Annie Unsworth - Economics Notes Topic 3.Docx[1]

8/3/2019 Annie Unsworth - Economics Notes Topic 3.Docx[1]

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Topic 3 Economic issuesEconomic Growth

Definition: Economic growth involves an increase in the volume of goods that aneconomy produces, or increases in real output or productive capacity over a period oftime.

Measurement Economic Growth = real GDP(current) Real GDP (previous) x 100

Real GDP (previous) 1

GDP per capita = value of GDP per person Real GDP = nominal GDP (price x quantity) adjusted for inflation Real GDP = Nominal GDP x 100

1. CPIGDP: calculation of the total volume of goods that an economy producesReal GDP is the best measure of economic growth because it cancels out the effectsof changes in prices and relates the actual change in production in the time period.

Keynesian rational The equilibrium income (Y) is the level of income in the economy from which

there is no tendency for change Y = C+ S E = C + I Y = O = E Equilibrium is where

Aggregate Demand (C + I ) = Aggregate Supply (C + S)

Y1YIncomeExpenditureAggregate DemandAggregate Demand 1Aggregate Supply

Aggregate Demand The amount of expenditure in an economy Total demand for goods and services AD = C + I + GE + (X-M)

Aggregate Supply The total available supply of goods and services in the economy Y = C + S + T

There is an autonomous increase in an aggregate demand component (C+I+G+X-M),which increases demand for resources and thus increases income. Increased income


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causes a multiplied level of change in national income, known as the multiplier effectwhereby the economy will return to equilibrium (S+T+M=I+G+X) at a higherincome. Economic growth occurs as there is an increase in consumption and

production. Businesses reach maximum capacity and invest in new productivecapacity because national income increases (induced investment)

The multiplier effect A change in autonomous expenditure is redistributed within the economy In general, a change in expenditure will lead to a greater than proportionate

increase In national income Shows the total change in national income, as the increased Autonomous

expenditure travels through the economy, being saved and consumed, untilworth 0

K= 1/MPS or K = 1/(1-MPC)

MPS =S/Y In general, the multiplier in Australia is about 1.6x

Sources of economic growth

Aggregate Demand Consumption (60% of GDP) Consumer expectations

Expectations about future rates of inflation, real incomes and general availability offoods

The level of interest rates

High rates means higher savings The distribution of income

Greater equality of income distribution means higher rates of overall spending Income levels and consumption preferences

Aggregate Demand Investment (21% of GDP)

The cost of capital equipment Affected by changes in interest rates, government policies

Labour productivity substitute labour for capital

Allow existing resources to be utilised more efficiently Business expectations

Expectations about future demand for their products Capital formation

Raises productivity Aggregate Demand Government (22% of GDP)

$42 billion stimulus package to pump prime the economy

Spend on the education revolution and infrastructure

Microeconomic reform achieved productivity growth through encouraging innovation, competition and the

adoption of new technologies Aggregate Demand Exports Imports

Terms of trade have improved

Fluctuations in the $A

Depreciation = improved international competitiveness, decreases export pricesincreasing AD

Comparative Economic Growth with China

Effects of economic Growth in Australia

Benefits Living Standards

Increased real GDP per capita


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A higher disposable income means higher material living standards

Investment

High consumer and business confidence

Taxation revenue Growth dividend occurs due to bracket creep, (employees move into

higher taxation brackets) Finance welfare and alleviate poverty as will as develop infrastructure

in the economy

Employment

Generates additional employment due to increased aggregate demand

Changes the nature of employment towards more highly paid and

highly skilled jobs

Research and development

Leads to innovation, technological progress and increases in

productivity.Costs

Inflation

Demand pull inflation particularly when the economy approaches full

capacity. Due to a wage price spiral

Current consumption forgone

Since capital accumulation and technology is needed to sustain

economic growth, resources are required to be diverted away fromcurrent consumption

Income distribution

Benefits of economic growth often flow mainly to shareholders or

company executives, rather than flowing more broadly to peoplethrough wage increases or improved public services

Structural unemployment

May increase due to technological and structural changes in production

Increased number of highly skilled jobs

Environmental impacts

Detrimental when economic policy peruses growth above all other

goals Can result in pollution, depletion of non-renewable energy sources and

damage to local environment

External Stability

Increased consumer and business spending results in a higher level of

imports Causes an increase in the CAD

Increased demand leads to increased imports


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Unemployment

Measurement Labour force: the section of the population o15 years of age and above who

are employed in full-time or part time work(work for 1 hour or more eachweek), or are unemployed but are actively seeking work

