Economics: Unit Three

The multiplier effect is caused by the basic economic facts that ____ ______ ________ __ _______ _____ _______ and extra income leads to further ________. . Technically, it occurs in a series of _____.

"One man's spending is another man's income"; XXX; steps.

Interest rate effect (as a reason for the inverse relationship between AD and the PL)

A rise in the PL tends to lead to an increase in real interest rates (since borrowing funds often becomes more common when this occurs as households require more credit to finance spending), which has a negative impact on C and Ip spending and, therefore, reduces AD.

Open economy/international effect (as a reason for the inverse relationship between AD and the PL)

A rise in the domestic PL relative to other countries reduces the international competitiveness of Australian G + S (with relatively cheaper foreign products becoming more attractive to buyers), thus reducing NX and leading to a decrease in AD, ceteris paribus.

Income or wealth effect (as a reason for the inverse relationship between AD and the PL)

A rise in the general level of prices (inflation) reduces the real purchasing power of household income/wealth, since the same amount of currency has now depreciated in real value. Thus, demand decreases when the PL rises.

Autonomous change

A shift in any of the AE curves caused by a change in any of the non-income factors affecting.

"Bottleneck"

A situation in which a shortage of resources exists in the factor market, since the economy is operating at full capacity.

"Mining Flu"

A situation in which growth in one economic sector (e.g. Mining) leads to an appreciation of the exchange rate or the diversion of productive resources to faster-growing sectors, harming competitiveness, output and productivity in other sectors.

Stagflation

A situation in which relatively high rates of inflation are present despite low economic growth and high UE.

Liquidity trap

A situation in which the economic climate (typically during a trough) is such that changes to the cash rate have a negligible effect on the level of economic activity.

Dissaving

A situation in which the level of C exceeds income, resulting in negative savings. This can be caused by consumers withdrawing funds, selling assets, claiming transfer payments, etc. and is represented graphically by the consumption function being above the 45 degree line/the savings function being below the x-axis. (Alternatively, when the consumption function is below the 45 degree line and income is greater than C, savings occur).

Equilibrium

A situation in which the level of income, output and expenditure in the economy is in balance; the level of economic activity is stable. At this point, there is no change in the inventories of firms. This will occur at the point where the AE function intersects the 45 degree line.

Contractionary gap

A situation in which the short-run equilibrium level of income and real GDP is below the long-run equilibrium level. This is typical of a business cycle trough and can also occur during the late downswing and early upswing phases thereof.

Expansionary gap

A situation in which the short-run equilibrium level of income and real GDP/output is above the long-run equilibrium level. This is typical of business cycle boom or even the late upswing and early downswing phases.

Economic indicator

A statistic that provides information about the performance of the economy and, therefore, its position on the business cycle.

Economic shock

An unanticipated event that affects the economy. These can be either demand-side or supply-side(or both) and unfavourable or favourable.

Full employment: Target

Approximately a 4.5% UE rate.

Law of supply

As the price of a product increases, the quantity of that product will also increase, ceteris paribus.

Law of demand

As the price of goods and services (G + S) increases, the quantity demanded decreases, ceteris paribus.

Net exports (X - M or NX)

The difference between total spending on goods and services (G + S) exports and imports in the economy.

Long-run aggregate supply (LRAS)

The economy's potential level of output at a particular point in time, which occurs when all resources are fully employed/there is no spare capacity in the economy. This is represented by a vertical line on the AD/AS model which is independent of PL and is vertical because, at this point, all resources are fully employed, meaning output cannot increase any more and further increases in AD will only increase the price level.

Multifactor productivity (MFP)

The efficiency with which people or firms convert combined labour and capital inputs into outputs of goods and services. This is a relatively broad and realistic measure of productivity, although it is also comparatively difficult to measure.

Labour productivity (LP)

The efficiency with which people or firms convert productive inputs of labour into outputs of goods and services.

Productivity

The efficiency with which people or firms convert productive resources into outputs of goods and services.

Business expectations (as a factor affecting Ip)

If business expectations about future levels of sales and profit are positive, then Ip will likely increase. However, Ip will probably decrease with a reduction in business expectations/confidence.

Easening monetary policy

Monetary policy characterised by a decreasing cash rate.

Tightening monetary policy

Monetary policy characterised by an increasing cash rate.

Borrowing from the central bank (by the government) increases ____ ______, since it injects ____ ______ into the economy. This can have an ____________ impact. On the other hand, borrowing from overseas does not affect _____ ______, due to Australia's ________ ________ ____ (although it does result in an ____________ thereof, ceteris paribus, reducing international competitiveness).

Money supply; "new money"; inflationary; money supply; floating exchange rate; appreciation.

Actual output

The level of output, income or expenditure achieved in an economy over a period of time, otherwise known as GDP or national income.

Keynesian range

The phase of the Keynesian AD/AS model in which the combined AS curve is horizontal, characterised by significant spare capacity in the economy. This is typical of a business cycle trough and, at this stage, the economy can expand (i.e. Real GDP can increase) with little impact on the PL.

Intermediate range

The phase of the Keynesian AD/AS model in which the combined AS curve is sloping upwards (i.e. In-between the horizontal and vertical stages), which is characterised by reduced spare capacity. This is typical of either a business cycle expansion or contraction and, at this stage, increases in real GDP or income will cause the PL to rise as factor markets tighten.

Classical range

The phase of the Keynesian AD/AS model in which the combined AS curve is vertical, due to the economy operating at the full employment level of output. This is typical of a business cycle boom and, because there is no spare capacity, further increases in AD have no effect on output but would be highly inflationary, increasing the PL greatly.

Boom/peak

The phase of the business cycle during which actual aggregate output in an economy is close, equal to or even beyond the potential level (i.e. The full employment level), due to a high level of economic activity.

Upswing/expansion

The phase of the business cycle during which the output gap decreases, due to increasing levels of economic activity. This consists of both the early and late phases.

Downswing/contraction

The phase of the business cycle during which the output gap increases, due to a decreasing level of economic activity. This consists of both the early and late phases.

Trough/slump

The phase of the business cycle during which the output gap is greatest, as the general level of economic activity is at its lowest level.

Short-run equilibrium

The point at which the AD curve intersects the SRAS curve on the classical model. This represents the economy's current level of production.

Interest rate

The price of borrowed money/return on savings over a period of time. These can be nominal (not adjusted for inflation or real (adjusted to account for the effects of inflation).

Multiplier effect: Formula (complex)

k = 1 / (MPS + MPT + MPM). - MPT: Marginal propensity to tax. - MPM: Marginal propensity to import.

Multiplier effect: Fomula

k = 1/MPS or k = final change in real GDP (or income) / autonomous change in expenditure.

UE rate: Current

7.5%.

Consumption expenditure (C)

Household spending on final goods and services.

Equitable distribution of income: Target

Gini coefficient of roughly between 0.3 and 0.35.

Savings function: Equation

S = -a + (1 - b)Y. - (1 - b) = MPS.

Weaknesses of monetary policy

- "Blunt" instrument; it cannot be targeted towards specific economic sectors, since its only vehicle is interest rates. This can create a two-speed economy, in which some sectors are growing faster than others, and reduces its effectiveness. - Can be ineffective during periods of low economic activity, since reduced interest rates may be insufficient to stimulate private spending when confidence is low. A "liquidity trap" can also arise and complementary fiscal measures may be required. - Suffers from long outside lags, specifically an extended impact lag, since the transmission mechanism is indirect and relatively slow to operate. - May cause the emergence of a housing bubble, whereby low interest rates encourage the accumulation of unsustainable household debt, which cannot be repaid during inevitable periods of higher interest rates.

Factors affecting Ip

- (Business) profitability; - Interest rates; - Government policies; and - (Business) expectations. Note: Think PIGE, or "piggy".

Advantages of full employment

- Avoids the economic cost of an output gap (the difference between potential and actual output in the economy) and, therefore, lost EG; - Avoids the cost of increased transfer payments, in the form of benefits to the unemployed; and - The social costs of UE are reduced, as are the personal costs.

Factors affecting NX

- Barriers to trade (e.g. Tariffs and quotas - the fewer there are of these, the less trade will occur); - Commodity prices; - Overseas business cycles; - Domestic business cycle; - Exchange rate; and - Terms of trade. Note: Think "B-CODET/code it".

