Economic Notes: Preliminary What is the Economic Problem? What is the economic problem?

The economic problem is a fundamental issue which looks at how a society can satisfy the unlimited wants with limited resources. Wants: Wants can be defined as material desires of individuals and or communities. Wants provide us with pleasure and satisfaction, when consumed. People desire or want necessities of life (food and water) which becomes needs. We also want non-essential items (movies and games). Individual wants depend on individual desires based on personal preferences and ability to purchase the goods and services (level of income). Collective Wants: Collective wants are wants desired by the whole community. The desires are decided by a group of people, rather than an individual. Collective wants are usually provided by the government; e.g. Local Government provides wants in terms of local parks and libraries, State Government provides in terms of schools and hospitals and Federal Government provides wants in terms of defence force. The Federal Government derive their money through tax revenue collected from the people. Our Wants change over time: As people age their wants change, which are influenced by age, technology and income (pensions). Some wants are recurrent, meaning these particular G&S will require time and time again (newspaper and petrol). Our wants are also complementary. The Economic Issues: 1. What to produce: Since resources are limited, no economy satisfy all individuals and or collective wants. Therefore, it must decide what to produce. 2. How much to produce: Due to the limited resources and the fact that there are unlimited wants that must be satisfied at maximum potential, it must decide how much to produce. Over production will cause wastage and produce too little there is a shortage. 3. How to produce: Allocating resources is crucial in its production process. It must look for the most cost effective and efficient method to produce, which also means using the least amount of resources. 4. How much to distribute: Having been able to produce the quantity of G&S, an economy must decide where to allocate it. A population must decide on a more equitable 9even) distribution or an inequitable (uneven) distribution. This question is difficult to answer as there is a conflict between equity and efficiency- more efficient system to produce = more equitable outcomes. Our wants are unlimited. Resources are scarce. Since resources are limited and our wants are unlimited, we must choose. We must then rank our preferences.

Economic Notes: Preliminary Opportunity Costs: When satisfying a want you are also foregoing another want. This can sometimes be referred to as economic or real costs. Production Possibility Frontier: PPFs can be used to represent opportunity costs that may arise when individuals or economies make decisions. The PPF shows the various combinations of two alternate products that can be produced e.g. food and clothes, given technology and a fixed quantity of resources, when all resources are used to their full capacity.

Food Clothing

200 0

150 40

100 80

50 120

0 160

Opportunity Costs Formula: Food Clothes

How Economies Differ

The Market Economy: In a pure market economy, all decisions are made by individuals and private firms. Under this system individuals are allowed to seek wealth, own private businesses, without government interventions. (Capitalists, Free-Market) The opposite of a pure market economy, would be a centrally planned economy, where government planners make the decisions and individual choice is almost non-existent. (Communism) Product Market: Is the interaction of demand for and supply of the outputs of production, i.e. goods and services. In the market the buyers constitute for the demand for G&S. Consumers tend to want to purchase products at the lowest prices, on the other hand, firms tend to want to sell their products at a higher price, to yield higher profits. Price Mechanism: Is the process by which market forces of supply and demand interact to determine the market price which G&S are sold, and the quantity produced. When there are changes in demand and supply the product market will also influence S&D in the Factor Market, which is the market for factors of production.

Economic Notes: Preliminary Factor Market: Is a market for any input into the production process, including land, labour, capital and enterprise. Private Ownership of Land: Individuals have the right to own means or factors of production, which they can use to accumulate wealth. They also have the right to trade their property. Consumer Sovereignty: This term refers to the ability for consumers to choose how they would distribute their income, to satisfy their wants. This allows for consumers to decide with freedom on what G&S to purchase. This means businesses will produce whatever is in demand. Therefore, consumer sovereignty refers to the concept of consumers questioning what and how much they want to produce. Freedom of Enterprise: Individuals have the right to choose whatever they want to choose, this means entrepreneurs are free to set-up profit- making firms and the right to determine what G&S they wish to produce and how they want to undertake production. This also means workers are free to choose which occupation they want. Competition: Is the pressure on business firms in a market economy to lower prices or improve the quality of output to increase their sales of G&S to consumers. Mixed Economy: It is safe to say that no economy is purely market based or centrally planned. Therefore, to describe an economy that is a mix of both would be a mixed economy. This can be defined as an economic system where decisions concerning production and distribution are made by a combination of market forces and government decisions. The govt. intervenes, due to the fact of inefficient allocation of resources: -Govt. G&S that are crucial to the community, such as the railway system, parks, roads and hospitals, which provide the private sector will not provide themselves. -Some essential G&S need to be provided by the govt., like the defence force, which would be safer in govt.s hands, rather than private armies. -Markets do not always operate freely and fairly. Therefore, the govt. enforces regulations that prevent firms from exploiting consumers (misleading advertisements).

