Topic 1: Introduction to Economics Joshua Hua YR11 The economic problem Scarcity causes us to be left in a state of dissatisfaction as our unlimited wants are burdened by the scarcity of resources. We are forced to choose between our wants. Understanding wants Wants are the desires of individuals or community. They derive utility (satisfaction) from consumption of goods and services.

● Individual wants- wants of each person ● Collective wants- wants of the whole community ● Complementary wants- wants that go in conjunction with one another ● Recurrent wants- wants that are never satisfied and go on and on ● Substitutable Wants- wants able to be swapped out for another

Future Implications Of Current Choices The main objective of engaging in economic activity is to maximise the returns from using the resources that are available, this is known as allocative efficiency (where resources are allocated according to the preference of consumers).

● Consumers- consumers have a limited income, current spending decisions reflect the individual's desire to maximise utility (satisfaction). Choices faced by consumers include: essential goods and services, now and foregoing luxuries or they could save.

● Businesses- Firms face the opportunity cost of producing some goods and services and not others. Businesses profits can be distributed as dividends to owners to satisfy wants or they could be retained and used for the future for investment in capital goods.

● Governments- Governments have limited taxation revenue which they spend on community infrastructure. Governments may choose to give a higher priority to satisfy immediate needs such as welfare payments and defence but they will be forced to spend less on other areas such as education. This will cause lower economic growth as there are lower skilled workers.

Factors Of Production

1. Land- all natural resources 2. Labour- human effort used in production 3. Capital- ‘produced means of production (goods used to produce more goods and

services in the future) such as machinery, tools etc. 4. Enterprise- the ability of entrepreneurs to organise the other FOPs in a business to

produce goods and services Key Economic Issues

1. What to produce? - Limited resources means we must satisfy the wants with the highest demand

2. How much to produce? - Allocate limited resources efficiently and maximise the satisfaction of wants in order to not waste resources

3. How to produce? - How to allocate resources in the production process, look for the most efficient methods of production

4. How to distribute production? - Who should get most of the resources first? Each person's share of total production depends on their level of income

Opportunity Cost Of Choices The cost of the alternative uses of resources. For example, if a person has $100 and they spend $60 on clothing and $40 on food, they sacrifice less food for more clothing. Possibility Frontier An economy’s possibility frontier (PPF) or curve refers to the maximum production potential of the economy with finite resources at a point in time, or all the possible combinations of the production of 2 goods/services. The main assumptions of the PPF are:

1. Economy produces only 2 goods/services 2. All resources are fully employed 3. Level of technology is constant 4. Quantity of resources are fixed

The Operation Of An Economy An economy refers to the way in which a society is organised to solve the economic problem. There are two broad types of economic systems:

1. The market or free enterprise economy is based on a system of markets and prices which allocate resources and allow private property rights, the profit motive, capitalism

2. The planned economy is based on a system of government ownership of most resources and the allocation of these resources depend on government plans, communism

Factors Of Production And Return

Resource Reward

Natural Resources (land)- all resources provided by nature in the production process

Rent- all income rewards derived from the productive use of natural resources

Labour- human effort in the production process. Changes overtime as population increases.

Wages- include all executive salaries, commissions, fees for professionals and earnings of self employed people as well as regular payments.

Capital- ‘Produced means of production’, capital goods are produced to be used in the production of other goods.

Interest-- When entrepreneurs borrow excess savings, they pass interest on their loans. Percentage they pay.

Enterprise- Organising factors of production into a business

Profit- revenue earned from the total business. They are entitled to rent for any use of land that they own, wages for their work, interest for any interest for any capital.

Circular Flow Of Income

Equilibrium occurs when the sum of all leakages are equal to those of injections. Disequilibrium occurs when there is an inequality between the two. S + T + M = I + G + X

● When leakages outweigh injections there will be a downturn in the level of economic activity (lower incomes, rising unemployment etc). As the level of economic activity falls, total leakages from the economy also fall as consumers have less to save and spend on imports. Therefore equilibrium will be restored eventually at a lower level of income. S + T + M > I + G + X

● When total injections outweigh the leakages there will be an upturn in the level of economic activity (rising wages, lower unemployment etc). As the level of economic activity rises, total leakages from the economy also rises as consumers have more to save and spend on imports. Therefore equilibrium will be restored eventually at a higher level of income. S + T + M < I + G + X

The government can have a significant influence on the circular flow of in that it can change the levels of taxation and government expenditure, therefore manipulate the total size of leakages and injections. How Economies Differ Market Economy- All major economic decisions are made by individuals and private firms, who are both motivated by self-interest and profit. NO pure market economy exists as governments intervene with the economy. Characteristics of a market economy:

● The market system- a market is a network of buyers and sellers. In the markets for goods and services, known as product markets, the buyers are the consumers and determine the demand. The sellers are businesses and supply products. The price mechanism (process where forces of supply and demand interact and determine price) brings supply and demand together.

● Consumer Sovereignty- Consumers are free to choose how they spend their income, therefore determine what is produced and how much (demand).

● Private Ownership- Individuals have the right to own the means of production and can use these to derive income and acquire wealth.

● Freedom of enterprise- individuals have the right to use their resources as they choose and are free to set up profit making activities. Workers are also free to choose their occupations.

● Competition- the force that allows price mechanisms to work effectively. Means that there are large numbers of buyers and sellers that ensures that no one buyer or seller is big enough to influence the market price to their advantage.

Mixed Economy- decisions concerning production and distribution are made by a combination of market forces and government decisions. Planned Economy- an economic system in which the government controls and regulates production, distribution, prices, etc. Government intervention

Governments intervene in production because the free market does not always provide the most efficient allocation of resources. There are 3 considerations:

1. Some necessary goods and services may not be provided under a pure market system 2. It is sometimes better for essential goods and services to be provided by governments 3. Markets do not always operate freely, competitively and in the best interests of the

economy. The government provides regulations to prevent exploitation The government intervenes in the distribution of output (income) because free markets will not provide a socially desirable distribution. This is done in 2 ways

1. Social welfare payments- age pensions etc 2. Progressive income tax- high income earners are taxed a higher rate

The market economy is subject to fluctuations of the business cycle. Governments smooth the effects of the cycle and reduce excess economic activity. Also during times where there is a threat of a major economic problem Topic 2: Consumers And Businesses Consumer Sovereignty Consumers determine what is produced (demand), their freedom to choose what they buy and which wants to satisfy. Firms will produce whatever goods and services are in the highest demand. As an economy becomes more prosperous, demand for luxury goods increases. There are several aspects of business conduct that can reduce the sovereignty of consumers:

● Marketing- Some marketing strategies aim to manipulate the behaviour of consumers and can diminish consumer sovereignty as loss of trust.

● Misleading conduct- Consumers can be deceived by false claims about a product, leading them to pay for items that they don't really want

● Planned Obsolescence- Firms produce goods that are purposely designed to wear out quickly in order to encourage consumers to make further purchases in the future

● Anti-Competitive Behaviour- Firms that operate in markets where there are few other sellers can also diminish the ability of consumers to choose what they really want.