Four stages of the business cycle

- Boom; - Downswing; - Trough; and - Upswing.

Weaknesses of fiscal policy

- Can cause crowding out (or, potentially, crowding in), which can negate the effect of fiscal policy; - Suffers extended inside (namely recognition and decision) lags, due to the fact that the Budget is only released once a year; - Can be heavily politicised; - Relatively inflexible, since the majority of areas of G remain consistent across Budgets out of necessity (e.g. Operating the public service); - Potential interest repayments on debt compromise future Budgets, raising concerns around intergenerational equity; and - Households may respond to stimulus by making unhelpful adjustments to savings.

Causes of productivity growth

- Capital deepening, especially through investment in capital and infrastructure; - Improvements in the quality of workforce, especially through investment in human capital (i.e. Education and skills training); - Improvements in technology, especially through innovation (e.g. Product, process and organisational) and R&D; - Improvements in enterprise; and - Greater competition (which incentivises innovation, specialisation and allocative efficiency).

Reasons for the (typical) differential between the planned and actual Budgets

- Changes in the level of economic activity between the release of the planned and actual Budgets; - Changes in conditions in world markets (e.g. An oil shock), especially economic schocks; - Other exogenous factors (e.g. Natural disasters), i.e. Those which originate from outside of the domestic business cycle itself (as opposed to endogenous factors); and - A change of government in the meantime, which might lead to a different political philosophy determining the Budget.

Causes of structural change

- Changing societal factors (e.g. Household structures and life expectancy); - Changing average incomes; - Technological change and innovation; - Microeconomic reform; - The emergence of major producers of industrialised goods in East and South East Asia and other exposure to international competition; - Changes in the level of education and skills training; - Changing consumer preferences; and - Concerns about sustainability and other negative externalities.

Factors affecting SRAS

- Costs of production (e.g. Labour wages, taxation rates and other input prices); and - Supply of resources.

Components of government expenditure (G)

- Current G (G1); and - Capital G (G2).

Disadvantages of price stability

- Danger of slipping into deflation (rising debts, falling profits, postponement of spending, etc.); - May involve a trade-off with AD and UE; and - Potentially allows for debts to fall in real terms over time, thus discouraging the lending of funds.

Characteristics of the upswing

- Decreasing cyclical UE; - Increasing inflation; - Rising economic growth; - Increasing C; - Increasing business and consumer confidence; - Improving levels of investment; - Falling inventories; and - Rising interest rates.

Reasons for the variance in LP across economic sectors

- Differing capital intensities per sector/industry; - Scale effects (i.e. Larger operations sharing fixed costs) are felt more in some industries than others; and - Different degrees of labour specialisation.

Strengths of fiscal policy

- Direct (changes in G and T can be implemented almost immediately, suffering very little outside lag and can have an immediate impact on real GDP); - Generally is not associated with any negative side effects; - Has a positive spending (and taxation, although to a lesser extent) multiplier effect; - Can be effectively targeted towards specific sectors; - If the size of the multiplier is large enough, then fiscal stimulus programs can be self-financing; - Generally complements automatic stabilisers; and - Is particularly effective during times of recession/economic troughs (where the self-adjusting mechanism can fail for an extended period).

Factors affecting G

- Discretionary changes in accordance with government policy objectives; - Automatic changes due to the stage of the business cycle; - The extent of market failure (i.e. The need for government intervention in certain industries); - Economic shocks; - Demographics; - The need for economic stabilisation; and - Social and political pressures. Note: Think "DAMTEDES", or "dam teddies".

Limitations of real GDP as a measure of sustainable EG

- Does not account for economic welfare; and - Does not consider sustainability.

Three phases of the Keynesian AD/AS model

- Keynesian range; - Intermediate range; and - Classical range.

Characteristics of the taxation system that must be present in order for productivity growth to occur

- Equitable (fair, both vertically and horizontally); - Efficient (not harmful to economic performance); - Simply (easily implemented, without high compliance costs); - Coherent (comprising a clear link between the payment of tax and the recipients of welfare); - Competitive (in relation to other countries); and - Sustainable (able to meet G obligations both now and in the future).

Strengths of monetary policy

- Especially during periods of high economic activity, through the transmission mechanism monetary policy can have a significant effect on the cash flow and levels of C, Ip and NX (and, therefore, AD) in the economy. - Flexible and comprising relatively short inside lags (i.e. Recognition, decision and implementation lags), since the RBA Board meets every month and its decisions do not require government approval. - Separate from the political process, since the RBA is an independent statutory authority that is unelected and is therefore free of political bias.

Disadvantages of sustainable EG

- Especially in excess (greater than 4%) it may cause inflation (either demand-pull or cost-push, due to the increased pressure on factor markets); - May lead to structural change and, therefore, structural UE, mainly in the short-term; - Could promote inequality if it is not occurring evenly throughout all economic sectors; and - In the case of it being unsustainable, it may damage the environment.

Importance of the multiplier effect

- Exaggerates the impact of an autonomous change in AE, thereby affecting the business cycle; and - Helps in the management of the economy.

Discretionary Budget stances

- Expansionary; - Contractionary; and - Neutral.

Components of NX

- Exports of G + S; and - Imports of G + S.

Coincident indicators: Examples

- GDP; - Manufacturing output; - Sales of consumer durables; - Retail sales; - Capacity utilisation; - Money supply; - Motor vehicle sales; - Production of building materials; and - Job advertisements. Note: Any economic indicator with the word "sales" in it is a coincident indicator.

Characteristics of a trough

- High cyclical UE; - Low level of inflation; - Relatively low level of economic growth; - Little C; - Little business and consumer confidence; - Relatively low investment; - Lower business profits (although this decline levels off, due to lower wages and interest rates - representing cut costs of production - and spare capacity); - Lower sales of consumer durables; - Higher savings rates; - High inventories; and - Low interest rates.

Consumption function: Assumptions

- Households can only spend their disposable income in one of two ways: To spend or to save; - Ip is at a fixed level, independent of income; - No inflation; - Ip, G, NX are autonomous/independent of Y; and - AE = C + Ip + G + (X - M).

Disadvantages of inflation (which are avoided by price stability; its advantages are the opposite of these)

- Households experience a reduction in real income/purchasing power (unless wages are rising at the same rate); - Nominal interest rates rise, which may adversely affect private expenditure on consumer durables or Ip; - Erodes the confidence in money as a store of value, leading to speculative activity as resources are diverted away from productive activity; - Rising costs make it more difficult for business to determine a rate of return on Ip and it becomes associated with a higher level of risk; - Australia's international competitiveness declines, as domestic prices rise relative to those overseas. This leads to reduced net exports (NX), as Australian exports are relatively more expensive, while imports from overseas are relatively cheap; - Capital-for-labour substitution (the replacing of labour with capital machinery) may occur (especially if wages are increasing faster than productivity), leading to structural UE; - Increased uncertainty; - Reduced value of savings; - A "negative" redistribution of income may occur, as people on fixed incomes (including the recipients of transfer payments) experience the greatest decline in purchasing power; and - "Pay as you go" taxpayers might suffer bracket creep.

Long-term effects of productivity growth (not including its effects on the government's major economic objectives)

- Improves international competitiveness; - Raises living standards (since output and income both rise, while products are also cheaper)

Reasons for the inverse relationship between AD and the price level (as per the law of demand)

- Income or wealth effect; - Interest rate effect; and - Open economy/international effect.

Characteristics of a downswing

- Increasing cyclical UE; - Declining levels of inflation; - Decreasing economic growth; - Decreasing levels of C; - Declining business and consumer confidence; - Lowering levels of investment; - Rising inventories; and - Falling interest rates.

Methods of implementing a contractionary Budget stance

- Increasing personal income and/or company tax rates; - Postponing or reducing the number of major spending projects; and -Increasing excise taxes.

Examples of leading indicators

- Inventories; - Business and consumer confidence; - Consumer expectations; - Share prices; - Building approvals; - New business startups; - New employment vacancies; and - Manufacturers' new orders.

