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Flashcards in Economic Issues Deck (30):

Economic Growth Formula

GDP 2 - GDP1 / GDP 1

Real GDP = GDP / CPI


EG influences on consumption

- consumption and savings
- consumer expectations
- level of interest rates
- distribution of income


EG influences on investment

- cost of capital equipment
- business expectations


EG influences on government spending and taxation

Main goal to maintain a strong and stable rate of EG, governments change level of spending or taxation to increase or reduce AD and EG


EG influences on exports

decrease of AUD - domestic industries more competitive with imports and exports vice versa


simple multiplier

1 / MPS or 1 / 1 - MPC



MPS = change in S / change in Y
MPC = change in C / change in Y


Sources and effects of EG in Aus.

Living standards: EG > GDP > wages > SOL

Employment: EG > jobs

Inflation: high EG > high prices and demand for higher wages = inflation

External stability: strong EG (increased spending) > more imports. Consumers spend large proportion of wages on G + S > stronger EG = increase in CAD

Income distribution: EG contributes to SOL but benefits of EG flow to a particular group rather than flowing more broadly to people through wage increases or improved public services

Environment impacts: EG negative on environment can result in pollution, depletion of non-renewable energy sources and damage to the local environment



economy's AS is determined by quantity and quality of the factors of production, AS can be increased when higher level of output can be produced for the same cost or if factors of production improve


Ways AS can be increased

- increase in population: less pressure on labour market
- productivity: factors of production
- LFPR: incentive to work
- discovery of new resources
- workers acquiring new skills
- increased capital
- new technology


Trends in business cycle for EG

 Global economic conditions: strong while China are still demanding our minerals also supporting us through the GFC
 Sustained terms of trade: remained strong throughout past decades, predicted increase
 Government used fiscal policy: injecting large amounts of money into the economy to encourage spending and boost economic growth


Policies to sustain EG

Macroeconomic policies
 Fiscal policy involves the use and the change of the government’s budget (increases expenditure, increases injections, increases economic activity and growth)
 Monetary policy by changing interest rates (used to encourage consumer and business spending to thus influence economic growth)

Microeconomic policies
 Increase economy’s sustainable growth rate by increasing aggregate supply
 Greater investment in workforce skills programs and infrastructure can overcome capacity constraints
 Boost labour productivity and labour force participation to increase competitiveness
 Increasing educational attainment to improve labour quality and productivity



 Unemployment is a major cost to the economy, because it results in the opportunity cost of lost production as well as increased social welfare payments and a loss of taxation revenue
 Unemployment leads to major social costs including increased poverty, family problems, crime and social division
 Australia’s current unemployment rate = 5.4%


Labour force

The labour force: the labour force can be defined as that section of the population 15 years of age and above who are either working or actively seeking work



- Labour force participation rate refers to the percentage of the population, aged 15 and over, in the labour force, that is either employed or unemployed
- Australia’s current LFPR = 65.7%
- People may decide not to participate in the labour force for many reasons such as wanting to do further study, taking care of family, devoting their life to leisure activities, if they think they are unlikely to find a job, or if they have other forms of income

LFPR = (Labour Force)/(Working age population (15+))


Unemployment Rate

Unemployment Rate (%)= (Number of persons unemployed)/(Total labour force) X 100


Recent trends for U

The level of unemployment peaked in the early 1990s with a rate of 10.7% due to a severe recession in Australia and the global economy. This was worsened by extensive structural change and microeconomic reform
Following the GFC in 2008, Australia’s economic slowdown reduced the demand for labour. Unemployment rose from 4% in Feb 2008 to 5.9% in June 2009, it recovered to 4.9% by March 2011, but with economic growth slowing, the unemployment rate then began inching up again


Okuns Law

Okun’s law explains the relationship between unemployment and economic growth, showing that to reduce unemployment, the annual rate of economic growth must exceed the sum of percentage growth in productivity plus increase in the size of the labour force in any one year

