for the jobs availableo ? Key policies for skill development – New apprenticeship centres to promote the skill formation of apprentices, expansion of school-based apprenticeship skills, funding for vocational and school educationo ? 2008-09 Rudd budget established Education Investment Fund which an initial allocation of $11b to be spent on higher educationo ? 2009-10 budget introduced Job and Training Compact at a cost of $1.5b over 5 years in response to unemployment due to GFCo ? 2011-12 & 12-13 Building Australia’s Future Workforce package included $3b for new skillo ? 2016-17 Youth Employment Package to assist more than 100 000 young people on a pathway to work·? ? ? Tax and Welfare reformso ? Australians Working Together package (2001), included reforms to help people out of work to return to the labour force through a system of working and training credits. It targeted parents, mature aged people, indigenous people and people with disabilities to seek paid work or training.o ? The federal government has reduced marginal rates of income tax and increased income tax thresholds for low income earners in successive budgets to reduce the incidence of poverty traps.o ? In the 2008-09 budget the federal government announced cuts in personal income tax designed to provide incentives for individuals, including part time workers to participate in the workforce.o ? In the 2014-15 budget the Abbott government introduced reforms to the transfer payments system to strengthen incentives for workforce participation and reduce the reliance on welfare support.·? ? ? Skill Shortageo ? Skills shortage in Australia is largely a reflection of shortages in the supply of labour in certain occupations (such as trades) and industries (such as mining, building and construction) in relation to the demand for these labour skills.o ? Geographic imbalance between job availability and supply of labour and shortage of labour skillso ? Over the medium term there are two main policies used government to address the skills shortage:§? Increasing labour force participation by retaining older workers with specific skills, and encouraging other groups such as younger workers and females to acquire higher levels of education and training. The government’s Building Australia’s Future Workforce package (2011) addressed these issues.§? Increasing the supply of skilled labour through an intake of skilled migrants in specific occupations and industries. Immigration overall also increases aggregate demand and hence the derived demand for labour.·? ? ? Program to develop labour skillso ? The skills shortage in the Australian economy is most evident in trades occupations and the Australian government has addressed this shortage by increasing the funding of vocational education and training (VET).o ? In the 2014-15 and 2015-16 budgets the Abbott government cut spending on vocational education by 1.8% in real terms as part of its Budget Repair Strategy and the conclusion of funding under the Skills Reform National Partnership Agreement (between the federal and state governments) in 2016-17.·? ? ? Jobs and Training Compacto ? Government allocated $1.5b in the 2009-10 budget to assist workers whose job prospects were adversely affected by the GFC. The government’s Jobs and Training Compact was designed to support young Australians, retrenched workers and local communities to secure future employment, add to their skills or learn new skillso ? The government’s fiscal and employment stimulus packages were expected to support labour demand and raise the level of GDP in 2009-10. The stimulus measures were estimated by Treasury to reduce the forecast peak unemployment rate by 1.5% in 2010 from 10% to 8.5%INFLATIONMEASUREMENT OF INFLATION:Inflation-sustained increase in the general price level over time?Deflation-sustained decline in the general price level over time?Average inflation rate since targeting = 2.5%To achieve goal of price stability, CPI must be in target band of 2-3%1.1-1.2% rate of annual inflationConsumer Price Index (CPI)-measures changes in $ of selected regimen of consumer goods and services over time by using price index numbers?5207004889500 INCLUDEPICTURE "" \* MERGEFORMATINET Headline InflationHeadline rate of inflation-quarterly rate of change in the CPI?CPI has 11 different categories, e.g. includes, food, clothing, housing, etc… and is 1 measure of inflation monitored by RBA, which is used to conduct MPAdv. of CPI is its simplicity, and widespread public recognition and understanding of the CPI as a measure of quarterly and annual inflation in the Australian economyUnderlying Inflationunderlying rate of inflation/‘core’ inflation-calculation of inflation that removes ‘one off’, seasonal or volatile