Effects of structural change

- Leads to higher levels of output (due to greater productivity) and, therefore, economic growth. Aggregate supply (AS) increases. - Business products and processes are structurally altered. - Uneven impact on the whole economy; expansion in some sectors (the more efficient ones) but contraction in others. This can lead to a two-speed economy and, consequently, the so-called "Mining Flu". - "Vertical disintegration". - Higher structural unemployment in the short-term (since skills that were of use in inefficient industries become obsolete). --> Lower short term Budget balance. - Potentially higher employment in the long-term, as business output and profitability increases as a result of greater productivity. --> Higher long-term Budget balance. - Globalisation (economic and financial integration of economies worldwide).

Factors affecting C

- Levels of Yd; - Cost of credit/real interest rates; - Stock of wealth; - Consumer expectations; and - Government policy. Note: Think "GYdCES/guises".

Economic policy institutions of Australia

- Parliament (fiscal policy; affects both AD and AS, although it is typically considered more demand-side); - RBA (monetary policy and the buying of government bonds; aimed at influencing AD); and - Productivity Commission (competition and industry policy, or recommendations thereon; supply-side).

Ways of using a Budget surplus

- Pay off any government debt; - Can be put towards the funding of future expenditure (e.g. Through trust funds); - Can be returned as tax cuts to taxpayers (and fulfil various political purposes); and - Can be deposited in the Reserve Bank of Australia (RBA).

Components of Ip

- Planned business investment (privately funded business spending on capital goods used in production); - Housing investment (private expenditure on new housing); and - Inventories (although these are excluded from the actual AE equation - they are only a component of I, not Ip). This means that net investment itself is equal to Ip plus unplanned investment.

Relationship between productivity and the government's major economic objectives

- Positively related to sustainable EG; - Positively related to price stability; - Uncertain how it affects full employment; - Positively related to the efficient allocation of resources; and - Indeterminate effect on the equitable redistribution of income???

Conflicting economic objectives: Examples

- Price stability and full employment: Policies aimed at reducing demand-pull (and cost-push) inflation tend to be designed to decrease the level of economic activity. - Sustainable EG and price stability: High levels of economic activity place pressure on resource prices, which leads to cost-push inflation. - Sustainable economic growth and an equitable distribution of income: Not all sectors of the economy may benefit equally from an increase in net income. - Sustainable EG (which tends to lead to structural change in the economy) and full employment (since structural unemployment rises).

Types of efficiency

- Productive/technical (occurs when resources are allocated to their best use, such that no more units of one product could be produced without sacrificing units of another product); - Allocative (occurs when resources are allocated according to consumer preferences); and - Dynamic (the productive efficiency of firms over a period of time). IMPROVE THIS.

Determinants of LRAS

- Q: Quantity of available resources/size of the labour force (including the participation rate and size of the population). - Q: Quality of the available resources (including the effects of productivity). - T: Level of technology.

Types of time lags

- Recognition (inside); - Decision (inside); - Implementation/action (outside); and - Effect/impact (outside).

Methods of implementing an expansionary Budget stance

- Reducing income tax, thereby increasing household disposable income and encouraging spending; - Cutting corporate tax, thus reducing business costs of production and incentivising increased employment; and - Increasing government spending.

Characteristics of an expansionary gap

- Relatively high rate of economic growth; - High inflation; - Low spare capacity and inventories; - Reduced cyclical UE; - Increased sales of consumer durables; - Increased company profits; - Higher interest rates; - Rising labour force participation rate; and - Reduced need for social security/transfer payments.

Characteristics of a boom

- Relatively low cyclical UE; - Relatively high levels of inflation; - Above-trend economic growth; - The economy operating at full capacity, perhaps even with a negative output gap; - Reasonably high levels of consumption expenditure (C), particularly on durable goods (which are expected to last for more than three years) and luxuries; - High business and consumer confidence; - "Bottlenecks", arising as a result of the economy operating at full capacity; - Relatively high levels of business profitability (although this levels off, due to high wages and cash rates - representing increased costs of production - and bottlenecks); - Low inventories; - High levels of borrowing; and - Relatively high levels of labour market participation.

Characteristics of a contractionary gap

- Relatively slow rate of economic growth; - Low inflation; - Spare capacity; - Higher cyclical UE; - Decreased sales of consumer durables; - Reduced company profits; - Lower interest rates; - Decreased labour force participation rate; and - Increased need for social security/transfer payments. Note: These also tend to be the characteristics of an economic trough/late downswing/early upswing.

Methods of financing a Budget deficit

- Selling government bonds; - Selling government assets (privatisation); - Borrowing from the central bank (or even potentially printing more money); and - Borrowing from overseas.

Economic objectives of the RBA (as established by the "Reserve Bank Act [1959]")

- Stability of the currency (i.e. Price stability, or 2-3% inflation per annum); - Maintenance of full employment; and - Preserving and increasing the economic welfare of the people of Australia.

Three types of Budget outcomes

- Surplus; - Balanced; and - Deficit.

Complementary economic objectives: Examples

- Sustainable EG and full employment: Higher AD during periods of increasing EG prompt firms to increase production and thus employ more resources. - Full employment and an equitable distribution of income: Work provides low-income households with a means to build wealth. - Price stability and sustainable EG: Low inflation reduces uncertainty and encourages resources to be allocated towards productive activities, as well as promoting international competitiveness. - Efficient allocation of resources and sustainable economic growth: Higher productivity increases both SRAS and LRAS, while the subsequent reduction in the PL leads to an expansion in AD.

Five major economic policy objectives of the government

- Sustainable economic growth; - Price stability; - Full employment; - Equitable distribution of income; and - Efficient allocation of resources. Note: Always provide the first three first when asked about the major macroeconomic objectives of the government, since they fit a broader range of questions.

Automatic stabilisers (types)

- Taxation revenue; and - Transfer payments (namely welfare).

Advantages of sustainable EG

- Tends to create employment; - Raises material living standards; - Increases the range of goods and services available for consumption; and - Avoids the "relative decline" of Australia compared with other countries.

AE model: Assumptions

- The level of Ip, G and X spending is autonomous (independent of the level of real GDP) and therefore at a fixed level; - M increase with the level of disposable income; - No inflation/change in price level; and - AE = C + Ip + (G1 + G2) + (X - M).

Lagging indicator: Examples

- UE rate; - Inflation rate (as measured by the Consumer Price Index, or CPI); - Interest rates; - Bankruptcies; and - Consumer debt.

Inflation rate: Current

-0.3%.

(Sustainable) EG: Current rate

-6.3%.

The current cash rate is just _____, with the economy in a ______ and characterised by sluggish _____ _____. Recent monetary policy has been compromised by high levels of _________ ____.

0.25%; trough; wages growth; household debt.

Gini coefficient: Current

0.34.

Stages in the transmission mechanism

1. An alteration is made in the cash rate. 2. Real interest rates change in response. 3. Other changes that affect output, employment, prices and the cash flow occur. 4. AD changes through C, Ip and NX (and an associated multiplier process). 5. The inflation rate and real GDP are altered.

Sources of government revenue (% of 2019-20 Budget)

1. Personal income tax (45.6%). 2. Company and resource rent taxes (19.8%). 3. Sales tax (13.9%). 4. Non-tax revenue (7.2%). 5. Customs duty (4.1%). 6. Fuels excise (4.0%). 7. Other taxes (2.0%) .8. Superannuation taxes (1.9%). 9. Fringe benefits tax (0.8%). 10. Other excise (0.7%).

Areas of G (% of 2019-20 Budget)

1. Social security and welfare (36.0%). 2. Other purposes and all other functions (29.3% combined). 3. Health (16.3%). 4. Education (7.3%). 5. Defence (6.4%). 6. General public services (4.7%).

RBA's method of implementing monetary policy (steps)

1. The RBA monitors a variety of economic indicators reflecting domestic and international conditions. 2. These are then assessed by the nine-member RBA Board, which meets on the first Tuesday of every month. 3. The appropriate cash rate decisions are then made and implemented.

Consumption expenditure accounts for __ to ___ of AE. Ip generally amounts to __ to ___, G ___ and NX __ to __.

55; 60%; 15; 20%; 25%; 1; -3%.

Government spending multiplier: Formula

1/(1-MPC) or 1/MPS or 1/(MPS+MPM+MPT) or change in real GDP/change in G.