Labour Force affected by Population size (Population growth rate (%) = Natural Increase (%) + Net Migration

(%) Level of net migraton Age distribution of population

Labour force = employed + unemployed

Participation Rate: The percentafe of the working age population who are inthe labour force (i.e. working or actively seeking work)

Labour Force X 100

Working age population (15+) 1

Unemployment Rate: the proportion of people who are willing and able towork, actively seeking work, but unable to find it. As of April 10 at 5.4%

Unemployed People X 100

Labour Force 1

Problems with the method used to measure unemployment: Underemployment

Unemployment doesnt take into account the hours that person work

for Many people are underemployed and would prefer to work longer

hours Hidden unemployment

Many people have given up seeking for work and are no longer

classified as part of the labour force According to the Australian Council of Social services there are 1.4

million hidden unemployed people in AustraliaTrends

Participation rates closely correlated with the unemployment rate and changesto the level of economic growth. As unemployment falls, participation levels

rise as it is easier to fid work. This saw the participation rate rise from 63.4%in 1999 to 65.25% in 2009 as previously discouraged workers re entered theworkforce

Participation rate growth from 61% to 65% from 1990 2008

Increasing female offset decreasing male

The number of married femaes I the labour force

The age of retirement

The school retention rate

The number of people in full-time post-secondary education

The level of economic activity/growth Unemployment


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Reduced 11% -4.5% between 1991-2007

April 2004

Skill shortages in healthcare, mining

Increasing part time work through GFC

Types of unemployment

Institutional Unemployment is caused by a price floor or minimum wage This restricts the price mechanism, as social objectiveness favoured over

economicMinimum Wage

Q of labour

Demand Side types of Unemployment Cyclical: Unemployment associated with the business cycle i.e. insufficient

aggregate demand to provide the required derived demand for labourE ($)

YfullYeADAD1ASUnemployment or deflationary gap

Yfull represents the full employment level of national income i.e. all

who seek a job can find a job. Ye represents the inadequate level of national income that exists

The unemployment gap represents the extant of or lack of demand for

labour in the economy The movement of AD to AD1 is the solution to cyclical unemployment


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Time Lag of 6 moths between a change in the level of economic

growth and a change in employment levels known as the ratcheteffect

Seasonal: unemployment based on the rapidly changing nature of some work

e.g. fruit picker, ski lift operator, Christmas operatorSupply Side types of Unemployment

Structural Unemployment

Structural changes within an economy (due to changes in technology

or patters of demand) may lead to a mismatch of labour skills with thejob vacancies provided.

It takes time for workers to acquire new skills before they can fill the vacanciesoffered

Skill Mismatch driven by: Industry closure Technologival change Inadequate education

Main source of Australias unemployment

Long Term Unemployment

Refers to persons unemployed for over 12 months (usually due to

structural unemployment) Hard to reduce:

Harder to be absorbed back into the workforce Normally dont possess the required skills Lose enthusiasm after numerous rejections

Underemployment: Where a person is working in an industry and not utilizing specialist skills

(e.g. o/s trained doctors as taxi drivers)OR

Where a person is working less than the desired amount of hoursHidden Unemployment:

Discouraged job seekers Those who may not be counted as part of the official unemployment statistics

because they have given up looking for work.Frictional Unemployment:

People moving between hobs or experiencing changing economic

circumstances Result of normal market turnover and the imperfect flow of

information between hob seekers and employers on the labour market.

Causes of Unemployment Cyclical Unemployment Cause

Deflationary gap arises when total spending is insufficient to

guarantee full employment of the economys resources Low AD means full employment cannot be produces there are fewer

employment opportunities Okuns law (used to justify pump priming the economy)

%Change GDP>%Change Labour force + %Change in Productivity (means that therewill be a decrease in unemployment)


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Unemployment is derived from GDP If it was equal unemployment would remain constant

Structural Unemployment Cause Microeconomic Policy forces business to increase efficiency to

compete; possibly reallocating resources, or causing labour capitalsubstitution

Tariff Removal Privatization of formerly public companies Deregulation of industries

Market orientated Change

Changes in tastes and preferences Globalization allows businesses to source foods from overseas

Technological Change

New products and new production methods, means that capital is substituted orlabour. New skills are needed wile old ones are made redundant