factors (e.g. higher food prices due to natural disasters; changes in oil $, or gov. induced tax changes) from CPI series.?a better indicator of trend than CPI inflation because quarterly CPI stats can be distorted by large price movements in 1 or 2 groups of expenditure.?Three measures of underlying inflation are calculated by the Reserve Bank:trimmed mean- an expenditure weighted average of the middle 70% of CPI price changes.weighted median- $ change in the middle of the ordered CPI distribution, including expenditure weights into account.CPI excluding volatile items, removes seasonal price rises or falls, eg. produce RECENT TRENDS IN INFLATIONHistorically Australia has been a high inflation country1970’s&1980’s-inflation averaged between 6% and 10%?1990’s&2000’s-stayed below 3% for CPIAustralia’s inflation rate averaged 2.7% between 1994 and 2016, slightly above the OECD average of 2%.?improved Australian inflation performance due to factors that reduced demand and cost pressures and eliminated wage-price spiral which eroded Australia’s competitiveness in the 1980s:Adoption by RBA of an inflation target in 1993 for operation of monetary policy-provided anchor for inflationary expectations, and made conduct of MP more transparent, credible and effectiveExposure of Aus. economy to increased levels of competition in product and factor markets through cuts in protection inc. implementation of the national competition policy 1995 (1988-2015)-put downward pressure on $ level in product marketsAdoption of productivity based collective enterprise bargaining in 1991 as a principle in wage negotiations-contain wage cost pressures in Aus. labour marketPermanent lowering of inflationary expectations through successful conduct of macroeconomic policy- improved economic performance and slow price growthTechnological change and globalisation- reduce production costs (economies of scale) and increased competitive pressure on all firms to contain price rises2006-08-upsurge due to the resources boom and increased wage pressures, CPI rising by 4.5% and underlying inflation by 4.3% (2007-08)2007-08-changed with impact of GFC and global recession in 2008-09 (lowered global commodity $=declining global inflation)2009-10-strong economic recovery+natural disasters, eg. cyclone Yasi rose $ of produce, eg. fruit=lifted the CPI inflation rate to 3.6%?2012-13-headline inflation eased to 2.4% with underlying at 2.6% due to lower food prices, weaker demand for some G&S, and effect of exchange rate appreciation=downward pressure on $ of many imported goods?Easing inflation pressures between 2013-2016 was due to:Tradables price inflation - extent of prices rises for imported goods and services, fell by -0.3% at the end of June 2015 as world oil prices fellNon tradables inflation - price rises for domestically produced g/s rose by 2.6% in the year 2015Moderation in wages growth wit Wage Price Index increasing by 0.4% in the March quarter 2016 to 2.1% over the year - spare capacity in the labour marketeconomic conditions changed with slower economic growth, a lower exchange rate and cuts in official interest rates?CPI inflation fell to 1% and underlying at 1.3-1.7%2015-16-partly driven by lower world oil prices= lower petrol and fuel prices and price inflation for volatile items eg. fuel, produce remained lower in 2016 and domestic cost pressures were lower with historically low wage and cost growth. Market services inflation also remained low due to increased competition.?THE CAUSES OF INFLATION: DEMAND AND COST PRESSURESInflation may arise from excessive growth in total expenditure or aggregate demand - if aggregate spending exceeds aggregate output there will be pressure for the price level to rise to ration the available output among consumers - known as demand pull inflation since excess aggregate demand is said to ‘pull prices up’Fig 9.4 - equilibrium level of national income is Ye determined by the intersection of the ad and as curves - Keynes argued that equilibrium level of income may not coincide with the full employment level of income?of Yf - if total spending exceeds full employment an inflationary gap of cd would arise - rise in inflation - higher price level and fall in purchasing powerYe – Equilibrium level of national incomeKeynes “Ye may not co-inside with full employment level Yf”Total spending > full employment level of the economy’s income = inflationary gapInflation rises – higher price level, fall in consumer purchasing power2930797-8463700Fig 9.5 - how demand pull inflation may occur using the AD/AS model of the economy - the economy's price level is measured on the vertical axis, real GDP is horizontal axis - AD is the sum of C + I + G + (X-M) - aggregate demand is negatively sloped