Price stability: Target

2 - 3% inflation p.a.

The mining boom occurred in _________. _________ constituted the post-boom trough. The economy is currently in a deep ______, which has been brought on by the cumulative effects of _______ ________ (e.g. Fires and floods) and the ________ pandemic; an economic shock.

2011-12; 2015-16; trough; natural disaster; COVID-19.

Sustainable EG: Target range

3 - 4% economic growth per annum.

Budget deficit

A Budget outcome in which G exceeds government revenue. This is characteristic of periods of low economic activity, namely business cycle troughs and (late) contractions.

Balanced Budget

A Budget outcome in which government revenue and G are equal. This tends to be implemented when the government's major economic objectives are being achieved.

Budget surplus

A Budget outcome in which government revenue exceeds G. This is characteristic of periods of high economic activity, namely business cycle booms and (late) expansions.

Movement

A change in AD or AS that occurs as a result of a change in the PL (which causes a movement along the relevant curve).

Shift

A change in the position of the AD or AS curve(s) that is caused by an alteration in one of the non-price factors affecting these.

Taxation (T)

A compulsory monetary contribution to government revenue.

AE/Keynesian Cross Model

A macroeconomic Keynesian model that demonstrates the relationship between AE (and the components thereof, on the y-axis) and the level of economic activity/income/real GDP (x-axis). It also tends to include a vertical line at the full employment level of income.

Consumption function

A macroeconomic model that demonstrates the relationship between the level of disposable income received by households and the level of consumption (and savings).

The business cycle

A macroeconomic model that shows the fluctuations in aggregate economic activity (as a regular sequence of phases) in an economy over time.

Classical AD/AS model

A macroeconomic model/graph which shows both AD and AS (which is split into SRAS and LRAS) in the economy at each respective price level (PL) over a given period of time. Real GDP/income (Y) is shown on the x-axis.

Exchange rate

A measure of how much one currency is worth in relation to another.

Gini coefficient

A measure of income inequality within a population, ranging from zero for complete equality, to one for complete inequality (lesser numbers equal less inequality).

Spare capacity

A measure of the underutilisation/unemployment of resources, which shows the extent to which the economy is operating below the potential level of production and output.

Inflation

A persistent and appreciable rise in the general level of prices.

Export (X)

A trade transaction in which money spent flows from overseas nations into Australia.

Import (M)

A trade transaction in which the money spent flows from Australia to overseas nations.

Terms of trade (as a factor affecting NX)

An increase in the terms of trade (which means that Australian products and both in demand and commanding a relatively high price in overseas markets) results in an increase in NX. However, a reduction in the terms of trade will decrease NX.

Capital deepening

An increase in the amount of capital per worker. In recent years, this has been the main source of LP growth.

Structural change arises from changes in the pattern of __ and, in response, __.

AD; AS.

AE: Equation

AE = C + Ip + G + (X- M).

AD is composed of _________ ___________ ____ in the economy. Therefore, the factors affecting __ and its individual components are also ____________ of AD, which comprises _, __, _ and __ spending.

Aggregate expenditure (AE); AE; determinants; C; Ip; G; NX.

Structural change

Alterations in the distribution of output, income and employment in the economy over time.

Keynesian AD/AS model

An alternative AD/AS model (as opposed to the classical version) which combines the SRAS and LRAS curves, although the AD curve remains unchanged.

Lagging indicator

An economic indicator that is not expected to show any change until trends in the rest of the economy have been confirmed.

Counter-cyclical indicator

An economic indicator that moves in the opposite direction to the general level of economic activity, e.g. The UE rate and inventories.

Pro-cyclical indicator

An economic indicator that moves in the same direction as the general level of economic activity, e.g. GDP and inflation.

Leading indicator

An economic indicator that predicts trends in economic activity, i.e. Changes before a direction becomes evident in the rest of the economy.

Production possibility frontier (PPF)

An economic model that shows all the combinations of goods and/or services that can be produced by an economy, given the available resources.

Investment demand curve

An economic model that shows the amount of investment demanded by an economy at a series of real interest rates (y-axis). This is an inverse relationship. The investment curve will increase or decrease when interest rates change, or shift when other (non-price) factors affecting investment change. To maximise profit, firms will invest up to the point where returns fall to the level of the real rate of interest.

Ways in which the government can promote productivity growth

By implementing policies that promote productivity-enhancing changes, reduce barriers to productivity growth or facilitate the improvements in productive efficiency throughprocesses such as: - Labour market reform; - Taxation reform; - Trade liberalisation; - Infrastructure policy; - Education and training policy; - R&D and innovation; and - Deregulation and competition policy.

Consumption function: Equation

C = a + bY. - a: Autonomous consumption. - b: The MPC (which represents the slope).

A boom ______ continue forever, for two main reasons. One is because, at some point, businesses sense that they have enough ________ to meet anticipated ______, which means further __________ would carry greater ____. The increased levels of _ that drove __________ and ______ may now result in price _________ as the economy reaches ________. In some sectors of the economy, _____________ may occur, further __________ the price level and discouraging _. Fully utilised stocks of ______ equipment cannot continue to increase output, hence, the rates of increase of ______, ______ and ___________ tend to level off. ___________ soon follows, which has further flow-on effects. Furthermore, the __________ and ___ often introduce ______________ economic policy, in order to reduce the high levels of economic ________ that is occurring.

Cannot; capacity; demand; investment; risk; C; investment; output; increases; capacity; "bottlenecks"; increasing; C; capital; income; output; expenditure; uncertainty; government; RBA; contractionary; activity.

The trough phase of the business cycle ______ continue indefinitely. __________ _________ is eventually worn out and requires replacement, leading to __________. Businesses also undertake _______ ___ _______ __________ (new products and more efficient processes) to attract buyers and seek a competitive advantage over their rivals. The level of economic ________ and __________ gradually rise as the economy resumes its long-term growth path. Furthermore, declining _____ - especially as a result of the relatively high levels of ____ ________ - and ________ _____ - represent cut costs of production for firms, encouraging increases in ______ which, in turn, leads to greater __________ and ______. The __________ and ___ also tend to implement expansionary policies at such a time, reinforcing this.

Cannot; productive machinery; investment; product and process innovation; activity; confidence; wages; spare capacity; output; employment; income; government; RBA.

Due to the economic problem (that society has scarce resources with which to satisfy the unlimited needs and wants of its members), some economic objectives will be ___________, while others will be _____________.

Conflicting; complementary.

Contractionary monetary policy stance

Constitutes a cash rate of above 4.5%. This tends to be implemented when economic indicators (especially inflation) suggest that the economy is growing too fast (especially in a boom); such that it is above the potential level of output and, subsequently, aims to restore the potential level of growth. An increasing cash rate may also be present.

Expansionary monetary policy stance

Constitutes a cash rate of below 3.5%, typically an easening one. This tends to be implemented when economic indicators (especially inflation) suggest that the economy is growing too slowly, below the potential level of output (especially in a trough) and, subsequently, aims to restore the potential level of growth.

On the consumption function, the level of ________ ________ is shown on the y-axis, while the level of __________ ______ is on the x-axis. The 45 degree line is ___________ between the two axes and thus shows all points where planned _______ ___________ equals _____ ______. ___________ occurs at the point where the consumption function intersects the 45 degree line. At this point, _______ will equal zero. Overall, this model shows that consumption _________ as the level of disposable income rises but not by __ ____ as the increase in income (i.e. The 45 degree line is ______ than the line representing C), due to the effect of _______.

Consumer spending; disposable income; equidistant; consumer spending; total income; equilibrium; savings; increases; as much; steeper; savings.

When an expansionary Budget stance is implemented, it tends to have the effect of increasing ___________ and __________ expenditure, since households and firms may be subject to less tax, or more relief or incentives, granting the former more __________ ______ and effectively reducing the _____ __ __________ for the latter. Also, _________ government spending is ________ increased (as is, therefore, AD). This creates a ________ __________ ______ throughout the economy, raising ______ and ___________ (i.e. __), leading to a matching increase in ______ as equilibrium is restored. This can expand an economy in a ______.

Consumption; investment; disposable income; costs of production; directly; government; positive multiplier effect; income; expenditure; AD; output; trough.

