Unit 3 AOS2b - Chapter 3: Macroeconomic Activity and the Australian Government's Economic Goals Flashcards
(157 cards)
1
Q
What are the Australian government’s economic goals?
A
The Australian government aims to improve material and non-material living standards for all people. To best ensure the improvement in living standards the government aims to achieve 5 economic goals:
- Low inflation
- Strong and sustainable economic growth
- Full employment
- External stability
- Equity in the distribution of personal income
When goals 1, 2 and 3 are achieved we have domestic economic stability.
2
Q
Explain the goal of low inflation.
A
The goal of low inflation (or stability of the currency) is achieved when the general level of prices for goods and services are increasing “fairly slowly” and within the target band of 2-3% “on average over the business cycle.”
Low inflation does not mean zero inflation, zero inflation and negative inflation (deflation) have an adverse effect on the economy because if people believe that prices will get lower then they will stop spending in order to save more of their money = struggle for businesses = ⬆️ unemployment = ⬇️ spending (a deadly cycle)
Come back
3
Q
What are the problems caused by not achieving low inflation? (How it hurts other economic goals)
A
All these affect living standards
- High inflation will cause decreased economic growth because
- it drives up interest rates (RBA responds with ⬆️ interest rates) which undermines confidence and slows C and I
- inflation undermines business confidence (because ⬆️$ of inputs = ⬇️ I) - Higher inflation will cause increased structural unemployment because:
- inflation makes our X uncompetitive (think car industry)
(Structural unemployment is unemployment caused by many factors including changes that occur to bus. profitability) - High inflation hurts external stability because
- X becomes uncompetitive (because consumer switch to cheaper stuff) may lead to rise in CAD and even cause exchange rate to depreciate = reduced purchasing power - High inflation hurts income distribution because those in fixed incomes are least likely to negotiate wage rises that keep up with inflation.
- think people on welfare and people in low skilled jobs (already on bottom rung of ladder and now their purchasing power descreases further)
4
Q
Who measures the inflation rate?
A
The inflation rate is measured by the Australian Bureau of Statistics (ABS). The most common indicator of the inflation rate is the Consumer Price Index.
5
Q
What is the consumer price index?
A
This measures quarterly changes in the retail prices of locally made and foreign-made goods and services that represent a high proportion of the expenditure of metropolitan households living in capital cities.
The feature of CPI include the regimen, the price surveyed, the weighting of items and the base year.
6
Q
Explain the features of CPI.
A
The regimen - this refers to the types of goods and services selected to measure changes in prices. The CPI measures the price changes of around 100000 individual items that are subdivided into eleven categories.
Price surveyed - The quarterly price survey is carried out in a representative range of metropolitan retail outlets spanning both the private sector and public sector.
Weighting of items - each item in the regimen in the regimen is weighted according to relative importance in overall household expenditure. Things that are expensive or frequently purchased have a greater bearing on index trends.
Base year - price changes over a period of time are compared to the price or cost in a representative starting year, or base year.
6
Q
What are the limitations of CPI as a measure of inflation?
A
The CPI data provides a guide to general retail price trends in the Australian economy. However, the accuracy of the published inflation rate depends on several factors.
. Lack of representativeness of the prices
. Weighting limitations of items in the regimen
. The effect of once off volatile events on the headline inflation rate
7
Q
Explain the following limitation of CPI as a measure of inflation: lack of representativeness of the prices
A
Only 100000 selected consumer items appropriate for metropolitan households are included in the CPI. Inflation rate figures may therefore be misleading indicators for people who do not live in capital cities.
8
Q
Explain the following limitation of CPI as a measure of inflation: weighting limitations of items in the regimen
A
For some categories of households, the weighting of items in the regimen may be inap- propriate and unreflective of the actual pattern of expenditure. For them, this makes the figures less useful. For instance, if meat went up in price and caused the CPI to rise faster, the inflation figure would be misleading for vegetarian households.
9
Q
Explain the following limitation of CPI as a measure of inflation: the effect of once off volatile events on the headline inflation rate
A
The rate of inflation, as measured by what is called the headline CPI is greatly affected by once-off, volatile and sometimes unavoidable events and developments that influence prices.
For some users like the RBA, the CPI fails to reveal the underlying or core rate of inflation in the absence of these unusual events.
The trimmed mean CPI and the weighted median CPI have been developed to measure the underlying rate of inflation. (These measures have smaller regimens that typically exclude various classes of volatile items eg. fresh fruit and vegetables)
10
Q
What is headline inflation?
A
The inflation measured through this is usually higher than the true rate of inflation
Together with underlying rate of inflation it helps economists see what adjustments need to be made to interest rates
11
Q
What is the underlying rate of inflation?
A
This tends to be a more accurate measure of inflation as it excludes volatile items which are affected by once off events. This includes taking out items like fresh fruit and vegetables (normally in the CPI regimen) which can easily be affected by events such as cyclones or droughts, which would usually cause higher measures of inflation.
12
Q
What are some recent trends in CPI and inflation?
A
The CPI rate reached 3.0% for the 2013-14 year (a trend of inflation staying within the target zone)
Falling world oil prices in the second half of 2014 along with declines in imported electronic prices = annual inflation rate figure below 2% by then end of the year.
Through 2014-15, inflation pressures remained low with the official CPI figure for the year coming in at 1.5% (partly due to the economic experiencing weaker growth for the year).
13
Q
What is demand inflation?
A
This typically occurs in a boom when spending (demand) outstrips production (supply) and there are widespread shortages of goods and services.
Australia’s rate of demand inflation accelerates and eases to reflect changes in the cyclical level of AD and economic activity. It moves up, especially when spending or AD (AD = C + I + G + X − M) is excessively strong and running ahead of production (AS) in a situation where the economy is at or near its productive capacity.
14
Q
How have demand-side conditions recently influenced demand inflation?
