Topic 1: Intro to Economics

The Nature of Economics

Section 1: The Economic Problem- the fulfillment of theoretically
unlimited wants through the allocation of limited resources.
Wants and Scarcity

 Material desires whereby Individuals derive utility (satisfaction) over the consumption of g/s
 Needs refer to the necessities of life i.e. food, water and shelter
 Wants to refer to the material desires of individuals or the community, they provide some
pleasure or satisfaction when they are consumed.
 Individual wants- the desires of each person and to be able to purchase these wants depends
on their income levels. Lower income earners can satisfy less wants and the higher income
levels can satisfy a larger number of wants.
 Collective wants- the desires of the whole community. What is desired depends on each
individual community and not only those of an individual. These are typically provided by the
Government i.e. schools, parks and hospitals
 Scarcity: Limited resources in an economy
o What to produce: Limited resources  unsatisfied wants
o How to produce: Govt. must find ↑ efficient production method
o How much to produce: Resources must be allocated efficiently and maximise
satisfaction of wants
o Distribution of production: Equitable/Inequitable distribution, dependent on income
level (↑ Income = ↑ consumption of g/s)
The need for choice by individuals and society

 Both individuals and society are limited by scarcity (limited economic resources, unlimited
human needs and wants)
o People want more than what they can have
o We need to make choices, i.e. people need to pick which of their desires they will
satisfy and which they will leave unsatisfied
Opportunity cost and production possibility frontiers

 Definition: Alternative use of resources (next best alternative foregone)

o Examples:
 Individuals: Choice between buying a car or going on an overseas holiday
 Businesses: An entrepreneur who decides to produce travel bags gives up the
opportunity to produce something else- such as electrical appliances- with
those resources.
 Govt: Local = parks, State = Schools, Federal = Defence Force
o Production Possibility Frontier: Graphical representation of all possible combinations two
goods/services (or two types) produced at any given
time (maximum output)
 Assumptions of the PPF:
 Economy only produces two goods
 State of technology is constant
 Quantity of resources remains
 Unchanged
All resources are fully employed
o Factors affecting PPF:
 New technology: More output with same resources
 New resources: More input  More output (e.g. immigration  population
expansion)
 Unemployment: Under-utilised resources  total output < max output
(Maximum satisfaction of wants is not achieved with minimum opportunity
costs)
o Real life model:
 PPF is concave to origin (resources are better suited for the production of
one good compared to another good  loss of productive capacity)

Future implications
of current choices by individuals, businesses and governments

 Definitions
o Allocative Efficiency: Resources are allocated according to preferences of society for
certain goods and services
o Consumer goods: G/s produced for the immediate satisfaction of
individual/community wants
o Capital goods: G/s utilised in the production of future g/s (↑ future productive
capacity)
Economic factors underlying decision-making by groups

 Individuals
o Spending and Saving
 Consumers can choose to either spend or save
 ↓ Y = ↓ Consumption, ↓ Savings. ↑ Income = ↑ C + S
 Motives
 Transactionary: Finance cash purchases
 Precautionary: Unforeseen expenses
 Speculative: Investing in shares/bonds/cash for returns
o Work
 4 Types of Employment: Professional/Trade/Semi-skilled/Unskilled
 ↑ Skills = ↑ Income  ↑ Consumption and saving
o Education
 Education Level increases individual’s professional work opportunity
 ↑ Professional work  ↑ Income
o Retirement
 Employers must make 9% contribution (of wage) to superannuation
  ↑ Income  ↑ Compulsory super  ↑ Potential voluntary super

oVoting Patterns and Participation in politics

 Pattern: Upper class = Liberal, Working class = Labour
 Political Participation
 Dependent on economic policies
 Keeping the economy strong
 Managing budget policy
 Delivering ↓ RATES of Unemployment/Inflation/Interest
 Businesses
o Pricing: ↑ Mark-up = ↑ Profit
o Production: Involves use of labour and capital
o Resource use: Producers try to maximise productivity (efficiently allocating
resources)
o Industrial Relations:
 Safety Net System: Govt enforces minimum wage
 Enterprise Bargaining: Employers working with employees to negotiate
wages
 Governments
o Taxes both individuals and businesses to fund its expenditure
o Influencing decisions
 Resource Allocation: Funds the provision of labour
 Transport/Schools/Hospitals/Roads
o Economy Stabilisation
 Use of fiscal/monetary policy (e.g. raising interest rates if high inflation and
vice versa)
 Redistribution: Individuals are taxed dependent on income
o Regulation of economic behaviour
 Price control
 Provision of a law framework
 National competition policy
 Minimum wage
 Pollution legislation

Section 2: The Operation of an Economy

Production of goods and services from resources

 Factors of Production (Resources used in production of goods and services)

F.o.P Capital Entrepreneurshi Land Labour

p
Items used for Individual who Natural resources Physical/mental
Definitio production of other organises other used in the human effort used
n goods, increases F.o.P’s to produce production process to produce goods
productivity g/s and services
Reward Interest: Bank Profit: interest, Rent: All income Wages:
interest rates, profit wages earned from Commissions,
 margins productive use superannuation,
sick pay, annual
leave
Limit of willingness Population size, Limits to amount Population size,
to invest, level of ability and of resources school leaving age,
Scarcity savings willingness to take available retirement age, on-
risks the-job training,
childcare
Machinery, tools, Bakeries, Cafes, Soil, forests,
Example
roads, networks Restaurants mineral deposits,
s
(telecommunication) fishing areas

Distribution of goods and services

 Individuals contribute to production process  Market economy provides them with income
 Income is used to obtain goods and services
o Factors influencing income
 Scarcity of resource and level of demand
 How much they work
 Skills and expertise
 Educational qualifications
 Bargaining power with employers
o Income is redistributed by government through taxation (social welfare)

Exchange of goods and services

 Money is used as a medium of exchange

 Prices are indicators of the relative value of goods and services
 Exchange occurs in a market economy

Provision of income

 Individuals are paid rewards for their contribution (Wages, Rent, Interest, Profit)
 Final Income = Income – Taxation (Direct and indirect)
 Government redistributes income
Provision of employment and quality of life through the business cycle

 Definitions
o Recession: Negative economic growth in two consecutive quarters
o Boom: Positive economic growth in two consecutive quarters

When the Economy expands:

 Production increases - businesses more goods and services

 Unemployment decreases - Fewer people are out of work, as businesses need more workers to
produce more output.
  Wages Increase - Because businesses are doing well, they need to attract and keep workers by
offering high wages.
 Consumer Spending Increases - People spend more because they are earning higher wages
 Prices Increase - Prices increase as consumers spend more. This is known as inflation. 

When Economy Contracts

 Production decreases: businesses produce fewer goods and services (output)

 Unemployment increases: more people are out of work, as businesses need fewer workers
 Wages decrease: Because businesses aren’t doing as well, they can attract enough workers at lower
wages.
 Consumer Spending decreases: People spend less as they are earning lower wages
 Prices decrease: price decreases as consumers spend less. This is known as deflation.

 High level of specialisation  Interdependence between individuals, businesses, and

governments
 Employment (Private and Public Sector)
o Primary: Raw material extraction (mining)
o Secondary: Manufacturing of products (Factories)
o Tertiary: Provision of services

Circular Flow of income (Sectors of economic activity)

Economists sometimes build theoretical methods that can help

Equations of each model:

Y=Income, E=Expenditure, O=Output, S=Savings, I=Investment, T=Taxation, G=Government

Spending, M=Imports, X=Exports

 Two-Sector Model: Y=E=O

 Three-Sector Model: S=I
 Four-Sector Model: S+T=I+G
 Five-Sector Model: S+T+M=I+X+G
 Individuals
o Supplies factors of production (labour/entrepreneurship) to businesses
o Receives incomes as reward (Interest, profit, rent, wages)
o Individuals either consume (local/overseas), save, or pay tax with income
 Businesses
o Spends profit earned on investment, could obtain government subsidies
 o Depends on individuals for supply of resources and consumption for the produced
goods and services
 Financial institutions (engaged in borrowing and lending of money)
o Accepts savings from individuals and lends them out to businesses
o Savings are essential if investment is to occur
 Forgoing current consumption increases future productive capacity
 Government
o The Australian Government is made up of local, state and Commonwealth levels. The
government sector is involved with the satisfaction of the collective wants (schools,
hospitals, defence).
o The government collects taxes (a leakage) from both individuals and businesses and
satisfies collective wants through government expenditure (injection).
o Government spending is referred to as the Public Sector
o Combining the Private Sector and the Public Sector is referred to as the Domestic
Sector.
 International trade and financial flows
o Exports: G/S produced in AU, sold to overseas consumers
 Money is paid to Australian businesses  Inflow of income
 Stimulates production and employment opportunities
o Imports: G/S produced overseas, sold to local customers
 Money is withdrawn from AU economy, paid to overseas businesses
 Lower economic activity (↓ income/output/employment opportunities)
o International money flows
 Injection: Foreigners lending or paying income to Australians
 Leakage: Locals lending or paying income overseas to foreigners

 Equilibrium: Sum of all leakages is equal to sum of all injections

 Disequilibrium: Inequality between total leakages and total injections
o Leakages > Injections: Contraction in level of economic activity (S+T+M>I+G+X)
 Falling incomes
 Falling production
 Rising Unemployment
 Less leakages (consumers have less to spend on imports/taxes)
 Leakages = Injections (Lower level of income in circular flow)
o Injections > Leakages: Expansion in level of economic activity (S+T+M<I+G+X)
 Rising incomes
 Rising production
 Rising employment
 More leakages (consumers have more to spend on imports/taxes)
 Leakages = Injections (Higher level of income in circular flow)
Section 3: Economies: their similarities and differences
Background Information

 Australia’s trading relationships are mainly with Asian economies

o Half of our exports destined for Japan, China, and South Korea
 Relatively strong performance through 2000 global downturn
o AU’s economic fortunes are linked with Asian economies’ fortunes
 Diverse group of economies
o Large/Powerful (China/Japan) vs. Small/Rel. poor (Tonga/Vanuatu)
o Wealthy (South Korea) vs. less-developed (Timor Leste)
o Fast-growing (India) vs. slow growing (Japan)
o Former centrally planned (Vietnam) vs pro-market (Singapore/Hong Kong)

Rank Country 2014 GDP ($US billion)

1 China 10,360
2 Japan 4,601
3 India 2,067
4 Australia 1,454
5 Republic of Korea 1,410
6 Indonesia 889
7 Thailand 374
8 Malaysia 327
 9 Singapore 308
10 Hong Kong 291
Economic growth and the quality of life