Spending Or Saving With a person's income, they either spend or save. The proportion of an individual's income that is spent on consumption is called average propensity to consume (APC). The proportion of an individual's income that is saved is known as average propensity to save (APS). The sum of APC and APS must be 1 C/Y = APC S/Y = APS Y= C + S C= consumption Y= disposable income S= Savings A variety of factors influence the decision about whether to spend or save (the 2 main factors are age and level of income):

● Cultural factors- some cultures tend to save more than those in industrialised economies

● Personality factors- some people are more cautious and prefer having savings for the future

● Confidence and future expectations- When consumers are worried about future economic downturn, they tend to save more. On the other hand if their income rises they spend more

● Any future plans- individuals might save for a major expense ● Tax policies- the tax system can make it more attractive to save (lower taxes on

superannuation savings) or to spend ● Availability of credit- if credit is readily available, spending is likely to be higher this

creates new source of money for expenditure. ● Income-As income rises, people tend to spend or save a higher proportion of their

income. The marginal propensity to consume (MPC) is the proportion of each extra dollar of income that goes to consumption (change in spending). The marginal propensity to save (MPC) is the proportion of each extra dollar that is saved. MPC= ΔC / ΔY (C2-C1/Y2-Y1) MPS= ΔS/ ΔY (S2-S1/Y2-Y1)

● Age- Our level of income constantly changes as we live. When people are young they tend to receive lower level of incomes as they lack skills and experience and education. Therefore they spend most of their income and save very little, they would often dissave (spending more than saving). However once people start working in their middle age, their income rises and they tend to consume a smaller proportion as they start saving for retirement. Once people retire, they no longer earn income. This theory is referred to as the life cycle theory of consumption.

Factors Influencing Individual Consumer Choice

● Level of income- As individuals earn higher incomes, they tend to choose to buy more items and items of higher quality.

● The price of the good/service- Consumers decide if they are willing to pay the nominated price for an item, given their level of income. Some goods are necessities and people will buy them regardless of price

● The price of substitute and complementary goods- The quantity of a good demanded at any time will be affected by the prices of other goods. Consumer consider some goods to be substitutes (good that consumers can buy in place of another) such as butter and margarine. If the price of butter is too high, they buy margarine. Complementary goods are goods bought in conjunction with one another such as DVDs and DVD players.

● Consumer taste and preferences- Consumers buy goods that give them the highest level of utility and some goods provide higher utility than others such. Innovation and technological progress lead to consumers demanding new and better products at the expense of superseded ones.

● Advertising- Advertising exposes consumers to new products creating demand Social Welfare Social welfare payments are payments made to assist and increase the incomes of individuals or families in need of assistance (also known as transfer payments). This income is collected through taxes and is a way governments can encourage spending.

● Assistance to the aged (pensions)- For people over 65 years of age and retired ● Family payments- for families with children ● Disability support- for people who are not able to work due to personal factors ● Unemployment benefits- for people who are seeking work but unable to find it

Business Firms And Industries A business firm is an organisation involved in using entrepreneurial skills to combine FOPS to produce goods and services. An industry consists of those firms involved in producing a similar range of items. Production Decisions

1. What to produce- Several factors influence these decisions ● The skills and experience of the business operator- a person is likely to be

successful in operating in an industry that they know well ● Industries where there is a strong consumer demand- an entrepreneur is

more likely to be attracted to an industry where rapid growth is being experienced ● Specific business opportunities- An individual might find a specific business

opportunity attractive. IE a region that does not have a particular kind of business

● Amount of capital required to start- An entrepreneur is attracted to a business with a low start up cost

2. How much to produce- This will be based on the level of consumer demand and its ability to convert that demand into sales of its items. If firms produce to little, they lose out on potential customers but if they produce too much, goods will spoil.

3. How to produce- The production process involves combining a range of inputs (resources) in order to create outfits (goods and services). A firm's decision about how to produce depends on the relative efficiency of the FOPs. Firms will choose a combination of FOPs that are most efficient as they are ever changing.

Business Contributions To The Economy A healthy growing private sector (no government influence) will generate higher rate of economic growth and a stronger revenue base to fund government services. Growing businesses also employ more people (reducing unemployment), contribute to regional development, increase an economy's productive capacity. This would be reflected in the outward shift in the PPF. Goals of firms include:

1. Maximising profits- making the biggest possible profit or the smallest possible loss is the main objective of firms. Profit = (output x price) - Cost

2. Meeting shareholder expectations- This is a legal responsibility governing operations of corporations in Australia. Company directors represent shareholder interests and this will sometimes cause tensions because there may be a conflict between actions that maximise share prices and dividends in the short term that most likely reduce the firm's value in the long term.

3. Increasing market share- business functions are generally split between the owners (shareholders) and paid managers. Shareholders take on the function risk, supplying capital therefore they demand maximum profits. Where as managers take on organisational functions and seek increased salaries, power and prestige.

4. Maximising growth- maximising the rate of growth of the firms assets, in the long term, a larger asset base should allow higher profits. This could lead to business failures.

5. Satisficing behaviour- Firm does not attempt to maximise any objective but rather seek an adequate level of attainment in each area.

Efficiency And Production Productivity refers to how much we produce with a given quantity of resources, per unit of time. Whilst production refers to the total amount of goods and services produced. Productivity contributes to an improvement in our standard of living in several ways:

● Less wastage of our scarce resources- we are using our resources more efficiently, we are able to produce more with a given quantity and time

● Lower production costs and higher profits for the business firms- each FOP can produce more in any given time period, it costs less to produce the same quantity of G/S.

● Higher incomes- since labour is more productive, firms can afford to pay better wage rates

● Improved international competitiveness of our industries- increased productivity compared with foreign businesses will make australian goods more competitive on international and local markets

Specialization and productivity Where factors of production are used more intensely for a smaller number of production process. The table describes how specialization can occur in relation to 3 FOPs.

TYPE DEFINITION EXAMPLE

Division of labour (specialization of labour)

When businesses break down their production process into a number of sub-processes, allowing labour to specialise in a particular part of process.

The assembly line approach to car production where each worker completes a small task in the construction of each vehicle

Location of industry (specialization of natural resources)

When a large number of businesses that produce similar goods and services congregate in the same area to reduce production costs by sharing similar infrastructure requirements

The concentration of advanced technology industries in the macquarie park industrial area.

Large scale production (specialisation of capital)

When businesses grow so large they can use highly specialised capital equipment in their production costs

A large wine producer that uses specialised machines to bottle and label wines

Internal Economies And Diseconomies Of Scale

● The concept that a firm needs to achieve a large scale of production in order to minimise cost is known as internal economies of scale, are experienced when average costs per unit of production falls as the size of output grows.

● A firm cannot grow and benefit from falling per unit costs of production indefinitely. It will eventually reach the point where costs of production will start to rise and these disadvantages are known as internal diseconomies of scale. Most factors that cause this are related to management factors, as the size of a firm grows, management may not be able to efficiently organize all areas of the business.

This is known as the long run average cost curve and Q represents the technical optimum (most efficient level of production). External Economies And Diseconomies Of Scale There are other cost advantages and disadvantages that can affect a business, which lie completely outside its control and these are known as external D and E of scale.

● External Economies Of Scale- cost saving advantages that accrue to a firm because of outside influences such as:

1. Increasing localisation of industry- means that all firms in a particular region would enjoy cost saving advantages such as locating near a highly populated area with a supply of labour

2. An industry as a whole grows- The government could provide special research and development to help promote the industry

3. A growing capital market would benefit all firms as it would provide cheaper investment funds.

● External Diseconomies Of Scale- cost saving disadvantages that often result from the growth of the industry from outside influences such as:

1. Growth causes pollution- can potentially cause restrictions 2. As an industry grows, the cost of a firm's raw materials can rise as the

increasing demand forces up the prices Investment, Technological Change And Ethical Decision Making Ethical decision making is when business decisions about production methods and other matters are made taking into consideration on the impacts on broader society and environments.