since the economy will only buy more output at a lower price level INCLUDEPICTURE "" \* MERGEFORMATINET Equilibrium price and output level is found where AD and AS intersect at price level P and GDPMain causes of demand pull inflation are excessive growth in any of the major components of AD [C + I + G + (X-M)]Increased C expenditure caused higher consumer confidence, wage increases, tax cuts, and interest rate fallsIncreased Investment spending caused by higher profits, higher business confidence, tax cuts, increased depreciation allowances, falls in interest ratesIncreases in money supply caused by RBA to stimulate the demand for credit, lead to increased consumer and business spendingIncreased net gov expenditure caused by rise in gov consumption, tax cuts,larger budget deficitIncreases in export income sourced from higher commodity prices and the terms of trade, causing growth in incomes and consumption or investment expenditure369796841293200Other major type/cause of inflation operates from the supply side of the economy - cost push inflation - results from a decrease in aggregate supply and may be caused by a rise in wage rates or cost of raw materials INCLUDEPICTURE "" \* MERGEFORMATINET Fig 9.6 - how cost push inflation can rise - initial equilibrium for the economy is at price level P and real GDP - decreased AS shift the curve left to AS1 - will cause new equilibrium to be established at a higher price level of P1 and a lower level of output at real GDP2 - economy contraction in real GDP and rise in inflation as price level increased - GDP contraction = increased unemploymentInitial E at P/GDP1Decrease in AS shift curve left to AS1New E at P1/GDP1Stagflation - lower growth, higher inflation, and rising unemployment - causes of cost push inflation are increases in the costs of production such as wages and raw materials - since input prices are determined in factor markets, any rise in the prices of the factors of production may lead to a fall in AS and a rise in the economy's price levelCommon sources of cost push inflationWage increases not reflected improvements in labour productivityRise in the price of domestic or imported raw materials?Depreciation of the exchange rate - raise import costRise in gov charges including taxes,royalties, and workers comp premiumsRise in general level of interest rates caused by a tightening of monetary policy - raises cost of borrowingMajor cause of inflation affected aus in 1970s was imported inflation - oil restrictions led to price increases - energy prices rose - ‘second round’ effects of high oil prices - g/s increase due to increased cost of transport37496392227280040% fall un orld oil prices 2014-15 with Bent crude oil trading at US$50 per barrel in 2015 - positive supply shock was expected to increase economic growthINFLATIONARY EXPECTATIONS AND THE PHILLIPS’ CURVEEconomy can experience demand pull and cost push inflation simultaneously through a wage-price inflation spiral. If excess aggregate demand leads to demand pull inflation, wage earners may anticipate a rise in the price level and seek higher nominal wages to maintain their real wages. If they are successful in gaining a wage increase, this may lead to a fall in aggregate supply and further rises in prices. If aggregate demand continues to increase, further price and wage increases may occur, leading to an acceleration in inflation.Inflationary expectations refer to people’s perceptions of future inflation based on past and current rates of inflation.379644414023500Tradeoff or inverse relationship between inflation and unemployment in the short run in Britain in the 1950s. This short run tradeoff is shown in Figure 9.7. A government in attempting to reduce unemployment below 4%, by increasing government spending, could trade off more inflation (2% to 5%) for less unemployment (4% to 3%). Alternatively a government might cut government spending to trade off less inflation (5% to 2%) for more unemployment (3% to 4%). INCLUDEPICTURE "" \* MERGEFORMATINET The Long Run Phillips’ Curve (LRPC) represents the natural rate of unemployment.?If the economy was operating at point (a) with 6% unemployment and zero inflation, and the government increased spending to reduce unemployment, this would cause a rise in inflationary expectations to 2% and a fall in unemployment to 5% in the short run at point (b).?However workers would increase their wage demands as prices have risen, reducing their real wages. Firms would cut back their demand for labour and unemployment would move back to its natural rate of 6%, and the economy would operate at point (c) on SRPC1.?Further use of expansionary policies to reduce unemployment will only lead to higher inflation and no change in unemployment