Inadequate Training and Investment Skills Shortages in trades people, nursing and chefs

Participation rates An increase in the participation rate will tend to increase

unemployment More people who previously were not looking for work (and were not

classified as unemployed) start actively seeking employment)

Productivity

Low productivity encourages employers to use capital in preference tolabour in production Increases in productivity also mean that the same level of output can

be produced with fewer workers

Cost of Labour Wages are established above market rates catering for future inflation

(award wages through trade unions) Demand for labour is lower. Capital may be substituted for labour or

alternatively employment may be rationed leading to unemploymentQD QS

QuantityWage

Unemployment is created, with the Award Wage reducing demand. Unemployment

represents QS-QD


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The Natural Rate of Unemployment (Non-Accelerating Rate of Unemployment) The rate of unemployment that is considered full employment in the labour

marker including seasonal, structural, hard-core, frictional The level of unemployment that exists when cyclical unemployment is zero It represents the supply constraint of the economy (the limit of labour

resources that the economy can use) Currently it is between 4-5% in Australia

UnemploymentInflationLong Run Phillips CurveShort Run Phillips Curve

Short Run Phillips Curve (SRPC): Indicates that there is a trade-off between the rates of inflation an

unemployment (Decreasing unemployment, increases inflation) Raised aggregate demand, raises demand for labour whilst producing inflation

Long Run Phillips Curve (LRPC) Once the natural rate of unemployment is reached, there is no longer a

trade off between inflation and unemployment Illustrates the limit of AD based polices to reduce unemployment

Further stimulation by the governmenta reduction in private sector spending by thecrowding out effect of higher I.R (demonstrates by the vertical Phillips cure)

Any increases in AD will only produce inglation as all cyclical unemployment isexhausted

The skill mismatch means that even though there is demand for labour,

the pool of unemployed workers does not fall.Costs of Unemployment

Economic Costs

Living Standards Unemployment reduces the production of both consumer and capital

goods Less consumer goods, leads to a reduction in current living standards and rates of

economic growth Less capital goods, decrease our future capacity to produce goods and services

Opportunity Cost Unemployment means that the economys resources are not being used

to full capacity Operating inside of the production possibility frontier


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Lower total output means lower household incomes and expenditure,

which may lower sales and profit Loess of potential economic growth as not all resources are fully

utilized

Skills Decline Unemployed will lose their labour market skills, self esteem and

experience, will become les employable

Taxation Revenue Falling incomes associated with unemployment will generate less tax

revenue Greater transfer payments misallocate government income towards

unemployment benefits, lab our market programs and trainingSocial Costs

Social Costs Severe financial hardship and poverty, increased levels of debt,

homelessness and housing problems, family tensions and breakdown,boredom, increased social isolation, crime, erosion of confidence andself esteem, loss of work skills

Increased inequality Unemployment occurs more frequently among lower income earners

in the economy, such as the young and unskilled

Groups Affected by unemployment Youth (15-19 years)

Often lack the required training, education, skills and experience

In 2009, 15.4% for males and 21.2% for females

Indigenous Australians Unemployment rate of almost 20% (4 times national average)

Age related unemployment Older workers have greater difficulty in finding work once they have

lost a job

Find it difficult to maintain the required skills and knowledge Remain unemployed for a longer period of rime

A person aged 35054 is unemployed for an average 57.8 weeks, compared with 31.8weeks for 20-24 year olds

Geographic Location Urban areas generally have slightly lower unemployment rates than

non-metropolitan areas In 2004, the figure were 52% urban compared to 6.2% rural

Occupations


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Semiskilled or unskilled occupations had unemployment rates of 7-

10% in 1998 compared to rates of 1-5% for managers, professionalsand trades people

Relationship between productivity and unemployment

Productivity the level of output produced per unit of labour in a unit of time

Okuns law Relationship between economic growth, productivity increases, labour

force changes and unemployment As productivity increases and economic growth and labour force remain

constant unemployment increases Unemployment is a lagged indicator

economic growth means that hidden unemployment reenters the labour

force

InflationInflation: A sustained increase in the general level of prices over timeFormula

Inflation Rate = Current Inflation Previous Inflation x 100Previous Inflation 1

Headline Measures the rate of change of the Consumer Price Index

The CPI summarises the movement in the prices of a basket of goods

and services (weighted according to their significance for the averageAustralian household)

Total Inflation within an economyUnderlying Excludes one off occurrences core inflation and real costs

Seasonal factors

Interest rate changes

A new government tax

Trends

Microeconomic policy, RBA targeting managed low inflation 2005-2007 saw heavy inflationary pressures peaked at 5%

Higher oil prices

Higher house prices (5%p.a.)