Economic Notes: Preliminary Circular Flow of Income: Five Sector Model Individuals Businesses Financial Institutions Governments International Trade (Imports and Exports) Equilibrium Equation: S+T+M=I+G+X Total Leakages Total Injections

Individuals: Individuals are only concerned with earning income and spending their income on G&S. Individuals are therefore, owners of productive resources and consumers in the economy. Factors of production are supplied by individuals like, labour enterprise. Rewards would be wage, rent interest and profit. Businesses: Businesses are only concerned with the purchasing of factors of production and using them to produce and sell G&S. Businesses also rely on individuals to provide them with resources to produce and also purchase their G&S. Leakages: Are the items that remove money from the circular flow of income, decreasing aggregate income and the general rate of economic activity. The three examples of leakages would be savings, taxation and imports. Injections: Injections into the circular flow of income are those that increase the aggregate income and the general level of economic activity. The three examples of injections are investment, government spending and exports. Financial Institutions:

Savings

Investment

Taxation Govt. Expend. Financial Institutions are needed by individuals and firms to allow savings and investments to occur Imports Exports throughout the economy. Financial Institutions are sometimes referred to as capital markets, which accept savings from the individuals/businesses which in turn can be lent out to businesses and individuals for investment purposes in the form of loans.

Economic Notes: Preliminary Effects of increasing investment: Increased Investment

Increased production of capital goods

Increased demand for resources

Increased demand for G&S Factors of Production:

Increased incomes

A factor of production refers to any resources that can be used to produce a product or service. The quantity and or quality can influence and determine the wealth of a country. Therefore, a country with less poverty, will be able to satisfy their needs and wants which would provide the country with a higher standard of living and quality of life. Natural Resources: Natural Resources refer to all the resources that are provided by nature and can be used for production (soil, water and natural deposits). The reward that an owner receives from natural resources is rent. Labour: Labour refers to the human effort required to produce the G&S. the number of supply of labour for a particular initiative depends on certain key factors: The countrys population (birth rate, death rate, and immigration), school leaving age, retirement age, social attitudes towards women in the workforce, availability of childcare and educational standards.

The reward received from contributing to the workforce would be wage. Capital: Capital is the produced means of production. An example of capital would be machinery. Infrastructure is usually another form of capital that is owned by the community. The amount of capital available can therefore have a significant effect upon the future earning capacity of an economy.

Economic Notes: Preliminary GDP: Is the total market value of all final G&S produced in an economy over period of time. Enterprise: Enterprise refers to the organisation of other factors of production. For the purpose of producing G&S. the right decisions made would mean for a successful business and if the wrong decisions id made, then it will result in failure. The reward for enterprise is profit. Entrepreneurs are also able to receive rent for land, wages for interest. The overall problem: Each of these factors of production poses a problem for the overall economy, due to scarcity: There are limits to the amount of natural resources available for production (land and fossil fuels) Our supply of labour is limited by the population size, labour market skills and willingness to work. Our supplies of capital are limited by the extent to which govt. and private sectors are willing to invest. The supply of entrepreneurial skills is also limited by the size of the population and a range of other cultural and economic factors, including- ability and willingness of individuals to take risks.

Impacts of a business cycle: Recession: Boom: Increasing production of G&S Rising levels of consumption and investment Falling unemployment levels Rising income levels Rising quality of life Falling production of G&S Falling levels of consumption and investment Rising unemployment Falling income levels Falling quality of life

Economic Notes: Preliminary Market Economy Decisions to spend and save: Level of income: A level of income determines a persons decision to spend and save. Price of G&S: When purchasing G&S you must first decide how much you are willing to pay. Some G&S such as necessities are a must which means despite price changes, they must be purchased. Price of Supplementary or Complementary goods: Demand for goods decrease when prices increase. Therefore, consumers substitute these goods for other things. However, complementary goods are goods that have to go together. Consumer tastes and preferences: Consumers tend to purchase goods that provide the greatest utility (satisfaction). More goods mean more utility. However, some consumers can be satisfied with minimal amount of goods. Age can affect consumer T&P, this can also be said about technology, poor decision-making experimentation.

Business Firm: An organisation involved in using entrepreneurial skills to combine factors of production to produce G&S. Goal of a Business Firm: Maximise Profit: The key goal of a successful business is to yield the most profits. Meeting Shareholder Expectations: Main objective of business directors is to serve its shareholders. Directors are elected by the board of directors, tension may arise between the objectives of meeting share holder expectations or maximise market share price. Increasing Market Share: In larger businesses the function of entrepreneurs is split between owners and managers. Owners rewards- seek profit at the expense of capital. Managers rewards- increased salaries, power and prestige. Profit Maximisation + Increased Market Share Price = Successful Business Satisficing Behaviour: Is the idea that firms will attempt to pursue a satisfactory level of goals ( alone. ) rather than profits

Productivity: (Refers to the amount of G&S a firm is able to produce per unit per time) Less wastage of our scarce resources. Lower production costs and higher profits for the business firm. Lower inflation rates. Higher Incomes. Improved international competitiveness of our industries.

Economic Notes: Preliminary Specialisation: Division of Labour: Occurs when businesses break down their production process into a number of sub-processes, allowing focus on a particular process. Location of Industry: Occurs when a number of businesses that produce similar goods, share the resources and common infrastructure requirements in the same area. Large scale production: Occurs when businesses have grown to allow specialised capital equipment.

Internal Economies of Scale: A larger firm will be able to invest in better capital equipment. A large firm can buy materials in bulk to save money. By becoming larger, a firm is able to take advantage of specialisation of labour.

Internal Diseconomies of Scale: Mismanagement and inefficiency can be decreased. Management become unaware of the staff and the issues they face, tension can arise between employer and employee.

External Economies of Scale: Increasing localisation An industry investing into research and development to promote their industry. Smaller firms will provide. Smaller firms will provide beneficial services to growing industries.