 4th largest economy when compared to Asian economic region

 Top 6 = Group of 20
 Asian economic region = Fastest growing economic region since WWII
o 1st Phase: 1950s and 1960s = Japan’s rapid industrialisation
o 2nd Phase: 1970s and 1980s = South Korea, Singapore, Hong Kong, Taiwan
 Pursued growth strategies (competitive labour costs + growing export
markets, particularly for manufactured goods)
o 3rd Phase: Emerging and developing economies
 Average annual economic growth of 7.5% (China, Indonesia, India)
 Newly industrialised economies: 5.7% (SK, Singapore, HK, Taiwan)
 Developed economies = 1.8% (Japan)
 Industrialisation = V. rapid economic growth, slows down once finished
 Australia’s average economic growth = slower than most Asian economies
o Achieved industrialisation + high living
standards before WWII (3.3%)
 Quality of life: Measure of welfare based on more
than just economic output per capita
o Human Development Index: A measure that
takes into account income, life expectancy
adult literacy and educational levels

HDI
GDP/capita HDI value Life expectancy Mean schooling
Ran Country
(2014, $US) (2014) (years, 2014) years (2012)
k
2 Australia 61,219 0.933 82.5 12.8
7 New Zealand 43,837 0.910 81.1 12.5
9 Singapore 56,319 0.901 82.3 10.2
15 Hong Kong 39,871 0.891 83.4 10.0
15 Korea 28,101 0.891 81.5 11.8
17 Japan 36,332 0.890 83.6 11.5
62 Malaysia 10,804 0.773 75.0 9.5
91 China 7,589 0.719 75.3 7.5
108 Indonesia 3,534 0.684 70.8 7.5
121 Vietnam 2,053 0.638 75.9 5.5
135 India 1,627 0.586 66.3 4.4
o Australia: highly favourable social conditions
 Temperate climate, relaxed lifestyle
 High degree of cultural diversity (25% born overseas)
 Political and religious freedoms
Employment and Unemployment

 Australia’s unemployment rate = 6.2%

o Lower than unemployment rates of Indonesia and Philippines
o Higher than rates of fast-growing economies (Japan, Korea, Singapore)
 AU’s employment patterns: similar to most advanced economies
o Majority (<75%) employed in services industries (retail, business, real estate)
o Manufacturing and construction = Substantial number of jobs
o Agricultural sector: smaller than previous decades (<5%)
 Less developed economies: Large proportion of workforce in agriculture (Indonesia: 51%)
o Process of mass urbanisation  People moving from rural to urban areas for work

Distribution of income

 Pure market economies: Unequal

distribution of income
o People who own
resources/have most skills >
People who lack resources
 Agricultural developing economies:
Unequal distribution
o Divisions between urban and rural populations
o Concentration of land ownership amongst wealthier groups
 Mixed market economies is an economic system characterised by private sector making the
majority of economic decisions, with the government also playing a role in providing
collective goods and services; stabilising economic activity through the use of economic
policies; redistributing incomes through progressive taxation and social security payments to
improve social welfare. Australia is an example of a mixed market economy.
 General industrialised economies were formerly developing economies of low per capita
incomes and low living standards, but through industrialisation they have raised their levels of
income to become advanced market economies. They have sustained high rates of economic
growth through increased exports, high labour productivity and the encouragement of FDI in
developing their resources and export industries. NIES examples include Singapore, Hong
Kong and South Korea.
 The market economy- freedom of enterprise, private property rights, the profit motive and the
use of a system of markets to allocate resources. What to produce and how much to produce
are determined by the operation of a price mechanism. America is an example of a market
economy.
 The planned economy- is characterised by government ownership of resources. Production,
distribution and exchange take place according to government or state priorities and targets. It
is heavily influenced by Karl Marx’s socialist theory of economics.
 Emerging economies have sustained high rates of economics growth relative to the advanced
economies, however, still have widespread levels of income property within their country. ER
examples include Brazil, Russia, India and China (BRIC).

Environmental sustainability

 AU: ↑ Environmental qualities (↓ water/air pollution, ↑ efficient industrial processes)

1
o Poor record of preserving biodiversity ( megadiverse, ↑ species than others)
17
  >50 birds/mammals have become extinct over the past 2 centuries, one third
of the global total
 1700 animals/plants at risk of extinction
o Low water productivity ($US of economic output/m3)
 AU = $38, relatively low compared to Japan ($53) and South Korea ($47)
 Higher than NA ($27) and avg. East Asia and Pacific region ($13)
 China: V. ↑ air/water pollution, widespread health problems (pollution, toxic chemicals)
 Climate change: Emission of greenhouse gases (CO 2, NO, CH4)
o 14/15 warmest years = 21st century
o Ice thickness has decreased 40% since 1960s
o Extreme weather events occurring with greater frequency
o Avg. global temperature = ↑ between 1.0 and 5.4 degrees in this century
o Consequence of rising temperatures: Rising sea levels, ↑ harsh weather events, ↑
threats to economic health, food security, human health
 Difficult to achieve international agreement on how to reduce greenhouse gas emission
o 2009: Copenhagen Convention (confine global temp increases to <2 degrees Celsius)
o No binding international agreement to reduce greenhouse gas emissions
 Previous = Kyoto Protocol, 1997-2012
 Australia: Reduce carbon emissions to 26-28% of 2005 levels by 2030
o Direct Action Initiatives: Grants for businesses for project that lower carbon
emissions
o 17 tonnes of CO2/person (>50% than Japan/Korea, >70% average adv. economies)
 Asian economies also face unique problems
o Indonesia: Significant contributor to climate change (deforestation)
o China’s CO2 emissions: Major
impact on climate
o India: Poor urban planning,
outdated infrastructure
o Domestic policies + greater
global cooperation required
The role of government in health care,
education and social welfare

 Asian economies
o Market economies: East Asia, e.g. Japan, Korea, Singapore, Indonesia
 Promote development of competitive export sectors and rapid
industrialisation
o Planned economies: Asian continent e.g. China, Vietnam, India, Cambodia
 Reduced govt. control over economic decision-making
 Australia: Market forces in agriculture, mining, construction, and manufacturing. Government
for telecommunications, aviation, banking, and insurance
o Recent decades: Reduced role through deregulation and privatisation policies
 Health care
o Australia: Well-established system of universal health care (Medicare)
 6.3% of GDP spent on health care
o Developing economies: Rel. undeveloped public health systems, reliance on private
health care
 Diseases of poverty: poor water and sanitation
 Lifestyle diseases: obesity, diabetes, and cardiovascular diseases
  Serious respiratory disease problems (high rate of smoking)
 20% (AU) vs 50% (China, Indonesia, Korea)
 Education
o Australia: Universal free education for primary and secondary (1/3 attend private
schools), HECS for repaying student loans
 Above average funding
o Asia: Compulsory primary school, most schools being run and funded. Schools
become voluntary during high school years (increased private funding)
 Education = Culturally significant (Intl. surveys of maths/science = strong
education systems in Singapore, Korea, Japan, other East Asian countries)
o Low govt. spending reflects larger reliance on private contributions, e.g. Korea/Japan
o Dev. countries: Low govt. spending = greater competition for scarce govt. resources

 Social Welfare
o Australia
 Greater assistance level: Min. living standard for people unable/looking for
work
 Un-employment benefits, pension, disability/family payments, paid maternity
leave
 Trend = restricting social welfare by tightening eligibility
 ‘means’ test, limiting benefits for people w/other sources of income
 Aging population: Govt. faces growing pressure to sustain social welfare
(providing other priorities, e.g. health care, education, and infrastructure)
o Asian economies
 Demands for social welfare will increase

Topic 2: Consumers and Businesses

The role of consumers in the economy
Consumer Sovereignty
Factors affecting consumer sovereignty
 Consumer sovereignty- Refers to how the pattern of consumer spending determines the
pattern of production and resource allocation.
 Marketing: Extensive research into wants/interests/desires/fears (by producers)
o Mass marketing (Media)
o Direct marketing (Direct mail/advertising on personalised web browsers)
 Misleading/Deceptive conduct: Deceived by dishonest claims
 o Weight loss programs
o Baldness treatments
 Planned obsolescence: Products are designed to wear out quickly over a period of time
o Emphasizing of keeping up with trends:
 Cars that look out of date may not be driven even though they are fully
functioning
 Latest technology, e.g. iPhone
 Anti-competitive behaviour
o Reduce consumers’ ability to purchase what they really want
 Only certain brand’s accessories can be compatible with a product
 Could work with other generic accessories

Factors affecting decisions about saving or spending

 Culture
o East Asian economies save MORE compared to other industrialised economies
o Older generations save MORE compared to younger generations
 Personality
o Outgoing  Spend more (enjoy immediate benefits)
o Cautious  Save more (saving for any future need)
 Confidence/Future expectations
o Confident about economic outlook  ↑ spending + ↓ saving
o Worried about economic outlook  ↓ spending + ↑ saving
 Future expenditure plan
o May save more if there is a plan to spend more, e.g. holidays, cars
 Tax policies
o More attractive to spend
 LOW taxes on consumption
o More attractive to save
 LOW taxes on superannuation savings
 Credit availability
o ↑ credit available = ↑ spending + ↓ saving (new source of expenditure)
o ↓ credit available = ↓ spending + ↑ saving

Variations with income and age

 Young people (↓ income: Lack skills, experience, and education)

o More attractive to save
 Tend to dis-save/borrow against their future income to fund their education
 Spend proportionally ↑
 ↑ proportion of each extra dollar of earned income consumed
 ↓ MPS and APS
 Save proportionally ↓
 ↓ proportion of each extra $ of earned income saved
 Middle-aged people (working class: peak earning years)
o Receive income (reward input towards the production process)
  ↑ saving (fund debts and for retirement: superannuation or assets)
 ↓ MPC and APC
 spend proportionally ↓
 ↑ proportion of each extra $ of earned income consumed
 ↑ MPS and APS
 Save proportionally ↑ for future consumption
 ↑proportion of each extra $ of earned income saved
 Elderly people (retired from the workforce: no longer earn income from labour)
o ↑ MPC and APC
 Rely on their superannuation, accumulated assets and government pensions to
consume goods and services
 Borrowing against past income
 Spend proportionally ↑
 ↑ proportion of each extra dollar of earned $ consumed
o ↓ MPS and APS
 Save proportionally ↓
 ↓ proportion of each extra $ of earned income saved
Factors influencing individual consumer choice
 Income
o More income  More items of higher quality  Increase in utility
o Less income  Less items of lower quality  Decrease in utility
 Price (Nominated Price)
o Individuals decide if they are willing to pay the market price of the good
o Necessities: Will be bought regardless of price (requirement for survival)
o Luxury goods: Will experience a decrease in demand (some choose to forego it)
 Price of substitutes
o Bought in place of another good
o HIGH price = HIGH substitute demand
 Price of complements
o Bought in conjunction with another good
o HIGH price = LOW complement demand
 Preferences/Tastes
o Changes over time (e.g. fashion)
 Consumers who don’t derive utility from a good will not purchase it
o Innovation/technological progress
 New/better products are demanded
 Mp3 players’ vs compact discs
 Advertising
o Can create demand for goods/services where there weren’t any before
o Can make consumers less responsive to higher price (loyalty building)