When a contractionary Budget stance is implemented, it tends to have the effect of decreasing ___________ and __________ expenditure, since households and firms may be subject to more tax/less relief or incentives, granting the former less __________ ______ and effectively reducing the _____ __ __________ for the latter. Also, _________ spending is directly decreased. This creates a ________ __________ ______ throughout the economy, reducing ______ and ___________ (i.e. __), leading to a matching decrease in ______ as equilibrium is restored. This can contract an economy in a ____.

Consumption; investment; disposable income; costs of production; government; negative multiplier effect; income; expenditure; AD; output; boom.

Being ________________, fiscal policy aims to _________ the fluctuations associated with the business cycle (as well as assist in the achievement of the government's other economic objectives).

Counter-cyclical; stabilise.

Monetary policy is a _______-cyclical ______-side policy (i.e. It only affects __). It is also _______________, reflecting the RBA's expectations about the future.

Counter; demand; AD; forward-looking.

By running Budget surpluses and paying off sovereign debt, the government can improve the nation's ______ ______; a measure of its ability to ______ its financial commitments. The _____ this is, the less risk is deemed to be associated with _______ funds thereto, reducing ________ _____ for the nation when it does need to borrow.

Credit rating; fulfil; lower; lending; interest rates.

Stock of wealth (as a factor affecting C)

Households that hold real assets such as property and shares tend to spend more when the value of these assets is rising. Also, higher levels of debt may lead households to reduce C.

Education and training policy can be used by the government to improve _____ _______, continual improvements in which increase ____________ (to a point, as dictated by the ___ __ ___________ _______).

Human capital; productivity; law of diminishing marginal returns.

Structural change can be caused by either __________ (from within the economy) or __________ (from sources outside of the domestic economy) factors.

Endogenous; exogenous.

During periods of lower economic growth, tax revenue will ________, while G on transfer payments will ________, thus automatically moving the Budget towards _______ (or increasing it if one already exists). Conversely, during periods of higher economic growth, tax revenue will ____, while transfer payments will ____, thus automatically moving the Budget towards _______ and ___________ the fluctuations of the business cycle.

Decrease; increase; deficit; rise; fall; surplus; stabilising.

Although its primary purpose is to fulfil the ______ __________ and _____________ roles of the government, fiscal policy can also impact __ (e.g. Spending on infrastructure).

Demand management; stabilisation; AS.

Microeconomic reform can be used by the government to implement ____________ and ___________ ______ (as well as _____ ______________ and _____________), thus improving productivity by promoting __________.

Deregulation; competition policy; trade liberalisation; privatisation; competition.

On the Keynesian AD/AS model, a change in the costs of production would be represented by either a shift ____ (in the case of them decreasing) or a shift __ (in the case of them increasing) in the AS curve, although the full employment/classical range position would not be _______. Furthermore, a change in ___ would be represented by either a shift _____ (in the case of an increase in these factors) or a shift ____ (decrease) in the AS curve, although the horizontal Keynesian phase would remain _________. A ___________ of these two types of shifts could also occur.

Down; up; altered; QQT; right; left; unaltered; combination.

The stage of the transmission mechanism whereby other changes that affect output, employment and prices occur is caused by a number of factors. Firstly, in the case of higher real interest rates, C is reduced, especially in relation to _______ goods, since funds are more _________ to borrow, the __________ ____ of spending (i.e. ______) is increased and __________ on existing _____ (e.g. Mortgages) are higher, decreasing household levels of __________ ______ and further reducing C. Also, ______ and ______ tend to decline in value compared to interest-bearing deposits, leading to less C thereon. Furthermore, business _____________ is reduced for Ip projects as a result of increased _____ __ __________ (an effect which is further enhanced by the increased __________ on existing loans). Likewise, the ___________ ____ of Ip is reduced and _______ funds held in interest-bearing ________ have a decreased rate of return. Finally, in the context of NX, an increase in real interest rates leads to an appreciation of the ________ ____. This reduces _____________ _______________ and, consequently, causes a ________ in NX, ceteris paribus. Naturally, in the case of lowered interest rates/a lowered cash rate, the ________ will occur.

Durable; expensive; opportunity cost; saving; repayments; loans; disposable income; wealth; assets; profitability; costs of production; repayments; opportunity cost; surplus; deposits; exchange rate; international competitiveness; decrease; opposite.

Keynesian graphs always show _ on the y-axis and _ and _ on the x-axis.

E; Y; O.

Coinicident indicators

Economic indicators that appear to change at the same time as trends in economic activity.

Conflicting

Economic objectives that cannot be achieved simultaneously.

Complementary

Economic objectives which can be achieved simultaneously.

In terms of labour market reform, a tradeoff often exists between __________ and ______.

Efficiency; equity.

Increased exposure to competition - including internationally - leads to those firms which are more _________ having a ___________ _________ and thus being more __________. This, in turn, results in them being able to grant higher _____ for labour, which, in the long-term, leads to the transferral of labour to more __________ industries (or even _______), thus causing structural change.

Efficient; competitive advantage; profitable; wages; productive; sectors.

Discretionary fiscal policy/stabilisers

Elective changes to expenditure and revenue that the government implements in the Budget, theoretically with the intention of stabilising the economy and/or achieving its major economic objectives. These alterations can be broadly defined as allocative, regulatory or redistributive.

Technological change can be either _________ (tangible) or ___________ (intangible, such as ideas and production methods).

Embodied; disembodied.

In the case of an expansionary gap, high levels of __________ should see wages ____, resulting in a ________ in SRAS (due to these increased _____ __ __________), back towards the ________ ___________ position. Thus, the self-correcting mechanism operates. Naturally, Keynesian economists propose that contractionary ______ and ________ policies are also required.

Employment; rise; decrease; costs of production; long-run equilibrium; fiscal; monetary.

If the level of income is either above or below ___________ level, then planned spending will not equal output and, therefore, firms' ___________ will change, signalling them to either increase or decrease production. Specifically, when AE is greater then the level of output, inventories will ____ and firms will respond by __________ output. On the other hand, when AE is lower than the level of output, these will ____, resulting in firms ________ output. Thus, the economy will automatically move towards ___________ level.

Equilibrium; inventories; fall; increasing; rise; reducing; equilibrium.

Current government spending (G1)

Expenditure on goods and services that are intended for current, or present, consumption by the government, e.g. Wages and salaries and purchases of goods and services.

Capital government spending (G2)

Expenditure on public infrastructure and public machinery that is undertaken by the government, e.g. Power and water supply, roads and communications networks.

Components of C

Expenditure on: - Non-durable goods; - Durable goods; and - Services.

Channels of the transmission mechanism

FILL IN!

Potential output

Full/economic capacity; the real GDP/output an economy is capable of producing, if full employment (and, therefore, economic efficiency) were to be present.

GDP growth potential: Formula

GDP growth potential = Labour force growth + LP growth (including technological improvements).

Non-durable

Goods that are consumed shortly after purchase, specifically up to three years after. These are also known as non-discretionary goods.

Durable

Goods that last for an extended period of time before being "consumed", specifically three or more years after purchase. These are also known as discretionary goods.

Transfer payments

Government grants (typically monetary) paid to individuals or businesses; unearned income. These include welfare benefits for the unemployed.

Graphically, the multiplier effect will (generally) result in there being a _______ x-axis change than y-axis change for any alteration in the level of AE, in the Keynesian aggregate expenditure model.

Greater.

The greater the MPC/the smaller the MPS, the _______ the multiplier (effect). Therefore, the ____ of the multiplier is determined by factors that affect the MPC/MPS.

Greater; size.

Commodity prices affect NX in that if Australian exports are demanding ____ prices, then NX will increase, whereas if they are relatively _____, NX will decline. Similarly, if imports are demanding ____ prices then NX will decrease, while if they are relatively _____ NX will increase.

High; cheap; high; cheap.

In general, any autonomous increase in one of the components of AE will be multiplied to result in a ______ level of real GDP, while any autonomous decrease in one of the components of AE will be multiplied to result in a _____ level of real GDP.

Higher; lower.