External Diseconomies of Scale: Growth of industry, resulting in pollution control which costs firms. Concentration of industry in one particular area causes prices to rise, which results in the population moving to the outskirts. This then results in transport bottlenecks.

Demand
Factors affecting market demand: The price of the good or service itself; necessities must be bought disregarding the price. Substitute goods, however, can affect the demand as consumers by other products in place of another as the price is cheaper. Future prices affect the demand. Consumers bulk buy if they predict the prices may increase in the future. Changes in consumer tastes and preferences and technological change will affect the demand. The level of income can affect the demand for G&S as consumers who earn a lower income can afford less than a consumer who earns a higher income. Income distribution could affect the demand, income is distributed to higher income earners then the demand for luxury would increase.

Economic Notes: Preliminary The age and population of a country can affect the overall demand for G&S. For instance, since Aust. is an ageing population the demand for retirement villages and aged care services.

Ceteris Paribus Assumption: Is an assumption used in economics to isolate the relationship between two economic variables. Movements along the demand curve: A contraction in demand occurs when an increase in prices causes the quantity demanded to fall. It is shown through the demand curve moving upwards. An expansion in demand occurs when a decrease in price causes the quantity demanded to rise. It is shown through the demand curve moving downwards.

Price Elasticity of demand: The price elasticity of demand measures the responsiveness of the demand for a particular G or S. it is calculated as the percentage in quantity demanded divided by the percentage change in price. Labour Demand and Supply What is a Labour Market? A labour market is where individuals seeking employment interact with employers who want to obtain the most appropriate labour skills for their production process. The Demand for Labour: Firms demand for labour by offering wages, like consumers demanding G&S by paying a price. The derived demand for labour refers to the demand for labour from the demand for G&S within an economy.

The Output of the Firm: The most significant influence of derived demand is the level of output. If consumers are demanding products from a particular firm, the firm will then increase its labour to meet the demand. The other factors that affect the level of output are the general economic conditions, the pattern of consumer demand and the demand for G&S produced.

The Productivity of Labour: For a firm, the importance of determining how it will organise its production is pivotal in the overall level of output. The decision a firm often makes would to either focus labour mainly on production or to either invest on technology and automated processes to produce the products. The productivity of labour can be defined as the output per unit of labour per unit of time. Total Output Labour Productivity = Labour

Economic Notes: Preliminary

Capital is the manufactured products used to produce G&S, commonly described as the produced means of production. The quality of a firms workforce in relation to labour productivity is determined by the level of education, skill, health and level of motivation. An increase in labour productivity can have both positive and negative impacts on the demand for labour. If aggregate demand rises faster than the productivity of labour then the firm will experience excess demand. If aggregate demand remains unchanged and the labour productivity rises, it will result in excess capacity. Finally if aggregate demand is falling, but the labour productivity continues to rise, it will result in excess of demand for labour.

FACTORS INFLUENCING LABOUR DEMAND Output Factors

General economic conditions. Conditions in the firms industry. Demand for an individual firms product.

Input Factors
Productivity of labour vs other inputs. Cost of labour vs other inputs. Cost of labour vs cost of foreign labour.

The Supply of Labour: Pay Levels: Wage levels are used as a determinant for the demand of labour for a certain occupation. If the wage levels are higher for a certain occupation, then the demand for labour will be higher. Other non- wage incentives can also be used to increase the demand for labour (Company car, accommodation and childcare). Working conditions that appear attractive and safe will increase the demand for labour. Firms that offer flexible working hours, work from home, holiday leave, leave entitlements and pleasant working environments will also increase the supply of workers. The skill or education requirements can limit the supply of labour as some workers may not fit the requirements needed. Jobs that require large amounts of human capital are more likely to experience low unemployment as the time to acquire the skills and knowledge requires sacrifice of time and money. Human Capital: is the total sum of the knowledge, skills, training and experience of workers, that contributes to the process of production. It reflects the quality of a labour force and it is the main influence on the productivity growth. The supply of labour is influenced by the mobility of labour in relation to different areas and industries. There are two types of labour mobility- occupational and geographical mobility. Occupational mobility- refers to the ability of labour to move between different occupations in response to wage differentials and deployment opportunities. Geographical mobilityrefers to the ability of labour to move between different locations in response to improved wage differentials and employment opportunities. Some of the factors that may affect the

Economic Notes: Preliminary geographical mobility of labour are the costs of relocating and personal upheaval that may come of it. The labour force participation rate, is the rate that is determined by the supply of labour in proportion to the population of Aust. In Aust. the working age population is anyone over the age of 15 to 64. The people that are included in the labour force consist of both employed and unemployed persons. The labour force participation rate is calculated: Labour Force Labour force participation rate (%) = Population aged 15 or over

Labour Market Outcomes Wage Outcomes: Average Weekly Earnings: Wage outcomes analyses the average wage earnings for all employees for both full time and part time employment. In 2011 the total wages earned for all employees was $1019.30 per week, an increase from 2% to 5%. However, such changes in statistics for nominal wage does not tell us whether people are better off because they do not take into account the changes in price levels. Therefore, the real wage levels are using the real purchasing power of money wages. For example, adjusting nominal wages for the effects of inflation. Employers can afford real wages if productivity increases, and therefore if the real wage is higher than productivity growth than real labour costs will rise and this will cost the employer. Hence, the reason why the employer decides to invest in technology that will substitute for manual labour.