Sources of income
 The return for resources Advertising
1. Interest Capital (Shares  dividends, bonds/cash management accounts  Interest,
Fixed Term Deposits, Superannuation, Financial Investments)
2. Profit Enterprise (Revenue less expenses, interest, and wages)
3. RentLand Investment Properties (All income earned from productive use)
4. Wages Labour high skilled workers receive higher wages while lower income
workers earn lower wages (main source of income=Y) (incl. worker’s compensation,
superannuation and fringe benefits – holiday pay and sick leave)
 Social welfare
Payments made by the government to increase the incomes of particular groups on society
o Pensions (Assistance for aged): Retired people over 65 years
o Family payments: Allowances, tested according to income level
o Disability support payments: Physical illness, handicapped etc.
o Unemployment benefits People actively looking, but unable to find work

o
The role of businesses in the economy
Factors influencing a firm’s production decisions
 What to produce
o Skills and experience of entrepreneur
o Strong consumer demand  More expansion opportunities
o Specific business opportunities, e.g. niche markets (tastes/characteristics)
o Amount of capital (low start-up costs = low risk)
 How much to produce
o Business must assess level of demand
o Difficult to determine the sales level of goods; shortages/excess supplies
o Could be determined using market research; can also determine price
 How to produce
o Relative efficiency of the factors of production
o Factors of Production:
 Capital: Investment in technologies, become obsolete (depreciation)
 Entrepreneurship: Unstable environment  LOW risk-taking
 Land: Finite resources, will run out
 Labour:
 Investment in education/training  ↑ workforce productivity
 ↓ birth rate/ageing population  ↓ quantity of labour

Business as a source of economic growth and increased productive

capacity
 Goals of the firm
o Maximising profits
 Revenue−Resource costs
 ↓ resource costs, ↑ price of g/s
o Maximising growth
 Aim to maximise assets of the firm
 Rewards
o ↑ profits in the long run
o ↑ salaries and prestige
o Increasing market share
o Shareholders  HIGH profits
 Managers = HIGH salaries, power, and prestige (HIGH sales)
o Meeting shareholder expectations
 Overrides concerns of business managers
 Shareholders are interested in maximising short-term returns on their
investment
o Satisficing behaviour
 Achieving satisfying level of attainment rather than maximising profit (new
competitors, government regulations
Efficiency and the production process
Internal and External economies and diseconomies of scale
 Internal economies of scale: Cost-saving advantages that result from a firm expanding its
scale of operations (Production is below technical optimum)
o Specialisation of labour (breakdown of production process)
 ↓ advertising costs
 Bulk buying: ↓ /unit cost
 Specialist managers
 Research and Development: Investment in both human capital (tailored
training programs) and machinery
 Secure loans with ↓ interest rates
 Can control (within the business)
o
 External economies of scale: Cost-saving advantages that result from the positive growth of
the industry  Reduce long run average costs for firms in that industry
o Localisation of industry: All firms in a particular region would enjoy saving costs
 Located in area of large population w/ skilled labour
o Govt. subsidies: Providing special R&D to help promote the industry
 CSIRO and their new strain of disease resistant, high yielding wheat
 Internal diseconomies of scale: Disadvantages faced by a firm, causing per-unit production
costs to increase (↓ managerial/administrative efficiency)
 Management loses touch with day-to-day running
 Rules and regulations (Red tape)
 Worsening workplace relations: Managers are unaware of problems and
issues  misunderstanding and disputes
 External diseconomies of scale: Disadvantages that result from the growth of the industry in
which the firm is operating
o Increased pollution: In China, rapid industrialisation + weak environmental controls
 ↑ pollution problems (illness and early deaths)
o Concentration of industry: ↑ concentration of industries in one urban area  transport
bottlenecks (Raises transport costs due to ↑ property prices)
o Rising raw material costs: ↑ demand of resources = ↑ price
o Rising unemployment rates: Large size of labour market
 Technical optimum: Most efficient level of production for a firm (Average costs of
production are at the lowest possible level). Point where the firm has taken maximum advantage of
economies of scale, without having to suffer diseconomies of scale

Production and Specialisation

 Definitions
o Productivity: Quantity of g/s an economy can produce with a certain amount of
resources
o Production: Total amount of g/s produced
o Higher productivity: Increase in output per factor of production, per unit of time
o Specialisation: FOP’s are used more intensely for small number of production
processes
 Improvement in standard of living
o Less wastage of resources (efficient usage)
o Lower production costs and higher profits for businesses
o Lower inflation rate
o Higher incomes
o Improved international competitiveness
o ↑ specialisation = ↑ output = ↑ profit = ↑ quality of capital = ↑ g/s quality

Type of Specialisation Definition Example

Production  Sub-processes Assembly-line approach (cars)
Division of labour ↓ time and effort = Utilising
skill in a particular focus area
Similar businesses located in Macquarie Park: Advanced
same area technology industries
Location of industry
↓ costs: sharing of resources:
infrastructure + machinery)
Intensely specialize using Wine producer: specialised
machinery machines to bottle, cork, and
Large-scale production label wines
Use of advanced capital
equipment
Impact of investment, technological change and ethical decision-
making on a firm through:
 Production methods
o ↑ capacity to invest in advanced capital  ↑ productivity levels  ↑ quality of goods
and services
o ↓ costs i.e. the factors of production which leads to cost advantages such as
specialisation and division of labour
o It allows businesses to have the capacity to make ethical decisions which benefit the
whole of society
o Example: investing in socially acceptable products to increase market share
 Prices
o Better understanding of the marketplace (Quick comparison of prices: consumers)
 Low profit margins (Cost reduction to compete w/ foreign firms)
 Businesses may outsource overseas (retain/maximise profits)
 Employment
o Loss of jobs: foreign firms’ competitiveness  cheaper offshore costs, or replacing
human capital w. capital goods
o Creation of jobs: Specific IT skills, e.g. computer programming
o Ethics: Hiring of more women/disadvantaged/discriminated people
 Output and Profits
o Low cost, better quality products
o More responsive to demand (customised to meet specific needs)
o ↑ demand  ↑ output  ↑ profitability
o Machine maintenance = ↑ production costs in the long run
 Types of products
o Expands range of products that could satisfy consumer demand
 Globalisation
o ↑ access to foreign markets: Cheaper products produced in an economy with fewer
regulations
o Ethics: May involve forced labour, v. low wages, dangerous conditions, denial of the
right to join a trade union and seek better pay
 Consumers/no govt. organisations place pressure on transnational
corporations (improve practices of their subsidiaries and their suppliers)
 Cadbury: Fair trade chocolate
 Coca-Cola: Extension of health coverage to African workers (HIV positive)
 Environmental sustainability
o ↓ pollution/waste, preserving natural environment, ↑ renewable energy
o Businesses change their practices according to consumers’ demands, government
subsidies or regulations, or from their own ethics regarding the environment
 Qantas: Environmental sustainability strategy
 ↓ landfill waste and H2O consumption by 20%
 Option of flying “carbon neutral”: Paying more to offset emissions
 Cut net emissions in half by 2050
 Requirement of new tech/investment
o Efficient aircraft
o More advanced navigational aircraft technology
Topic 3: Markets
Demand
Demand:

 Quantity of a particular good or service that consumers are willing and able to purchase at
various price levels at any given point in time.
 Consumers demand goods in order to maximise their utility of needs and wants  as
quantity consumed increases, marginal utility decreases
 Consumers are demanders of any market  consumer sovereignty applies
 Individual Demand: demand of each individual consumer for a particular good or service
 Market Demand: the demand of all consumers for a particular good
The Law of Demand shows price and quantity as an inverse relationship, such that when price
increases, the quantity demanded decreases and when price decreases, quantity demanded
increases

The Demand Schedule and Curve:

The Demand Schedule is a table representing the quantity of goods that will be demanded over a
range of price levels The Demand Curve is a representation of the relationship between the amount
of a particular good or services that buyers want to purchase in a given time period. The typical
demand curve slopes to the left, illustrating the relationships outline in the law of demand. Example:

Factors affecting market demand:

There are 6 main factors that influence demand:

1. The price of the good or service itself

 A consumer must decide whether or not they are willing to pay the nominated price for the
item. While some goods are considered necessities for daily life, people will need to buy them
regardless of price changes. This leads to a reduced demand for other goods such as luxury
goods that are not necessary for everyday life.
1. The price of other goods and services (substitutes and complements)
  The quantity of a good demanded is also affected by the prices of other goods. Consumers
consider some goods to be close substitutes, so if the price of the substitute good rises, there
is an increased demand for the other good. Example - Price for margarine increases, demand
for butter increases.
 Some goods are considered to be complements and consumers tend to purchase them
together - car and petrol. Thus, if the price of cars increases, one would expect a decline in the
quantity of cars demanded, as well as a decrease in demand for its complement good, petrol.

1. Expected future prices

 The current consumption of a particular good or service will be affected not only by current
prices, but also by expected future prices. If consumers expect that the price of a certain good
will increase in the near future, they will bring forward their consumption and increase the
current demand for that product.
1. Change in consumer tastes, preferences and fashion
 As consumer tastes change over time, so too will the demand for particular goods. For
example, clothing that comes into fashion will face an increase in demand, while demand for
clothing that is going out of fashion will decrease.
 Innovation and technological progress lead to consumers demanding new and better
products at the expense of superseded ones.
1. The level of income
 As income levels in the economy change, so too will consumer demand. As people earn
higher incomes, they become more willing and able to purchases more goods and services.
Rising incomes would tend to increase the demand for luxury goods more than demand for
necessities, which are not very sensitive to change income levels.
 Consumer expectations about future income levels and prospect will influence their decision
to buy certain types of goods. Example: consumers would be less likely to buy expensive goods
if the economic outlook was uncertain and they feared that they might lose their job.
 A change in income distribution could also change the level of demand for particular goods.
Example: a redistribution of income towards higher-income earners would lead to a greater
demand for luxury goods.
1. The size of the population and its age distribution
 Population size will affect the total quantity of goods demanded, while age distribution will
affect the type of goods demanded. With Australia's ageing population, it is expected that a
higher demand for retirement villages, age care services and other goods and services would
be required by older people.