A
Changes in consumer confidence and disposable income:
- when confidence and disposable income increase = shortages (if it outstrips production) as firms can’t automatically catch up to increased demand = demand inflation accelerates
- seen in mid 2008 and then in 2009-2010 (contrast following GFC in 2008-2009)
Changes in the level of overseas economic activity and our terms of trade:
- favourable terms of trade and economic activity overseas = X sales and AD. If there is limited unused capacity = general shortages = higher rates of demand inflation
Changes in the exchange rate for the Australian dollar
Changes in interest rates and monetary policy set by the reserve bank of Australia
Etc.
15
Q
What is a budget deficit?
A
A budget deficit occurs when the value of government outlays exceeds the value of government revenue in a given year.
16
Q
AD graphing
A
When AD sits at the goldilocks point on AS = ideal levels of spending result in domestic economic stability and low inflation
When AD sits on the vertical part of AS = (excessive) demand exceeding the economy’s productive capacity resulting in widespread shortages and an inflationary boom (due to strong demand-side conditions)
When AD sits on the horizontal part of AS = (insufficient) supply exceeding the demand from households, businesses, governments and overseas for goods and services (due to weak demand-side conditions)
17
Q
What is cost inflation?
A
Cost inflation exists when cost rises are passed on by firms as higher prices to protect their profit margins.
If it costs firms more to produce or sell their goods or services, then most businesses are eventually forced to pass on the cost rises to consumers in the form of higher prices at the counter. Failure to raise prices in response to higher production costs would otherwise mean lower profits, losses or even business failure.
18
Q
How have supply-side conditions recently influenced cost inflation?
A
Rises in oil prices as a production cost:
- The cost of oil affects the cost of producing many things in our economy because it is not only used to produce goods but also transport many too. Between 2008–09 and 2012–13, there was a spectacular 84 per cent rise in oil prices, so prices had to be passed on.
Changes in climatic conditions affecting production:
- Adverse climatic conditions involving drought, floods, fires and storms, are an adverse aggregate supply-side factor that can affect the prices paid for meat, fruit and vegetables. This is because there is reduced production or supply and costs for farmers are higher. As happened between 2008 and 2013, these rises are then passed onto the consumer, again contributing to cost inflation pressures.
19
Q
AS graphing
A
When AS moves to the left/up the AD line this shows new less favourable supply-side conditions = less supply. This causes cost inflation.
When AS moves to the right/down the AD line this shows more favourable supply-side conditions = more supply. However, this can cause over-supply/surplus.
20
Q
Explain the goal of strong and sustainable economic growth.
A
The goals of strong and sustainable economic growth has 2 key aspects:
1) the rate of economic growth needs to be growing in a manner that does not adversely effect the other economic goals (Eco growth should be at the goldilocks point)
2) the rate of economic growth needs to be environmentally sustainable and not reduce the material and non-material living standards of current and future generations (this is why MAP and GPI are used)
21
Q
What is a current account deficit?
A
This refers to the total value of current payments (debits) for goods, services, primary incomes and secondary incomes exceeding the total value of equivalent credits.
22
Q
What are the effects of economic growth on the other economic goals?
A
- Low inflation
- high Eco growth tends to increase inflation, this is especially the case if production is at full full capacity - Full employment
- high Eco growth will increase employment as the Eco activity will generate jobs - External stability
- high Eco growth tends to increase spending (especially on imports) and therefore worsens external stability - Equity
- creation of jobs via Eco growth should improve equity, however, distribution of profits also has an impact.
23
Q
How do you measure economic growth and living standards?
A
. GDP
. Chain volume/real GDP
Also alternate measures that give clearer indications of living standards as GDP assumes ⬆️ Eco growth = better living standards (when in reality there are positive and negative externalities that should be considered).
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Explain GDP as a measure of economic growth.
Economic growth occurs when there is an increase in the value of final goods and services produced in Australia from one year to the next. GDP is the measure used to identify the Eco growth year on year. It is usually expressed as an average of 3 estimates, being:
. GDP(E)
. GDP(I)
. GDP(P)
25
What is GDP(E)?
E = expenditure
This should be equal to the total annual market value of expenditure (AD). Here expenditure on GDP consists of C+I+G1+G2+(X-M).
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What is GDP(I)?
I = income
This should be equal to the total market value of incomes paid to sellers of resources needed for production. Incomes here include:
wages + salaries + supplements + gross operating surplus/profit of firms.
27
What is GDP(P)?
P = production
This should be equal to the total market value of final goods and services produced each year. Total market value of sales - price pf all inputs purchased by firms.
28
Explain chain volume/real GDP as a measure of economic growth.
A measure of GDP which takes out the effect of inflation
Inflation and deflation affect the growth rate in the market value of national production = misleading impression of the actual size of GDP.
- Inflation would exaggerate the rise in the marketed value of goods and services produced and sold
- Deflation would cause the market value of output to be underestimated.
If nothing was done to compensate for this problem, our GDP figures would be almost meaningless, especially in times when general prices were rising or falling. The ABS now statistically removes the impact that annual price changes would have on the value of production measured at current or market prices by using a measure called chain volume GDP.
Chain volume GDP refers to the market value of goods and services produced by Australia, adjusted to remove the effect on the value of national production caused by changes in prices against a reference year.
29
What are the limitations of the GDP measure?
Non-market production is excluded: value of some types of non-market production is excluded from the GDP figures because its value is too difficult to calculate (eg. illegal production part of the black economy, home repairs, volunteer work).
Quality changes are ignored: in some cases quality can increase whilst the price paid/value of production actually decreases.
Calculation involves possible error: this is due to the fact that the value of some production included in GDP must be estimated.
Distribution of GDP not expressed: GDP fails to show how some people benefit more than others, because not everyone benefits equally.
GDP does not tell the story of non-material living standards: this is because a large chain volume GDP is considered to automatically make people better off.
30
What are the alternative ways of measuring Australia's Living Standards?
. Genuine Progress Indicator (GPI)
| . Measuring Australia's Progress (MAP)
31
What is the Genuine Progress Indicator?
This uses the same personal consumption data contributing to GDP, but it p makes positive and negative adjustments to it. This so it reflects the good or bad effects of different types of activity and spending on society's welfare.
So measuring economic growth with more concern for living standards
32
What is Measuring Australia's Progress?