Wage differentials between different occupations: Different occupations in the industry require education, experience and skills. Higher wage levels would usually mean more experience, higher education levels and more skills to attain the job. In terms of occupational mobility, jobs that require people achieve a standard of education or university degree, it would result in the wage levels increasing.

Wage differentials in the same occupation: Wage differentials in the same occupation reflect the degree of experience each worker possesses. Therefore, they are usually paid more. Geographical mobility, productivity of labour and capacity of the firm to pay will also influence the wage levels in the same occupation. Age, gender and ethical cultural background can also influence the wage levels.

Economic Notes: Preliminary Enterprise Bargaining: refers to negotiations between employers and employees (or their representatives) about pay and work conditions at the level of the individual firm. Income distribution: refers to the way in which an economys income is spread among the members of different social and socio-economic groups. Superannuation: is a form of saving that individuals cannot access until they reach retirement age. None-wage outcomes: are the benefits that many employees receive in addition to their ordinary and overtime payments- sick leave and superannuation. Economic Benefits of inequality: Inequality encourages the labour force to increase education and skill levels. Inequality encourages the labour force to work longer and harder. Inequality makes the labour force more mobile. Inequality encourages entrepreneurs to accept risks more readily. Inequality creates the potential for higher savings and capital formation.

Economic costs of inequality: Inequality reduces overall utility. Inequality can reduce economic growth. Inequality reduces consumption and investment. Inequality creates conspicuous consumption. Inequality creates poverty and social problems. Inequality increases the cost of welfare support.

Unemployment: To be classified as unemployed, a person must be over the age of 15 and without a job or stood down from a job with pay, but actively seeking a full-time job or part-time work. To be actively seeking a job you must be regularly checking advertisements, being willing to respond to advertisements and registering with any employment placement provider that is a member of Job Services Australia. The rate of unemployment can be calculated using the below formula: Number of persons unemployed Unemployment rate (%)= Total labour force

Economic Notes: Preliminary Types of unemployment: Cyclical unemployment: is caused by a downturn in the business cycle. It occurs due to the demand for labour is derived demand. When a downturn in the business cycle occurs, the demand for G&S falls. Firms are therefore, forced to cut back production and will lay off some workers in order to maintain their profit levels. Structural Unemployment: occurs when the economy decides to restructure from old industries to emerging industries and the introduction of new technology will usually will cause structural unemployment. Long-term unemployment: to be classified as long-term unemployed the person must be out of the workforce for at least 12 months or more. Seasonal Unemployment: occurs because of the seasonal nature of some jobs in the labour market which occur regularly each year, independent of the business cycle. Hard-core Unemployment: refers to those individuals who might be considered unemployable because of some personal characteristics, such as a mental or physical disability, anti-social behaviour or drug abuse. Recession: is the stage of the business cycle where there is decreasing economic activity, defined as two consecutive quarters of negative economic growth. Structural Change: refers to the process by which the pattern of production in an economy is altered over time, and certain products, processes of production, and even industries disappear, while others emerge. Casualisation of work: refers to the growth of casual employment (and the relative decline of fulltime permanent jobs) as a proportion of the total workforce. The Changing Australian Labour Market Industrial Relations: involves the laws, institutions and processes established to manage the relationship between employers and employees. The structure of the industrial relations system determines the process of wage determination and conflict resolution in the Australian labour market. The Role of Trade Unions: is an association that works to achieve improved wages and working conditions for other workers in workforce. Most trade unions are affiliated with the Australian Council of Trade Unions (ACTU). Occupational unions: members are drawn from people who possess a particular skill. Industry-based unions: these unions cover workers in a particular industry, regardless of the type of work that they do. Enterprise-based unions: these unions represent only the workings of one specific enterprise. This kind of union is very rare although government policies have tried to encourage the creation of enterprise-based unions.

Economic Notes: Preliminary General unions: general unions cover a whole range of workers with many different skills across various industries.

Factors that contribute to a decline of union membership: Changes to wage determination: the movement away from centralized wage determination to enterprise bargaining has tended to reduce the overall influence of unions in wage outcomes. Changes within industries: the industries that have experienced the greatest growth in recent years do not have a history of high levels of union membership. Changes in the nature of employment: the fastest employment growth has occurred in casual, part-time and temporary employment, and among contractors, all of which have lower levels of trade union membership than that for permanent full-time employees.

The role of unions in the labour market: Unions can influence the labour market in two ways- by restricting the supply labour and by exercising their bargaining power in wage negotiations. By restricting the supply of labour is by engaging industrial action- strikes and stop work meetings. Trade unions exercise their bargaining power in negotiations with employers by forming a committee, made up of employees. As a group employees can exercising their power to gain increased wages and improved working conditions.

The role of employer associations: Employer associations: are organisations that are formed to represent the interests of businesses, especially in industrial relations and in lobbying the government. They represent and promote the interests of their members by lobbying the government on matters such as industry assistance and industrial relations policies. They assist employers in managing industrial relations issues, such as by representing their members in the various industrial tribunals set up to settle industrial disputes.

The role of employer organisations in the labour market: Assisting members in wage negotiations. Providing advice, training and direct assistance to employers. Lobbying the government for changes to government policies, especially relating to industrial relations and skills training. Representing employers interests in any hearings in industrial tribunals.