Network Externalities:

The behaviours of other consumers can influence an individual’s decision to demand a good or
service. If one person’s demand is affected by the number of other people who have purchased the
good, there is a network externality:
o Positive Network Externality: (Bandwagon Effect) - occurs when people demand a good
because almost everyone else has one. Example: Air pods
o Negative Network Externality: (Snob Effect) - occurs where demand for a good is higher
when there is fewer people who own it, such as rare works of art and limited-edition
items.
Movements along the Demand Curve:

Assuming that all other factors remain constant, any change in the
price of a good will lead to a change in the quantity demanded in
the opposite direction of the price change. This lead to a
movement along the demand curve, referred to as expansions and
contractions.

 A contraction in demand allows for movement up the

demand curve and occurs when an increase in price from P1
to p2 causes the quantity demanded to fall from Q1 to Q2.
(price levels go up, quantity decreases)
 An expansion in demand allows for movement down the
demand curve and occurs when a decrease in price from P1 to P3 causes the quantity
demanded to rise from Q1 to Q3. (quantity increase, price decrease)

Shifts of the Demand Curve:

A change in any of the six factors that can influence demand will lead to a shift of the entire demand
curve. These shifts are referred to as increases and decreases in demand and are brought about by
changes other than price changes.

 Increase in Demand -
A movement in the demand curve to the right is called an increase in demand. This is shifted
to the right because the change in demand is not due to a price change, rather, another factor.

 An increase in demand means that

consumers are willing and able to buy
more of the product at each possible
price than before. In the above
diagram, at price P1, consumers
originally demanded Q1 goods.
However, following an increase in
demand, consumers now demand
more of the product at the same price
(Q2)

 An increase in demand also means that

consumers are willing to buy a given
quantity at a higher price than before.
Consumers were originally willing to
pay P1 to obtain a quantity of Q1,
however, following the increase in demand, consumers are no prepared to purchase the same
quantity (Q1) at a higher price. (when demand increases, the bidding process starts and
eventually leads to a higher price)
  Decrease in Demand -
A movement in the demand curve to the left is called a decrease in demand.

 A decrease in demand means that

consumers are willing and able to buy
less of the product at each possible
price than before. At price P1,
consumers originally demanded Q1,
however, following a decrease in
demand, consumers now demand less
of the product (Q2) at the same price.
 A decrease in demand also means that
consumers are willing and able to buy a
given quantity at a lower price than
before. Originally, consumers were
prepared to pay P2 to obtain quantity
of Q2, however, following a decrease in
demand, consumers are only prepared
to pay a lower price (p1) in order to purchase the same quantity (Q2) of the product

Factors that cause an Increase or Decrease in Demand

Price Elasticity of Demand:

The price elasticity of demand measures the responsiveness or sensitivity of the quantity demanded
as a result of a percentage change to its price.
o Fall in price will cause an increase in quantity demanded, but if that increase in quantity
demanded is proportionately greater than the fall price, then the demand would be very
responsive to change and this said to be relatively elastic.
o A less than proportionate change in quantity demanded would indicate relatively inelastic
demand.
 o If the proportionate change in quantity demanded is the same as the proportionate change
in price, demand is said to be unit elastic.

The Importance of Price Elasticity of Demand:

A knowledge of price elasticity of demand is important to both business firms and the government.

Business Firms:

Firms needs to understand price elasticity of demand for the goods they sell in order to decide on
their optimal pricing strategy.
o
If demand was relatively elastic, the firm would now that lowering the price would
expand volume for sales and this increase total revenue.
o However, if demand was relatively inelastic, their firm could increase their price which
would lead to an increased revenue.
o Awareness of the elasticity of demand in different price ranges is important for
determining the best pricing strategy for a firm and in deciding whether or not to change
prices.
o Firms often engage in statistical market research in order to determine consumer
preferences and in particular price elasticity of the demand of their product.
Government:

The government needs to understand price elasticity of demand when pricing the goods and services
that provides for the community (public transport, roads)
o It also needs to be able to predict the effects of changes in the level of any indirect taxes,
such as sales tax, excise duties on goods such as alcohol. These taxes and changes raise
the price of goods affected, and the government needs to be able to gauge the
responsiveness of demand in order to accurately estimate the amount of revenue they
will raise.
o Governments tend to charge indirect taxes on those goods that are relatively inelastic
since regardless of the price, people will still buy them.

Measuring Price Elasticity of Demand

The Total Outlay Method is a way of

calculating the price elasticity of demand by
looking at the effects of changes in price on
revenue earned by the producer.

 If price and revenue move in the

same direction, the demand is said
to be inelastic
 If they move in opposite directions,
the demand is said to be elastic
 If the revenue remains unchanged
in response to a price change, the
demand is said to be unit elastic
Price Elasticity and the Slope of the Demand Curve:

The slope of the demand curve should not be used as a measure of the price elasticity of
demand. The price elasticity will vary as one moves down the curve.
 In the upper part of the curve, (where prices are high), demand will be relatively elastic
(quantity demanded is highly responsive to price changes), whereas, at low prices, demand
will be relatively inelastic.
Perfectly Elastic Demand:

 Perfectly elastic demand is an extreme of elastic demand, where a

change in price will have an infinite effect on quantity (all quantity levels
will clear at one price, anything above that price will lead to no sales)
 It is a theoretical situation that underpins the price-taking behaviour of
perfect competition - where all sells must sell at the same price. No
individual seller would be able to charge a higher price, since he or she
would lose all customers to the others selling identical products.

Perfectly Inelastic Demand:

 Perfectly inelastic demand is an extreme of inelastic demand, where a

change in price will have zero effect on quantity (price has no impact and
sales occur no matter what)
 It is a theoretical situation that does not occur in practise.
 It could apply to medication for life-threatening diseases which patients
would pay any price in order to survive.
 It is often argued that governments should regulate such markets, in
order to prevent the exploitation of vulnerable consumers.

Factors affecting the Elasticity of Demand:

1. Necessities and Luxuries:

o Products that are necessities such as bread and milk are relatively inelastic
compared to luxuries such as holidays or new cares which are price elastic. This is
because consumption of essential necessities is unlikely to change even when their price
increases are they are needed for survival.
2. Addictiveness/Habit forming:
o Habit forming or addictive products such as alcohol, tobacco, gambling or illicit drugs
tend to be price inelastic due to consumers becoming addicted and dependent on these
products. Hence price changes are likely to be ineffective in changing the quantity
demanded - price inelastic.
3. Existence of Substitutes:
o When close substitutes exist, products will tend to be price elastic due to their ability
to be substituted should prices increase.
4. Proportion of Income spent:
o If a low proportion of income is spent on the product, demand will often be inelastic
as these changes have an insignificant effect on the overall amount of spending and
hence little effect on demand.
o However, if the proportion of income spent is large, the demand will be price elastic.
5. Length of time since price change:
 o Since consumers often take time to adjust their demand and spending patterns
either through finding substitutes or reducing their consumption, price elasticity tends
to rise as time passes since a price change.
o Initially after a price change, demand is relatively inelastic before gradually
becoming more elastic.
Supply
Supply:

 A quantity of a good or service that all firms in a particular industry are willing to offer for
sale at different price levels at given point in time.
 Producers supply goods in order to maximise profit and will tend to supply more products at
higher prices rather than lower prices as producers attempt to maximise revenue.
 Producers are suppliers of any market and because consumer sovereignty applies, producers
must respond to the preferences of consumers by supplying what they want.
 Individual Supply: supply of individual producers at the various price levels
 Market Supply: sum of the individual firm supplies of individual producers at the various
price levels. The quantity that corresponds to a given price on the market supply curve is the
sum of the quantities supplied at that price by all individual producers in the market.

The Law of Supply shows that the quantity supplied of a good varies directly with price (price
increases leads to increase quantity supplied, whist a price decrease reduces the quantity supplied)

The Supply Schedule and the Supply Curve:

The supply schedule is a table representing the quantity of goods that will be supplied over a range
of price levels. The supply curve is representation of the relationship between the amount of a
particular good or service that sellers want to supply in a given time period and the price of the good
or service. The typical supply curve slopes right to left, illustrating the relationships outlined in the
law of supply.

Factors Affecting Market Supply:

Factors affecting Market Supply:

1. The price of the good or service itself
 The market price of the good or service will influence the producer's ability and
willingness to supply it. For example, if the price were too low, some producers would not be
able to cover their costs of production and would not supply the item.
2. Expectations of future prices
 The expectations of suppliers about the future price of a good or service also influences the level
of supply - if the supplier believes the price will rise in the future, perhaps due to change in
consumer taste, supply of the good will increase. This is due to the possibility of increased profits
arising from supply of the good.
3. The price of other goods and services
 As firms and entrepreneurs aim to maximise revenue, they will aim to produce
goods which have a high market price. If the good they are producing falls in price relative to
other goods, they may shift production to other goods which will sell for higher prices.
4. State of technology
 Improvements in technology lower production costs and allow more firms to supply
more goods at a given price. They also allow firms to adjust production runs to quickly
accommodate changing demand patterns while also improving quantity of output, leading to an
overall increase in supply.
5. Changes in the cost of factors of production
 Any fall in the cost of factors of production would allow firms to supply more of a
particular good or service, whereas any rise in factor costs would make it more difficult for firms
to maintain present supply.
 A rise in the price of a factor of production would often lead to a decrease in supply
of that good whose production was heavily reliant on that factors input.
6. Quantity of the good available
 The actual quantity of the good available is an overall limiting factor that affects
supply.
 In many industries, the number of suppliers also affects the quantity of the good or
service available. As more supplier enter an industry, supply increases and vice versa.
7. Changes in producer preferences
 Businesses may also prefer certain products due to their existing expertise or
knowledge of the product, leading to an increase in supply. However, a change away in
preferences will decrease supply.
8. Changes in the number of firms in the industry
 If more firms enter the industry it will grow, hence increasing supply. Likewise, if the
industry shrinks either through structural change or falling profits, the supply decreases.
9. Climatic and seasonal influence
 Changes in climatic conditions and season will obviously affect agricultural
production. For example, an extended period of drought would cause the supply of most
agricultural products to decline.