i.e. the economy will move from point (c) to point (d), and to point (e) on SRPC2 where inflation is 3%, but unemployment is unchanged at 6%. INCLUDEPICTURE "" \* MERGEFORMATINET THE NEGATIVE AND POSITIVE EFFECTS OF INFLATIONNEGATIVEConsumers suffer a loss in purchasing power and real income. Unless consumer incomes keep pace with inflation, the cost of living continues to rise, reducing real incomes and living standards;Workers or wage earners suffer a fall in real wages if their money wages do not rise by the same percentage as the increase in the rate of inflation and cost of living over time;Producers or businesses react to higher costs or excess demand by putting up prices. This may lead to higher ‘menu costs’ as they adjust their prices. Producers may also react to higher costs by reducing their work forces to cut labour costs, which may lead to higher unemployment;Exporters and import competitors (in the tradable goods sector of the economy) may find it difficult to pass on higher production costs in the form of higher prices in markets, and may suffer a temporary or permanent loss of international competitiveness in global markets;Savers will find that the real value of their savings will decline if nominal interest rates do not keep pace with inflation. Lenders will charge higher nominal interest rates to compensate for the loss in their purchasing power caused by inflation, which reduces the real returns on their loans;Investors will find the higher costs of borrowing will make some investment projects less profitable and will reduce their demand for investment funds. Some investment decisions will be distorted if asset prices (such as shares, real estate, bonds and derivatives) are rising faster than the prices of other goods and services, leading to more speculative rather than productive investment; andGovernments will find that the costs of providing goods and services will rise, causing an increase in government expenditure. However, taxation revenue will also rise as taxpayers pay more tax on higher priced consumer goods and services, and wage earners are pushed into higher tax brackets (i.e. ‘bracket creep’). Government revenue will tend to rise because of ‘fiscal drag’ (i.e. higher tax revenue due to higher prices and incomes), but spending will also rise due to the higher costs of providing infrastructure, welfare payments and collective goods and services to the public.A reduction in the purchasing power of consumers and producers and a fall in real incomes;A redistribution of income away from wage earners and fixed income earners (such as welfare recipients such as pensioners and the unemployed) to those receiving profit and dividend income;A misallocation of resources caused by distortions in the price level and the economy’s cost structure;A loss in international competitiveness as export prices rise (relative to foreign competition) and import prices fall relative to the prices of competing domestically produced goods and services;A reduction in real savings and real investment which reduces the rate of capital accumulation;A rise in unemployment if firms substitute capital for labour because of rising wage inflation; andA deterioration in government budget outcomes and higher debt interest in the future.POSITIVESIf there is a speculative boom in the share market or real estate market, driven by excessive levels of confidence and demand, this can lead to asset price inflation.Asset price inflation can lead to a distortion in resource allocation such as the growth in borrowings by investors to purchase real estate in 2014-15 in the booming Sydney market. This led to higher property prices and capital gains for investors, but at the expense of shutting many first home buyers out of the market and increasing the risk of a collapse in the property market.POLICIES TO REDUCE INFLATIONAn example of a more restrictive stance of monetary policy to reduce inflation was the Reserve Bank’s seven increases in the cash rate of 0.25% from October 2009 (3%) to November 2010 (4.75%). Higher official interest rates led to rising market interest rates and tighter monetary conditions in Australia.?The effects of higher interest rates, were slower growth in retail spending, a reduction in levels of debt, and reduced demand for credit from financial institutions.An example of a more restrictive stance of fiscal policy specifically used to reduce inflationary pressures was the Gillard government’s 2013-14 budget which aimed to reduce the growth of public demand and the fiscal stimulus used to support the economy during the Global Financial Crisis in 2008-09. Total government expenditure was forecast to increase from $367.3b in 2012-13 to $391.2b in 2013-14.?However as a