Australias current industrial relations framework: Fair Work Australia: is the government agency that regulates industrial relations in Aust. it combines the functions of an industrial tribunal (such as the Industrial Relations Commission) with a role of education and promotion of enterprise bargaining. The industrial relations system is now governed by the Fair Work Australia Act 2009.

Economic Notes: Preliminary Minimum employment standards: Minimum weekly hours of week- 38 hrs/ week. Right to request flexible working arrangements. Leave- paid leave, public holidays and carers or compassionate leave. Notice of termination and redundancy pay: 1-4 weeks. Types of Financial Markets The Role of Financial Markets: The role of financial markets in the modern market economy is that it provides a return for those who have excess funds, making these funds available to those who require additional money. Financial Intermediaries are firms that receive the funds that are accumulated from individuals or firms, and with the funds they make loans for other individuals or firms. These intermediaries act as bridges between savers and borrowers. Sources of Savings: The proportion of income that is not spent is saved. When govt. budgets for surplus they accumulate funds. Aust. can borrow funds from overseas and access foreign savings.

Reasons for Borrowing: Consumers borrow when their demand for goods and services exceed their income earned. Businesses borrow funds to expand their business. The govt. becomes a borrower when they budget for deficit. Australian financial institutions can send money to overseas borrowers. Primary and Secondary:

Primary Financial Markets: functions as a facilitator of financial assets, known as securities (bonds and shares), that can be traded in the economy. If a company wishes to raise the funds of the company it can borrow money by issuing new debt securities or expand by selling new shares. Secondary Financial Markets: involves transactions of financial assets that already exist in the primary market. Companies whose securities are already being traded on the secondary market do not receive money for these transactions. Main Financial Markets: The Share or Equity Market: where ownership shares in companies are issued or exchanged. The Debt Market: where debt securities are exchanged, or cash is lent or borrowed. The Derivatives Market: where people buy and sell financial assets that are based on the value of other financial assets. The Foreign Exchange Market: where financial assets defined in one country's currency are exchanged for assets defined another country's currency,

Economic Notes: Preliminary The Limits of Markets: The free operation of market forces does not always achieve the most desirable outcomes, economically and socially. Under the free market system (laissez faire), some community's wants may not be satisfied, due to the limited resources available. Therefore, inequality between people and regions occurs, and at times the market may cause economic instability, hence the reason why the government intervenes to tighten the inequality gap between the rich and poor. Market Failure in the provision of G & S: Market Failure is problem that occurs for several reasons. The market may fail to provide certain goods and services to the community or it may be more desirable that they are not provided by the private sector. An example of a good that comes from market failure are public goods- a good that once provided, is difficult to prevent anyone from using, regardless of whether they pay for its use. Therefore, it can be said that public goods are non-excludable and will thus always attract free riders (groups of individual who benefit from a good or service without contributing to the cost of supplying the good or service) whom will not contribute to the costs, as a result the government in a free market system is likely to under supply public goods relative to demand for that good. Public goods are also said to be non-rival, meaning there is no such thing as inequality of satisfaction of the good as public goods usually benefits everyone in the community. Securities: are any form of financial instrument, including shares and bond, that provide the holder of that instrument with a claim over real assets or a future income stream. Australian Securities Exchange: is the major share market in Aust. where the purchase and sale of most shares in public companies occurs. The share market brings together people wishing to buy and sell shares to allow transactions to occur. Credit: are loans to individuals, businesses and govt. for spending on consumption and investment. Bonds: are a written record of a debt. The borrower sells a bond in return for a loan. The holder of a bond receives interest payments and the final payments. Bonds can be sold in secondary financial markets. The Money Market: Factors affecting the demand for funds: Individuals that possess surplus funds can choose to both keep the money in accounts and allow the amount to accumulate with interest or they can invest in shares or bonds. The benefit of holding money is liquidity, which allows the ease of usage in times of need. However, investing in financial assets can allow for returns on them.

Liquidity: is the ease with which a financial asset can be transformed into cask so it can be used as a medium of exchange. Reasons for holding money: Transactions motive: people have to make transactions on a day-to-day basis.

Economic Notes: Preliminary Precautionary motive: unpredictable circumstances or emergencies where money is needed immediately. Speculative motive: buying financial assets carries the risk of yielding profits or losses.

Lenders: the supply of funds Individuals that decide to place their money in the hands of financial institutions are, in effect, lending the money to the banks so that they can lend it out to others in need of it. Businesses that yield large amounts of profits may decide to deposit their funds in a financial institution. In doing so they are able to gain interest on top of their profits. Governments are also lenders as they can lend money out to other countries in need of it. However, most governments dont do this unless they are constantly running a surplus after every financial year.

Money and money supply: Money is measured in three main indicators- money base, M3 and broad money. Money base consists of all currency in circulation and all banks deposits with the Reserve Bank. It is a measure of liquid financial assets, which can be used immediately. M3 consists of the money base plus all bank deposits. Broad money consists of M3 plus deposits in non-financial intermediaries minus their holdings of bank deposits. Money Base = Currency + Bank deposits with RBA M3 = Money base + Bank deposits Broad money = M3 + NBFI deposits NBFI deposits in banks.