Tradable prices inflation raise 1.3% 2009 inflation steadied

Despite heavy stimulus, low consumption kept low inflation 1.4%

CausesASDemand Pull Inflation

ExpenditureAD

Inflationary gap


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National IncomeYf

Y

Y full denotes full employment the economy is at maximum productivecapacity as all resources (L, L, C, E) are fully utilized

At Y the economy has exceeded full capacity Aggregate Demand Exceeds Aggregate Supply leads to an inflationary gap Too much money chases limited resources. Consumers auction up the price of

goods and services (as there is limited available), while businesses auction upthe price of resources

Consequently demand pull inflation

Cost Push Inflation

Price LevelAggregate Supply

P1

P

Real GDPAggregate Demand

Real GDP1 Real GDP

A decrease in aggregate supply caused by increase input costs (higher costs ofproduction), to remain competitive these costs are past on to theconsumercauses a new equilibrium, established at a higher price and a lower output of

real GDP The economy experiences a contraction in real GDP (less economic growth)

and a rise in inflation cost shocks Increased wages

Increased interest rates

Raised resource costs

Imported Inflation Inflation transferred to Australia through international transactions Caused by either

A rise in the price of imports

The depreciation of the Australian dollar

Inflationary Expectations


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Consumers and Business perceptions of future inflation based n past andcurrent rates of inflation. Such will try and protect themselves

If employers expected future increases in their costs of production,

they may raise prices in order to cover the expected costs, resulting ininflation

If employees expect a certain level of inflation, they are likely to factorthis inflation into their wage claim, leading to cost-push inflation

Inflationary EffectsHouseholds

Purchasing Power - wages

Potential wage price spiral to mitigate inflation exaggerating effects

Reduction in real purchasing power distorts economic decisions

Savings and investment decrease

Producers are uncertain about future prices, costs and profit. Less

willing to invest Consumers spend in the short term, as purchasing power reduced over

time Unemployment

In the shorter term, there is an inverse relationship between inflation

and unemployment Illustrated in the Phillips curve

However may cause stagflation

Income distribution

Lower income earners often find that their incomes do not rise as

quickly as prices More likely to have fixed incomes, and les likely to have income indexed for the rate

of inflation.Firms Resource allocation

Investment and resources reallocated to avoid inflationary pressures-

due to the rising cost of production Exchange rate

High inflation is a major cause of depreciation, due to decreased

international demand Exporters lose export market as international competitiveness declines

International Investment

International investors are reluctant to invest their funds in a high

inflation economy Reduces international competitiveness. Imports become domestic

substitutes corroding CADGovernment

Taxation revenue

Inflation raises nominal income, causing bracket creep, where more

and more people movie into higher tax income brackets and hence paymore in taxation

Interest Rates

Higher inflation requires contractionary policy

Deflationary Effects Fall in the general level of prices


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Consumption delayed for future price falls Idle capacity form Collapse in asset prices, wealth is destroyed and consumption expenditure is

lower, leading to a recession Investment is reduced, reducing national income and creating a potential

deflationary spiral

Role of Price (Why solve inflation?)

Prices allocate resources to different alternative uses send a signal to theowners of resources that more resources are required in the industry.

Prices distribute incomes Prices ration goods and services between households cast a vote in products

markets

Relationship between inflation, unemployment and economic growth

Stagflation

Philips curve inverse relationship between inflation and unemployment Cost- push inflation both inflation and unemployment rising at the same

time Experience in Australia in 1970s as OPEC restricted oil supplies =

cost shock Stagflation

Typically low rates of economic growth were also causing falling demand forlabour

Resulted in the need for microeconomic reform to generate low inflationarygrowth.

