Economic Issues in the Australian Economy (Topic 3 Economic)

• Economic growth is the increase in a country’s productive capacity over time (real GDP). Australia experienced 28 consecutive years without a recession (as of mid 2020), and is one of the few economies in the post-WWII period to achieve this. A recession is defined as two quarters (i.e six months) of negative economic growth.
• Aggregate demand = Consumption + Investment + Government expenditure + (Exports – Imports)
• Keynesian economic thought refers to the theory that output (and therefore growth) is determined by expenditure of consumers, firms, the government and exports, totalling to aggregate demand. During an economic downturn, overall spending decreases and demand contracts. Keynesian economic thought suggests that governments should intervene to stimulate demand and support economic growth.
• Aggregate supply = Consumption + Savings + Taxation. Aggregate Supply (AS) is the total productive capacity (income) when all factors of production are fully utilised over a period of time. It is defined by the equation below. Consumption is included in AS as it comes from personal income earned and is therefore a result of production and supply.
• Equilibrium is when AD = AS. This is where the quantity of real GDP demanded equals the quantity supplied. Balancing the equations for AD and AS, consumption cancels out and we have: I + G + X = S + T + M injections = leakages
• The Marginal Propensity to Consume (MPC) is the proportion of the any extra dollar earned that is consumed. In the case of the multiplier, this ‘extra income’ is an additional injection into an economy. It measures how much more individuals will spend for every additional dollar of income. The formula to calculate MPC is: Change in consumption ÷ Change in income .
• The Marginal Propensity to Save (MPS) is the proportion of the extra dollar earned that is saved. The formula to calculate MPS is: Change in savings ÷ Change in income
• The MPS + MPC = 1. This is because every extra dollar earned is either spent or saved, therefore the sum will be 1.
• The multiplier is the proportional increase in national income, due to an increase in AD. This increase in income is greater than the initial injection. Re-spending increases income and employment while boosting economic confidence. For example, an initial injection of $50 million into the economy to increase the NSW road networks should result in an even greater boost to AD over time. Some of the funds spent on construction will go to labourers, who will use this money to purchase goods and services. An initial injection into an economy will lead to money being continually re-spent.
• Australia’s GDP is US$1.5 trillion (2019). Real GDP is the increase in value of goods/services compared to the previous year adjusted for inflation. Australia’s real GDP growth rate for 2019 was 2.2%. Real GDP per capita (per person) = Real GDP ÷ population. This is used to compare standards of living between countries. A per capita recession occurs when the population increases faster than real output.
• Anything that encourages growth in AD (C + I + G + (X–M)) will be a source of economic growth.
• AS can increase through increased productivity, which is dependent on the sources of economic growth as contributors to increased overall productivity and efficiency. The capacity constraint refers to the point at which the economy approaches full employment and cannot grow any further. When an economy approaches full employment in the short-term, resources become scarce and the capacity to grow decreases. This causes a sharp increase in prices. This is a common phenomenon in the labour market.
• When unemployment nears 0, inflation grows exponentially as labour becomes scarce and firms must offer higher wages to attract staff. The AS curve becomes steeper and inelastic towards the full employment level of income, illustrated below in the Phillips curve. In the long run, AS must increase to match AD, because if it doesn’t then further AD (economic growth) will simply cause inflation.
• The unemployed refers to people willing and able to work, actively seeking work, but unable to find employment (in the previous week at a minimum) according to the ABS. This occurs when total demand for labour (available jobs) is less than the total supply of labour (available workers).
• The casualisation of the workforce refers to the trend of decreased full-time work and increased parttime and casual work. This has been mostly due to the flexibility casual workers offer firms. However, this has caused an increase in underemployment in recent years. The labour underutilisation rate refers to the sum of the unemployment and underemployment.
• Okun’s law: to reduce unemployment, the annual rate of economic growth must exceed the sum of the rate of productivity growth and labour force increases. This is because an increase in productivity decreases the demand for labour, and an increase in the labour force increases supply of labour, both causing an increase in unemployment. In Australia, this is estimated to be 3%
• Fiscal policy and monetary policy: influence the economic cycle and aim to always minimise the unemployment rate while balancing the other economic objectives. • Rising participation rates: when people who were not looking for work start looking for work again (for example, in better economic times), then they are counted in the labour force, and the unemployment rate may rise in the short-term.
• • Structural change: (microeconomic reform) will have longer term impacts on the patterns of employment, and in the process will cause structural unemployment. This may increase unemployment in the short-term; but in the long-term, job opportunities should increase in more efficient industries. • Wage-induced unemployment: where the price of labour exceeds the price of capital machinery or the price of overseas labour. This may displace jobs if firms decrease employment.
• Non-accelerating inflation rate of unemployment (NAIRU). The NAIRU represents the lowest unemployment rate which can be sustained without an increase in inflation. Recently, Australia lowered the NAIRU estimate from 5% to 4.5%. This revision was made mainly due to low wage growth and inflation. Hence, the RBA recognised the Australian economy still had spare capacity in the labour market. The natural rate of unemployment refers to the level of unemployment at which there is no cyclical unemployment.
• Inflation: percentage change in the general level of prices, measured by the Consumer Price Index (CPI). Inflation must be maintained to achieve the objective of price stability.
• CPI is the average level of prices of the goods/services that a ‘typical household’ buys. It measures changes in the prices of selected household items, weighted according to significance, monitored by the ABS. The CPI figure for inflation is released every 3 months. The inflation rate for 2019 was 1.9%. Inflation rate = (Current CPI – Previous CPI divided by Previous CPI) × 100
• Headline inflation is the actual inflation rate, but it may include one-off events that distort the figures (e.g. GST in the year 2000). Underlying inflation is a more accurate measure of inflation because it removes the effects of one-off events that distorts the figures. The RBA has a target framework for the inflation rate, of between 2–3% since 1993. This rate maintains economic growth and price stability within an economy
• Demand-pull inflation: When demand exceeds the available supply, resources become scarce and prices rise in the short-term.
• Cost-Push Inflation: When production costs increase, firms must also raise prices to cover these costs. Cost-push inflation can be caused