● Production Methods- Technological change and innovation have increased the productive capacity of the economy by making it possible to use existing resources more efficiently.

● Prices- Technology has allowed for a more well-informed marketplace as search engines give consumers access to price comparisons, forcing firms to reduce their costs to compete

● Employment- Technology has made previous jobs redundant as machines can do jobs quicker and more efficient, resulting in job losses. However it provides job opportunities for employees in IT. Ethical decision making also impacts employment strategies such as hiring women.

● Output And Profits- businesses that invest in technology are likely to be able to offer better quality products at a lower price. By using the latest tech they are able to better

respond to changes in market demand and customise their output to the specific needs of the market. This is beneficial in the long term but in the shorter term, businesses must be prepared to make a substantial investment

● Types Of Products- New tech expand the range of products that may be produced to satisfy market demand. Tech creates completely new products and industries and are a major reason why some people regularly update products.

● Globalisation- The development of global money and stock markets has made it possible for businesses to attract investment funds from across the world. The low costy of communication allows for inform,item to flow more freely fro, overseas to consumers and businesses, allowing better informed decisions.

● Environmental Sustainability- minimising pollution and waste, preserving natural environment and increasing the use of renewable energy.

Topic 3: Markets Part 1 Role Of The Market A market is a situation in which buyers and sellers are in contact with each other for the purpose of exchange. The interaction between product and factor markets involves the principle of derived demand, where the demand for productive resources are derived from the demand of the output. Markets are the main price mechanism for solving the economic problem. Market economies discriminate in favour to those with the highest income. There are 2 types of markets:

1. Product markets- where and how final goods and services are bought and sold. Consumers buy the final output with their money incomes

2. Factor markets- refer to markets where FOPs are bought and sold such as the labour market.

Role Of Price In Market Economies The interaction between supply and demand determines equilibrium (no tendency for the price and quantity demanded or supply to change). Prices serve 5 main functions:

1. Reflect the relative scarcity of goods and services in terms of their supply 2. Help allocate resources in the production process which yields the highest returns 3. Act as incentives for producers and entrepreneurs to take risks in organising FOPs 4. Act as a rationing device in enabling markets to clear 5. Act as an equilibrating device in markets.

Factors Affecting Demand

● Price of the good or service itself- consumers must decide where or not they are willing to pay the nominated price for an item. Some goods are considered necessities and people will buy them regardless of price change

● The price of other goods- consumers consider some goods to be close substitutes such as butter and margarine. If one goes up, they buy the other. Some goods are considered to be complimentary meaning they are bought in conjunction.

● Expected future prices- If consumers expect future prices to fall, they will hold off on buying a particular good/service but if they expect it to increase they will consume more

● Changes in consumer tastes/preferences- Innovation and technological advancement has lead to consumers demanding new and better products at the expense of superseded ones.

● Level of income- As people earn higher incomes they become more willing and able to purchase more goods and services that they previously couldn’t afford.

● Size of the population and age distribution- Population size will affect the total quantity of goods demanded whilst age distribution will affect the type of goods demanded

Movements In The Demand Curve Movements are only caused by the change of the price of the good/service itself. There are 2 types:

1. Contraction- occurs when an increase in price, causes the quantity demanded to fall

2. Expansion- occurs when a decrease in price causes the quantity demanded to rise

Shifts Of The Demand Curve Shifts are caused by other factors that exclude the price of the good itself. There are 2 types:

1. Increase- a rightward shift, meaning consumers are willing and able to buy more of the product at each possible price than before.Also, consumers are willing to buy a given quantity at a higher price than before.

2. Decrease- a leftward shift means that consumers are willing to buy less of the product at each possible price than before. Also consumers are willing and able to buy a given quantity at a lower price than before.

Factors That May Cause An Increase/Decrease In Demand

● Price of other goods and services- a rise of the price substitute goods will cause consumers to demand the alternative and vice versa. A fall in the price of complementary goods may cause increase in demand.

● Expected future prices- If consumers believe a particular product will increase in price in the future they will buy more now

● Consumer taste and preferences- If something is more fashionable, consumers would want to buy more of that item at that price. Technology also makes makes more high quality items making old items superseded.

● Consumer Income- a rise in the level of income will mean consumers can afford to buy more items

● The size of the population and age distribution- increase in population means an increase of demand for all of that item and age will determine type.

Price Elasticity This measures the responsiveness of quantity demanded to a change in price. Firms need to understand price elasticity of demand for the goods they sell in order to decide on their optimal pricing strategy. If demand was low, firms would lower prices to increase the volume of sales. Governments need to understand this when pricing the goods and services it provides for the community as well as any indirect taxes that affect the elasticity. Price increases- revenue increases = inelastic Price increases- revenue decreases= elastic Price- increases- revenue stays the same= unit elastic

Perfectly Elastic And Inelastic

● Perfectly Elastic- consumers will demand an infinite quantity at a certain price but nothing at all at a price above this.

● Perfectly Inelastic- consumers are willing to pay any price in order to obtain a given

quantity of a good or service. These are considered necessities.

Factors Affecting Elasticity Of Demand

● Whether the good is a luxury or necessity- Goods and services that are necessities are relatively inelastic as an increase in price will not cause a great fall in demand

● Whether the good has any substitutes- Goods and services that have substitutes generally have high elastic demand as if one good becomes too expensive, they simply buy the other.

● The expenditure on the product in proportion to income- Goods that take up a small proportion of income would have a lower elasticity

● The length of time subsequent to price change- consumers generally take time to become aware of price changes.

● Whether the good is addictive- Goods like cigarettes are relatively inelastic as they continue with their habits

Factors Affecting Market Supply Supply is the quantity of a good or service that all firms in a particular industry are willing and able to offer for sale at different price levels, at a given point in time. The law of supply states that ‘ceteris paribus’, the quantity supplied in a market is positively related to price. As price increases, supply increases. Factors that affect supply:

● The price of the good or service itself- the market price of the good or service will influence the producers willingness and ability to supply.

● Price of other goods or services- If the price of one good remained the same whilst another increased, it would be more profitable to produce the good that increased in price

● State of technology- improvements in technology lower production costs and allow more firms to supply more goods at a given price.

● Changes in costs of FOPs- A fall in the price of FOPs would mean more production and vice versa

● The quantity of the good available- this involves scarcity, number of suppliers also affects the quantity of the goods or services available.

● Climatic and seasonal influence- Changes in season mostly influence agriculture

Price Elasticity Of Supply This measures the responsiveness of quantity supplied to a change of price.

● Perfectly elastic supply- suppliers would supply an infinite amount of the good whereas below the price they would not

● Perfectly inelastic supply- The quantity supplied is fixed, producers are willing to supply a given quantity no matter the price.

Factors Affecting Elasticity Of Supply

● Time lags after price change- The greater the amount of time that producers have to respond to a price change the more elastic the supply. In the short run, the price elasticity of supply increase after a price change although it is still likely to be inelastic. In the long run the producer would be able to increase any of the inputs in response to a price change making supply elastic.

● The ability to hold and store stock- The easier it is to hold stock, the more elastic the supply. Some goods are perishable and cannot respond to a price change such as vegetables making supply inelastic

● Excess capacity- when a firm is not using its existing resources to their full capacity. Supply is elastic when firms have excess capacity because they can respond quickly to any price increase by using their resources more intensely.