Demand- pull inflation Unemployment is a derived demand and a lagged indicator Phillips curve

Environmental Management

Ecologically Sustainable development

Development that meets the needs of the present generation withoutcompromising the ability of future generations to meet their own needs

Brundtland Report - 1987

Intergenerational equity This means that current economic growth and development should not result

in long term damage to the environment or depletion of scarce resourcesResource use and exploitation

If the rate of harvest (use of resources) > rate of regeneration = extinction Renewable resource

Can be sustained despite useage and usually encompass all biologival

resources in the environment E.g. fish

Non-renewable resources Cannot be sustained with increasing usage as their supply is finite and

may be exhausted E.g. coal

Definitions Private costs


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Expenditure incurred by consumers or producers in giving up a part of

their money income in purchasing resources, goods or services Private benefits

Profits made by producers selling goods and services and the utility

gained by consumers through satisfying their own needs and wants

Social Costs Are imposed on or borne by society as a result of private actions

Social benefits Accrue to society as a results of private actions

Price Mechanism The interaction between demand and supply, to reach an equilibrium price and

quantity of production Solves the problem of scarcity In market economics Price to the consumer

Represents relative value

Communicates information to the supplier

Price is a rationing device

Price to the producer Shown through profit

Determined by costs of production

Increase in price more resources allocated to the production

Price and CostMSCMPCMPB

PsPm

Qs QmQuantity

MPB (Marginal private benefit)= Benefit from an additional unit of consumptionMPC (Marginal Private cost) = cost of extra good or serviceMSC (Marginal Social Cost)= total cost to society of an extra unit producedPm too low to allow for sustainable use of resourcesPS price at a sustainable levelThe price mechanism considers private cost of production but not social costs of

productionPublic vs Private goods

Private goods are excludable and rival, transferrable Public goods are non-excludable and non-rival


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An item that private forms are unwilling to supply as they are not able

to restrict usage and benefits to those that are willing to pay for thegood

E.g. air, oceans

Definitions

Non- excludable It is not possible to prevent people who are unwilling to pay for it from

obtaining it Fully accessible to everyone

Non-rival No matter how many people consume them, the benefits available to

others will not be reduced One persons consumption does not reduce the amount available to

everyone else Free Riders

Non-paying users of a good

Market Failure Less than optimal allocation of resources around the economy

Public goods Environmental goods are public, meaning that they are non-excludable

and non-rival Inability to set a price

No price means no control over demand: Free riders and the tragedy

of the commons Exploitation

Accelerated extinction of non-renewable goods Non- enewable: harvest is greater than renewal

Property Rights Price mechanism only accounts for private costs and benefits

Price mechanism does not take into account social costs (externality)

The total cost or gain accruing to society from a particular activity may not beregistered reflecting a misallocation of resources

Does not take into account future demand for goods, which may not be satisfiedbecause resources have been destroyedQuantity

Qs QmPsPmMPCMSCMPBPrice and Cost

ABExternality


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B= ecologically sustainable price and quantityA = unsustainable level of resource useExternalities

The costs or benefits to the environment and society tht are not included in theprice of exchange between the producer and consumer

Leads to a misallocation of resources Factors that lead to externalities

Private costs of exchange are too low

The environment is a public good lacks property rights

Human nature individualistic Examples

Pollution (impurities that reduce environmental quality)

Environmental Management Policies Carbon Pollution reduction scheme

Garanaut report 2008

Rudd proposed a carbon pollution reduction scheme has delayed this

Proposition- give property rights to carbon

Various enterprises are given fixed permit numbers or pollution.

Failing to adhere requires payment of fine

Internalized the externality Costs exceed price of new capital promote research and

development OP represents income reallocated to Government for research and

cleaning Business may pass on the costs, reduce real income or cut workers to

remain competitiveDemandOQP

Price of carbonFixed SupplyQuantity of Permits


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Direct Ban Forced closure of industry

E.g. CFCs

Rebates and Subsidies Income and resources directed towards environmental friendly power

production $AU 1.4 billion on solar panels over 6 years

Quotas Ration: lesser form of direct ban

Rate of renewal exceeds tate of harvest

E.g. 5620 tonne tuna fishing limit

Excise Tax Internalised economy

Dissuade consumption and reallocates investment and resources

Marginal Social Costs unkown

TaxPrice and CostQuantityQs QmPsPmMPCMSCMPB

Conflicts of Ecologically sustainable development Impact of economic growth on ESD

There is often a trade off between high growth in the short term (associatedwith high immediate living standards) nd long term growth

Growth draws upon natural resources

Excessive consumption raises the rate of harvest for renewable and

non-renewable resources Depletion and damage to scare resources

Illustrated by an inwards shift in the product possibility curve: there are physicallyless resources for future growth