Exchange rates (as a factor affecting NX)

If the Australian dollar ($AUD) appreciates (increases) in value, then imports become relatively cheap and exports became relatively expensive compared to other currencies (i.e. International competitiveness is reduced). Therefore, NX decrease. On the other hand, a depreciation (decrease) in the AUD results in Australian exports having improved international competitiveness, with exports becoming relatively cheap and imports relatively expensive. Therefore, NX will likely increase.

Deregulation and competition policy: Example

In 2014, the government commissioned the Harper Review to inquire into the nation's competition policies. It made over 50 recommendations, some of which were adopted by the government.

Trade liberalisation: Recent example

In 2019, the Morrison Government negotiated a FTA with Indonesia.

Taxation reform: Example

In 2019, the Morrison Government passed its Income Tax Cuts Bill, which issued a series of tax cuts to Australian households, and in the 2019-20 Budget it outlined reforms to the taxation system to simplify it and thus make it more competitive and efficient, which will come into effect in 2022-23.

Education and training policy (implemented to improve productivity): Example

In the 2019-20 Budget, the Morrison Government subsidised 80 000 new apprenticeships to implement this policy.

Financial markets represent the ____________ between ______ and _________, or _______ and _________. There are three main types of these: ____, ____ and ____ markets. These have a significant impact on the levels of ________ and ________ ________ and, in turn, are impacted by ________ _____ and, therefore, the ____ ____.

Intermediary; savers; investors; lenders; borrowers; loan; bond; share; spending; economic activity; interest rates; cash rate.

Automatic stabilisers

In-built mechanisms that smooth the fluctuations associated with the business cycle without the government making and implementing decisions about changing revenue or expenditure patterns.

Equilibrium; inventories; fall; increasing; rise; reducing; equilibrium.

Increase; decrease.

Technological change and innovation (as a cause of structural change)

Increased technology levels tend to lead to improved transportation and communication techniques (through improved speed and cost efficiency), which drive the globalisation of markets and expose firms to more competition.

A point inside the PPF represents an ___________ outcome. This will be present in all three of the _________, _____ and _______ phases of the business cycle, since the economy is not operating at ____ ________ and an ______ ___ is present, which is represented by the distance between the point and the ___ itself. However, during a ____, this will not exist, since the economy is operating at ____ ________ and will be sitting on the ___ itself; an _________ outcome.

Inefficient; downswing; trough; upswing; full capacity; output gap; PPF; boom; full capacity; PPF; efficient.

An output gap is ___________, because it means that the economy is not operating at ____ ________.

Inefficient; full capacity.

Inflation rate: Formula

Inflation rate = (CPI[year 2] - CPI[year 1])/CPI(year 1) x 100.

The AD/AS model accounts for _________ in its depiction of the price level. It can also be used to show an output gap and, therefore, ____________ (of resources)/_____ ________.

Inflation; unemployment (UE); spare capacity.

R&D boosts productivity in that it leads to __________ which, in turn, reduces _____ __ __________ for private firms and grants them a competitive advantage. It is also associated with a number of ________ _____________ (e.g. Greater stock of human capital) which can also improve productivity, however, since R&D is not necessarily associated with ______, it may not be provided by the _______ sector, meaning the government has to intervene.

Innovation; costs of production; positive externalities; profit; private.

Productivity growth also has the effect of increasing _____________ _______________, since domestic firms should gain an advantage over foreign firms in terms of both _____ (since _____ __ __________ are effectively reduced when firms are able to produce more outputs of goods and services with the same amount of inputs, thus __________ supply) and _______.

International competitiveness; price; costs of production; increasing; quality.

__ is the most volatile component of AE, due to the high level of ____ it is associated with. _, on the other hand, is the most stable component of AE, due to the perpetual need for spending on ___________ products by _________. Furthermore, __ can also be a relatively volatile component of AE.

Ip; risk; C; non-durable; consumers; NX.

LP (growth): Formula

LP = Capital deepening + MFP (growth).

While changes in one of the factors affecting ____ will likely result in a shift in both LRAS and SRAS, an alteration in one of the determinants of ____ will almost certainly only shift the SRAS curve.

LRAS; SRAS.

The G multiplier will always be ______ then the taxation multiplier (by ___), because changes in tax only alter the net amount of ___________ through the ___ (i.e. _______ is a factor), whereas changes in G directly affect ____ ___ and the level of economic activity. Therefore, it is more effective to influence the level of economic activity through changes in _, rather than _.

Larger; one; consumption; MPC; savings; real GDP; G; T.

An increase in the PL causes a movement ____ (and __) along the AD curve, while a decrease in PL causes a movement _____ (and ____).

Left; up; right; down.

Government bonds

Loans to the government, which raise a small amount of funds for their issuer (through the low rate of interest charged).

Government policies (as a factor affecting Ip, including the RBA)

Lower levels of taxation on firms will typically result in increased Ip, as will government incentives to produce (e.g. Subsidies), due to the greater business profitability these policies promote. Changes in the cash rate also influence interest rates, which also affect Ip. The government's ability to provide a stable macroeconomic environment is also a key determinant of Ip, as is the degree of business regulation.

The _____ the level of real interest rates, the _______ the level of C, ceteris paribus. This is due to the fact that __________ on loans are reduced at such times - increasing the likelihood of households _________ loans to spend - and therefore consume less __. Also, the ___________ ____ of C falls, as saved funds have a lower rate of return.

Lower; greater; repayments; acquiring; Yd; opportunity cost.

The _____ the interest rates, the higher the levels of Ip, ceteris paribus. This is because _____ interest rates lead to less __________ on borrowed money (borrowing money is usually required for investment on _______ equipment to occur), increasing business _____________, and a reduced ___________ ____ of investment, since investment ____________ (such as _______, which will grow in proportion to the interest rate) are less attractive. However, the _________ of __________ ______ with respect to ________ _____ contradicts this, since the current stage of the business cycle is typically ____ likely to influence investment than interest rates.

Lower; lower; repayments; profitability; capital; opportunity cost; alternatives; savings; elasticity; investment demand; interest rates; more.

Relationship between the MPC and MPS (formula)

MPC + MPS = 1

MPC: Formula

MPC = ΔC / ΔY (gradient - [y2-y1]/[x2-x1]). - Δ: "Change in".

Taxation multiplier: Formula

MPC/(1-MPC) or MPC/MPS or G multiplier - 1.

Capital equipment requires ___________. Therefore, improvements in ______________ tend to improve productivity, since it assists in the provision of this.

Maintenance; infrastructure.

Microeconomic reform

Measures implemented by the government to amend relatively small-scale markets.

Real GDP

Nominal GDP adjusted for/less inflation.

A shift in the consumption function is caused by a change in a __________ determinant of C. A change in the ___ will alter the gradient of this line.

Non-income; MPC.

Time lag

Occurs when a period of time/gap exists between when an economic activity takes place and its when its impact becomes apparent.

Long-run equilibrium

Occurs when all three curves (AD, SRAS and LRAS) intersect; when actual output equals potential output and economic indicators are in their target range.

Equitable distribution of income

Occurs when net earnings in the economy are dispensed in an even manner but not to the extent that the incentive to work is undermined.

Unemployment

Occurs when people who are actively seeking work, and are both willing and able to participate in work, cannot find employment.

Efficient allocation of resources

Occurs when resources are assigned to their best use such that the amount of output per unit of input (productivity) is maximised.

Price stability

Occurs when the general level of prices is experiencing little or no sustained appreciable rise or decline.

If the MPC was equal to zero, then the multiplier effect would equal ___. Any value larger than this for the MPC and the multiplier is _______ than this. Technically, since an MPC of one would make the multiplier equal to ________, there is no _____ _____ to the multiplier. However, in reality, the size of ________ associated with savings, taxation and imports ______ the value of the multiplier.

One; greater; infinity; upper limit; leakages; reduce.

Ideally, inflation-targeting results in the _____ economic indicators also ___________ and it is generally effective in keeping ________ _____ under control during periods of economic _________. This helps achieve ___________ economic growth and avoids _________ business cycles. It also has a major impact on household and business __________.

Other; stabilising; interest rates; expansion; sustainable; boom-bust; confidence.

An increase in AD causes a rise both the __ and ______ (represented by ____ ___/______), as well as a decline in __, and is shown by a shift _____. On the other hand, a decrease in AD will theoretically lead to a reduced __ and ______ but a rise in __. This is shown by a shift ____.

