Topic 3 – Economic Issues

Resource Description

CHAPTER  7

SUMMARY: ECONOMIC GROWTH

• Economic growth: the increase in a country’s productive capacity measured by changes in real GDP over time
• Outward movement in PPC curve à aggregate supply increased
• Target of 3-4% real GDP growth annually
  AGGREGATE DEMAND AND ITS COMPONENTS: Y = C + I + G + X – M
• Aggregate demand: Y = C + I + G + X – M
•  Consumption: 60% of total spending à largest influence on economic activity
  § Factors affecting level of consumption:
• Consumer expectations
•  Cost and availability of credit
• Government policy e.g. taxes
• Income levels
• Tastes and preferences
•  MPS + MPC
• Distribution of income
• Investment: 20% of total spending à expenditure on new capital equipment for production
  § Factors affecting level of investment:
•  Past profits
•  Interest rates (cost of I)
•  Government policy (tax concessions, invest. allowances)
• Price + productivity of labour (capital vs. labour)
• Technological change
•  Business expectations
•  Government expenditure: 21% of total spending
  § Gov. expenditure is highly stable à funds are allocated to major spending areas e.g. health, defence, education
• Net exports (X – M): -1% of total spending à M > X = BOGs deficit
  § Exports most affected by world income + EG
  § Imports most affected by domestic income à domestic EG # = D for M #
  § Other factors: exchange rates, tariffs, quotas, international competitiveness
• Increased aggregate D will # EG in short-run à when the economy reaches full capacity #demand = inflation
• To achieve EG in long run, a nation needs to increase its productive capacity (i.e. aggregate supply – PPC
  outwards)

THE SIMPLE MULTIPLIER: k = 1 / (1-MPC)

• How changes in the level of aggregate demand influence the equilibrium level of national income
  • Multiplier process: the greater than proportional increase in national income from an increase in AD
• When there is a shock to the economy there is a change to leakages and injections
  § Each time the injection moves around it gets smaller because some of Y is saved à Y = C + S
•  How to determine the level of national Y generated by an increase in investment:
  § K = 1 OR 1 à MPC + MPS = 1
  MPS 1 – MPC
• Example: if consumers spend 80c of every extra $1 and save 20c then MPC = 0.8 and MPS = 0.2
  If there is an increase in investment by $10 000:
  Spent = 0.8 x $10 000 = $8000 Saved = $2000
  That $8000 is then re-injected into the economy
  Spent: 8000 x 0.8 = $6400 Saved: 2000 x 0.2 = $1600 etc… The multiplier is 5

MEASUREMENT OF GROWTH THROUGH CHANGES IN REAL GROSS DOMESTIC PRODUCT

• EG measured by comparing real GDP in different time periods
• Gross Domestic Product (GPD): total value of all final G+S produced or consumed in an economy over time
• Inflation must be taken into account to avoid distortion § Real GDP (yr 2) = Nominal GDP (yr 2) x CPI (yr 1) à adjusted for inflation

CPI (yr 2)

•  Limitations of GDP as a measure of economic growth and welfare:
  § Benefits may be unevenly distributed
  § GDP doesn’t record many economic transactions e.g. voluntary work, cash transactions
  § GDP doesn’t consider externalities
  § GDP doesn’t consider the quality of goods
• doesn’t provide an accurate measure of welfare

SOURCES AND EFFECTS OF ECONOMIC GROWTH IN AUSTRALIA

• Supply factors:
• Without additional demand, improving the supply function will not lead to EG § Ability to sustain EG is b/c improvements in quality and quantity of FOP § Supply side sources of growth:
•  Land: exploration, use of fertilisers, irrigation
• Labour: adult education, migration
• Capital: foreign investment, new technology
• Enterprise: management training, enterprise initiatives

ECONOMICS

• Demand factors:
• Increases in demand are a pre-requisite for EG § Increasingly important elements of extra demand come from globalisation
• Allocated factors:

Technical efficiency: an efficient economy produces more G+S with a given quantity of resources than an inefficient one

•  Allocated efficiency: minimising opportunity cost
•  Effects of economic growth:
• Living standards: POSITIVE
  § Income + consumption increased à improved living standards
  § Higher levels of savings à reduces savings-investment gap = reduced debt
  § E.g. Aus experienced 2.3% annual growth in per capital real income in 2000s, compared with 2% in 1990s
• Employment: POSITIVE
  § Consumption = demand for labour increases (derived) à unemployment decreases
• Government revenue: POSITIVE
  § Increased revenue (tax, GST) = increased infrastructure spending + welfare – multiplier effect
•  Inflation: NEGATIVE
  § If economy is close to full employment of resources, increases in demand = demand pull inflation
  § May lead to an increase in imports
  § Gov. aim to keep within 2-3% so it doesn’t push CAD higher
•  External stability: NEGATIVE
  § Strong EG = # demand for M à worsens BOGs + CAD
•  Income distribution: NEGATIVE
  § Increases gap between rich and poor
  § Returns on physical and financial assets (e.g. art + shares) à capital gains benefit higher income earners
•  Environmental impacts: NEGATIVE
  § EG obtained by increases in S can lead to the depletion of resources
  § Negative externalities e.g. pollution, deforestation = damage environment
• EG = increased profits = investment in R+D = ­ productivity growth
• CASE STUDY: Population growth
• Concerns about adverse impacts of rising population on infrastructure + environment
• Skilled migration program à valuable to Australia’s labour supply
• CASE STUDY: Impact of mining and resources boom
  Dutch Disease: caused by structural re-adjustment as workers and resources are snapped up by mining sector = skills shortage + excessive wage demands in other sectors § NB: High AUD affects the competitive position of non-mining exports

INCREASES IN AGGREGATE SUPPLY – IMPROVEMENTS INEFFICIENCY AND TECHNOLOGY

•  Increases in quality + quantity of natural resources
•  Quantity of land is fixed à exploration for new resources, converting non-useable land to productive land
•  Improve quality of natural resources = ­ productivity of current ones
• Increases in quality + quantity of human resources
• Quantity of labour improved by: increasing working age pop. + PR + birth rate, immigration
•  Quality of human resources improved by: increased education + training, improved health facilities
•  Increases in supply of capital
• Increased domestic savings, positive investment climate, export promotion schemes, tax benefits, growing
  domestic + global market, low inflationary expectations and IR
• Increases in technology à Increased research and development (R+D)

TRENDS IN BUSINESS CYCLE:

•  Since 1991 Australia has experienced over 2 decades of continuous growth averaging 3.3% per annum
•  2008-09: GFC = EG fell to 1.4% à China’s increased demand for Aus X provided a buffer
•  2009-10: GRB = EG rose to 3% à stimulus package of $42 billion to stimulate economy post-GFC
• 2010-11: EG was 1.9% à slower growth in China impacted X
• 2011-12: EG was 3.4% à GRB = strong investment in mining and increased commodity X à BUT growth in other sectors below average, high AUD reduced competitiveness of X à RBA cut IR
• 2013-14: 2.7%
•  2015: 3% EG
  • Sustained improvement in Australia’s TOT: Lifted domestic incomes and EG
• Sep 2011: highest in 140 years at 118.5
  • Productivity growth:
• The 1990s: record levels à labour productivity increased by 2.6% p.a. (micro) à competition + new tech
• 2011à: 2.1%
• 2001-14: averaged 1% à capacity constraints e.g. shortage of skilled labour, and need for investment in infrastructure