Also, the unsuitable disposal of waste products associate with growth

reduces environmental quality e.g. air pollution or land and soildegradation (farming, mining), and prevents long term use of theenvironment

Reduced quality of life with lesser environmental enjoyment


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Unsustainable development Economic Growth

Inward shifts of the product possibility frontier Unemployment

Structural change: resources are exhausted shifting production materials Quality of life

Reduced quality of lift rthrough reduced environmental enjoyment External Stability

Australian growth commodity based. Resource exploitation shifts PPF inwards,reducing exports and requiring imports to satisfy demands

Inflation

Cost Push: raised input prices raise production costs, which are passed ontoconsumers

Income Distrbution

Relative Poverty. Greater proportions of poor persons income spent on needs Water, food

Relationship between the external cost to the community, amount of pollutionabatement and the cost of reducing pollutionPACMECAmount of pollution abatement i.e. the reduction of pollutionExternal costs to the community i.e. social cost or negative externality ($)Cost of reducing pollution or abatement costs ($)A

MEC = marginal external cost the line traces out the cost of pollution to the economy


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PAC pollution abatement cost The cost of reducing pollution

E.g. new technology, permits Point A

The optimum leve of pollution abatement

Where the cost of reducing pollution is equal to the benefit to the environment andsociety of the ower level of pollutionExplanation of Diagram

Cost benefit analysis A behaviour should be changed only to the point where the cost of

changing behaviour is equal to the benefit of the change in behaviour This is represented by Point A

Assumption All costs of production are known

We can measure the benefits of lower levels of pollution The costs of reducing pollution can be calculated

There is a direct relationship between money spend on pollution

reduction and benegit ot society

Income DistributionIncome: the value of benefits received by individuals during a period in return fortheir factors of production (land, labour, capital and enterprise) or as a transfer

payment from the governmentWealth: the net value of real and financial assets owned by individuals at a particular

point in time.Quintile: 20% groupings of a population

Lorenz Curve Illustrates income distribution Graphs data on income shares for equal groupings od the population Enables for a comparison between the income received and the income

recipients The Lorenz curve lies below the line of perfect equality


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A shift to the right represents increased inequality, whilst a shift to the leftrepresents increased equality

Gini Coefficient A mathematical expression of the degree of income inequality It is the are between the line of perfect equality ad the Lorenz curve

Gini Coefficient = Area A/ (Area A + Area B)

A gini coefficient of 0 is perfect equality A gini coefficient of 1 is complete inequality

Source of income Wages and salaries

Income derived form the supply of labuor

55-65% of total household income

Property Income Returns on factors f production (profits, dividneds, rent and interest)

20-30% of total household income

Transfer payments Payments received whereby nothing is given directly in return e.g.

social security 10-15% of total household income

Other Superannuation

Sources of wealth Link between wealth and income

People with little wealth usually have low incomes

Income generates wealth and wealth generates income Dwelling capital

Includes land, houses and home units 59% of total household wealth in 2004


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Business Capital

Includes shops, offices, factories and farms Accounted for 37% of total household wealth in 2004

Consumer Capital

Includes, cars, boats, furniture, appliances and jewellery

Accounted for 3.5% of total household wealth in 2004 Other

Investment in government securities Australian investment overseas Holdings of cash denoted as money base

Dimension and Trends to Income and Wealth Gender

Female Earnings represent 78% male earnings

Reasons for this

Greater percentage of women working part-time (32%) compared with men (23%) A younger age structure among full time female workers Lower educational qualifications for older women Occupational bias (with women under-represented in managerial/ administration

positions) Less overtime Duration and continuity of unemployment, (due to women normally acting as the

primary caregiver) Age

Lowest income age bracket is 15-24 years

Less experience and education Highest income age-bracket is 35-44 years

Occupation Training increases, supply decreases

Male professionals earn $1700 per week whilst laborers earn $800 p.w.