MAP is a statistical "tool" used by the ABS to examine progress across both material and non-material living standards. This helps to indicate whether life in Australia is actually getting better.
It measures across 4 broad categories, being:
. Society (health, life expectancy, crime)
. Economy (national income, unemployment, inflation)
. Governance (informed public debate, trust and effective governance)
. Environment (waste and recycling, greenhouse gas emissions and land)
Areas are marked with either a tick (progress), cross (regress), question mark (not enough data) or line (no or little change).
(With this range of measures we are able to build up a picture of our material and non-material well being).
33
What are the limitations of MAP?
. Living standards cannot be condensed to a single statistic or figure, meaning you can't say living standards have improved just because there are more ticks than crosses.
. This is because the selection of specific measures is subjective (meaning some people see improvements in health as more important as improvements in crime rates).
. There is also inadequate statistical data, meaning the ABS does not measure all aspects
Subjective
34
Recent trends in Australia's economic growth and living standards.
GDP per capita has grown steadily over the last decade (generally viewed as indicating a rise in material wellbeing for all Australians).
GDP (chain volume measure) was below 1% in June 2015, whilst Real GDI was at 0%. (Percentage changes)
35
Explain the goal of full employment.
The goal of full employment describes achieving the lowest possible rate of unemployment without causing inflation. Therefore we aim for zero cyclical unemployment. Because we will always still have a level of unemployment due to structural, frictional, seasonal and hardcore unemployment. Economists currently state that:
Zero cyclical unemployment = natural rate of unemployment = aggregate of frictional, structural, seasonal and hardcore unemployment (FSSH) = 4.5% unemployment
36
What is employment?
Employment is when people aged 15 and over have a paid job and work for more than one hour per week.
37
What is unemployment?
Unemployment is when those aged 15 and over who are actively looking for work cannot find a job.
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What is the unemployment that is unavoidable?
Natural unemployment of perhaps around 4.5–5 per cent is unavoidable, even in a healthy economy. It occurs due to the existence of frictional, structural, seasonal and hard-core factors.
FSSH
39
What is the labour force?
The labour force includes people over 15 years old who are able and willing to work and are either employed or unemployed.
Meaning students aren't counted (btw don't get this confused with the participation rate participation rate = total of labour force/everyone over 15)
40
What is cyclical unemployment?
Cyclical unemployment is the loss of jobs due to weak aggregate demand-side conditions, a lack of AD and a downturn in economic activity or recession.
41
What is unemployment due to structural change?
This is also known as structural unemployment and can arise as a result of:
. new technology making some jobs obsolete
. the mismatch of skills held by the unemployed to the jobs available
. business relocation or closures
. cost cutting
. rationalisation by firms such as the introduction of cost cutting measures
. and some government microeconomic policies
42
What is unemployment due to frictional influence?
Frictional unemployment is when people are unemployed between one job and the next.
43
What is unemployment due to seasonal factors?
Seasonal unemployment is unemployment that occurs at the same time each year; for example, shearing sheep and fruit picking are seasonal.
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What is unemployment due to hard-core aspects?
Hard-core unemployment arises due to personal characteristics that make holding down a job difficult. Eg. a person with a criminal record may find obtaining employment difficult or a person who has been rejected many times and has now lost confidence.
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What is NAIRU?
This is another way to remember the goal of full employment. We aim for Non-Accelerating Inflation Rate of Unemployment.
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How can the failure to achieve full employment effect the other economic goals?
1. Economic growth - unemployment will decrease Eco growth and therefore material living standards. Also unemployment tends to decrease personal wellbeing and raise crime rates which brings down non-material wellbeing too.
2. Inflation - unemployment tends to assist the achievement of low inflation.
3. External stability - unemployment will effect both X and M, final outcome will vary.
4. Distribution of income - unemployment will always worsen the distribution of income because unemployment benefits are lower than paid employment.
47
How is unemployment measured?
The ABS conducts a survey and month to examine the state of play in the labour force. Some key aspects of these measurements are:
. The labour force
. Employed persons
. Unemployed persons
48
How does the ABS define employed and unemployed persons?
The ABS defines employed people as working either full time or part time and being aged over 15.
The ABS defines unemployed people as those who are actively looking for full time or part time work but are unable to find it. They are able and willing to take up a job and are over 15 to.o.
49
How is unemployment calculated?
When calculating unemployment we need to consider a few different measures:
1) participation rate = people in labour force\everyone over 15.
2) unemployment rate - represents % of the labour force who are participating but can't find work.
50
What are job vacancies?
Job vacancies are job offers advertised by firms looking for staff to fill them.
51
What is the underutilisation rate?
This includes the unemployment rate as well as the underemployed.
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What is hidden unemployment?
Hidden unemployment includes people who would like work but who are discouraged from seeking jobs for various reasons, such as a repeated failure to find work, and who have left the labour force and are therefore no longer ‘actively looking for work’.
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What is disguised unemployment/underemployment?
This is where individuals have jobs but are underemployed and
not working to capacity, such as in part-time jobs with limited hours.
54
What are the recent trends in unemployment?
```
June 2015 (000's)
Total employed: 11772
Full-time: 8158
Part-time: 3614
Total unemployed: 75
Unemployment rate: 6.1%
Participation rate: 64.8%
Under utilisations rate: 14.6% = 8.5 (underemployed rate) + 6.1 (unemployment rate)
```
In 2nd half of 2015, the unemployment rate fell to 5.9%
55
Explain the goal of external stability.
The goal of external stability is a desirable situation which is achieved if Australia is living within its means and able to meet its international financial obligations. Generally this is indicated by:
. A low Current Account Deficit (CAD) to GDP ratio
. sustainable Net Foreign Debt (NFD)
. and a stable exchange rate
56
What is the current account deficit?
The CAD is a statistical record of the financial transactions between Australia and the rest of the world. The CAD is one half of the balance of payments. The other half is known as the Capital Account.
The key information for the capital account is that it is in surplus when the current account is in the deficit and approximately by the same amount.
57
How is the current account deficit measured?
Through the balance of payments account.