percentage of GDP, government expenditure was forecast to fall from 25.2% to 24.5%.Furthermore the automatic stabilisers in the budgetary framework were expected to result in revenue growing from $350.4b (23% of GDP) in 2012-13 to $376.b in 2013-14 (23.5% of GDP)Microeconomic policies are most effective in containing cost inflationary pressures such as rises in wages not based on productivity improvements, or rises in the price of raw materials and other productive inputs due to a lack of competition and efficiency in product markets. Examples of microeconomic policies used to support the objective of price stability in Australia include the following:The national competition policy to promote rules for competitive conduct in product markets;Tariff reform to increase competition from imports in domestic markets, leading to lower prices;Taxation reform to remove indirect taxes such as sales tax which distorted prices and raised cost structures for firms;The reform of public utilities and trading enterprises to increase their efficiency and lower prices;?The deregulation of markets to increase the levels of competition and lower prices; and??The introduction of the principle of workplace or productivity bargaining (through enterprise agreements) in the labour market to contain wage pressures not based on productivity improvements.Measurement of the current account deficitExternal stability is achieved when export income is sufficient to finance import expenditure, the servicing costs of Australia’s foreign liabilities are met and exchange rate is relatively stable over timeExports are an injection of funds into the circular flow of income – demand determined by: Real GDP growth of rest of world, extent of international specialisation and factor endowments, prices of AUS g/s relative to the prices of similar g/s made external to AUS, the lower the value of AUD the greater demand for exportsImports – leakage of funds as they are domestic demand for foreign gs – demand influenced by: Real GDP growth in Aus, extent of international specialisation, AUS prices relative to foreign process, prices of foreign made g/s relative to prices of domestic g/s, lowed AUD = greater demand for foreign importsCAD as percentage of GDPAUS total imports exceed exports, persistent CADs are recordedCAD averaged -4.5% of GDP since 198- and economic growth averaged 3% - the CAD is unsustainableCurrent Account Deficit/GDP ratio = CAD/GDP x 100/1Net foreign liabilities as % of GDPNet foreign liabilities – difference between AUS total foreign assets and foreign liabilities – NFL as a % of GDP indicates debt and equity servicing costs of accumulated CAD2017-18 net foreign liabilities of $953,430m represented 52.5% of GDPNet Foreign Liabilities/GDP Ratio = NFL(debt + equity)/GDP x 100/1Net foreign debt as % of GDPRefers to foreign debt assets minus foreign debt liabilities2017-2018 net foreign debt of $1,036,408m represented 57.1% of GDPNet Foreign Debt/GDP Ratio = NFD/GDP x 100/1Terms of TradeTerms of trade measure the relative prices if Australia’s exports and imports - rise occurs when export prices rise faster than import prices – greater volume of imports can be financed with the same volume of exports2008-09 – weaker world growth due to GFC – coal, iron ore, and general commodity prices fell by 40% - 18% decline in terms of trade – rose again then declined from 2012-2016 due to slower world growthEffect of rising terms of trade – increase in export income in the BOP due to higher prices of mineral exports – stimulus to AD through rising incomes, increased investment, and gov taxation reveueThe Exchange Rate- ? ? ? Major impact on resource boom and Aus rising terms of trade was in the exchange rate – resource boom lifts commodity prices, causing greater demand for Aud- ? ? ? Sustained portfolio and direct investment also increased the demand for AUD as foreign investors purchased shares and equity in the mining sector in search of high returnsInternational Competitiveness- ? ? ? Movements in exchange rate for AUD against the currencies of AUS trading partners influence international competitiveness – appreciation of the exchange rate from 2010-2011- ? ? ? GFC – depreciation in real exchange rate, lifting competitivenessTrends in the current account Deficit, net foreign debt and net foreign liabilities- ? ? ? Servicing cost of net foreign debt- interest payments abroad which are recorded as net primary income debits in the current account – debt accumulated as the private sector during the 1980s preferred overseas borrowing rather than equity borrowing- ? ? ? Debt servicing/repayment cost results in further deterioration of the current account balance – if CAD continues to grow, more overseas borrowing may