The “Actual” Supply Curve:

 In reality, the supply curve for both product and factor

market goods and services is not a straight line with a
constant gradient but rather a curve with an increasing
gradient - this is due to the principle of increasing
opportunity cost or 'low hanging fruit principle'
 This principle states that a firm or individual will exploit
their most attractive opportunity (less costly) first before
moving to other costly opportunities.
  As production expands, the opportunity cost of producing the good or service increases
causing an increase in the gradient of the of the supply curve.
 Example: An apple picker will pick the lowest hanging apples first, because they are
relatively cheaper to gather before moving on to pick the higher apples as they require most
costly methods to collect such as the use of ladders or machinery.

Movements along the Supply Curve:

Assuming all other factors remain constant, any change in the price of a good will lead to a change in
the quantity supplied in the same direction as the price change. As a result of a price change, there is
movement along the supply curve, which we refer to as expansion and contractions.

From the Diagram:

A 
contraction
in supply
occurs when
a decrease
in price
causes the
quantity
supplied to
fall.
 An expansion in supply occurs when an
increase in price causes the quantity supplied to rise.

Shifts of the Supply Curve:

A change in any of the factors, other than the price of the good itself, will lead to a shift of the entire
supply curve for the produce. These shifts are referred to as increases and decreases in the supply
and are brought about by changes in conditions for the business firm, and not price changes.

1. Increase in Supply-
A movement in the supply curve to the right is called an increase in supply. This is
shifted to the right because the change in supply is not
due to a price change, rather another factor.
 An increase in supply means that firms are willing and able to
supply more of a product at each price level than before.
  An increase in supply also means that firms are willing to supply a given quantity at a lower
price than before, moving from P1, to a lower price of P2, while staying at the same quantity
level.

2. Decrease in Supply -
Movement in the supply curve to the left is called a decrease in supply.
 A decrease in supply means the firms are willing and able
to supply less of a good at each price level than before -
staying at the same price but lowering the quantity.

 A decrease in supply also means that firms are only

willing and able to supply given quantity at a higher price
than before. In light of a decrease in supply, firms originally
supplying at Q2 at a lower supply will be supplying at a now
higher price (p1).

Factors that cause an Increase or Decrease in Supply:

Price Elasticity of Supply:

The Price elasticity of supply measures the responsiveness of the quantity supplied of a
product to changes in price. It is the percentage change in the quantity supplied cause by a
one per cent change in price. (for most goods, since a rise in price will cause an expansion in
supply, price elasticity is generally positive)
o Rise in quantity supplied is proportionately greater than the increase in price, then we
could say that supply is very responsive to a price change, thus being relatively elastic
 o A less then proportionate change in quantity supplied would indicate relatively inelastic
supply.
o If quantity supplies rises by the same proportion as the price increase, supply is unit
elastic.

Price Elasticity and the Slope of the Supply Curve:

Perfectly Elastic Supply –

 When supply is perfectly elastic, the supply curve is a horizontal

straight line.
 The diagram below shows that at price, 0P, suppliers would
supply an infinite quantity of the good, whereas below that
price they would not be willing to supply any. (Unlikely
situation) - so responsive that you don't need to change the
price

Perfectly Inelastic Supply –

 When supply is perfectly inelastic, the supply curve is a vertical

straight line
 The diagram below shows that the quantity supplied is fixed at
0Q regardless of the price.
 It is where producers are willing to supply a given quantity of a
good or service, regardless of the price (Concert Tickets when you
can't attend)

Factors affecting elasticity of supply:

1. Time lags after a price change

 The greater amount of time that producers have to respond to a price change, the
more elastic the supply for the product in question - means a lot of response to a change
in price
 Following a price increase, producers are restricted in their attempts to increase the
production in the short run
  The time immediately after price change, supply would be perfectly inelastic as the
producer can't increase any input, as a result, they increase production with existing
workers
 Short run:
o producers can vary inputs to production so they can respond to price
changes (number of workers, quantity of materials)
o The price elasticity of supply increases, although it is still likely to be
relatively inelastic
 Long run:
o The producer would be able to increase any of the inputs (size of
production, amount of machinery) facilitating a greater increase in production in
response to a price change
o Making supply relatively price elastic.
2. The ability to hold and store stock
 It is possible to store goods and not offer them for sale when there is a downturn in
market conditions and the price falls - inventory (can be offered for sale when prices are
high again)
 The easier it is to hold stock, the more elastic the supply, depending on the nature of
the good (highly perishable items)
 If inventory costs are high or producers are unable to hold stock, supply will be more
inelastic - producers don't have accumulated inventory to add to their supply if prices
increased, hence limiting their ability to respond to price changes.
3. Excess Capacity
 Excess capacity exists when a firm is not using its existing resources to their full
capacity.
 If firms are operating at full capacity, their supply will be price inelastic as they have
no additional means to increase their production.
 Supply will be elastic when firms have excess capacity because they have room to
increase their production in response to higher market prices, making it price elastic.

Market Equilibrium:
Market Equilibrium is the situation of free market based economies, where the forces of demand and
supply are equal, hence creating a price and quantity level where there is no tendency for change
and the market clears  market clears - everything in the market is fine and there is no excess
supply or demand.

Price Mechanism is the process by which the forces of supply and demand interact to determine the
Market Price.

Equilibrium Price (Market Price) is the price at which the quantity demanded, and quantity supplied
are qual

Equilibrium Quantity (Market Quantity) is the quantity that is bought and sold at the market price.

Market Equilibrium Point is the point where the supply and

demand curves cross. The market equilibrium is stable
equilibrium because no matter where demand and supply
start off, they will always gravitate towards the point.
(Figure 1)
Establishing Market Equilibrium

Market Equilibrium occurs where the demand supply curves intersect – the point where the
quantity demanded is exactly equal to the quantity supplied.

Excess Demand:

 The diagram shows that the quantity demanded exceeds the

quantity suppled
 Competition amongst buyers for the limited quantity of the
goods available means that consumers will start bidding up
the prices  rise in price will mean an expansion in supply
and a contraction in demand.
 This will continue to occur until we reach the intersection of
the services, where the price and the quantity supplied is
equal to the quantity demanded by consumers.
This is often called a shortage  quantity demanded exceeds
quantity supplied

Excess Supply:

 The diagram shows that the quantity supplied exceeds the

quantity demanded
 Excess Supply  in order to remove it, sellers will offer to sell
at a lower price and thus the result of the price fall will be an
expansion in demand and a contraction in supply.
 This will continue to occur until we eventually reach the
intersection of the supply and demand, where they are both
equal.

The price mechanism in action: the market forces of supply and demand interacting to bring about
the equilibrium price that clears the market and eliminates any excess supply or demand.

Changes in Equilibrium
The equilibrium price and quantity can be changed by any circumstances that lead to a shift in either
both the supply and demand curves. The shift in the curves are caused by external conditions, not the
price of the good itself.

Increases in Demand:

 An increase in demand means that more of a good will be

demanded at any given price
 An increase in demand will lead to an increase in both
equilibrium price and quantity
 Shift to the right
 Competition amongst buyers for the limited quantity of the
product will force the price up, causing an expansion in
supply  continue to occur until the market clear again at
a new equilibrium price.
 Supply must extend to meet this new equilibrium

Decreases in Demand:

 A decrease in demand means that less of a good will be

demanded.
 A decrease in demand will lead to a decrease in both the
equilibrium price and the quantity.
 Shift to the left
 As the new demand curve now intersects with the supply
curve at a new point, supply must contract to meet this new
point.

Increases in Supply:

 An increase in supply means that firms are supply more of a

good or service
 An increase in supply lowers the equilibrium price and
raises the equilibrium quantity
 Lower price: the firm will lower their price to try and get rid
of the massive supply  if they had a high price, no one
would buy it
 Shift to the right
 Demand must extend to meet this new equilibrium

Decreases in Supply
  A decrease in supply increases the equilibrium price and decreases the equilibrium
quantity.
 Shift to the left
 Increase in price: businesses will increase the price to balance out the lack of supply
 Demand must contract to meet this new equilibrium point

The Role of the Market:

In a market, the price mechanism plays the most important role in determining the solutions to the
economic problem. The price determined by the market conveys important information that helps in
providing answers to questions of:

1. How should we produce?

2. How should we distribute what we produce?
3. How do we exchange goods and services in the economy?
Product Markets

The price mechanism attempts to solve the economic problem in product markets.

 Product Market is the interaction between demand and supply of outputs of productions
(finished goods and services)
 The demand curve  represents the wants of the individuals in the economy
 The supply curve  represents the production of firms with limited resources
The interaction of demand and supply determines a price and quantity that best satisfies
individual wants with the limited resources available t firms, giving a solution to the economics
problem facing all economies.

 Producers will only produce those goods that are in demand – what to produce?
 Increasing demand for a good will be translated into a higher price, which will be a signal for
producers in the economy to reallocate resources away from other areas in order to produce
more of a product. – How much to produce?
o Information about tastes and preferences us conveyed between consumers and
producers in the economy through relative price changes and without any central
coordination or nee to obtain such information directly from consumers.
Factor Markets

The price mechanism also plays a central role in the markets for the factor of productions, or factor
markets

 Factor Market is a market for any input into the production process, including land, labour,
capital and enterprise
 Demand and supply forces in factor markets determine the price paid for the factors of
production and thus share of total output that is received by individuals.
o Those individuals who possess resources or produce goods and services that are
scare and in high demand will command higher incomes and greater proportion of
total output.
The Price Mechanism is efficient because:
  Any consumer willing to pay the market price for a good or service will be satisfied
 Any producer offering goods and services at the market price will be able to sell all they
produce

Market Failure:

The failure to answer all four economic questions thus leads to a market failure  A situation where
the allocation of resources of goods and services are not socially optimal.

 Whilst it may be efficient market-wise, it is not optimal for society’s wants and needs.
Left to operate by itself, the market can still create unsatisfactory outcomes:

 The market price for goods and service in product/factor markets may be considered too
high or too low
 The equilibrium quantity that results from free interplay of
demand and supply may also be considered too high or too
low
 When markets do not produce the desired outcome, it is
called a market failure. This occurs because the price
mechanism takes account of private costs and benefits of
production but does not take into account social costs and
benefits  when this occurs, the government may
intervene.
Graphical Representation of Market Failure:

 The social optimum price is higher and social optimum

quantity is lower  the market price undervalues the
natural environment.
 The aim for economic policy makers is to attempt and bring
the Private Supply curve in line with the social supply curve
 by implementing taxes and increasing the private costs.