When debits for imports exceed credits for exports there is a current account deficit.
58
What is the balance of payments? (look at year 11 flashcards)
This is annual statistical record of the money value of both current, capital and financial transactions between Australia and the rest of the world.
When there is a current account deficit there is a capital and financial account surplus.
59
What is the current account? Year 11 flashcards
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60
What are the 4 sub-accounts of the current account?
. Net goods
. Net services
. Net primary incomes
. Net secondary incomes
61
Explain the following sub-account of the current account: net goods
This is the difference in total value between export credits for goods sold overseas minus import debits for goods purchased from abroad.
Goods sold overseas - also called merchandise (eg. wool, minerals and manufactured items.
Goods purchased from abroad - eg. oil, electronic equipment and machinery.
62
Explain the following sub-account of the current account: net services
Net services are equal to the difference between the value of service credits received by Australia (eg. tourism, education, transportation, construction, financial, royalties and licence fees, for example) minus service debits paid abroad (eg. transportation, tourism, education, royalties and licence fees, and insurance)
63
Explain the following sub-account of the current account: net primary incomes
This is the difference in value between income credits received from overseas (eg. wages, salaries, interest, dividends and profits) minus income debits paid out abroad (eg. wages, salaries, interest, rent, dividends and profit remittances).
64
Explain the following sub-account of the current account: net secondary incomes
These refer to the difference between the value of secondary income credits received by our residents (eg. non-life insurance transfers such as pensions) minus the value of secondary income debits paid abroad (eg. gifts, taxes and some non-capital type foreign food aid donated by our residents).
Secondary incomes are different from other transactions in that they are a one-way transaction with nothing exchanged in return.
65
How is the current account deficit calculated?
Net goods + net services + net primary incomes + net secondary incomes = overall balance on the current account (in Australia's case, the result turns out to be a large CAD).
66
What are the capital and financial accounts? Year 11 flashcards
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What are the 2 sub-accounts of the capital account?
. Net capital transfers
| . Net acquisition of non-produced financial assets
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Explain the following sub-account of the capital account: capital transfers (year 11 flashcards)
Capital transfers generally involve the net inflow of funds to Australia by permanent migrants.
69
Explain the following sub-account of the capital account: net acquisition of non produced, non financial assets
The net acquisition/disposal of non produced, non-financial assets covers the excess of credits over debits for the sale of copyright, patents, franchises and trademarks of a tangible nature.
Of these two items, capital transfers are by far the largest item.
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What are the 5 sub-accounts of the financial account?
```
. Net direct investment
. Net portfolio investment
. Other investment
. Reserve assets
. Net errors and omissions
```
71
Explain the following sub-account of the financial account: net direct investment
Net direct investment involves the purchase or expansion of companies and assets
in Australia by foreigners (classified as credits or assets), or similar investments overseas by Australian residents (classified as debits or liabilities).
72
Explain the following sub-account of the financial account: net portfolio investment
Net portfolio investment has to do with transactions into and out of Australia involving shares, debt and securities.
Portfolio investment or capital inflow from overseas is recorded as a credit or asset, while this sort of investment abroad by Australian residents is recorded as a debit or liability on our financial account.
73
Explain the following sub-account of the financial account: other investment
Other investment includes credits or assets minus debits or liabilities for loans,
deposits and trade credits.
74
Explain the following sub-account of the financial account: reserve assets
Reserve assets contains both RBA and government transactions involving dealings
in reserves of foreign currencies, gold, special drawing rights and required contributions to the International Monetary Fund (IMF).
Moneys received from overseas are categorised as credits or assets, while payments overseas are categorised as debits or liabilities on Australia’s financial account.
75
Explain the following sub-account of the financial account: net errors and omissions
Net errors and omissions reflects inaccuracies in the previous calculations and estimations.
When this category is taken into account, the positive balance on Australia’s capital and financial account will exactly offset the negative balance on current account (the CAD).
76
What is the exchange rate?
. This measures the price or value of the Australian dollar when it is swapped for other currencies.
. Exchanging currencies is necessary because a nation's residents normally want to be paid in the currency unit appropriate to their currency.
This is another indicator of Australia's external strength.
77
What exchange rate do we have in Australia?
In Australia we have a floating exchange rate, meaning the value of the equilibrium price for the Australian dollar is decided in the foreign exchange market by currency buyers (demanders) and currency sellers (suppliers).
One consequence of a floating exchange rate is that market forces sometimes create instability and unpredictability in the exchange rate of the Australian dollar.
78
What can effect the value of the Australian dollar?
$AUD appreciates when ⬇️supply and ⬆️demand (can happen due to better terms of trade, increased overseas economic activity etc.)
$AUD depreciates when ⬆️supply and ⬇️demand (can happen due to global recession etc.)
79
What are the 2 measures of the Australian exchange rate?
. Individual exchange rates
| . Trade weighted index
80
Explain the following measure of the Australian exchange rate: individual exchange rates
The Australian dollar has a separate exchange rate for every currency in the world, including the rate for US dollars, the euro, British pounds sterling, Japanese yen, Chinese renminbi and the Indonesian rupiah. These rates express how many currency units for each country can be purchased with one Australian dollar.
81
Explain the following measure of the Australian exchange rate: trade weighted index
The trade weighted index (TWI) represents the average exchange rate for a basket of foreign currencies weighted according to their relative importance for Austral- ia’s trade (for example, the US dollar is weighted more heavily than the Indonesian rupiah). Because the TWI is an index, a base year (May 1970) is used to compare changes in the currency’s value in subsequent years.
82
What is Net Foreign Debt (NFD)?
This is the difference in value between what Australian households, businesses and governments have borrowed from and owe overseas minus what Australia has lent or invested abroad. Debt can be good, providing that it is used wisely for sound project. Our overseas debt can also make up for the deficiency in local savings and make access to credit more affordable when interest rates are high. However there is the problem of interest payments.
It also indicates Australia's external position.
83
What are the two main types of overseas borrowing?