PL; output; real GDP; income; UE; right; PL; output; UE; left.

Economic growth is __________ related to structural change. Specifically, economic growth ______ structural change, because it raises ______, which changes patterns of _. If it is __________, it can also cause _____ in some sectors while others _______ - further structural change. Likewise, structural change ______ economic growth, because it reflects a ____________ of resources, typically to more _________ uses.

Positively; causes; incomes; C; unbalanced; growth; decline; causes; reallocation; efficient.

Productivity growth is __________ related to price stability, because, with _____ __ __________ effectively reduced, SRAS _________, putting _________ pressure on inflation/the price level.

Positively; costs of production; increases; downwards.

Productivity growth is __________ related to the efficient allocation of resources, because it ________ the rate at which productive inputs are converted into outputs of G + S, including all _____ of efficiency.

Positively; improves; types.

Productivity growth is __________ related to sustainable EG, because it _________ SRAS, thus __________ output (at a _____ PL, which leads to a subsequent _________ in AD), income and expenditure without consuming a greater amount of ______. The LRAS curve also shifts _____.

Positively; increases; increasing; lower; expansion; inputs; right.

Discretionary consumption expenditure can be _________ and is therefore a relatively _______ component of consumption and has a ____________ relationship with the level of income.

Postponed; volatile; proportional.

Contractionary Budget stance

Present when the Budget is implemented with the intention of decreasing the general level of economic activity, by decreasing expenditure or increasing taxation relative to the previous Budget (and thereby indirectly reducing household and business spending). This is characteristic of a boom or expansion and tends to be associated with a Budget surplus.

Expansionary Budget stance

Present when the Budget is implemented with the intention of increasing the general level of economic activity, by increasing expenditure (or decreasing taxation) relative to the previous Budget (thereby stimulating household and business spending). This is usually associated with a Budget deficit and is typical of an economic trough or contraction (and, therefore, tends to have very little impact on price levels, since there is a large amount of spare capacity).

Neutral Budget stance

Present when the Budget is implemented with the intention of maintaining the current level of economic activity, by not altering (or only minimally changing) the previous Budget's expenditure and revenue patterns. This tends to result in the Budget outcome moving towards balance and may occur when the government's primary economic objectives are being met.

Headline inflation rate

Price changes measured by the Consumer Price Index (CPI), which simply uses the quarterly changes in a "basket" of goods and services that account for a high proportion of household expenditure.

The _______ sector is responsible for the majority of Australia's output and, therefore, drives productivity growth in the nation. However, the ______ sector can also influence this.

Private; public.

Trade liberalisation improves productivity by reducing _____________ and expanding the ______ of firms to a wide range of markets, thus increasing their exposure to ___________. Through this process, Australia's economy has become relatively ____.

Protectionism; access; competition; open.

MFP growth reflects changes in output occurring for reasons other than increases in the ________ of ______ and _______, i.e. _______ improvements.

Quantity; labour; capital; quantity.

Because economic growth is measured using ____ ___, it is dependant upon __.

Real GDP; AD.

A positive relationship exists between the PL and SRAS, because increases in production should lead to an increase in the price of _________ (especially ______, represented by _____ _____), causing the general level of ______ to increase. Likewise, decreases in production lead to reduced _____ __ __________ overall (again, especially ______) and, therefore, a lower __.

Resources; labour; wages rises; prices; costs of production; labour; PL.

An increase in SRAS is represented by a shift _____ and causes a decline in _________ but an increase in ______ (and thereby a reduction in __). However, a decrease in SRAS (shown by a shift ____) leads to both _________ and __ (as a result of reduced ______ and, therefore, _____ ________).

Right; inflation; output; PL; left; inflation; UE; output; spare capacity.

Over time, LRAS shifts _____, due to an increasing __________ ____/________ pool and improving ____________ and levels of __________. ________ _____ also tends to drive the same process for the AD and SRAS curves.

Right; population size; resource; productivity; technology; economic growth.

The stage of the transmission mechanism whereby real interest rates change in response to an initial alteration to the cash rate is caused by/reflects the new level of ____ associated with borrowing and the need for _________ (the ability to convert assets to cash), as well as the changed _____________ of banks in the financial market.

Risk; liquidity; profitability.

Structural balance

The difference between allocative, regulatory and redistributive G and taxation, which is the result of discretionary fiscal policy.

Classical economists split AS into ____ and ____, whereas Keynesian economists represent it as a single curve, albeit with three different ______.

SRAS; LRAS; stages.

Keynesian economists do not believe in the effectiveness of the _______________ _________ of the economy, since they hold that wages are ________ and that, therefore, __________ intervention is required to restore ________ equilibrium in the economy.

Self-correcting mechanism; "sticky"; government; long-run.

Over time, in relation to structural change, Australia's ________ sector has expanded greatly, now being responsible for roughly ___ of all output. The ______ sector has expanded slightly, producing approximately __ of all output, while _____________ (___) and ___________ (__) have declined in their respective shares of output and employment.

Services; 77%; mining; 8%; manufacturing; 10%; agriculture; 5%.

On the Keynesian AD/AS model, there is no need to distinguish between _________ and ________ equilibrium, since the ____ and ____ curves are combined into a single __ curve.

Short-run; long-run; SRAS; LRAS; AS.

Government expenditure (G)

Spending on goods and services that are intended for current consumption (G1) or public infrastructure (G2) that is undertaken by the government.

During periods of low economic activity, the government tends to aim to _________ the economy, whereas during periods of high economic activity the government traditionally attempts to ________ the economy. This is typically achieved by targeting __________ and __________ in the ______.

Stimulate; contract; households; businesses; Budget.

The Budget stance is determined by the __________ balance, not the _______ balance.

Structural; overall.

Structural reform and productivity growth are both ___________ policies; they directly affect __.

Supply-side; AS.

Main assumption of the Keynesian AD/AS model

That wages are "sticky"; they do not change readily, especially in a downwards direction.

Labour market reform: Example

The Howard Government's "WorkChoices Act (2006)" reformed the labour market and promoted productivity by limiting the ability of unions to operate in the deregulation thereof.

Infrastructure policy (undertaken in order to improve productivity): Example

The National Broadband Network (NBN), which was provided by the government from 2009 onwards in order to deliver higher-speed internet connection to households.

Profitability

The ability of a firm to make a profit/generate an adequate return on invested resources.

Autonomous consumption

The amount of consumption that occurs no matter how much disposable income consumers possess, in order for them to satisfy their basic needs. This is a constant and appears graphically as the y-intercept.

Disposable income (Yd)

The amount of income households receive after tax.

Budget

The annual government statement that estimates government revenue and the cost of expenditure plans for the coming year.

Trend output/growth

The average growth rate achieved in previous years.

Infrastructure

The basic underlying framework of the economy, which allows for its maintenance and productive operation.

Vertical disintegration

The breaking down of the production processes in the production chain into distinct stages which are undertaken by separate companies, each performing and specialising in a subset of activities required to create the finished product.

Monetary policy

The cash rate decisions made and implemented by the Reserve Bank of Australia (RBA) in order to affect financial conditions within the economy (by influencing interest rates), with the aim of achieving its economic objectives.

Law of diminishing marginal returns/utility

The continual decrease in the marginal output of a product as units of a productive output are continually incrementally increased, eventually to the point of this becoming negative.

Investment (Ip)

The creation or accumulation of capital (machinery which is used to assist labour in production), as well as additions to inventories and housing investment.

Cyclical balance

The difference between G and T resulting from automatic changes in the level of taxation revenue and expenditure on transfer payments.

Output gap

The difference between actual and potential output in an economy. On the Keynesian AE model this is represented by the distance between the equilibrium level of income and the full employment level of income.

Profitability (as a factor affecting Ip)

The greater a firm's profitability, the higher the level of Ip. This is often due to the greater pool of funds available to firms to spend on new capital equipment.

Levels of Yd (as a factor affecting C)

The greater the amount of Yd households have, the greater the level of C.

Domestic business cycle (as a factor affecting NX)

The greater the level of domestic economic activity, the greater the level of imports and, therefore, the lower NX (and vice-versa).