be required and CAD-Foreign debt cycle may become self-perpetuating: Increasing CAD -> Increased stock of net foreign debt -> increased interest servicing costs -> increased net primary income deficit -> Increasing CAD- ? ? ? Only successive reduction of CAD and repayment of debt obligations can correct cycle – this is why AUS cant sustain economic growth rate excess of 5% if the CAD deficit rises to over -5% of GDP – since debt servicing/repayment obligation becomes greater than capacity of economy- ? ? ? The Pitchford Thesis: The financial Account ‘Drives the Current Accounto ? CAD was result of capital and financial account surplus – sets up high servicing cost in terms of interest, profit, and dividend payments remitted overseas = increasing size of net primary income deficit and CAD – rising CAD increase need for foreign borrowings = Increase debt – not an issue if funds are invested into export industries as this would generate future incomeCauses of the CAD- ? ? ? Growth in foreign borrowings during 1980s- ? ? ? Higher public sector borrowing requirement or the public sector underlying deficit in 80s led to higher foreign borrowing by public enterprises- ? ? ? High inflation and lower international competitiveness in 80s reduced AUS export income relative to import spending- ? ? ? Collapse in AUS terms of trade in 80s resulted in falling commodity prices -reduce export earnings and raise cost of imports- ? ? ? Saving/investment gap and spending/output gap: CAD associated with domestic savings being unable to finance all domestic investment, requiring foreign borrowing reliance – gross national expenditure exceeds GDP- ? ? ? Lowering protective barriers of trade and growth of domestic demand led to increased import volumes – increased import expenditure relatic to export earnings- ? ? ? Asian region recession in late 90s, early 2000s – large increase in goods deficit- ? ? ? Depreciation of AUD – early 2000s – debt servicing increase – increased interest payments and net primary income deficit- ? ? ? Drought – farm export slow-downCauses of Net Foreign Debt- ? ? ? Increasing CAD due to overseas borrowing – shift from equity to debt financing in 80s- ? ? ? Long term depreciation of AUD against OECD currencies- ? ? ? Decline in domestic saving – private and public- ? ? ? Persistent federal budget deficitsThe Structural Problem of Low National Saving- ? ? ? Shortfall of national savings in relation to domestic investment – national savings = public + private savings- ? ? ? Increased reliance on foreign saving to finance national investment – not national savings- ? ? ? AUS gov attempt to achieve budget surpluses – economists argued that a rise in public savings could help reduce CAD and debt- ? ? ? ‘twin deficits’ hypothesis =o ? Y = C + I + G + X – Mo ? Y = C + S + To ? Subtract eq’n 1 from eq’n 2?S – I = (G – T) + (X – M)Suggests difference between savings and investment is equivalent to the sum of the difference between gov spending and revenue – reduce CAD = reduce budget deficitNational saving rate has trended higher over recent years – post-GCF uncertainty1991 Hawke Gov’s Superannuation Guarantee Levy (SGL) – raise private saving – compulsory 9.5% levt accumulated $2100billion+ (2016)Hawke government implemented to raise national saving – return to budget surplus, reduce CTH general net debt from 20% (1995-92) to 1.3% (2004-05), introduced tax rebates for private savingThe CAD and National Saving and Investment2005-06 & 2008-09 CAD good due to rising terms of trade – increased volume and value of mineral and resource exports Recent changes to Australia’s net lending position (difference between national saving and investment) in the economy:Household lender position shifted to borrower in early 2000s – post-GFC saving ratio became 11% - 2016-17 saving rate declined to 5%Gov increasingly becoming net lenders – had rising savings due to surpluses – now become borrower due to budget deficits and public debtBusiness sector = borrower – high rates of investmentThe effects of the CAD and Net Foreign DebtAus has the 4th highest CAD as % of GDP (-2.2%) out of OECD major 7: economic effects of large CAD -Persistent CAD financed by foreign borrowings increase size and servicing cost of foreign liabilities – leads to ongoing CAD as borrowing used for consumption not investmentIncreased exposure to economic external shocks such as terms of trade collapses (2015) – reduce export income and increase debt servicing cost – lenders may lose confidence = higher loan rates and cost of capitalAUD susceptible to exchange rate fluctuations – depreciation bc of CAD – valuation effect on part of the net foreign debt denominated in foreign currency – more AUD paid back + depreciation = higher