Markets Part 2 Equilibrium Equilibrium occurs where the demand and supply curve intersect and achieved when any consumer willing to pay the market price for a good/service is satisfied and any producer who offers to sell their g/s at market price is able to sell. Factors shifting demand:

● Increase in sub price ● Decrease in comp price

● Increase in future expectancy price ● Incomes ● Increased population ● Change in taste and pref

Factors shifting suppkly

● Lower FOP price ● Improved tech ● Lower profit of sub goods ● Seasonal changes

Role Of The Market The price mechanism (market price of goods and services determined by interaction of supply and demand) plays the most important role in solving the economic problem. Attempts to solve the economic problem in the product market (demand and supply for outputs of production) by determining the price and quantity that best satisfies individual wants with limited resources. Producers will only produce goods and services with high demand. Price mechanism also plays a role in the factor markets as demand and supply in the factor market determines price of FOP. ALso ensures allocative efficiency (economies ability to distribute resources to satisfy consumer wants). Competition And Market Power

Market Structure

Number and size of firms

Product characteristics

Barriers to entry

examples Pricing power

Pure competition

Very small firms but many

Homogenous (all sell the same products)

none Purely theoretical -fruit and veg

none

Monopolistic competition

Large number of relatively small firms

Similar but not identical ->product differentiation

Some small barriers Ie brand loyalty

restaurants small

oligopoly Small number of large firms

Similar but differentiated products

High barriers

Banks, oils, airlines, supermarkets

high

monopoly Only one firm

One of a kind, no substitutes

Extremely high

water absolute

Government Intervention Governments intervene to stop market failure. Market failure occurs when the price mechanism takes account of private benefits and costs of production to consumers/producers but fails to take into account indirect social costs such as damage to the environment. Social costs and benefits that firms and consumers do not consider are called externalities.

● Quantity intervention- Demerit goods that create negative externalities can be limited by artificially restricting the production of goods through laws such as pollution emission permits. Governments can also impose taxes that pay for the social costs.There are also positive externalities that come from merit goods such as public transport and vaccines. The government may intervene to encourage the production/consumption of these goods through subsidies or producing the good itself.

● Price intervention- government may determine that some prices are too high or low. They implement price ceilings or price floors to influence the distribution of income. Price ceilings will redistribute income from sellers to buyers and floors will do vice versa. Main problem is that these cause market disequilibrium.

Price Controls

Price ceiling Price floor

A maximum price for a good or service is established below market equilibrium -aims to help buyers

A minimum price that a government may establish above the equilibrium price -aims to protect sellers

Examples: Sydney water Example: Minimum wage

Effect on market outcome:

A price ceiling below equilibrium will cause: ● Cause disequilibrium in the market

since the quantity demanded exceeds the quantity supplied

● Results in shortage of goods in the market

A price floor above equilibrium will cause: ● Causes disequilibrium since the

quantity supplied (q2) will exceed the quantity demanded (q1)

● Results in surplus of AB

Issues ● Controls needed to ration the

available goods, can cause equity problems as wealthier individuals have greater access to g/s

● Potential corruption and black markets as consumers may be willing to pay market price for a good (concert ticket etc)

● Suppliers may collude to maintain high price

Issues ● Surplus: government must remove

this surplus which is costly ● Dumping: sellers may ‘dump’ excess

in other markets ● Inefficient: misallocated of productive

resources

Imposition Of Taxes

● Impact of tax- refers to who it is levied on ● Incidence of tax- refers to who ultimately pays the tax ● Direct taxes are paid by those that the tax is levied on and cannot be passed on to

others (eg income tax) ● Indirect taxes are levied on one group but usually passed on partially or fully to the final

customer (eg GST, excise tax) Governments can intervene in the price mechanism through indrect taxes as sellers will reduce supply by size of tax due to reduced incentives to produce at a lower price. Indirect taxes aim to -raise revenue (eg GST) -encourage certain economic behaviours due to scarcity or negative externalities

Topic 4: Labour Market The Demand for labour Firms demand labour by offering wages, however the demand for labour differs from consumer demand for goods and services because the demand for labour is a derived demand. This means the demand for labour is dependant on the demand for goods and services. When consumers demand higher levels of g/s, firms are forced to increase their level of output. 3 main factors to influence a firms output are:

● General economic conditions (aggregate demand)- higher rates of economic growth are associated with falling unemployment levels and vice versa. Therefore changes in the demand for labour will occur as a result of fluctuations in the business cycle.

● Conditions in the firms industry- labour is a derived demand. ALso an industries barrier to entry and level of regulation or price competition.

● Demand for an individual firm's product- effectiveness in selling its goods. Even in an economic downturn, a firm can still experience growth through customer service and marketing. IE specialisation of g/s that makes the product unique

Flowchart on how an economic downturn affects demand for labour:

The productivity of labour A firm generally has choices between using labour more intensely or relying on technology (capital). The productivity of labour and overall labour costs in comparison to inputs such as tech will determine the extent of use. Formula for productivity of labour: Labour Productivity = Total output / Labour Input Generally, labour productivity depends on the quality of the workforce, including its overall level of education, skills, health and depends on how efficiently labour can be combined with other FOP. Labour productivity could also increase with the help of capital without improvement to employees. In the short run, higher labour productivity means that a fixed number of workers will be producing more goods and services, causing output of a firm to rise without the firm having to hire more workers. The overall effect of an increase in productivity of demand for labour in the short term will depend on the current level of aggregate demand.

● Rising AD- if AD is rising, there is higher demand for g/s. If AD is rising at a faster rate than the increase in productivity, the higher demand will be greater than the higher production generated by workers. FIrms will increase the demand for labour to meet the level of AD.

● Falling AD- if AD is falling but productivity is rising, the demand for labour will fall even more. Existing workers will be producing more output but there will be less demand for that output in the economy. IF businesses wish to maintain profits, they will lower demand for labour

● AD is unchanged- If AD is unchanged but labour productivity is rising, existing workers will be producing more g/s but there wont be higher demand in the economy. This

means that firms have excess capacity and will not need more labour causing demand for labour to decline.

The cost of other inputs In determining the ratio of labour to capital, firms attempt to measure the full cost of labour against the full cost of capital investment over time. Capital is a substitute for labour, so changes in the price of capital have a similar effect on the demand for labour. A firms demand for labour will be more elastic (respond more sharply to price changes) when:

● It is easy to substitute between labour and capital ● Labour costs are a relatively high proportion of its total costs ● It is more difficult for the firm to pass on increased labour costs in the form of higher

prices to consumers The cost of labour for employees does not just reflect wage rates; it also includes other labour on-costs. There are additional costs of employing labour, such as: long service leave entitlements, sick leave, holiday pay, superannuation etc. The cost of capital is represented by a number of factors. Interest rate being the most important, as it represents the cost of borrowing funds to purchase new capital equipment . The IR also represents an opportunity cost as the funds used to invest in capital could be used in savings to earn return. A firm might also consider outsourcing its operations overseas Factors influencing labour demand

Output factors Input factors

● General economic conditions ● Conditions in the firms industry ● Demand for an individual firm's

product

● Productivity of labour vs other inputs ● Cost of labour vs other inputs ● Cost of labour vs cost of foreign

labour

. The Supply of labour Individuals supply labour when they are ready and willing to work in the labour market. The supply curve for labour slopes upward as the higher the wage level, the more individuals are ready and willing to work. Factors influencing the supply of labour, participation rate(microeconomic):