Price Intervention:

The government, taking into consideration the social cost, may feel that the market price for some
commodities are too high or too low. Therefore, the government may intervene in the market place
in order to impose: price ceilings and price floors. The main reason for influencing prices in this way is
to affect the distribution of income.

 Price ceilings will redistribute money from seller to buyers

 Price floors will redistribute money from buyers to sellers
Price Ceilings –

 A price ceiling is a maximum price for a product

established by the government below the
market equilibrium and below the market price.
 It is called a ceiling because the price cannot
push further upwards that the ceiling
 If the government considers the equilibrium
price to be excessively high, it may impose a
price ceiling – the maximum price that the good
can be charged at.
  Price ceiling are used to ration a product that is limited in supply, in order to ensure access is
fair and consumers cannot be discriminated based on price.
 At the maximum price – producers would be willing to produce a certain quantity while
consumers are demanding a larger quantity  disequilibrium with excess demand for the
product.
Price Floors –

 A price floor is a minimum price for a product

established by the government above market
equilibrium and above the market price.
 It is called a price floor because the price
cannot push further downwards than the floor
 If the government considers the equilibrium
price of a commodity too low, they may impose
a price floor – the minimum price a good can
be charged at.
 Price floors are used to guarantee a minimum
price, in order to ensure supplier income is
stable and suppliers re protected from market
price fluctuations.
 At the minimum price – the price of the product
will increase  market in disequilibrium with
an excess supply of wheat.

Quality Intervention:

Quantity of some goods and service provided may be too high or too low  individual business firms
and consumers do not consider the social costs and benefits of the production and consumption of
certain goods and services.

Such social costs and benefits (externalities) are not taken into account in the operation of the price
mechanism.

 Process of production  producers consider obvious costs but do not consider social costs of
the production process (negative externalities)  pollution and environmental damage
o Governments can restrict production levels through laws or may impose taxes on
businesses  increases their production costs and reduce production levels.
o Making the individual business pay for the social costs created by production as
known as internalising the externality.
 Individual consumers do not consider the social benefits (positive externality) that come with
their individual consumption of goods and services  museums, public parks, public
transports and art galleries.
o Government may intervene to encourage the provision of these merit goods and
services that have positive externalities through subsidies to consumers or producers
to lower prices and increase consumption
o Merit Goods: goods that are not produced in sufficient quantity by the private sector
because there is not enough value placed on those goods  involved in positive
externality that are not fully enjoyed by the individual consumer (education and
health care)
 o Some goods and services will not be provided by individual firms at all  once
provided, producers would not be able to exclude those who are unwilling to pay
from using and obtaining the benefits of those public goods.
 national defence  everyone may benefit from the security provided by the
defence forces but they would be unlikely to contribute voluntarily 
government intervene to supply these items and finances them with its tax
revenue.
 police service
 roads and waterways
o Public Goods: goods that private firms are unwilling to supply as they are not able to
restrict usage and benefits to those willing to pay for the good. Because of this 
governments should provide these goods.

Market Structures:

The degree of competition in an industry is primarily determined by the market structure, which
refers to the number and relative size of the firms within an industry, the nature of the product being
sold, and the ease which new firms can enter into that industry. In reality, markets exist on a wide
spectrum of diluted to concentrated market power.

There are five major market structures that are present in market economies: (1 being the most
saturated and 5 being the least)

1. Perfect Competition
2. Monopolistic Competition
3. Oligopoly
4. Duopoly
5. Monopoly
Perfect/Pure Competition

Firms operating under pure competition are faced with the following market conditions:

 Large number of sellers of a homogenous (identical) product, which means there is little
ability for firms to influence the market price. As they don’t have the ability to effect market
 price, they must simply accept the market determined by the forces of supply and demand 
price-takers.
o Sellers can sell as much of their product as they like, at market price.
o If they try to sell above the market price, no one will buy it since buyers can get
exactly the same product at the lower price elsewhere.
o They will not sell at a price below the market price since this would not be profit-
maximising as they can sell the same amount at a higher price.

 Buyers do no incur any cost for moving from one supplier to another.
 Little barriers to entry as each seller only holds a small market share.
 Example: fruit, vegetables and wheat (commodities)

Monopolistic Competition

Monopolistic competition is a form of imperfect competition and is characterised by the following

conditions:

 Large number of relatively small firms  small influence over price and independence of one
another
 Products sold in the market are similar, but not identical (slightly differentiated)  engage in
product differentiation (they package and present their product to appear different from
others)
 Product differentiation gives some forms some degree of price-setting power, but they do not
have market power as it is aware that there are many close substitutes for its product 
hence fierce competition.
 Some small barriers to entry for new firms entering the market  existing firms have loyal
customers, brand loyalty
 Market share is small  price-takers
Oligopoly

Oligopoly is a form of imperfect competition and is characterised by the following:

 A few relatively large firms  between 3 and 8 who dominate the industry in terms of
output and market share
 Sell similar but still differentiated products  able to control the market due to their high
barriers to entry.
 Largely independent  coordinate each other’s actions to control the market price and
output using market power  each firm must carefully consider the reactions of its
competitors whenever it decides to change its price or output policy
 Oligopolies tend to compete through advertising campaigns promoting their products.
 Governments need to regulate oligopolies in the event where they abuse power through
restricting competition and price setting.
 Oligopolies are price-setters due to their large market power  tend to earn supernormal
profits.
Monopoly and Duopoly

A monopoly is regarded as the opposite of pure competition, characterised by the following:

 Only one firm selling the product, and there is no market competition  the product has no
close substitutes
 High barriers to entry  prevents any potential competitors from entering the market
  Monopolist  great control over market price and is a price-setter (set the price in order to
maximise profit)
 Government law and regulations used to limit their power.
A duopoly is where there are two sellers, different to a monopoly where it has one:

 Duopolists have full control of the market  set price and quantity where it can maximise
profit
 Price-setter
 High-barriers to entry
 Example: Boeing and Airline

Topic 4: Labour Markets

Demand for Supply and Labour Definitions:

Labour is the human factor of production and includes the hours of intellectual and physical effort
that workers input in order to earn a wage income.

Labour Market is the marketplace where supply of a demand for labour meet to determine wages
and employment levels of the economy. It is where individuals seeking employment interact with
employers who want to obtain the most appropriate labour skills for their production processes.

In a labour market, the demanders are the employers and the suppliers are the employees.

 Wages are hence not only the income of the employees, but also the price businesses must
pay in order to gain access to labour resources  competing forces between consumers who
wish to increase wages to maximise utility and businesses who aim to minimise wage
increases to reduce cost of production.

Demand for Labour:

Firms demand labour by offering wages, just as consumers demand goods and services in product
markets by offering to pay a price. The demand for labour is derived demand.

Derived Demand:
  The demand for labour is derived from the demand for goods and services within the
economy. When the aggregate demand increases, firms are forced to increase their level of
output to meet the higher demand.
 Firms will hire more labour, increasing labour demand.
As with normal demand, the demand for labour follows the Law of Demand. When the price of
labour (wage) increases, the demand for labour decreases. Vice versa.

Microeconomic Factors Influencing Demand for Labour:

Microeconomic factors are concerned with specific industries and/or firms, making them smaller in
scale. They include:

1. Nature and Size of the Industry: (Both)

 Large labour-intensive industries (retail, finance, banking) are labour intensive and hence
demand a large number of workers. However, capital intensive industries (manufacturing) tend
to hire less labour as they rely on machines. Automation in recent times continues to change
industries and the amount of labour they require.
2. Wages and Work Conditions: (Both)
 As the price mechanism in the labour market is implemented through wages, industries and jobs
with higher wages and better benefits will attract more workers. However, firms aim to maximise
profits and will tend to keep wages low to reduce cost of production. If specific work conditions
are expensive to uphold, firms will be less likely to demand labour as they would have to spend
more money.
3. Productivity of Labour: (Both)
 Productivity is the output per unit of labour input, and hence firms increase their demand for
labour when productivity within their industry increases as they can maximise output whilst
reducing costs.
 If productivity Is low, firms prefer to substitute labour for capital, hence reducing demand for
labour.
 If the price of capital relative to labour is low, this could further reduce demand for labour.
4. Rate of Structural Change: (Both)
 Structural change refers to a shift in the fundamental functioning of an economy.
 This is often represented in the growth or decay of specific industries, which hence shift the
composition of the economy’s products and hence its demand for labour.
 Generally, if industries grow, so too will demand for labour as it is a derived demand.
5. The demand for an individual firm’s product (Both)
 A firm’s output is ultimately determined by its effectiveness in selling its goods and services in the
marketplace.
 This is determined by factors such as the quality of its products, the reputation and the size of the
firm, its customer service and its marketing efforts.

Macroeconomic Factors Influencing Demand for Labour:

Macroeconomic factors are concerned with the entire economy, and hence is concerned with the
level

of aggregate demand. Aggregate demand is hence the combined demand of the groups in the
circular flow.

1. Changes in the total level of economic activity or aggregate demand (output of the firm)
(Both)
 When the economy grows during a boom and aggregate demand is high, demand for labour is
also high as labour is a derived demand. This is because firms will be expanding their output to
meet the increased spending and hence require additional human resources to produce these
goods.
 The unemployment rate falls, wages rise and labour force participation increases
 During a recession, spending and production fall, and hence firms reduce their demand for
labour, leading to increased unemployment and failing wages.
2. Productivity of Labour: (Both)
 Firms increase their demand for labour when overall productivity increases as they can maximise
output whilst reducing costs.
 If labour productivity is low, firms prefer to substitute labour for capital, reducing demand for
labour
3. The cost of other inputs: (Both)
 If wage rates are higher than the cost of capital, employers will substitute labour for capital as
this will be more profitable, leading to unemployment
 If wage rates are lower than the cost of capital, employers will increase demand or labour
4. Governmental Industrial relations policy: (Increase)
 Governments can also implement policies which aim to increase demand for labour (Youth Jobs
Path  program that encourages businesses to provide unemployed youths with internships so
they can gain employable skills)
 Governments also further aim to reduce on-costs by decentralising and deregulating the labour
market  introducing enterprise bargaining to link wage increases to productive growth,
increasing demand for labour.
5. Level of Industrial Disputation: (Decrease)
 High levels of industrial disputation (strikes and lockouts) due to disagreements on wage and
working condition outcomes will decrease demand for labour as firms are often hesitant to hire
more staff during periods of uncertainty.
 To increase demand for labour, there must be low levels of industrial disputation and mutually
agreed upon work agreements.