Ethnic Background English speaking migrants: highest

Non- English speaking migrants: lowest

Indigenous Australians earn considerable less than non-indigenous

Australians Family Structure

Couple with no dependent children

Median income $704

Couple with dependent children median income $659

Single Parent

Median income $446 58% wealth from allowances

Single Person

Median Income $535 p.w

Benefits of Income Inequality Economic Benefits

Incentive effect

Reward of higher wages and improved living standards encourages employees to:


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Undertake higher education, training and skillsacquisition

Work longer, harder hours improving labourproductivity

Labour mobility (occupation and geographic) due to

relative wage flexibility, which helps to allocate labourmore efficiently

Entrepreneurs Accept risks more readily with potential profit Greater innovation, technological advances, and

employment opportunities Capital formation

High income earners save greater proportion of income which can fund capital Greater productivity of labour, increase in the output of goods and services, hence

leading to higher living standards Reduces reliance upon foreign capital by providing domestic savings

Social Benefits Unrealistic: May arise if inequality promotes a desirable social

structure Whereby relative productivity of individuals within society was reflected by their

financial position, so that the more productive and individual was, the wealthier theywould become

Economic Costs Welfare support

Welfare payments reduced government spending on capital goods, place a tax burdentaxpayers, and may deteriorated the governments fiscal position Economic growth reduced

Lower consumption (due to lower MPC): lower aggregate demand Reduced economic activity, employment, investment and living standards

Social Costs Poverty and social problems

Inequality of income causes relative poverty Inequality of opportunities in terms of health, housing, education and employment Increased levels of crime, disease and reduced life expectancy (police resources)

Social class divisions Social and economic instability through class tensions E.g. wage disputes between workers and employers Democracy may be undermined

Wealthier members of society have greater politicalinfluence

Polices to reduce income and wealth inequality Social security

aged pensions, family assistance, sole parent pensions

Reforms to income tax brackets Widening income bands, lowering tax

Income tax rebates for low income earners


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Saving exemptions Reductions in capital against tax Increase in minimum wage by Fair Work Australia by $26 p.w.

However, the more flexible enterprise bargaining has meant that represented

labour has higher than average wage increases than unskilled, unorganized andunrepresented labour (migrant women)

Wage growth for these workers is 1-3% compared to 4-5% for

represented workers

The social wage Transfer payments made by federal court

Unemployment benefits, family assistance, disability pensions Provision of Medicare

Minimum wage

First home buyers grants

Nation Building and Job Plan

Hospital reform package

These policies are MICRO in nature

External Stability

CAD as a percentage of GDP Chronically negative 2002-2008 averaged 5.8% GDP. This fell to 3.75% GDP in early 2009 before

an expected rise to 5.5% GDP by 2009/10 The CAD is considered unsustainable If it exceeds the growth rate of the

economy Servicing cost of external liabilities is greater than the growth in

income or output Formula

CAD/GDP ratio = CAD x 100

GDP 1Net foreign debt as a percentage of GDP

Refers to foreign debt assets (debt lending by Australians to foreigners) minusforeign debt liabilities (debt lending by foreigners to Australians). Keep below40%

Formula

Net foreign debt/ GDP ration = Net Foreign Debt x 100GDP 1

Gradually rising from 47.9% (2004-2005) GDP to 58.5% (2008-2009)Net foreign liabilities as a percentage of GDP

Net foreign liability is equal to net foreign debt and net foreign equity Total value of assets in Australia such as land, shares and companies in

foreign ownership minus the total vale of assets overseas, owned byAustralians

Formula GDP Ration = Net foreign liabilities (debt + equity) x 100

GDP 1The current Account

Covers external transactions that are not reversible


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Consists of Net goods (X-M)

Net services (tourism and education)

Net income (earnings on investment i.e. rent, interest, profit

Net current transfers

Causes of a High CAD The savings/ investment Gap

The capital and financial account drives the Cad

Aggregate Demand = Aggregate Supply C + I + G + x-M = C + S + T

Cancelling put consumption and putting likes together X-M = S-I + T-G

External Balance = private sector debt + Public sector underlying balance CAD = S/I Gap + net PSUB

In 2004 national savings was 18% of GDP, while investment was 24%

of GDP Since investment leads to economic growth via the multiplier effect, no

government wants to slow down investment This lack of domestic savings means we rely on foreign savings

Australian residents then pay interest, rent and dividends on foreign

equity and foreign debt and this leads to the deficit on the net incomeof the current account

Recently exaggerated through huge fiscal stimulus.

The yields on Investment in Australia (structural) Yields refer to the rate of return in cash 9interest rates, shares/equity

(dividend yield) and real estate (rentals) Since Australias interest rates (4-5%) are relatively high compared

with the USA and Japan (0-3%), non-residents are encouraged to ld toAustralia (foreign debt) or invest in Australia (foreign equity)

This is seen in the large net income deficit of the current account

(approx. 70% in 2009) In structural terms, this net income deficit is the underlying problem of

the current account deficit.