Underlying inflation rate

The headline inflation rate minus the volatile and seasonal elements, in order to more accurately determine the "true" rate of inflation.

Overseas business cycles (as a factor affecting NX)

The higher the level of economic activity in the economies of the nation's trading partners, the greater the demand for Australian exports and, therefore, the greater the level of NX.

Changing average incomes (as a cause of structural change)

The higher the levels of income, the greater the demand for discretionary/durable products, which become more affordable. Demand for inferior goods will also decline in such a scenario.

Sustainable economic growth (EG)

The increasing capacity of the economy to satisfy the material needs and wants of its members, without having an adverse effect on the price level or negatively impacting future generations or the environment.

Budget stance

The intended impact of structural fiscal policy on the level of economic activity.

Planned Budget

The intended relationship between G and T that the Government aims to achieve in the Budget.

Human capital

The knowledge, skills and attributes embodied in human beings.

Government policy (noting the effects of the RBA)

The lower the level of taxation and/or the higher the level of government spending (including on welfare), the higher the level of C is likely to be. In relation to the RBA's monetary policy, the lower the cash rate, the greater the level of C, due to the effect this has on interest rates through the transmission mechanism.

Natural rate of UE/full employment

The minimum level of UE that can be achieved given the current characteristics of the labour market and without causing inflationary pressure. This is equal to the combined structural and frictional levels of UE.

Consumer expectations (as a factor affecting C)

The more positive household expectations are, the greater their spending likelihood.

Cash rate

The official interest rate on overnight loans in the money market (i.e. Between banks borrowing funds from one another in exchange settlement funds), which is set by the RBA.

Transmission mechanism

The process whereby a change in the cash rate affects the overall level of economic activity.

Privatisation

The process whereby government-owned assets are sold to the private sector.

"Crowding out"

The process whereby higher demand for scarce funds or resources in financial/labour markets created as a result of increased government borrowing (and, therefore, expenditure) results in private sector difficulty in attracting funds and resources, thus causing public investment to replace private investment. This reduces the effectiveness of G, especially in the context of investment (albeit usually only to a minor extent).

Self-correcting mechanism

The process whereby macroeconomic equilibrium is automatically restored in the economy over time. This is a feature of the classical AD/AS model.

"Crowding in"

The process whereby reduced demand for scarce funds or resources in financial/labour markets (as a result of reduced government borrowing and expenditure) causes an increase in private sector investment, as the availability of funds improves and, therefore, interest rates decline. This reduces the effectiveness of contractionary Budget stances (albeit usually only to a minor extent).

Deregulation

The process whereby regulatory impediments to production are removed, in order to boost efficiency and, therefore, productivity.

Inflation targeting

The process whereby the RBA, in setting the cash rate through the implementation of its monetary policy, focuses primarily on the economic indicator of inflation and keeping it within its 2-3% p.a. target range.

Labour market reform

The process whereby the labour market (i.e. The exchange of this factor of production) is amended, especially in order to promote productivity.

Multiplier effect (k)

The process whereby the net level of income/GDP in the economy changes in proportion to an initial autonomous change in AE (or one of the components thereof).

Taxation reform

The process whereby the taxation system is amended, typically in order to better satisfy the criteria of a system that allows for productivity growth.

Marginal propensity to save (MPS)

The proportion of any change in income (represented as a decimal) that is saved. This represents the gradient of the savings line in the consumption function.

Marginal propensity to consume

The proportion of any change in income (represented as a decimal) that is spent on consumption. This is the slope/gradient of the consumption function.

Marginal propensity to import (MPM)

The proportion of any change in income that is spent on imports of goods and services.

Budget outcome/balance

The relationship between G and T that is achieved in the actual Budget itself.

Trade liberalisation

The removal of barriers to free trade (e.g. Tarrifs, subsidies and quotas) in order to promote a more open economy characterised by the unhindered exchange of goods, services and ideas with overseas nations. This often takes the form of negotiating free trade agreements (FTAs).

Macroeconomics

The study of large-scale economic performance and growth.

Aggregate expenditure (AE)

The sum of all spending on finished goods and services undertaken in the economy over a certain period of time.

Implementation/action lag

The time that passes between decisions being made as to appropriate policy changes (in response to the recognition of an economic activity) and the execution of these decisions.

Recognition lag

The time that passes between economic indicators changing and this alteration being acknowledged.

Effect/impact lag

The time that passes between policy decisions being made and their effect on household and business behaviour.

Decision lag

The time that passes between recognising changes in economic data and deciding upon the appropriate policy changes.

Aggregate demand (AD)

The total amount of expenditure in the economy that occurs at each respective price level over a given period of time.

Aggregate supply (AS)/short-run aggregate supply (SRAS)

The total amount of production of G + S in the economy at each respective PL over a given period of time.

Gross Domestic Product (GDP)

The total value of all final goods and services produced in a country over a period of time (usually a year). This is the most common measure of the level of economic activity, or output.

Inventory

The unsold stock that a firm possesses. This is also known as unplanned investment.

Fiscal policy

The use of government expenditure and revenue collection (i.e. Taxation) - through the Budget - to directly and indirectly influence the level of economic activity in the economy and achieve the government's major macroeconomic objectives.

Changes in the level of education and skills training (as a cause of structural reform)

This can improve efficiency in certain sectors, making them more competitive and eventually resulting in an increase in their share of output and employment. Occupational mobility can also be hereby improved.

The emergence of major producers of industrialised goods in East and South East Asia and other exposure to international competition (as a cause of structural change)

This has led to more competition internationally (e.g. China, Japan, Malaysia and Thailand), thus leading to structural reform as the less efficient firms are forced out of the market. In this context, production patterns have shifted from elaborately transformed manufactures (ETMs) to simply transformed manufactures (STMs), although changes in commodity prices and the exchange rate have also driven this.

Microeconomic reform (as a cause of structural change)

Trade liberalisation and other competition policies (including deregulation and privatisation) lead to increased exposure to competition and, therefore, structural reform, as the less efficient firms are forced out of the market.

Recession

Two consecutive quarters of negative real GDP growth.

Cyclical unemployment (UE)

UE that is caused by deficient levels of aggregate demand, as the demand for final goods and services fluctuates with the ups and downs of the business cycle.

In the case of a contractionary gap, according to the self-correcting mechanism, higher __ should lead to a fall in real _____, ultimately shifting the SRAS curve _____ (due to decreased _____ __ __________), towards the ____ level. Thus, the long-run ___________ level of output is eventually restored. A contractionary gap can also be shown on the Keynesian AD/AS model. Specifically, the horizontal distance between the _______ level of output and the ____ __________ level (which occurs in the vertical _________ _____) represents a this.

UE; wages; right; costs of production; LRAS; equilibrium; current; full employment; classical range.

The impact of productivity on employment is _________. Specifically, while short-term __________ __ may occur (with businesses potentially being able to produce the same output with fewer workers after _______ _________), firms may seek to gain a ___________ _________ over rivals by hiring ____ workers. Also, new _______ equipment might necessitate the employment of ____ skilled workers to operate it, potentially increasing employment.

Uncertain; structural UE; capital deepening; competitive advantage; more; capital; more.

As a measurement, UE has its limitations in that it does not reflect the full ________________ rate since it does not account for those who are _______________ (currently in part-time work but are both willing and able to participate in, as well as actively seeking, full-time employment). Furthermore, the ________ of UE is not considered, nor is the ___/________ demographic reflected in the headline rate.

Underutilisation; underemployed; duration; age; regional.

The Keynesian AE model can be used to show ____________ and _________. Specifically, when the economy is not achieving equilibrium at the point where the ____ __________ line cuts the 45 degree line, then ____________ is present, as is a ____________ gap (this also occurs with a ________ in AE). However, when the economy is operating above the ____ __________ level/when an ________ in AE occurs, an ___________ gap is present and ____________ is reduced.

Unemployment; inflation; full employment; unemployment; deflationary; decrease; full employment; increase; inflationary; unemployment.

MFP: Formula

Value of output (or GDP) / (labour hours + capital inputs).

LP: Formula

Value of output (or GDP) / total labour hours worked.

Consumption function: Equation describing income

Y = C + S.

MPS: Formula

ΔS / ΔY.