inflation due to increasing import pricesDowngrading of AUS AAA credit rating making future borrowing more costlyTighter monetary policy – higher interest rate needed to slow economic growth to reduce import demand Policies to reduce the CADMacroeconomic (monetary and fiscal) and microeconomic to reduce size of CAD to under -5% of GDPMonetary policy – used to control CPI inflation – 2-3% target inflation band – important to achieve export and import sector competitiveness – important to reduce CAD. Contractionary monetary policy can be used to reduce import sector growth if CAD is unsustainable Fiscal policy – most used due to medium term focus of raising public savings by accumulation of surplus – eliminates public sector call on national saving through the retirement of public debt – reduce part of debt owned by gov – accumulated deficits 417639516065500Microeconomic policies – long term to improve allocative efficiency and productivity – ie. Fair Work Act 2009 – helps contain wage expectations and encourages competitive labour and management practises. Infrastructure reforms – electricity, transport, water, gas – international competitiveness, export growth, and increased productive capacityDistribution of Income and wealthMeasurement of the Distribution of IncomeEconomists measure the distribution of income and wealth by constructing a Lorenz Curve which graphs the income shares for equal groupings of the population or income unitsThe Lorenz curve has 4 important properties:Begins at zero, with zero families earning no incomeEnds where 100% of families earn 100% of all incomeLine of perfect equalityThe curve lies below the line of equalityArea A is used as a measure of inequality – a shift to the left indicates a reduction in inequality and a shift to the right indicates an increase in inequality The Gini Coefficient is a mathematical expression of the degree of income or wealth inequalityGini co-efficient = (Area A) / (Area A + Area B)Perfect equality = 0Perfect inequality = 1The Sources of IncomePersonal income refers to the money and the value of benefits in kind received by individuals during a period of time, for their factors of production41001959017000Earned personal income include wages and salaries – 54.9%Unearned income include rent, interest, profits from businessesIncome is a flow concept as it can vary over time3 main elements of the governments tax transfer system are the following:The system of progressive taxation35% of tax revenue is spent on transfer paymentsOther assistance is through public spending on health, education, transport, etc.The Sources of WealthPersonal wealth is the net value of real and financial assets owned by individualsReal or non-financial assets include property and consumer durablesFinancial assets include bank deposits, shares, super, worth is a stock concept, since it is the amount of a person’s net assets at any one point in timeTrends in the distribution of Income and WealthThe ABS calculate the % of total equivalised disposable household income received by each quintileEquivalised disposable household income adjusts disposable income for the different needs of householdsAustralia’s Gini co-efficient was 0.330 in 2016Normally the degree of inequality is greater for the population as a whole than for a subgroupSingle parent households experience higher inequalityThe distribution of wealth is more unequal than the distribution of income in AustraliaEconomic and Social Benefits and costs of inequalityMany economists believe that the market economy is the most efficient mechanism for resource allocation and that inequality is an inevitable outcomeSome economists believe that inequality causes the marginalisation of some groups in society‘incentive effect’ – rewards harder workers and promotes educationEntrepreneurs may also be willing to take more risks if the potential reward is higherHigher incomes boost national saving and investment – growing market economies results in more job opportunitiesSocial divisions are a cost of social inequalityPolicies to reduce income and wealth inequalityAustralia’s progressive tax and tax-transfer system reduces inequality in the distribution of income and wealthTax policy can also be used to lower marginal taxation rates for low income owners and to reduce the effect of bracket creepFringe benefits tax raise marginal tax ratesExpenditure on social security represents 35.2% of budgetary expenditureEnvironmental SustainabilityEnvironmental sustainability is an issue due to climate change concernsManagement of environmental problems is important for ensuring that the quality of life is not reduced through the over exploitation of both renewable and non-renewable environmental resourcesEcologically