. Public sector or official government borrowing
| . Private sector or non-official borrowing
84
Explain the following types of overseas borrowing: public sector or official government borrowing
This is when federal, state and local governments borrow money from overseas to help cover their often large budget deficits in 2012-13 the public sectors foreign debt comprised approximately 26% of the NFD.
85
Explain the following types of overseas borrowing: private sector or non-official borrowing
The main private sector borrowers are the large companies who need to raise capital for financing business expansion and takeover.
86
What are the effects of international transactions on living standards? Look at notes and summary mind map at back of chapter
International transactions greatly affect Australia’s CAD, exchange rate and NFD, and in so doing, have an impact upon the achievement of other government goals and, ulti- mately, our standard of living.
87
How do international transactions affect economic growth, unemployment and living standards? Look at notes tool for all of these
The levels of imports, exports and foreign investment influence the level of AD.
Exports, for example, represent around 20 per cent of AD and, directly or indirectly, employ nearly a quarter of all workers.
```
⬆️X values and ⬇️M values
= smaller CAD
= stimulated AD and economic growth
= ⬆️job creation and ⬆️incomes
= improvement of our material living standards.
```
If ⬆️M and ⬇️X
= larger CAD
= slow economic activity
= ⬆️ cyclical unemployment.
. A change in the exchange rate is one of many factors that could cause this rise or fall in the value of net exports (X − M).
. So a rising exchange rate, for example, can result in fewer exports because they have become dearer to overseas buyers, while at the same time, cause more imports because these are now cheaper for us to buy.
. This, then, increases the CAD, slowing rises in AD, economic activity, employment, income and overall living standards.
88
How do international transactions affect efficiency, resource allocation and living standards?
. The Australian government has adopted the policy of trade liberalisation.
. This involves reducing protection of local industry by cutting tariffs (general rate is now 5%) and signing more free trade agreements (FTAs) with two or more countries.
Reducing protection of local industry
= need to specialise in the production of those goods and services where they are strongest
= producers need more efficient allocation of resources in order to compete
= thereby lifting our sustainable rate of economic growth.
89
How do international transactions affect the inflation rate and living standards?
Australia’s level of inflation reflects both demand and cost pressures.
. Our inflation rate affects the purchasing power of incomes and hence living standards.
. Both cost and demand inflation are affected by international transactions and performance externally.
⬇exchange rate (will result in ⬆️ demand inflation)
= encourages X (because cheaper) and discourages M (because dearer)
= stimulated AD and economic activity
= upward pressure on demand inflation
⬇️ exchange rate (⬆ cost inflation)
= imports of goods and services from abroad become dearer
= firms lifting prices to cover costs
= undermined purchasing power and material living standards.
⬆️ Australian dollar (eg. 2011–12)
= could cause slower demand and reduced cost inflation, thereby lifting our material living standards.
90
How do international transactions affect income distribution and living standards?
International trade impacts on both the level of national income and the way this income is distributed or shared between different groups of Australians.
Rising exports (as occurred in the recent minerals boom to 2012)
= ⬆️ incomes for business owners and those who work in export industries.
= ⬆️ share of national income relative to that going to other groups or individuals in the community.
⬇️ exchange rate
= ⬆️ incomes and material living standards of exporters relative to those of importers and the rest of the community.
91
Explain the relationship between the CAD and the NFD.
. ⬆️CAD = ⬆️borrowing (to fill gap X-M) = ⬆️NFD
. ⬇️CAD = ⬇️borrowing = ⬇️NFD
. ⬆️NFD = ⬆️interest repayments = ⬆️debits = ⬆️CAD (becomes an unforgivable cycle)
. ⬇️NFD = ⬇️interest repayments = ⬇️debits = ⬇️CAD
(These interest rate payments are debits on primary incomes)
92
Explain the relationship between the TWI and the CAD.
. ⬆TWI ($AUD appreciates) = X less price attractive = ⬇️X = ⬆️CAD (as debits exceed credits)
. ⬇️TWI ($AUD depreciates) = X more price attractive = ⬆️X = ⬇️CAD (as credits exceed debits)
. ⬆️CAD = ⬇️demand for X = ⬇️demand for $AUD to buy Australian products = ⬇️TWI = X more price attractive
(⬆️TWI = ⬆️️CAD = ⬇️TWI = ⬇️CAD - this is a correcting cycle)
NOTE: ⬇️demand for X = ⬇️demand for $AUD (this is because Aus. Exporters won't accept payments in foreign currencies)
93
Explain the relationship between the NFD and the TWI (Australian dollar).
. ⬆️NFD = ⬆️interest repayments overseas = ⬆️demand for forex (because they want payments in their currency) = ⬆️foreign currency values = ⬇️$AUD = ⬇️TWI
. ⬇️NFD = ⬇️interest repayments overseas = ⬇️demand for forex = ⬇️foreign currency values = ⬆️$AUD = ⬆️TWI
. ⬆️TWI = ⬇️NFD (at parity $1AUD = $1USD, but if ⬆️TWI then $1AUD = $1.5USD, less debt to pay)
. ⬇️TWI = ⬆️NFD (at parity $1AUD = $1USD, but if ⬇️TWI then $1AUD = $0.5USD, more debt to pay)
Forex = foreign currencies
94
What does external instability occur?
When we are not able to pay our way in our international financial transactions and are not living within our means,
95
How can we explain Australia's recent external weaknesses?
By looking at how both aggregate demand-side factors and aggregate supply-side factors determine the size of our CAD, the level of the exchange rate and the NFD, and the extent to which the goal of external stability is achieved .
96
What does external instability occur?
When we are not able to pay our way in our international financial transactions and are not living within our means,
97
How can we explain Australia's recent external weaknesses?
By looking at how both aggregate demand-side factors and aggregate supply-side factors determine the size of our CAD, the level of the exchange rate and the NFD, and the extent to which the goal of external stability is achieved .
98
Aggregate demand-side conditions with external stability.