Factor definition/characteristics

Increase supply of labour

Decrease supply of labour

Pay levels The higher the wage, the more people are willing to supply their

Higher pay Lower pay

labour

Working conditions Attractive working conditions = more willing to supply labour. Conditions such as: Opportunities, entitlements, work environment, education

Better conditions Worse conditions

Human capital requirements

Education, skill and experience are all elements of HCR. Some jobs like medicine require a greater capacity of skill

Decreased requirements

Increased requirements

Education and training cost/opportunities

Some jobs requires time, sacrifice and effort to obtain skills required

Decreased costs and increased opportunities

Increased costs and decreased opportunities

Occupational mobility The ability of labour to move between different occupations in response to wage differentials and employment opportunities

Increased occ mobility

Decreased occ mobility

Geographical mobility The ability of labour to move between locations in response to improved wage differentials and employment occupations

Increased geo mobility

Decreased geo mobility

Labour market institutions (employer associations and trade unions)

Could impose minimum standards for education and training that restricts the job

Lower standards Increased standards

Government policies Can limit the supply Lower restrictions Increased restrictions

of particular occupations by imposing certain qualification and license restrictions as well as taxes on certain g/s

(macroeconomic)

Size of population A larger population causes a greater potential workforce, increasing the quality and supply of labour

Increased population Decreased population

State of the economy Participation rate is procyclical so if the economy is in a state of prosperity, people would be actively seeking jobs

expansion contraction

Age distribution of population

Would negatively impact the labour force in the long run as there is a decreased amount of young workers if people retire at a later age.

Younger population Older population

Key Definitions

● Working age population - number of people aged 15 and over ● Labour force (workforce)- all employed and unemployed people at a given time, does not

include those not actively seeking work (must be 15 and over) ● Participation rate- labour force / working age population X 100

The Australian Workforce The work force can be divided into 2 categories, employed and unemployed. A person that is employed works one or more hours a week and an unemployed person is define as a person actively seeking work but unable to find it. A person is included in the workforce if:

● Aged 15 and over ● Employed at least 1 hour a week

OR ● On paid leave, strike or workers compensation ● Unemployed- actively seeking work but cannot find it

A person is not included in the workforce if: ● Retired ● Aged under 15 ● Performing full time domestic duties ● Full time student ● Not seeking a job

The size and quality of the workforce is affected by three main factors, size of population, age distribution and educational patterns.

● Population size- the larger the population, the greater the potential workforce. Population growth is influenced by 2 factors. Natural increase which is when there are excess births over deaths. Net migration which refers to the excess permanent new arrivals from overseas.

● Age distribution- the workforce is comprised of 15-65 year olds. There has been a decline of the people under 15 and increase in the 65 which diminishes the long term labour market. The older you are the more experience in the industry you have generally

● Education patterns- the single most important factor influencing the quality of workforce. Individuals who have years of training and education will benefit from higher earnings. This will benefit the economy in the long run

Wage Outcomes Key definitions

● Nominal wage- wage received by an employee in dollar terms ● Real wage- actual purchasing power of the wage ● Inflation- the rate of price increase ● Labour productivity- quantity of output produced in a production process per unit of

labour at a given time ● Average weekly earnings- the average weekly gross rate of pay. In 2016, the average

total earnings of all employees was $1192 per week and the ABS earnings report shows that average total earnings has grown at an annual rate of 3.5 percent during the past 2 decades. During the past 5 years to 2016, wage growth slowed to an average of 2.5 percent

ABS earnings report 2016 shows that wages are the most important outcome to households as they provide 55 percent of income. If nominal wages rise fasterp than inflation, real wages increase (more spending power). If nominal wages rises slower than inflation, then real wages decrease (less spending power) Differences in wage outcomes

Wage differential

Key australian stats 2015 causes

Between occupations

-Highest paid group are managers with a mean weekly income of $19131/week. This reflects a higher level of education and training -lowest paid group were labourers with an average of 1119/week

-different occupations require different levels of skill and wage differentials reflects this. IE retail assistant vs doctor -people generally receive higher incomes for working in an industry that requires greater skill and longer period of training -Some occupations have less appealing working conditions like mining due to isolation and dangers -occupational mobility. If there is greater OM, it causes a lower wages due to the greater levels of labour supply. If OM is low, there is a lower amount of labour, causing higher wages

Within occupations

In the 2011 mining boom, companies were offering year 10 school leavers up to $100,00 as an apprentice starting wage

-reflect various degrees of experience -geographic mobility will influence wages. IE, a miner is employed in isolated locations, which causes higher wages -productivity of labour, greater productivity generally allows greater bargaining power -capacity of the firm, some firms are more profitable and have greater capacity to pay wages

age Wages highest between 25-65 year olds

Income levels reflect the degree of experience and are generally lower in the earlier stages of life and decline when people retire

gender 1990, 345 females were employed compared to 520 males

-women are generally discriminated against in the workforce which means fewer job opportunities -women also retire to fulfil other roles such as raising children

Migrant status

Almost 3/10 of every australian worker were born overseas

-although workers who have migrated to Australia have higher wages, they have fewer rewards, most likely because of the lack of english proficiency -overall, migrant and austrlaina born workers slowly conform to the average for

all Australians

Cultural background

Indegenous Australians do not follow the trends and are at a disadvantage. Their weekly earnings are only 63% of the average.

Trends in the distribution of income from work Key definitions:

● Industrial relations system- interactions between employers and employees and the laws and industries that regulate these interactions

● Award wages- documents setting out the minimum pay and conditions for different industries and occupations. Fair work act 2008

● Enterprise bargaining- negotiations between employers and employees about pay and work conditions at the level of the individual firm. The trend for the past decade is decentralising of EB

● Quintile- five equal sized income groups ranked from the lowest to highest As employers gain more power over the determination of wages (decentralising of enterprise bargaining), wage differences increase greatly causing an inequality. Evident in the ABS household income and income distribution table: The past decade, the highest quantile have seen an increase in their total income, receiving 40.8% of total earnings. Over the decade, income inequality has gotten worse due to decentralising of EB as shown in 1996 where the highest quantile earned 37.1% of total earnings and in 2018, they earn 40.8%.Declining rates of union membership and different levels of education/skill qualifications are the causes of wage differences. Non-wage outcomes non wage outcomes are benefits that employees receive in addition to their ordinary payment. IE, sick leave, superannuation etc. Several types of non-wage outcomes exist. Popular ones:

● Salary packaging- employees receiving a car,laptop, and other types of assistance from the employer

● Bonus cash payments- normally made as a performance bonus either based on company profit performance or the employee’s individual work performance

● Improve flexibility for employees in their work patterns- might include study leave, paternal leave, work from home etc.

Costs and benefits of inequality Economic benefits of inequality:

● Inequality encourages the labour force to increase education and skill levels- those with higher qualifications and skills reap higher income rewards, new entrants and existing employees will be encouraged to improve their education/skill levels. Leads to a healthier workforce.

● Inequality encourages the labour force to work longer and harder- the potential to earn higher incomes produces an incentive for workers to work longer hours or to work overtime, which may enhance economic growth. Workers will only do this tradeoff if the extra income is more valuable than their leisure time

● Inequality makes the labour force more mobile- higher incomes can act as an incentive to encourage labour to move to where it is most needed. Leads to a more efficient allocation of resources and a higher rate of economic growth.

● Inequality encourages entrepreneurs to accept risks more readily- unless entrepreneurs received extra reward for risk taking, there would be fewer entrepreneurs and businesses, a lower rate of economic growth, higher unemployment and reduced productive capacity.