Money supply: is the total amount of funds in an economy that can be used a medium of exchange, a measure of value, a store of value and a method of deferred payment. The Reserve Banks measure of the money supply is M3. M3: is a measure of the money supply that consists of all currency in circulation, bank deposits with the Reserve Bank and private sector deposits in banks. Interest rates: are the costs of borrowing money expressed as a percentage of the total amount borrowed. Factors affecting interest rates: Stronger investment demand will usually lead to higher demand for borrowing by firms seeking to finance their capital expansion, putting upward pressure on interest rates. A higher level of savings means that there is an increased supply of loanable funds, which should put downward pressure on interest rates. If individuals choose to hold their funds, rather than investing in shares or securities, it will result in upward pressure on the interest rate. Inflation reduces the value of money and financial assets. Therefore, if inflation is expected to rise lenders would expect to pay more to compensate for their loss of value of their financial assets.

Economic Notes: Preliminary If a government is in a budget deficit, it will result in upward pressure on interest rates. However, if the government is a net lender in financial markets, it will cause the interest rate to decrease. If the domestic rate of interest was higher than the overseas rate, domestic lenders would seek to invest their funds overseas, thus reducing the supply of loanable funds and putting upward pressure on the interest rates. The RBAs influence on domestic market operations will have a direct influence on the returns for short-term loans and an indirect influence on interest rates on longer-term loans.

Domestic Market Operations: are actions by the Reserve Bank in the short term money market to buy and sell securities- either outright or through repurchase agreements- in order to influence the cash rate and general level of interest rates. Cash Rates: is the interest rate paid on overnight loans in the short term money market. The Limits of Market: Why governments intervene: Governments decide to intervene in markets because in order to achieve a better allocation of resources, a more equitable distribution of income and greater economic stability. The challenge is to find out how much government intervention is actually needed, as too little may leave us exposed to instability and too much may stifle innovation, efficiency and growth. Market failure in the provision of G&S: Market failure occurs because the operation of market forces unfavourable outcomes. This is due to the pre-conditions for markets at which they operate are not always borne out in reality, which is why the govt. decides to intervene. A market can fail if they do not provide certain G&S. An example would be public goods. A public good is something that the govt. cannot disregard anyone from using and will be impossible to convince the public to pay for them. Therefore, public goods are known as non-excludable goods, which will always attract free-riders. As a result the govt. may tend to under-supply these goods as no one is expected to pay for it. Public goods are also considered to be non-rival, meaning everyone is entitled to enjoy the good and that no one is allowed to diminish anothers enjoyment of the particular good. Markets may sometimes provide what is known as merit goods, such as healthcare or a performing arts centre. These goods benefit the community as a whole. However, govt. may produce too much of merit goods, which can turn into demerit goods.

Free Riders: are groups or individuals who benefit from a G&S without contributing to the cost of supplying the G&S. As a consequence, the G&S is likely to be under-supplied in relation to the total demand.

Economic Notes: Preliminary Market failure in income distribution: Absolute poverty: refers to a situation where individuals have only just enough income to enable them to survive. Relative poverty: refers to those whose standards of living is substantially lower than the average for the economy as a whole, and is often defined as a level of income below 30% of average earnings. Welfare State: a comprehensive system of welfare benefits such as the aged pensions and unemployment benefits, free access to health care, and subsidies access to other got. Services.

Market failure in externalities: Externalities: are external costs and benefits that private agents in a market do not consider in their decision making process. For example, airlines and passengers do not consider aircraft noise when negotiating airfares. Negative externalities: have harmful effects on the economy. Usually we refer to negative externalities as being spill-over effects that production have on the environment. An example would be reducing freight costs by transporting goods by road which may cause noise pollution and damage to roads. Positive externalities: an example would be the improvement of water quality when an environmentally friendly lodge cleans up the polluted water reserve.

Market Failure in the abuse of market power: Monopolisation: occurs when a firm uses its dominant market position to eliminate existing competition, or prevent up and coming firms from entering the market. Price discrimination: occurs when firms sell the same type of product in different markets at different prices. An example of price discrimination would be early bird pricing or concession prices for movie tickets. Generally firms tend to price their products at the price where the consumer is willing or able to pay at. Exclusive dealing: occurs when a firm sets conditions for supply that exclude retailers from dealing with other competitors. According to the Australian and Consumer Competition Act 2010, firms are not permitted to impose obligations on their customers. Collusion and Market Sharing: occurs when firms get to together and agree on a pricing and market-sharing arrangement (often known as a cartel) that reduces effective competition between them and tends to inhibit the entry of new competition in the market.

Market instability: the business cycle: Business cycle: refers to fluctuations in the level of economic growth due to either domestic or international factors. Without govt. intervention, a free-market economic system is likely to experience irregular movements and sustainable economic growth will be difficult to achieve.

Economic Notes: Preliminary Market forces can bring about boom periods where there is an excess in demand for G&S which causes inflation and as there is a shortage of supply for these G&S. In return high inflation can put upward pressure on interest rates, which can cause recession. Recession causes unemployment, business failures and other social economic problems. The govt. therefore intervenes to reduce the harmful effects of inflation to work towards economic stabilization. The govt. does this through fiscal and monetary policies.

Government macroeconomic policies.

Government microeconomic policies.