Generally any demand-side factors that would cause an ⬆️ in AD (eg. Business confidence, ⬇️ interest rates, ⬆️ population etc.) will tend to cause an increase in consumption spending, a part of which must be on imports. (X unchanged due to ceteris parabis)
⬆️AD = ⬆️M = ⬆️CAD
Higher cyclical levels of economic activity caused by excessively strong domestic demand-side conditions (such as consumer and business confidence, disposable incomes, population growth, tax rates) usually:
. accelerate AD
. cause the cyclical CAD to rise (perhaps from around 3–4 per cent to 6 per cent of GDP or even higher as in 2007–08 or to a lesser extent in 2009–10).
. causes the exchange rate to weaken
. and the NFD grows.
By contrast, when demand-side conditions are generally weaker and AD grows more slowly as in 2010–11 the cyclical CAD usually shrinks.
99
Aggregate supply-side factors with external stability.
Adverse supply-side conditions (eg. Low productivity, high wage costs etc.) tend to make Australian exports less competitive in the international market.
Eg. ⬆️RULCs = ⬇️AS = ⬇️X = ⬆️CAD
Adverse supply-side conditions in the economy result in:
. an ongoing structural CAD (perhaps equal to at least around 3–4 per cent of GDP)
. a rising NFD
. and a gradually declining value for the Australian dollar.
However, if supply-side conditions generally become more favourable, the structural CAD should fall.
100
How do government policies effect external stability?
The Australian government’s trade policies have an influence on the nature and level of Australia’s international transactions and, hence, on our living standards. Essentially, governments can choose between free trade or protectionist policies.
101
What are some protectionist policies?
Each type of protectionist policy aims it promote local producers when competing with foreign imports.
. Tariffs - indirect tax added onto the price of imports to make them dearer to local consumers and protect local industries from overseas competition.
. Quotas - government restriction on the quantity of particular goods that can be imported.
. Subsidies - a cash payment by the government to local producers to help reduce their production costs and selling price, making them more competitive against imports.
102
What are the claimed advantages of protectionist policies?
. To help infant industries
. Defence reasons
. To improve economic stability
. To maintain jobs
103
Explain the following claimed advantages of protectionist policies: protection to help infant industries and protection for defence reasons.
Protection to help infant industries: The infant industry argument is based on the point that new industries that are just getting started will have higher production costs than those that are well established. In the case of these industries, tariffs supposedly provide a helping hand for a few years, until firms get established and become more efficient. However, sometimes the infant has refused to mature and become competitive, even in old age!
Protection for defence reasons: During wartime, countries are often isolated without access to imports. The use of tariffs during peacetime can help maintain inefficient or uncompetitive industries so that there is an assured supply of essential goods and services in an emergency. This non-economic argument has been used in Australia by a number of industries including the car and shipbuilding industries, but a likely cost of this policy is lower immediate living standards.
104
Explain the following claimed advantages of protectionist policies: protection to improve economic stability and protection to maintain jobs.
Protection to improve economic stability: Some critics of free trade argue that open, exporting economies are more likely to experience booms and recessions in the level of economic activity caused by the business cycle in overseas countries. While this is partly true, the same sort of reasoning could also be used to stop or limit interstate trade and production, since potentially there could also be instability here as well — a suggestion that could not be taken seriously.
Protection to maintain jobs: One of the most frequently heard reasons for keeping tariffs is that they help protect local jobs and employment from destruction by imports from low-wage countries such as Indonesia or China.
105
What are the problems of protectionist policies?
While there may be some basis for this argument, several counterpoints can be made:
. Potential of substituting technology
. Overseas retaliation
. Protection of one industry can effect others
. Hard to see how more jobs will be created
106
Explain the following problems of protectionist policies: Potential of substituting technology and overseas retaliation.
Potential of substituting technology: Although labour or wages are relatively expensive in Australia, this problem can
often be overcome by substituting technology. The use of machines or capital equip- ment in our country is relatively cheap, possibly giving us the competitive advantage.
Overseas retaliation: We cannot expect other nations to allow our exports into their country if we use tariffs to repel their competition. It is likely that a move by Australia to raise tariffs would cause retaliation overseas, lower exports, and result in a loss of jobs and reduced living standards.
107
Explain the following problems of protectionist policies: Protection of one industry can effect others and it is hard to see how more jobs will be created.
Protection of one industry can effect others: Although tariffs may help protect one industry, in so doing they cause the production costs of others using imported materials and equipment to be higher than otherwise. This makes them less profitable, so tariff protection of one industry can lead to businesses closing down and the destruction of jobs in others.
Hard to see how more jobs will be created: In the long term it is hard to see how more jobs can be created by using tariffs that are designed to encourage industries that are inefficient and unprofitable. Logically, we should create more jobs and have higher living standards if Australia specialises in the things we make best — that is, we should concentrate on selecting areas of production where we have a comparative cost advantage (or least disadvantage).
108
What is free trade?
Free trade involves abolishing protection of local industry by removing tariffs, subsidies and import quotas. This means there are no restrictions in place to alter the international flow or movement of goods, services and capital between countries, thereby forcing local firms to become more internationally competitive.
Free trade is also advanced through the signing of bilateral and multilateral free trade agree- ments (FTAs).
109
What are the claimed advantages of free trade?
. Greater efficiency, economic growth and incomes
. Increased international trade
. More jobs and employment
. Lower inflation and more choice
110
Explain the following claimed advantages of free trade: increased international trade and greater efficiency, economic growth & incomes.
Greater efficiency, economic growth and incomes: Free trade means that efficiency in the allocation of resources should be maximised. One reason for improved efficiency is that under this system, resources are guided into various uses by the free exercise of consumer sovereignty, and by price and profit signals coming from various markets. Resources will only flow into areas of production where the firm or country has a comparative cost advantage. Inefficient firms and unviable industries will wither and their resources put to more productive uses elsewhere. In other words, our existing resources can be used elsewhere to produce a bigger output and, hence, a higher level of income and wellbeing. As a result, the potential for exports should be maximised, leading to increased economic and employment growth, higher incomes and improve- ments in material living standards.
Increased international trade: As noted, freer trade causes the international trade vol- umes (including exports) to grow more quickly. This is especially the case if the policy is being adopted globally by most countries (as in recent years). Indeed, experience shows that our exports have grown three times faster than our GDP, thanks to having freer and increased access to expanding foreign markets. Again GDP, incomes and material living standards benefit.