  by an increase in the price of wages, rent, supplies or other

  business inputs. If these increase, the costs are generally

  passed onto consumers in the form of higher prices.
• External stability refers to the Australian economy’s financial relationship with the world. The main aspects of external stability include: • The current account • Net foreign liabilities • Exchange rate
• If the size of the debt is rising faster than the increase in GDP, the interest payments on the debt will take up a greater proportion of GDP. This may pose debt sustainability problems in the future, as the size of debt exceeds the level of income growth. This can also impact on our credit rating as a nation. As of 2020, Australia has a AAA credit rating from all three world credit rating agencies. If the credit rating falls, this may decrease investor confidence and cause a contraction in AD, lowering economic growth. Recently, Australia’s net foreign debt as a percentage of GDP is 56%.
• The negative wealth effect is when the price of housing falls it can make people feel poorer (as their assets are worth less, and they have less wealth). This may cause households to cut back on their spending. Community wealth includes publicly owned infrastructures such as roads, railways, and bridges. These are often referred to as public goods.
• According to the Organization for Economic Cooperation and Development (OECD), if Australia follows environmentally sustainable practices in the short-term, it will increase economic growth by 1% per annum.
• A short-term exploitation of natural resources can deplete and permanently damage the environment. This reduces productivity in the long run and can be described as anthropocentric (human-centred) behaviour.
• A private good is owned and used by individual consumers. A public good has two qualities: non-excludability (or non-rivalry) and non-diminishability. • Non-excludability: it is impossible to exclude anyone from consuming the good • Non-diminishability: one person’s consumption does not diminish or lower another person’s ability to consume the same good
• To ensure economic growth can continue in the future, the environment must be preserved. This ensures intergenerational equity of production, as resource usage now has the ability to limit or expand future generation’s resources and production possibility