The price elasticity of Demand for Exports The price elasticity of demand refers to the sensitivity of buyers to a

change in price Price elastic means buyers and sensitive Price inelastic means buyers are relatively insensitive to price changes

A substantial amount of Australias exports are low value added

agricultural products There are numerous competitors wit Australian wheat exporters, so if Australian whet

prices increase then our buyers will look to the USA, Canada and Europe . Priceelastic

On the other hand, Australian demand for high value added imports is

price inelastic Should price increase due to a depreciation in the $A Australians will spend more to

buy less


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The income Elasticity of Demand for Imports Australias demand for imports is aggregate demand elastic

This means as Australian aggregate demand increases, demand for imports grows at afaster rate

As aggregate demand increases this leads to an increase in national income via the

multiplier effect, which leads to an increasing demand for imports. This is sometimes called the income elasticity of demand for imports

As for exports, an increase in incomes overseas will not result in a

large increase in demand for agricultural products If incomes overseas increase, consumers tend to buy better quality food rather than

more, so out exports tend to be income inelastic

Comparative Economic Growth In cyclical terms, when the domestic economy grows faster than the

world economy or the economies of Australias trading partners,import demand tends to outstrip export demand

The goods balance deteriorates, adding to an existing current accountdeficit.

Terms of Trade Australias vulnerability

Australia Is vulnerable to the terms of trade since it is very reliant on mineral exportsfor earning export income

The price and income elasticity of demand for such commodities tends to be quiteinelastic

This means that a fluctuation of price will affect revenue

BOGS balance recorded 1.4% surplus in December 08 as terms of trade balanceimproved 68% Combined with law consumer confidence which saw imports fall, CAD reduced

Causes of High Net Foreign Debt Persistent CAD

Required financing through overseas debt and equity borrowing

Long term depreciation of the Australian dollar Increased debt servicing loans for the foreign debt denominated in

foreign currency loans Decline in domestic funds due to low borrowings There was an early shift to debt financing after deregulation

The outflow of investment from Australia

Effects

Debt Trap scenario (perpetuating cycle) A high CAD requires and inflow of foreign funds (either foreign debt

or selling Australian assets to foreigners) to finance CAD With a larger foreign debt, servicing costs become greater

These interest payment constitute a large part of the income debits that

flow out on the current account Threat would exist ig Australia was unable to attract a reasonable

level of investment

Susceptibility to Exchange fluctuations


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Valuation effect on debt

Debt sustainability problems As debt increases; it becomes increasingly difficult to service he debt

Australia cannot sustain a growth rate in excess of 5% if the CAD rises

to over -5% of GDP (if the increase in CAD is greater than the rate ofeconomic growth) has average 4.5% over the last two decades

Since the debt servicing obligation becomes greater than the capacity of the economyto increase its income

The interest payments on the debt will progressively take up a greater proportion ofour CAD

Results in decreased investment spending This reduces Australias standard of living and the growth potential of

the economy However, Pitchford thesis suggests if debt/ equity borrowings are put into

income generating assets, debt is irrelevant Since Public sector debt is 8% of net foreign debt while private sector debt is

92%

Increase in Australias international credit rating High net foreign debt is seen as a significant risk to an economies

future performance Credit rating downgrading Great capital outflows

Hence, it may increase the cost of borrowing through higher interest

rates

High interest costs hamper capital formation

Contractionary policy May require contractionary policy to reduce CAD

Policy to Reduce CAD

Monetary Policy Inflation management maintaining import competitiveness

Fiscal policy The budget directly relaties to CAD and the net income

Aggregate demand = Aggregate supply

C + I + G + X- M = C + S + T Cancelling out consumption and putting likes together X-M = S-I + T-G

Fiscal consolidation has historically eliminated public sector debt

More savings can be used for private sector investment reducing

reliance on foreign investment Recent stimulus has worsened the Cad raising PSUD and the savings

and investment gap Twin Deficit theory

Reduction of budget deficit government borrowing less more domestic funds

available for the private sector there is domestic borrowings and dont need to go

overseas reduces foreign debt reduction in CAD


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Microeconomic Reform Superannuation

Compulsory 9% p.a. to reduce low national savings Deregulation, privatization

Raise competitiveness and export markets

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Annie Unsworth - Economics Notes Topic 3.Docx[1]