Sustainable DevelopmentThe Brundtland Report defined sustainable development as development that meets the needs of the present without compromising the ability of future generations to meet their own needsESD is now a major issue due to the rapid advance of climate changeNatural environment is a source of raw materials or environmental inputs35775904953000The natural environment is a receptacle for both biodegradable and non-biodegradable wasteThe natural environment provides environmental amenities or renewable resource flows which can be used for recreation or leisure activitiesAn economy’s use of the natural environment is usually viewed in an anthropocentric wayPrivate and social costs and benefitsThe price mechanism rarely allocates environmental goods in an optimal manner because prices do not always reflect the real costs of using environmental resourcesPrivate costs refer to the expenditure by producers on resources to produce output. Private benefits include the profits made nu producers in selling g/sSocial costs are a result of private actions – social benefits include positive spill over effects of private production on the community such as shopping centres and carparksMarket failure occurs when natural resources aren’t traded or exchanges efficiently – with environmental resources the occurrence of market failure is linked with negative externalitiesSpill over effects are effects which fall outside the parties to a market exchange – if the external effect is beneficial it is called an external economy, while if it is detrimental it is known as an external diseconomyProperty rights enable market exchange to occur because they exhibit 3 important featuresExcludability – the owner of a property has the right to exclude others from enjoying the benefits of using the propertyTransferability – property rights are marketable and can be bought and sold in a marketEnforceability – property rights are legally binding and courts can settle legal disputesThe problem of the commons – unrestricted access to public property which may lead to over exploitation of resourcesPrivate goods are excludable as individuals who are unwilling or unable to pay for g/s in markets are excludedThe consumption of private goods is said to be rival as it is no longer available for consumption by anyone else in the marketPublic goods are non-excludable and non-rival in consumption – pure public goods include national defence etc. Environmental commodities can be viewed as impure public goodsAnother problem which construes the price mechanism’s efficiency are ‘free riders’ or non-paying usersAlthough the provision of a public good may create net social benefits for the community if there is little preference in the market, little of the goods will be supplied – free riding can prevent allocative efficiency from being achievedEconomists tend to view environmental resources in an anthropocentric sense, viewed in terms of value provided to humans. Non-use values had also been acknowledged by environmental economistsExistence value is the benefit obtained simply from the knowledge that a resource is in existence370586024257000A consumer may obtain option value by avoiding the depletion of an environmental asset like the Amazon Bequest value is the current generations benefit to enjoy by preserving the environment - Intergenerational valueIssues facing the current environment:Land and soil degradationLand transformationOver exploitation of resourcesPollution of the environmentExternal diseconomies impose an unwanted cost on a non-consenting third party who does not receive compensation361823023558500Negative externalities arise from society’s willingness to give away some of its natural resources at zero costNegative externalities extend to virtually every sector of the economyThe Pigouvian tax is the use of tax on pollutionThe issue of renewable resources is sustainability – sustainable yields must be achievedNon-renewable resources may have the capacity for recyclingEnvironmental PoliciesThe Australian federal, state and local governments use a combination of regulatory and market-based instruments to manage the environment:Regulatory or command and control regimes include clean air and water legislationMarket based economic instruments include pollution charges of taxesThe AUS gov is a signatory to the Kyoto Protocol and the Paris Climate AgreementEmissions trading would be the key mechanism for achieving a reduction in carbon emissions in a flexible and least cost wayThe labour gov agreed that a cap and trade scheme would provide a strong incentive for businesses to cut carbon pollutionThe market for tradable emissions permits ................
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