Supply of Labour

Individuals supply labour when they are ready and willing to work in the labour market  the higher
the wage, the more willing an individual is to work.

Factors that Influence Supply of Labour

1. Pay Levels:
 The wage or salary paid to employees is an important determinant of the supply of labour for
any individual
 The higher the wage offered, the more people will be prepared to sacrifice their leisure time and
supply their labour.
 Other non-wage incentives  use of company care, extra superannuation would influence one’s
willingness to supply labour
2. Working Conditions:
 Attractive working conditions encourage a higher supply of labour, whereas unattractive working
conditions would discourage workers
 Firms that offer employees more flexible working hours, the opportunity to work from home,
generous holiday leave entitlements and a pleasant working environment tend to attract more
labour than those that don’t.
 Some jobs offer opportunity to travel and experience different cultures  more attractive than a
well-paid job for some people.
 Other jobs may provide excellent training opportunities and experience  higher priority for
young
3. Education, skills and experience requirements
 The education, skill and experience requirements for some types of jobs can limit the supply of
labour  elements of human capital
 A country with relatively high levels of human capital is more likely to achieve low
unemployment
 Education, skills and experience requires time, sacrifice and efforts  low supply of labour to
those firms and industries that require higher levels of education, skills and experience.
4. Mobility of Labour:
The supply of labour will be affected by its responsiveness to changes in the demand for labour in
different areas and industries. There are two types of labour mobility:

 Occupational Mobility
 Refers to the ability of labour to move between different occupations in response to
wage differentials and employment opportunities.
 Degree of occupational mobility depends on the education and skills required for a
particular occupation  time taken to gain those credentials.
 As the skills required increases  more difficult since more time and effort is needed
 Geographical Mobility
 Refers to the ability of labour to move between different locations in response to
improved wage differentials and employment opportunities. Factors that limit
geographical mobility of labour include:
 The costs of relocating  travel, transportation
 The personal upheaval associated with moving  breaking tis with family and
friends
 Those jobs that require workers to relocate to more distant locations, with fewer
educational and entertainment opportunities will receive a lower supply of labour. As a
result, employers in in remote locations may need to offer higher wages to attract
workers.
5. Size of the Population:
 The size of the working age population (15-64) will determine the overall supply of workers in the
labour force.
 The larger the population, the larger the labour force
 Population can increase in two ways  natural increase and new overseas migration.

Equilibrium in the Labour Market:

Demand for labour is from firms and downward sloping because

firms which to minimise their labour costs, and hence demand
more workers when wages are low.
Supply for labour is from workers and upward sloping because workers will be more willing to work
at higher wages  substitute their own leisure time to work more hours when it is profitable to do
so.

Equilibrium wage and full employment is determined at the intersection of the supply and demand
curves – the equilibrium wage rate occurs where the quantity of labour supplied is exactly equal to
the quantity of labour demanded by firms.

Changes in the Equilibrium:

Any changes in the conditions that determine the supply and

demand for labour will being about changes in the wage and the
quantity of labour employed.

The Diagram shows an Increase in Demand –

 The increase in demand would shift the curve to the right,

causing an increase in the wage rate and an increase in the
level of employment.

Higher and Lower than Equilibrium:

The Australian workforce:

The workforce can be defined as that section of the population 15 years of age and above who are
either working or actively seeking work. It
can be divided into two categories:
Employed and Unemployed.

Employed: A person is defined as being

employed if they have one or more hours of
work per week
Unemployed: A person is defined as unemployed if they are currently available for work, are actively
seeking work, and are unable to find it.

Labour Force = Employed + Unemployed

Factors affecting the nature of the Workforce:

1. Population Size:
 Gives us a starting point in determining the size of the workforce  sets a limit to which it can
grow
 Larger population  larger workforce
 Nations population tends to increase over time  natural increase and net migration
2. Age Distribution:
 Australia’s workforce mostly compromises people in the 15-65 age group (children at school and
retirees over 65)
 Greater the proportion of the population in the 15-65 age group, the greater potential for a
larger workforce
3. Education Patterns:
 Education outcomes are the single most important factor influencing the quality of a nation’s
workforce
 It is critical for an economy to have a highly skilled and productive workforce  individuals who
endure years of training and studying benefit through higher earnings

Employed

 Employed workers are those 15 years and older, currently working for at least one hour per
week for payment.
 This also includes those who are on paid or unpaid leave, worker’s compensation, those on
strike or lockout and self-employed workers.
 Full-time workers  usually work 35 hours or more
 Part-time workers  more than 1 hour but less than 35 hours
 Since the Global Financial Crisis in 2008, part time employment has grown at twice the rate
of full-time employment.
 87.7% of the labour force works in tertiary services, reflecting a growing emphasis on the
services industry as Australia adapts to a post mining boom economy.
 Australia has a strong human capital, however there is a need to constantly retrain and
sustain skills as human capital can depreciate over time.
 Employers would prefer to hire part time  more flexible in work hours, don’t have to pay
on-costs such as superannuation and holiday leave, cheaper to pay them off
Participation Rate

The Participation Rate refers to the proportion of the working age population who are actually in the
labour force as either employed or unemployed.
  The rate in Australia is most affected by young people finishing their studies and looking for
their first job and women returning from maternity leave
 The participation rate for men is higher than women, but it has steadily increased for women
and will continue to increase.

Unemployed

 Unemployed workers are those who are 15 years and over, not studying, actively seeking
work by are unsuccessful in finding work and those waiting to start a new job in the past four
weeks.
 They are expected to submit job applications and are willing to attend interviews for suitable
job vacancies.

 Unemployment grew significantly during the 2008/09 Global Financial Crisis as firms laid off
workers due to the lack of demand across the economy  as the economy recovered, so did
the unemployment rare
 Implications of low wage growth on the labour market and unemployment  reduced
consumption and spending which means less aggregate demand. Hence, less demand for
labour and as a result, unemployment rate goes up.

Types of Unemployment:

1. Cyclical Unemployment:
 Caused due to a contraction in aggregate demand during the business cycle.
 Since labour is derived demand, when aggregate demand is low (recession), demand for
labour is consequently low  leading to unemployment
2. Structural Unemployment:
 Results from a mismatch between the skills of the unemployed and the jobs available.
 Jobs that have been automated and industries which have shut down
3. Hard-Core Unemployment:
 unemployment among individuals who have been jobless for a long time. These people are
also the least likely to find or want jobs
 We often use the term colloquially and include people who have never had full-time jobs
4. Frictional unemployment:
 Moving between jobs and searching for a new job
 Includes young people leading studies and parents returning from child rearing leave
 Level depends on the quality of job services provided  more efficient job searching
services will minimise time spent looking.
5. Seasonal Unemployment:
 Work which is seasonal in nature such as harvesting and fruit pickers
 It depends on the nature of the season to be able to work
6. Underemployment:
 Refers to those who are working part time r casually (not unemployed) but would be able
to work more hours if they were available and wanted to
 Basically, someone who wants more work
7. Hidden Employment:
 Not counted in the official ABS statistics as they do not meet the unemployment definition
is ‘searching for work’
 Discouraged workers who have given up
8. Long-term Unemployment:
 Unemployed for over 52 weeks
 Lack if skills or training or hard-core unemployment issues
 Personal issues preventing person from working
 Need of significant assistance with job searching.

Causes of Unemployment:

1. Cyclical Unemployment:
 Lack of aggregate demand domestically and internationally through a lack of consumer
confidence and spending  reduce the demand for labour as it a derived demand (no one
will buy our exports while our economy is heavily dependent on it  60%)
 Governments increase spending and the RBA cut its cash rate  fall in unemployment
2. Frictional Unemployment:
 Occurs due to the imperfect flow of information between employers and employees.
 Lengthy and rigid recruitment process  68 days to hire
 Frictional unemployment in between jobs
3. Structural Unemployment:
 Changes to the fundamental structure and operation of the economy will lead to employees
being displaced  when industries become automated or government stops funding
inefficient industries  cuts in the workforce.

4. Underemployment:
 Caused by the casualization of the workforce leading to more part-time jobs as opposed to
full time jobs  more employees are underemployed
 High wages and on costs for full time employees means that businesses are incentivised to
hire part time or casual staff in order to reduce costs.
5. Geographic Factors:
 Since the mining boom has concluded, parts of Australia have experienced a rise in
unemployment due to the structural shift from mining to services.

Differences in Income from Work:

Labour market outcomes refer to how efficient the labour market is in determining wage and
employment levels. High unemployment  an inefficient labour market as there is a surplus of
workers.

Wage Outcomes – refer to the monetary rewards from work that include:

- Wages
- Salaries
- Fringe Benefits (company car, phone)
- Loadings
- Bonuses
 These will vary depending on demographical factors.

Non-Wage Outcomes – refer to the nature and quality of employment that the labour market
provides  part time, casual, full time (It looks at the rate of unemployment and
underemployment)

 Non-wage outcomes are the benefits that many employees receive in addition to their
ordinary and overtime payments such as:
o Sick leave
o Superannuation
o Company car
o Study leave
o Working from home  flexibility in working patterns
These outcomes are important to economists as they will affect real wage growth and the level of
employment, which thus determines the micro economy’s rate of economic growth, living
standards, productivity and distribution of income.

Differences in Incomes/Wage in the same occupation:

The labour market is made up of different micro markets – a market for each occupation and each
individual enterprise – and wage differentials occur between these markets.

Age:

 Income varies over the course of life

 Income levels are low in the earlier years of working life since people have less experience
and education/skills.
 It then peaks around the middle of an individual’s lifetime before declining as people get
older and need to rely on aged pensions or other forms of retirement income.
 Statistically, older adult males and females earn more than younger males and females,
peaking between 45-54  higher levels of experience
Gender:

 Discrimination by employers against different groups in a society means that some people
have limited job opportunities and less access to higher paid jobs.
 Australia has held a 14-16% gender pay gap, with males earning considerably more than
females.
 Women tend to accept more part time and casual roles  limited flexibility in their work
schedule due to family commitments, lower education and training qualifications than
males. As well as negative social attitudes towards women in paid work.
 Existence of a ‘glass ceiling’ for women who are not given equal access to managerial and
executive positions.
Ethnic and Cultural Background:

 Income distribution for migrants is strongly influenced by the length of time that they have
been in Australia, the countries from which they have migrated from and their level of
English speaking.
 Persons born overseas  higher average wages than those born in Australia
 Recent migrants from English speaking countries have higher incomes
 Recent migrants from non-English speaking background have lower incomes.
  Indigenous Australians also earn considerably less than non-Indigenous Australians and are
often supported heavily by social welfare.
Occupation:

 Workers who are managers or professionals earn the highest wages reflecting a higher level
of qualifications, training, education and responsibility.
 This contrasts with labourers and sales workers who earn significantly less due to the large
supplies of their skillset.
Geographic Mobility:

 Geographical mobility will influence wage rates within the same occupation  when
employers find it difficult to attract labour, they must resort to offering higher wages to get
employees.
 Thus, a similarly qualified worker may be paid a higher wage in order to be attracted to work
in more distant location.
Income Groups:

 Wages represented 54% of income in 2018  making them by far the largest component of
household income over profits, rent and interest.
 The distribution of income in Australia is relatively unequal  lowest quintile only earned
7.7% oh household income whilst highest quintile only earned 39.8%.