Individual firms and industries. Competition policy, Trade policy

Influence Examples

Entire economy Fiscal Policy, Monetary Policy

The aim of using these policies is provide counter-balance in relation to the business cycle. During periods of excessive growth the government increase interest rates, taxes and spends less on infrastructure to avoid inflation and economic bubble bursting. During a period of slow economic growth the govt. aims to stimulate the economy by cutting taxes, lowering interest rates and spending more, (e.g. Stimulus Package) this is done to avoid recession. The Role of Government in Australia:

The structure of government: Commonwealth: The Commonwealth Govt. holds overall responsibility for the economy and has the most influence on economic performance. The power of the C.Govt. has gradually increased since Federation, which has allowed for Aust. to become more singular nation, facing rising economic issues as a nation, rather than separate states. Through the Aust. Constitution, C.Govt. have become increasingly powerful. However, C.Govt. still share power with State governments, as they require the permission from them if they want to implement major economic changes. State: The S. Govt. play an important role in developing infrastructure, delivering govt. services and fostering regional development. S.Govt. have a much more limited role than the C.Govt and their importance to the national economy has declined over time. However, the S.Govt understands the specific needs of their cities and regions and has extensive responsibilities to deliver their needs. States operate the health system, school education and infrastructure such as roads and transport system. Local: are responsible for local planning and development decisions, providing some local services such as rubbish collection and road building and maintenance, and community facilities such as parks and libraries. Local property rates are a form income for local governments, and other forms of income would be fees, licenses and fines imposed by councils. Constitution (Australian): is the document that provides the overall framework for Australias system of democratic government and the relationship between the Commonwealth (or federal) and state governments.

Economic Notes: Preliminary The Public Sector: Public Sector: refers to the parts of the economy that are owned or controlled by the government. It includes all tiers of the government as well as government business enterprises. The public sector consists of Commonwealth, State and Local government, as well as government authorities like Sydney Water, State Rail and Aust. Post. Two important indicators that can demonstrate this are public sector outlays (spending) as a percentage of GDP and public sector employment as a percentage of total employment. As a percentage of GDP, total public sector outlays show the proportion of total annual expenditure by all levels of govt. compared to the expenditure for the economy as a whole. Australias public sector, since WWII has grown between the ranges of 35-42 per cent, compared to other industrialised countries Australias public sector is quite small. Over time the govt. have tended to spend less on infrastructure and more on social welfare payments and community services. Transfer payments constitute to about one-third of C.govt. expenditure. These payments are more commonly referred to as being social welfare payments and pensions. Employment is another indicator that helps the govt. determine the size of the public sector. Although the size of the public sector has remained quite reasonable, the employment rates have, however decreased due to the govt. contracting out their jobs to the private sector.

A change in approach to economic management: A change in the approach to economic management of an economy has meant that the govt. has spent less on infrastructure as it brings about high tax levels and excessive borrowing from the private sector. Therefore, during this time the govt. decided to privatise many of their businesses as it became too expensive to run. However, the Keynesian theory was put into practice during the GFC as it meant that the govt. had to focus their spending and borrowing on improving the business cycle by stabilising it and supporting the financial institutions that were on the brink of collapse. The success of Fiscal stimulus meant that Aust. Recovered quite quickly and by 2010, the economy had stabilised.

Provision of govt. services: As economies grow and develop, living standards also improve. Therefore, the community has higher expectations of the govt. which means that the govt. focuses more on providing improved standards of healthcare, education and other govt. services. Nowadays govt. have been forced to deal with the problems of rising economic growth, including pollution and the depletion of natural resources.

The reallocation of resources: The govt. influences the allocation of resources in two main ways: By influencing the way businesses and consumers behave in the market through taxation or spending. The other by producing G&S itself.

Economic Notes: Preliminary Taxation: Govt. can influence the price of G&S, and thus influence consumer demand through the introduction of taxes either levied on the consumer or the producers. Govt. can use tools of direct and indirect taxes to achieve their resource allocation goals: Direct Taxes: a payment that is made to the individual or business on which they are levied on. Direct taxes cannot be passed on to someone else. An example would be Income Tax which must be paid by the person on which it is levied on. Other examples include Capital Gains Tax and Company Tax. Indirect Taxes: are payments that are levied on an individual or firm, which can be passed on. Indirect Taxes are usually placed on G&S, an example would be GST- a sales tax of 10% that is levied on the seller but is passed on the consumer when purchasing the item at a higher price.

Spending: Govt. spends to redress failures of the market to provide an allocation of resources that the broader community needs or wants. Govt. spending can include: Funding: for the arts, which might otherwise be unprofitable. Grants: for start-up business or new growth industries that, without a proven track record, might lack access to finance. Subsidies: for telecommunications companies such as Telstra to provide broadband services in regional areas where those services would not be profitable. Cash Payments: to private employment search businesses, which find jobs fir unemployed people.

Privatisation: occurs when the government sells public trading enterprises to the private sector. Taxation: Taxes play an important role in the distribution of income, as recent statistics show a widening gap between the rich and poor. Therefore, the govt. focuses on redistributing the income to allow for a fairer, more equal society through the taxation system and social welfare payments. The types of taxes include: Tax Base: this is simply the items that taxed. There are three main bases for the imposition of taxes- income, wealth and consumption. In Aust. Income forms the main tax base. ART: The proportion of total income earned that is paid in the form of tax. MRT: the proportion of any increase in income that must be paid as tax.

However, the ART changes depending on an individuals income and its increments: Progressive tax: under a progressive tax system, higher income earners would pay more tax in proportion to their income, and lower income earners pay less tax. Personal Income Tax is an example of Progressive Tax.

Economic Notes: Preliminary Regressive Tax: under a regressive tax system higher income pay less tax compared to lower income earners in proportion to their income. GST is an example of regressive tax system. Proportional Tax: under a proportional tax system, all income earners pay the same amount of tax in proportion to their level of income. Company Tax is an example of proportional tax.