111
Explain the following claimed advantages of free trade: More jobs & employment and lower inflation & more choice
More jobs and employment: If free trade leads to greater efficiency, more exports and stronger economic growth in the long run, it should also lead to the creation of more jobs. Indeed, it has been estimated that one in four Australian jobs depends directly or indirectly on export sales. In the short term, increased levels of structural unemploy- ment may result from reduced protection of industries that are unprofitable and are forced to close down because their costs are too high and they cannot compete with imports. Examples include Mitsubishi Motors and various appliance manufacturers. However, in the long term free trade releases resources for redeployment into other areas of comparative cost advantage, where even more jobs can be created in competi- tive and expanding local industries.
Lower inflation and more choice: Without tariffs, domestic inflation rates should be lower due to stiffer competition from imports. In addition, local firms are forced to become more efficient and cut their production costs in order to survive. In the absence of tariff protection, there is also much more consumer choice that can lead to cheaper, more affordable and better quality goods and services. As a result of free trade, the purchasing power of our incomes is greater and so material living standards should be higher.
112
Explain the goal of equity in income distribution.
The goal of equity in income distribution is achieved when:
. every person has access to basic goods and services
. enjoys a reasonable standards of living
. and absolute poverty is avoided.
113
What is income?
Income represents money recurve in the form of wages, rent, dividend and profits over a period of time, normally from the sale of resources.
114
What are the different types of incomes?
. Earned income
. Unearned income
. Factor income
. Transfer income
115
What is earned income?
Earned income includes wage and salaries and represents a reward for work, personal effort, and the sale of mental talents and physical power. This is the main source of income for nearly 60 per cent of households.
116
What is unearned income?
Unearned incomes might involve receiving interest, dividends, profits and rent. As such, these incomes arise from the ownership of various assets or wealth including property, shares, businesses and savings, and appear to involve very little or no personal effort. Just over 10 per cent of households have this as their main source of income.
117
What is factor income?
Factor incomes are gained by those taking part in production or selling resources. They are a combination of both earned income and unearned income as outlined above.
118
What is transfer income?
Transfer incomes. Transfer incomes mainly include government welfare assistance or direct cash benefits provided to needy families and individuals (for example, aged, sick, those seeking work, veterans, single parents and youths). These payments make up the main source of income for almost 30 per cent of all Australian households.
119
What is income distribution?
This refers to how evenly or unevenly the nation's income cake is divided, for example, between individuals, genders, states and occupations. This affects equity and living standards.
120
What are the effects of income distribution on living standards?
The way Australia divides up or distributes its national income cake has important economic and social effects on us all. There are both costs and benefits of any particular type of income distribution, whether it is fairly even or highly unequal. As we shall
soon see, the real challenge for governments and society is to find the correct or optimal balance between too much equality and too much inequality, so that our general living standards can be maximised.
121
How does income distribution affect consumption and living standards?
Income distribution greatly influences both material and non-material living standards. Eg. if there is much income inequality and one individual gets a small slice of the nation’s income cake while someone else gets a much bigger slice, clearly people’s material living standards and daily lives will be vastly different. The latter will have access to proper health and dental care, tertiary education, exciting holidays etc.
122
How does income distribution affect resource allocation and living standards?
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123
How does income distribution affect efficiency, unemployment, the motivation to work and living standards?
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124
How does income distribution affect economic growth, inflation and living standards?
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125
How does income distribution have social effects that impact on living standards?
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126
How is the distribution of income measured?
The A.B.S conducts a survey of households to determine the level of income distribution, the level of income can be measured at a number of different stages:
. Private income - personal income prior to government efforts to redistribute income more evenly
. Gross income - income after the receipt of welfare benefits before tax
. Disposable household incomes - income after the receipt of means-tested welfare payments and after the payment of progressive personal income taxes
. Social wage incomes - income after taking into account welfare payments, progressive taxes and the value of government services provided free of charge or at a subsidised price
. Final incomes - income after the payment of direct and indirect taxes, welfare benefits and provision of government services.
127
How do we graph the distribution of incomes?
This is done by initially dividing population into groups (quintiles - broken into 5 groups of 20% or deciles - broken into 10 groups of 10%) and then indicating what percent of income each group receives. The resultant graph is known as the Lorenz Curve.
128
What are equivalence scales?
These are used to make adjustments to the incomes of individuals to reflect differences in personal circumstances of various types of income units (eg. A single person, a couple without children).
129
The distribution of various types of income.
Distribution of market or private incomes from personal sources (such as wages, interest, rent, dividends and profits)
PLUS
The receipt of government direct cash welfare benefits or income support
EQUALS
Distribution of gross income (total income from all sources)
MINUS
The payment of government personal income tax
EQUALS
The distribution of disposable household incomes (spendable incomes)
PLUS
The receipt of indirect benefits including government community services (for example, education and health often provided cheaply or free)
EQUALS
The distribution of social wage income
MINUS
The payment of indirect taxes (such as GST)
EQUALS
The distribution of final incomes (after all government income redistribution measures above
have occurred)
130
What is a Lorenz diagram?
This is used to help shoe the way income or wealth are divided or shared, usually by quintile. It contains Lorenz curves and a diagonal line representing total equality. The greater the deviation of the Lorenz curve from the line of total equity, the greater the level of inequality.
131
What is net wealth?
Net wealth or net worth represents the value of assets owned by individuals, such as a house or shares, after taking any debt into account. The distribution of this can also be plotted on the Lorenz diagram.
132
What is the gini coefficient?
This is the numerical value given to the information shown in the Lorenz curve. It is a number between 0.0 (total inequality) and 1.0 (total inequality) that represents a measure of how income or wealth is shared. The higher the Gini number, the greater the degree of inequality in distribution.
133
What are some shares of disposable income or net worth?