EG > Productivity Growth + increase in LF



 NAIRU refers to the level of unemployment at which there is no cyclical unemployment, i.e. where the economy is at full employment although even at full employment there will be some frictional, seasonal, structural and hard-core unemployment
 When unemployment is above NAIRU there is still some excess capacity in the labour market
 Current Australian NAIRU = 5%
 A lower NAIRU increases the economies chance to grow without inflationary pressure
 To improve NAIRU in the long-term governments, need to adopt policies that improve the skills of unemployed people, overcome hurdles that address work participation and the workplace more suitable for people with disabilities


Policies to reduce NAIRU

 If the NAIRU is too high - Counter cyclical macroeconomic policies such as
o Expansionary fiscal (subject to budget constraints)
o Expansionary monetary policy (drop interest rates)
 If NAIRU is too low the government will use microeconomic policies to encourage the efficient operation of markets


Explanations for U

 People don’t have adequate opportunities for education and training
 People don’t have the right skills to match job vacancies
 Macroeconomic policies – stance will impact the demand for labour
 Constraints on economic growth (inflation and high CAD in the 80’s constrained economic growth)


EG as a cause for U

 Demand for labour is derived demand – derived from the demand for goods and services. Hence, a downturn in the economy reflects the downturn in the demand for labour
 Unemployment starts rising when growth falls below 3%
 When growth is about 3.5% unemployment will fall


Other causes for U

- rising participation rates
- structural change
- technological change
- productivity
- inadequate levels of training and investment
- rapid increase in labour costs


Main types of U

- structural
- cyclical
- frictional
- seasonal
- hidden
- underemployment
- long-term
- hardcore


Economic Costs of U

Opportunity costs

 Unemployment means an economy’s resources are not being used to its full capacity – operating below production possibility frontier

 Output is therefore lower and household incomes are lower – reduced business and investment etc.
Lower living standards: whilst living off benefits - not contributing to production process – meaning those working will have to shoulder greater costs – in the end this leads to a reduction in living standards
Decline in labour market skills for the long-term unemployment

 Unemployment leads to a loss of skill s among the existing workers who find themselves out of work for a period time – persistent unemployment will mean they will lose their labour market skills –making them more employable

 Hysteresis is the process whereby unemployment in the current period results in the persistence of unemployment in future periods as unemployed people can lose their skills, job contacts and motivation to work
Costs to the government: less tax revenue and more payouts to unemployment benefits and welfare – this can deteriorate the government’s budget balance

Lower wage growth: excess levels of labour supply in the economy leads to a fall in equilibrium level of wages


Social Costs of U

- increased inequality
- other social costs including; poverty, loss of work skills, crime


Reducing U

 Reducing unemployment is one of the most difficult tasks of economic management
o Sustained reductions are achieved over long-term periods with high economic growth
o In times of rising unemployment – government must aim to achieve the fastest possible way to achieve short term unemployment to bring back the figure in the long term
 The broader challenge is to reduce long term structural unemployment through a combination of the labour market policies, investment in training and wider economic reforms aimed at moving individuals off welfare and into paid employment
 Government will choose policies based on what they see is the main causes E.g. structural unemployment (they will provide training to improve skills)


Macroeconomic policies to reduce U

 During a downturn, unemployment can rise rapidly and take decades to fall back down therefore governments should try to avoid sharp downturns to minimise cyclical unemployment
 Central goal since 1990’s: unemployment between 3-4% and inflation between 2-3%


Microeconomic policies to reduce U

governments can decrease this through policies that aim to increase the economy’s efficiency, growth and job creation over long term as well as policies such as training and industrial relations


Labour market policies to reduce U

 Policies for general regulation of the labour market have an influence on how the market forces interact with the aim to increase productivity
 Governments can influence the labour market through immigration policies to focus on skilled workers
 Another policy aimed at the supply side of the labour market involves lifting workforce participation by reforming the way that the tax and welfare systems interact through reducing effective marginal tax rates providing incentives to lift workforce participation and increase employment
 Governments can reduce frictional unemployment by helping match jobseekers with job vacancies