Stabilisation and sustainable growth: Policies that are used to smooth and stabilise fluctuations in the business cycle are called macroeconomic policies. Monetary policy is used to as a main stabilisation of interest rates, as high interest rates will slow down economic growth, while low interest rates will encourage spending and business investment. Fiscal policy plays important role as it effects spending, taxing and borrowing. Monetary Policy: Tight monetary policy: if the govt. realised that the economic growth rate was moving too fast, it would practice the tightening monetary policy. This would put upward pressure on the interest rates and reduce money supply. High interest rates would dampen consumer demand for money and encourage them to save rather than spend. However, the down side is that it can also encourage cyclical unemployment. Loose Monetary Policy: if the govt. decided to increase economic activity, they would do so by loosening monetary policy. This would result in downward pressure on interest rates and increase money supply. This would boost consumer investment and spending and will reduce cyclical unemployment, but can lead to inflation.

Government business enterprises: are businesses owned and managed by a government at either the Commonwealth or state level. Corporatisation: occurs when the government encourages public trading enterprises to operate independently from the government as if they are private businesses in order to improve efficiency and profitability. Competition: is the pressure on business firms in a market economy to lower prices or improve the quality of output to increase their sales of G&S to consumers. Australian Competition and Consumer Commission: is Australias competition watchdog, which ensures that businesses do not engage in anti-competitive behaviour. Non-renewable resources: are inputs to production where the stock of the resource is reduced in the process of production and consumption e.g. petroleum and coal. Renewable resources: are inputs into the production process that reproduce themselves, ensuring that present consumption of these resources does not necessarily reduce the ability of future generations to consume these resources in the future.

Economic Notes: Preliminary Government in Action The Budget: is the tool of the govt. for the implementation of fiscal policy. It shows the govt. planned expenditure and revenue for the next financial year. Fiscal Policy: is a macroeconomic policy that can influence resource allocation, redistribute income and reduce the fluctuations of the business cycle. Its instruments include govt. spending and taxation and the budget outcome. Revenue and expenditure: Commonwealth Govt. revenue: C.Govt. expenditure budgeted for revenue of $350 billion in the 2011-2012 financial year. 94% of govt. expenditure comes from C.Govt. taxation, which are indirect and direct taxes. Personal Income Tax: makes up of about half of C.Govt. tax revenue. The system that is used by the C.Govt is the (PAYG) or Pay-As-You-Go system. Tax is deducted regularly from your weekly pay cheques of wage and salary earners. Personal Income Tax is a progressive tax in nature, which means higher income earners pay more tax than low income earners. Company Tax: accounts from 21% of govt. revenue, which is a flat rate of 30% on net profit of both private and public corporations. Businesses also pay fringe benefits tax for non-cash benefits that they provide for their employees. GST: is the main indirect tax in Aust. and is a tax that is placed on G&S sold in Aust. (10%). The tax is then distributed to all the states and territorial government. Excise duty: is a tax that is imposed on the producer of certain goods and is based on the quantity of a product. It accounts for 7.5% of government revenue. Customs duty: a tax that is imposed on importers of G&S and accounts for 2% of government revenue. Other tax revenue: these taxes account for 1% of government revenue. Non-tax revenue: these non-tax revenue accounts for about 6% of government revenue and includes profit from government enterprises.

Commonwealth Govt. expenditure: Social security and Welfare: the largest Commonwealth Government outlay. This category represents transfer payments. Provision of infrastructure or social overhead capital: examples include roads, rail, ports and communication networks. Industry assistance and development: providing financial assistance to Aust. businesses by way of subsidies and grants, as well as promoting Aust. products, both domestically and overseas. Protecting the environment and promoting ecologically sustainable development: a small but growing area of govt. expenditure, which includes investment in clean energy and low carbon emission technologies, energy efficiency and better management of water resources.

Economic Notes: Preliminary

The impact of budget outcomes:

Balanced budget Budget surplus Budget deficit

Planned govt. revenue = planned govt. expenditure Planned govt. revenue > Planned govt. revenue Planned govt. revenue < Planned govt. expenditure

An expansionary fiscal policy stance: expansionary fiscal policy aims at reducing economic activity by stimulating aggregate demand. This leads to a reduction in unemployment and increase production. It does this by reducing taxation and increasing govt. expenditure. A contractionary fiscal policy stance: using this policy govt. tend to increase taxation and or decreasing govt. expenditure. This should decrease the level of economic activity and dampening aggregate demand, hence reducing inflation, but increases unemployment. A neutral fiscal policy stance: the budget should have no effect whatever so ever.

Automatic stabilisers: Automatic Stabilisers: are instruments inherent in the govt. budget that counterbalances economic activity. In a boom period, they decrease economic activity and, in a recession, they increase economic activity. The most common examples are transfer payments and progressive tax system. An increase in the level of economic activity: when the economy is growing, income levels increase, leading to a rise in taxation revenue for the govt. Unemployment falls, reducing government expenditure on unemployment benefits. Thus the stabilisers are used as an automatic contraction in aggregate demand. A decrease in the level of economic activity: in times of recession, income levels fall which leads to a fall in taxation revenue. Therefore, unemployment rises, hence increasing govt. expenditure on unemployment benefits. It therefore, stimulates aggregate demand.