CQ0 (0%), CQ1(20%), CQ2(40%), CQ3(60%), CQ4(80%), CQ5(100%), Gini Coefficient
```
Equalised disposable income share by cumulative quintile (2011-12) (Lorenz curve)
cq0-0
cq1-7.5
cq2-20.1 20.1 - 7.5 = 12.6%
cq3-37.4 37.4 - 20.1 = 17.3%
cq4-60.4 60.4 - 37.4 = 23%
cq5-100 100 - 69.4 = 39.6%
gc-0.320
```
```
Household wealth (net wealth) share by cumulative quintile (2011-2012)
cq0-0 cq1-0.9 cq2-6.1 cq3-18.3 cq4-39.2 cq5-100 gc-0.630
```
Total equity in income/wealth distribution
cq0-0 cq1-20 cq2-40 cq3-60 cq4-80 cq5-100 gc-0
Total inequality in income/wealth distribution
cq0-0 cq1-0 cq2-0 cq3-0 cq4-0 cq5-100 gc-1
134
How is the gini coefficient calculated?
The gini is calculated using the Lorenz diagram. It involves measuring the area between the diagonal line of absolute equality and the actual Lorenz curve. The resulting figure is then expressed as a proportion of the total triangular area below the diagonal. Gini figures collected over a number of years can also be compared to determine trends in the distribution of either income or wealth.
135
What is the gini coefficient equation?
Gini coefficient = Area A\(Area A + Area B)
Area A = area between line of total equality (45 degree line) and the Lorenz curve
Area B = area between Lorenz curve and the line of total inequality
136
Measuring wealth distribution.
. Until fairly recently, there was no up-to-date government statistical data showing the distribution of Australian wealth.
. However, during 2013 the ABS released its 2011–12 estimates (latest data currently available) of the distribution of Australian wealth, which is called net worth (net worth is positive when an excess of assets is owned by households over their liabilities).
. These data are published as the share (percentage) of net worth by quintile, in the same way as for the distribution of income.
. Again, a Lorenz curve can be drawn for net worth and the Gini coefficient calculated from the information.
137
What is the poverty line?
The poverty line represents a measure where people with incomes that fall below this benchmark would be living with material depravation. This means they have inadequate access to basic food, shelter and clothing. Those measuring Australia's poverty usually have relative poverty in mind.
138
What is relative poverty?
This is where people's material living standards are low or serious in comparison to some changing level deemed acceptable to the community. This was what Professor Ronald Henderson had in mind when he devised a measure based on the Australian poverty line.
139
What is the level of poverty?
This is extremely difficult to measure, however most attempts to measure Australian poverty use the disposable cash income of a family. This is also known as the Henderson poverty line.
140
What are equivalence scales?
These are used to come up with a range of poverty lines so that different combinations of individuals in different income units would suffer the same degree of poverty. Different academics use different equivalence scales, this can lead to disagreements about the level of poverty.
141
What are the limitations of measuring personal income distribution?
. Definition problems
. Statistical problems
. Subjectivity of poverty measures
142
Explain the following limitation of measuring personal income distribution: definition problems
Equity, or fairness, in income distribution distribution is subjective. No single index adequately measures equity in income distribution. It is one thing to establish the degree of inequality in income or wealth,mouth it is another to determine whether or not there is equity or inequity. In the end, our judgement, perhaps, comes down to personal values and beliefs.
143
Explain the following limitation of measuring personal income distribution: statistical problems
The statistics gained from measuring income and wealth inequality are not totally accurate. This is due to sampling error, false information and the unreliability of making equivalence adjustments to allow for the different family needs, circumstances and the number of breadwinners. Additionally, ABS income surveys are not conducted every year, so there are gaps in the data.
144
Explain the following limitation of measuring personal income distribution: subjectivity of poverty measures
Subverts that measure poverty rates provoke heated debate over their accuracy. Eg. With Henderson's poverty line, there is a problem with defining poverty, the issue of making appropriate adjustments for income units and determining where the poverty line should sit relative to the percentage of the community's average income.
145
Costs and benefits of inequitable distribution of income
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146
What are some recent influence on Australia's income distribution?
. Changes to Australian wage systems
. Changes in rates of unemployment
. Changes in inflation and asset valuation
. Changes in female participation rate
. Changes in the rates of part-time and casual work
. Changes in federal government budgetary policy
. Changes in severe weather conditions
147
Explain the following recent influence on Australia's income distribution: changes to Australia's wage system
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148
Explain the following recent influence on Australia's income distribution: changes in rates of unemployment
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149
Explain the following recent influence on Australia's income distribution: changes in inflation and asset valuation
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150
Explain the following recent influence on Australia's income distribution: changes in the female participation rate
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151
Explain the following recent influence on Australia's income distribution: changes the the rates of part-time and casual work
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152
Explain the following recent influence on Australia's income distribution: changes in federal government budgetary policy
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153
Explain the following recent influence on Australia's income distribution: changes in severe weather conditions
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154
What does the goal of equity involve?
The goal of equity involves a "trade off" between equity and efficiency.
Where equity = more equal income distribution
And efficiency = less equal income distribution and therefore greater incentives to work, study etc,
Total equity = totally inefficient
So when the economy moves toward efficiency (and away from total equity) it is likely the economy is achieving economic growth, low inflation and full employment. However, if the efficiency is too great (too much inequity) it may cause social division, crime and larger hardcore and long term unemployment which actually undermines the economic goals.
155
What is the effect of excises on equity?
These are taxes on items such as petrol, tobacco and alcohol. It is usually used to try and reduce consumption (of item). Sales taxes (eg. GST) and especially excise taxes worsen equity because:
. Sales taxes - impact 10% of a person's spending but because poorer people are likely to spend all their income to survive, they therefore pay a higher % of their income to tax
. Alcohol and cigarette tax - will worsen equity because for people in bottom quintile a greater % of weekly shop likely to be on cigarettes.
. Petrol taxes - worsen equity because poorer people have old cars, live in
156
What is the terms of trade index?
The terms of trade index is another measure of external success that greatly affects our international transactions. It shows the ratio of export prices (the average prices over- seas buyers are prepared to pay us for Australian exports) to import prices (the average prices we pay for our imports). It is measured as follows.