● Inequality creates the potential for higher savings and capital formation- higher incomes means higher savings and this will reduce Australia's reliance upon foreign capital by providing domestic funds for investment

Economic costs of inequality:

● Reduces overall utility- people who earn higher incomes gain less utility from an increase in income than lower earners. Explained through the law of diminishing marginal utility: as more of a good is consumed it will provide progressively less utility to the consumer.

● Can reduce economic growth- low income earners spend a higher proportion of their income, whilst high earners often save majority of their increased earnings.

● Reduces consumption and investment- directly ties into eco growth. The cost of basic essentials such as housing and food take a higher proportion of low income earners so they spend a bigger proportion of their income.

● Creates conspicuous consumption- conspicuous consumption is the consumption of expensive goods and services such as designer clothes for the purpose of displaying wealth. This can lead to a culture where an individual's sense of worth is dependant on their social status

● Creates poverty and social problems- causes relative poverty, contributes to the development of an underclass of low income earners who have limited access to education and suffer health and other issues that causes a low participation rate.

● Increases the cost of welfare support- governments provide safety net income support for those in need. This demands government revenue as a larger amount of people require government assistance.

Social benefits of inequality:

- Gives incentives for individuals to work harder and improve their skills Socia; costs of inequality:

- Lower levels of well being - social problems such as mental illness, crime, lower levels of life expectancy are a result of inequality. The herald/age-Lateral Economics (HALE) index of wellbeing adjusts GDP to measure collective wellbeing and the recent rise of inequality is reducing well being by $2 billion per quarter

- Social class divisions - upper class, middle class, lower class. Can cause tensions between classes

- Poverty - poverty tends to trap families in a vicious cycle of low incomes and limited economic opportunities

Inequality of opportunity exists in Australia because:

1) Existing inequality in the distribution of income tends to perpetuate inequality of opportunity. Higher income earners tend to have greater access to resources

2) People who acquire wealth from inheritance have a greater opportunity to build up even more wealth

3) People like migrants may have limited access to networks of people that lead to new opportunities.

4) Not everyone has the same mental and physical attributes with regard to acquiring wealth and income. Some people may be more fit to do labour work causing a lower income.

Unemployment Unemployment refers to a situation where individuals want to work but are unable to find a job, as a result labour resources in an economy are not utilised. An unemployed person is classified as someone aged over 15 without a job, but actively searching for work (willing to look for jobs, attend interviews and work when asked). Unemployment rate % = number of persons unemployed / total labour force Types of unemployment:

Type Description

cyclical Caused by fluctuations in the business cycle impacting demand for labour (as it is a derived demand)

structural Due to mismatch between skills demanded by employers and unemployed. As the economy restructures from old to new industries, new skills are needed

seasonal Some jobs are more prominent in certain times of the year Ie a santa.

frictional Moving between jobs

Long term People who have been unemployed for a year or more. The longer a person stays out of work, the harder it is to get a job

Hard core Individuals who are unsuitable for work due to personal reasons such as mental illness etc

hidden Individuals who have given up searching for work or have returned to school -> not counted in official unemployment figures. Increases in hidden unemployment will be reflected in a fall in the labour force participation rate.

underemployment Includes individuals who wish to work more hours per week.

Movement Away from fulltime work Key terms:

● Part time employment- work 20 hours or less a week ● Casualisation of work (this is the recent trend)- growth of casual employments, decline of

full time ● Contractors- firms pays another business to do a service that is not fill time over an

extended period of time ● Outsourcing (subcontracting)- when a firm pays another business to perform a function

Factors causing the casualisation of work: some employees prefer part time work, allowing them to balance other responsibilities (work life balance). Women carry a greater child carrying responsibility, development of technology (communication and information) allows for more flexible work arrangements. Factors causing the increase of contractors and outsourcing- more flexible for employers as the less secure work arrangements allow for businesses to change their staffing levels more easily. Also some foreign labour could be cheaper than domestic. Advantages and disadvantages of casualisation

Advantages Disadvantages

-Flexibility for employers to increase or reduce staff levels -employers may avoid paying some non-wage costs such as redundancy entitlements -flexibility for employees for a work life balance

-less job security -more difficult for employees to plan for the future -less staff loyals and skill development

Australia’s Industrial Relations framework The relationship between employees and employers is known as industrial relations. The industrial relations system 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 Austrlian

labour market. Australia's IRS is governed by the fair work act 2009. The fair work commission is the government agency that regulates industrial relations in Australia. Minimum Employment Standards Australian employees have 10 guaranteed employment conditions which are set out in the law through a document called the national employment standards. These provisions include:

● Maximum weekly hours of work: a full time employee must not exceed 38 hours a week ● Right to request flexible working arrangements: parents or carers may request a change

in working arrangements to assist them caring for a child. Employers can only refuse on ‘reasonable business grounds’ and must justify their actions in writing

● Leave: Employees have the right to paid annual leave, public holidays and carers and compassionate leave. They further have the right to unpaid parental and long service leave

● Notice of termination and redundancy pay: employers are required to give between one and four weeks notice of job termination, determined by how long the person has been employed for. They are sometimes entitled to redundancy pay determined by duration of their employment

In addition, a national minimum wage provides a safety net for any employee not covered by an award. Fair work commission is responsible for setting the rate. Industrial Awards (safety net) Awards are a set of pay and conditions that are specific to an employee’s work or industry sector. Awards provide a safety net of minimum wages and conditions. Australia has minimum pay rates in 122 different awards set by the fair work commission. Awards extend the protections of the NES with provisions tailored to the needs of the specific industry or occupation. Enterprise Agreements The most common method of wage determination in Australia is a work placement agreement that is negotiated collectively through enterprise bargaining between an employer and employees (usually represented by unions). All agreements must comply with the NES standards and cannot offer pay rates below the award. Must also pass the “Better off overall test” (BOOT) requiring that employees be made better off by an agreement than an applicable award. Administered by the fair work commission. Collective enterprise agreements usually cover all of the workers up to management level in a workplace. Unions usually negotiate these agreements, covering issues like wage increases etc. Common Law Contracts Common law contracts (individual agreements) are not part of the formal industrial relations system but they comply with all of the minimum standards. They resolve disputes through the legislative system. They cannot offer pay rates below an award but there is an exception when they offer pay above 138 900 dollars.

The role of trade unions A trade union is an association of workers that aims to advance the interests of its members. The main role of trade unions is to represent their members' interests by negotiating wage increases, but also presenting employee interests in issues such as training and safety.

● Representing employee interests - Provides a voice for workers when management is implementing organisational changes and issues such as better training and conditions

● Exercising their bargaining power in negotiations with employers - their collective bargaining strength puts pressure on firms to increase the wage rate

● Restricting labour supply - unions can pressure firms to hire only certain people and causes a decrease in the wage rate which increases wage rates.

The role of employer associations Operate as industry based lobby groups to represent business interests on issues of economic policy such as taxation. In relation to the labour market they have 2 roles:

● They represent and promote the interests of their members by lobbying the government on industrial relations policies

● They assist employers in industrial relations issues such as wage agreements

Topic 5 Financial Markets Role Of Financial Markets

● Financial market- markets that create products that provide a return for those who have excess funds, making these funds available for those who need additional consumption or investment.play the role of providing a means for both savings and investment to occur which is key for eco growth.

