topic 6: government and the economy

• Limitations of the operation of the free market

  • Provision of goods and services, public goods, merit goods
  • The market may produce goods or services that are demanded by society and may produce insufficient quantity at an unacceptable price
• Public goods


  Not normally provided by the private sector because profits would not be made for that business
• Free rider


  An individual, household or firm that benefits from a good or service without paying for a share of the cost
• Public goods


  • Non-excludable: cannot be confined solely to those who have paid for them
  • Non-rival: consumption by one consumer will not restrict consumption for other consumers
• Merit goods


  • Not provided in sufficient quantities by the free market
  • Provide benefits to the community which go beyond individual who enjoys them directly
• Merit goods


  • Provided by both the public and private sector
  • Government: indirectly through subsidies, directly through operation
• Merit goods


  • Excludable: confined solely to those who have paid for them
  • Rival: consumption by one consumer restricts consumption for other consumers
• Demerit goods


  Goods that are considered bad for you, leading to negative externalities
• Government intervention for demerit goods


  • Imposing taxes on producers or consumers
• Externalities


  The price mechanism fails to properly reflect the social costs and/or benefits of transactions
• Price of a good

  • Reflects: cost of production (SUPPLY), benefits to the purchaser (DEMAND)
• Positive externalities


  Benefits to third parties from private production and consumption
• Negative externalities


  Damaging effects of private production on society
• Market failure


  When the price mechanism takes into account private benefits and costs of production but fails to take into account the indirect costs to society
• Negative externality: carbon emissions

  Companies may factor in the social cost, leading to more sustainable production but higher prices for consumers
• Monopoly


  Only one seller or producer of a good or service
• Monopoly


  • Firms in highly concentrated industries possess substantial market power
  • Easier to exploit customers
  • Inefficient allocation of resources
  • Prices can be higher than the equilibrium price in a competitive market, leading to less demand and higher profits
• Abuse of market power

  • Monopolisation
  • Price discrimination
  • Exclusive dealing
  • Collusion and market sharing
• Natural monopoly


  Where it is only feasible for there to be one producer in the market
• Business cycle


  The recurring pattern of economic expansion and contraction characterized by fluctuations in overall economic activity, including production, employment, and income levels, over a period of time
• Stages of the business cycle


  • Boom
  • Upswing
  • Recession
  • Downswing
• Functions of government


  • Reallocation of resources
  • Redistribution of income
  • Stabilisation of economic activity
• Monetary policy


  A macroeconomic policy conducted by the RBA where they manipulate the cash rate to influence the cost and supply of money in order to influence AD
• Monetary policy goals


  • Maintain price stability, achieved by keeping inflation at 2-3%
  • Influence employment
• Inflation


  The general increase in prices of goods and services over time, resulting in a decrease in the purchasing power of money
• Interest rate


  The cost of borrowing money or the return earned on savings or investments, expressed as a percentage over a specific period of time
• Cash rate


  The interest rate that banks pay each other. The difference between this rate and the interest rate that individuals pay to banks, represents the profit that the bank earns on these transactions
• Cash rate changes


  When economic activity is high, monetary policy tightens and the cash rate increases. When economic activity is low, monetary policy loosens and the cash rate decreases.
• Transmission mechanism


  The process by which changes in monetary policy, such as interest rate adjustments, impact economic variables like inflation, output, and employment through channels such as interest rates, credit availability, exchange rates, asset prices, and expectations.
• Fiscal policy


  The government can change the level of GDP through the budget, they use taxes and government spending
• Government policies


  • Macroeconomic policies
  • Microeconomic policies
• Aggregate demand formula


  AD = C + I + G + (X-M)
• Any increase in any of the components of AD will accelerate economic growth, and any decrease in any of the components of AD will dampen economic growth
• Influences on government policies in Australia

  • Political parties
  • Business
  • Unions
  • Environmental groups/organisations
  • Welfare agencies
  • The media
  • Other interest groups
  • International