● Financial intermediaries- firms that receive the accumulated funds of individuals or firms and than make loans to other firms or individuals. Act as the bridge between borrowers and savers, makes the savings and borrowing of funds more efficient

● Securities- any form of financial instruments such as shares and bonds that provide the holder of the instrument with a claim.

Primary And Secondary Markets

● Australian Securities Exchange (ASX)- the major share market in Australia ● Derivatives- a security that is based on another financial asset

Primary financial market -enables the creation of a financial asset (security) which can be sold into the economy, providing funds to company

Examples: -banks (shares) -When a mortgage is just taken out

Secondary financial market Examples:

-allows transactions of existing financial assets. Most transactions occur here

-share holder selling shares to another buyer -bank selling your mortgage to another bank

Main financial markets: ● The share or equity market - where ownership shares in companies are issued or

exchanged ● The debt market - where debt securities (such as bonds) are exchanged or where

money is lent and borrowed ● The derivative market - where people buy and sell financial assets that are based on the

value of another asset ● The foreign exchange - where financial assets of one country are exchanged for assets

in another Financial Market Products

● Credit - the loans extended to individuals, businesses and governments ● Interest - money paid regularly at a particular rate for the use of money loaned ● Bonds - written record of debt which lenders receive regular fixed payments (coupon

payments) and receive the principal value of the debt (face value) at the end of the bond period (date of maturity).

Variety of financial market products in the economy to meet the various needs of lenders and borrowers:

Consumer credit Allows consumers to purchase goods and services in advance of actual payment. Most common type of consumer credit is the credit card but have to repay interest. There are also personal loans offered by banks and credit unions.

Housing loans Long-term loans to purchase property requiring periodic payments with interest. Offered by banks and mortgage brokers.

Business loans Form of debt that allows businesses to invest in their business operations such as new technology or capital.

Short term money market Market involving banks and the RBA. short term securities (commonwealth government securities) are sold

bonds Bonds are longer term securities where lenders receive fixed payments (coupon payments) and receive the principal value (face value) at the end of the bond period (date of maturity)

Financial futures and options (derivatives)

Financial futures and options are contracts to trade in financial instruments at a certain date for a certain price. -Futures allow investors to protect themselves against changes

in the interest rates by agreeing on a price before hand -options give the holders the right to make such a transaction but not the obligation

Foreign exchange The market for buying and selling of foreign currencies

share A type of financial security that provides an individual with ownership over part of their business

The share market

1. Share - a financial asset that provides an individual with ownership of a country 2. Share market- the financial market where investors buy and sell shares 3. Share holder- an individual who owns shares in a company

Businesses can sell shares to raise funds needed for growth and individuals or other businesses can gain returns on surplus funds. A firm must be a company (incorporated) to sell shares. An incorporated business (company) is a company that is recognised as a separate legal entity from those individuals who own/manage the business. This means that it has ‘limited liability’ so if the business fails, the individuals who operate the business are protected from bankruptcy.

Public company Private company

An entity, whose shares are traded freely on the share market and are not subject to any restrictions on being transferred to other parties

Restricts ownership of shares to only a few individuals and places restrictions on share transfers so that ownership cannot be freely bought/sold.

The share market brings together buyers and sellers in a medium of exchange. Most transactions take place through a market facilitator known as a stock exchange. Shares are traded through the internet, increasing the speed, efficiency and accessibility of the market. The largest share market in Australia is the ‘Australian Stock Exchange (ASX). It matches sellers who have a desire selling price for a certain share with buyers who are willing to pay that price. Must be done through a broker who is registered with the ASX. Role and functions of the share market

● Dividends - the profit returns received by the shareholders of a business

● Capital gains - the profits made by investors who sell their shares at a price above the original buying price

● Float - when a company publicly sells their shares for the first time Sale of new shares = primary financial market transaction Sale of existing shares = secondary financial market The ASX acts as both a primary market and financial market as it allows for the creation of new shares as well as the sale of existing shares.

Role of the share market

For investors For companies

● Gain a stake in the company’s profits - dividends

● Capital gains from increases in share prices (when shareholders sell their shares)

● Limited risks - shareholders only stand to lose the amount they initially invested in the shares

● Opportunity to raise new funds for investment and business growth

● Changes in the share market is important in determining the structure and operation of a company:

Effect on the economy Share markets are an indicator of a country’s economic conditions as rising share markets indicate more investment which indicates that the economy is in a good position. The relationship between general economic conditions and share values can be measured through the ‘All Ordinaries Index’ which measures changes in the overall value of companies listed on the ASX. The share market also acts as a method of allocating resources to different types of production. The sectors with the best growth prospects will be able to use funds more effectively, therefore raise the most funds when floated. Speculation - buying shares with the intention of making a profit Regulation of financial markets

● Council of financial regulators - provides advice and information sharing for cooperation and collaboration amongst its 4 members: RBA, APRA, ASIC, and Treasury

● Reserve Of Australia (RBA) - Australia's central bank which has many functions: conducting monetary policy on behalf of the government, systematic stability, control of note issues, Banker to the banks (ESA), holding Australia’s gold and foreign exchange dealings, financial and economic advice for governments, regulation of payment system

● Australian prudential authority (APRA) - regulate all deposit taking institutions, life and general insurance, and superannuation funds

● Australian securities and investment commission (ASIC) - corporate regulation, consumer protection and the oversight of financial products

● Treasury - main source of economic policy advice to the government The Money Market The market for borrowable funds. Borrowers demand funds and lenders supply funds. The price in the money market is the interest rate. Borrowers - the demand for funds

● individuals : mostly for personal purposes (most common form is mortgage arrangements for the purchase of a home)

● Businesses: do most of the borrowing. They borrow to expand production, invest in research and development, complete any other special projects

● Governments: deliberate borrowing to raise the level of economic activity, fund major infrastructure

Factors affecting the demand for funds: Liquid funds: assets which are able to be easily converted into cash to be used as a medium of exchange. The demand for liquid funds was driven by 3 major motives:

● Transactionary motive: holding money or demanding funds due to individual demands for buying g/s

● Precautionary: holding money to have funds for unforeseen events such as illness or saving for expensive purchases

● Precautionary: holding money to take advantage of investment opportunities that might provide a return

Factors affecting Demand for Liquid Funds

Rate of economic growth Increase in economic growth -> increase real incomes + increase investment -> increase in demand for funds

Level of interest rates Falling interest rates -> larger proportionate increase in demand for funds

Ease with which one can convert non-liquid assets into money

Age Old people tend to hold more cash

Money and money supply Money plays a crucial role in the functioning of any modern economy. This is because:

● The value of all goods and services as well as resources can be expressed in terms of money

● A stable money system is important for the performance and growth of an economy

1) a medium of exchange - goods and services are exchanged for money

2) measure of value - money can be used to compare the relative value of g/s and resources

3) a store of value - money can be held over time and used for future exchanges

4) a method of deferred payment - money allows for the system of lendings and borrowings

Definitions

● Money supply - the total amount of funds in an economy that has the 4 key characters of money (RBA uses money supply)

● Money base - total amount of money in circulation and all bank deposits with the RBA. this is a measure of the most liquid financial assets. Currency + Bank deposits with RBA

● M3 - consists of all money base plus all bank deposits. RBAs definition of money supply Money base + bank deposits

● Broad Money - consists of m# plus deposits in non bank financial intermediaries M3 + NBFI deposits - NBFI deposits in banks

Topic 6 The limits of markets Market failure is when market operation forces creates unfavourable or inefficient outcomes. Governments intervene in markets to resolve market failure which occurs in 5 areas:

1. The market failure often fails to provide public goods, which may be socially valuable, but because of a lack of incentive, the private sector fails to provide these goods in sufficient quantity or quality

2. The market distributes income unequally. Distribution of income is based on the relative marginal productivities of the FOP

3. The market often fails to allocate environmental resources efficiently, leading to the problem of negative externalities

4. The market system may lead to the abuse of market power -> monopoly 5. Market economies suffer from regular fluctuations in economic activity

Characteristics and example Justification for gov intervention

Public goods -non excludable -non rival

-firms lack incentive to produce goods that may be socially

-eg: national defence valuable because of free riders

Merit goods -benefit the community beyond individual utility -eg: vaccines

-often there is little merit goods and providing them benefits the whole community

Demerit goods -g/s that are harmful to the community -eg: alcohol

-firms may produce too many g/s that harm the community

Natural monopolies

-market structure with one producer

Structure of Government

● Australian government/commonwealth - overall responsibility of economy and has most influence on the economy

● State governments - developing services and infastructure ● Local governments - minor role, community service etc

Constitution is the law making powers of the governments and sets the laws on how a country is governed.

Key roles Revenue source

commonwealth Business regulation, taxation, health and education

tax

state Public order, safety, health systems, education, infrastructure

Payroll tax grants

local Rubbish, roads grants

Public sector Refers to the parts of the economy that are owned or controlled by the government. Includes all tiers of the government. Key indicators of size of public sector

Changes over time Reasons for change

Total public sector outlays (spending) as a percentage

-increased spending in the second half of the twentieth

-changes in government spending, spend less on

of GDP century infrastructure and more on social welfare payments

Total public sector outlays (spending) as a percentage of total employment

-since 1985, public sector employment have declined

-governments have been contracting out many of their activities to the private sector

Australian Government Economic Function - Reallocation of resources Refers to the pattern of production in the economy. It directs resources towards the production of g/s that it considers desirable and promotes more efficient use of scarce resources. They aim to discourage the production of demerit goods and encourage merit goods. Internalise costs The government can affect the allocation of resources in three ways

1. Influencing consumer behaviours through tax or spending 2. Producing the good themselves 3. Regulatory policies like 18 age limit.

-taxation. Governments implement taxes to add costs to production, diverting resources away from certain types of economic activity (eg excise tax on harmful products). Contrastly, tax concession can attract resources towards specific areas. In turn, producers will adjust prices to reflect these cost changes which affects consumer demand. There are 2 types of taxation:

● Direct taxes - paid by individual on firm that the taxes are levied on and cannot be passed on (eg income tax)

● Indirect taxes - levied on individuals but can be passed to someone else. Attached to the product rather than the economic entity (eg GST)

NOTE: impact of tax refers to where tax is imposed. Incidence of tax refers to who bears the cost -Spending. Governments can directly reallocate resources or influence consumer decisions. The aim is to stop misallocation of resources

Spending type Purpose Example

Public Funding Ongoing financing of organisations providing socially beneficial goods or services

parks

Grants Specific funding for the establishment of socially beneficial businesses or activities

Educational systems

Subsidies Funding to reduce the cost of provision of goods or services

Cheaper transport (opal)

Service-agreement (cash payments)

Funding to organisations to provide specific services

Trade

Australian government economic function - redistribution of income Why redistribution? Without government intervention, high levels of inequality would occur as wealthy people tend to continue to earn more. THeir wealth brings in revenue from the FOP and they have higher opportunities to succeed. Top 20 percent of earners receive almost half of private income How redistribute? 1)Taxation -Tax base: the items that are taxed, generally 3 main bases for the imposition of taxes, income, wealth and consumption -Average rate of tax (ART): proportion of total income earned that is paid in the form of tax -Marginal rate of tax (MRT): proportion of any increase in income paid as tax. Different types of tax:

● Progressive tax - higher income earners pay a greater proportion of their income as tax than lower income earners. Eg, personal income tax

● Regressive tax - higher income earners pay a smaller proportion of their income as tax than lower income earners. GST is an example

● Proportional tax: all income earners pay the same proportion of tax. Company tax is an example

2)Social welfare payments -benefits low income earners -reduce inequality as high income earners are ineligible to receive benefits Australian government function - stabilisation and sustainable growth The business cycle follows a series of booms and busts and governments smooth out those fluctuations which in the long run, results in higher average levels of economic growth and improved living standards. There are 2 macroeconomic policies the government uses

1) Monetary policy - involves the actions taken by the RBA to influence the cash rate. This is done through its DMOs where CGS are bought and sold to influence the transmission mechanism. If the government wished to slow eco activity it would tighten MP if it wanted to speed up eco activity it would loosen MP.

2) Fiscal policy - basically tax system Public Enterprises GBEs are businesses owned and or managed by the government at either the commonwealth or state level. They play the role of monopolising businesses to encourage efficiency as well as funding businesses that the private sector refuses to produce.

Corporatisation occurs when the government encourages public trading enterprises to operate independently from the government as if they are private to improve efficiency and profit. Privatisation occurs when government sells off their businesses to the private sector. The Budget Fiscal policy is a macroeconomic policy that involves the use of taxation and spending powers through the commonwealth budget in order to achieve certain economic objectives (resource allocation, income redistribution, stabilising business cycle). Revenue 93% of the commonwealth government's revenue comes from taxes which can be split into direct and indirect taxes. -income tax (direct) makes up 68% of total government revenue:

● Personal income tax makes up 46% of the commonwealth revenue. ● Company tax accounts for 19% of revenue and imposed at a flat rate of 30% of net

profits of both private and public corporations. ● Small proportion of income tax comes from superannuation contributions (2%)

-Goods and services tax GST (indirect) 10% of most items sold in Australia except basic food. Makes up 15% of its revenue -Excise tax 8% of government revenue and is imposed on the producers of certain goods. -Non-tax revenue The government raises 7% from its profits Expenditure Major spending in areas:

● Social security and welfare - the largest government expenditure, represents transfer payments (payments aimed at redistributing income from taxpayers to welfare)

● education - funds education programs, scholarships etc ● Health - funds medicare and public hospitals ● Provision of infrastructure - roads, ports etc ● Protecting the environment and promoting ecologically sustainable development -

investment in clean energy and low carbon emission tech (small area of spending) Impact of budget outcomes The budget outcome gives an indication of the overall impact of fiscal policy on the state of the economy. There are three possible outcomes

Balanced budget Planned government revenue = planned government expenditure

Budget surplus Planned government revenue > planned government expenditure

Budget deficit Planned government revenue < planned government expenditure

The change in the budget outcome from one year to the next can indicate change in a government policy stance. Three stances are possible:

● Expansionary: the government might reduce taxation or increase government expenditure or both, creating a smaller surplus than previous or a bigger deficit. Aims to increase economic activity by stimulating AD → decrease unemployment but inflation grows

● Contractionary: increase taxation or decrease expenditure, creating a bigger surplus or a smaller deficit than in previous. Has a dampening effect on economic activity by decreasing AD.

● Neutral: does not change the budget outcome from previous years Automatic stabiliser The levels of revenue or expenditure can change automatically in response to economic conditions, knee jerk reactions. Automatic stabilisers are instruments that are inherent in the government's budget that is countercyclical. The two main types are progressive personal income tax and unemployment benefits.

● In an increase of economic activity - income levels increase which mean that tax revenue increases, unemployment falls which means unemployment expenditure falls