Differences in Incomes/Wage in different occupations:

 Different occupations require different levels of educations and skills to perform the jobs
 Labour market  receive greater rewards for working jobs with higher level of skills and
longer period of training
 Some unappealing jobs give high wages since not many people are willing to work
 Occupational Mobility: The ease of labour moving from one job to another influences
occupations wage  occupational mobility is high; supply of labour is likely to be high where
there is a need for employers to raise wages to attract labour

Trends in Distribution of Income:

 Australia has experienced an increase in income inequality  with the income Gini rising
significantly
 Undergone drastic changes that have altered the way in which people receive their wage
increases
 Shift towards enterprise bargaining  employees and employers negotiate wage increases
at the workplace levels has created greater differences in wage outcomes for individuals

Arguments for and against a more equitable distribution of income from work:

FOR

 Inequality causes reduced overall utility and growth:

o As high-income earners derive less satisfaction or utility from their income 
inequality will diminish the overall level of satisfaction in the economy, indicative of
market failure.
 Inequality causes social division:
 o Inequality can lead to different social class forming  low income earners become
the main recipients of welfare but alienated from the market economy due to their
relative poverty, whilst high income earners
o Further, there is evidence of a ‘working poor’ class, workers with limited skills and
hence relying on minimum wage increases to increase their living standards.
 Inequality creates poverty traps:
o Poverty traps arise through welfare dependency can also arise as the income
generated from employment must exceed the loss of income from social welfare.
AGAINST

 Inequality creates an incentive effect:

o Inequality encourages workers and entrepreneurs to develop higher skill levels,
extend their education, work harder and take more risks in order to receive higher
wages and salaries  increases labour productivity and the efficiency of labour
market resource allocation, boosting overall GDP.
 Inequality limits spending on social welfare:
o The government must spend on taxation revenue on transfer payments to the
unemployed, low income families and the elderly to sustain their living standards 
place higher tax burden on taxpayers.

Labour Market Trends:

The Labour Market is dynamic  undergoes significant technological, demographic and structural
change over time  best highlighted by the rise in the service industry (now 87.7% of the
employment rate, subsequent fall in manufacturing.

Unemployment and Underemployment:

 Unemployment has fallen due to the rise of underemployment (part-time, casual)

 Cyclical unemployment rose significantly after GFC
 Underemployment has become increasingly significant trend due to its role in dampening
wage growth  as jobs become increasingly casual, wage growth falls (wage growth falls
means less spending and no economic activity
 Underemployment has grown and affects young people more than any other age group 
force to accept part time roles due to lack of experience.

Labour Market Institutions

 Labour market institutions aim to influence the levels of market power available to
employers and employees, regulated by state and federal tribunals to intervene in the
labour market in order to achieve more socially optimal outcomes
 Trade Unions:
o Employee organisations which represent a group of workers  increasing their
overall bargaining power
o Raise employee wages and improve overall working conditions
 Employer Associations:
o Employer associations represent business groups in industrial matters, aiming to
protect employer interest during negotiations with the trade union  during
minimum wage reviews and enterprise bargaining processes
o Aim to maintain the profitability and competitiveness of businesses and industries
The movement away from full-time work:

The labour market has been undergoing substantial change as a result of changes in business
practises, economic conditions and government policies  the shift away from full-time work
towards work that gives businesses and individuals flexibility:

 Part-time employment
 Casual jobs
 Outsourcing
 Individual contracts
 Sub-contracting

Part-time employment:

 Defined as those employees regularly working 20 hours or less per week, whereas casual
employment occurs when employees have occasional working hours by do not follow any
set pattern
 Casual Employees  most insecure due to lack of job security or certainty about whether
they will have to work in the future
 Part-time workers have grown dramatically over recent decades  experience a large
increase in casual employment – casualization
 Some employees prefer part-time work  allows them to balance other responsibilities such
as family commitments
 More women work part-time than men  child-raising responsibilities
 Option to shift has been made easier in industries  more flexible arrangements such as
working from home
 Allows employees to negotiate part time or casual working hours that best suits their needs
 increased employment as it is an incentive to work there.
 Part-time can be choice of the employer not employee
 Employers hold great flexibility in their staffing arrangements if a substantial proportion of
their employees are less than full-time workers  increase or decrease hours easily, no on-
costs
 Recessions and downswings have led to a rise in part-time employment due to employers
reducing demand and hence cutting hours or shifting workers to part time.

Topic 5: Financial Markets

Financial Market Summary
Types of financial markets
 Financial intermediaries: Firms that receive the accumulated funds of
individuals/firms, and then make loans to other individuals who can make use to
them
o Channels excess savings (net savers) to those who wish to borrow funds (net
borrowers)
 Financial Markets: Create products that provide a return for those who have excess
funds making these funds available for those who wish to consume or invest
Primary and secondary fi nancial markets

 Definitions:
o Securities: Any form, of financial instrument, including shares and bonds, that
provide the holder of that instrument with a claim over real assets or a future
income stream
 Derivatives: Price is derived from the underlying assets
o Australian Securities Exchange (ASX): Where the purchase and sale of most
shares in public companies occurs, bringing together people wishing to buy
and sell shares (transactions)
 Primary: Facilitate the creation of securities that can be sold into the economy
 Secondary: Involves transactions with financial assets that have already been issued
on secondary markets
 Primary Financial Transaction: Sale of new shares
 Secondary Financial Transaction: When an existing shareholder sells their shares to
another shareholder

Market Description
Shares Where ownership shares in companies are exchanged
Bonds Bond is lending money to the Govt/company that issued the bond,
and in return, the government or company that issued the bond is
 agreeing to pay your money back, with interest, some point in the
future
Where people buy and sell financial assets that are based on the
Derivatives
value of other financial assets
Where financial assets defined in one country’s currency are
Foreign Exchange
exchanged for assets defined in another country’s currency

Financial
Description
Institution
Offers wide range of services

 Deposits (savings), Advances (loans)

Banks  Credit cards, stored-value cards, travellers’ cheques
 Overseas payments and fund collection
 Provision of safe deposit facilities and financial advice
 Arranged external fund managers to invest an individual’s savings
Finance Borrow from the public (issuing debt securities) to obtain funds
companies Reloan funds to households/SMEs at higher rates of interest
Uses surplus funds to borrow from companies (short-term basis)
Investment banks Lends funds to other large companies (expansion) and the
government
Non-profit, co-operative organisations (members = particular trade,
industry, profession, reside in a particular area)
Credit unions
People can deposit or borrow money, with any profits returned to
members
Accept deposits from the public and provide funds mainly for home
Permanent loans. They can also offer other personal and business loans, although
building societies their interest rate structure is controlled by some degree by state
governments
Mortgage funds who offer home loans to consumers, e.g. Aussie
Mortgage
Home Loans, RAMS (bought by traditional banks after GFC)
originators
 Offer low interest rates and more flexible repayment options
Superannuation Provide retirement income for employees and employers by investing
funds the contributions in financial assets

Financial Description
 products
Credit: Loans to individuals, businesses, govt. for spending on
consumption
CC: Allows consumers to purchase g/s and repay their borrowings
Consumer w/interest
Credit
 Issued by banks, credit unions, businesses: MC/Visa +
Woolies/Virgin/Jetstar
Personal loans offered by banks and credit unions

 Interest rate: Personal loans = 10 – 15%, Credit Card = 10 – 20%

Long-term loans to purchase property, requires periodic payments
Housing loans
w/interest, offered by banks and mortgage originators (Aussie/RAMS).
Investment in operations, such as with new tech or expanded office
space.
Business loans
Rates are typically higher than household lending rates
Large corporations = 1% more, small businesses = 5% more
Brings together people and businesses with temporary shortages and
Short term surpluses of funds (Banks)
money market Debt securities (bank bills/promissory notes) are issued, EXP. Less than
one year
Longer-term securities for which lenders receive regular fixed payments
Bonds (coupons) from the issuing institution, receiving the principal value of the
debt (face value) at the end of the bond period (date of maturity)
Contracts to trade in financial instruments at a later date for a certain
Financial price
futures and
 Protection against adverse movements (interest rates/share
options
price)
 Early agreement of the price for a future transaction
Market for the buying and selling of foreign currencies
Foreign
Exchange  Individuals: Going on holiday
 Businesses: Required for overseas transactions

The share market

 Definitions
o Share: Type of financial asset that provides an individual with ownership over
part of a business or company
 o Public 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
o Dividends: The profit returns received by the shareholders (owners) of a
business
o Capital gains: Profits made by investors who sell their shares or assets at a
price above the level that they originally paid for them
o Float: When a company lists itself on the stock exchange and offers its shares
to the general public for the first time
o Speculation: Investors buy assets with the intention of re-selling them for a
higher price

 Role and Function

o Investors
 Gain a stake in a company’s profits (dividends awarded on a per share
basis), make capital gains from increase in share prices (↑ company
value)
 Right to vote for a company’s board of directors
 Appoint senior managers who decide how to maximise
shareholders’ wealth
o Company
 Opportunity to raise funds (investment + business growth)
 Can access equity funds by issuing an approved prospectus for
the release of new shares
o Reduces control that existing shareholders have over
the company
 Effect on the economy
o Indicator of a country’s economic conditions
 Rising share prices: new and better economic prospects
 Lower share prices: fewer economic opportunities
o Method of allocating resources to different types of production
o Many share purchases are speculative (re-sold within a short period)

Shareholders Managements
Share price rises Value of investment Possible bonuses and
increases increased job security
Share price falls Value of investment Increased pressure
 decreases Threat of takeover
(insecurity)
 Not being bought to gain a long-term income stream
o All Ordinaries index: Measures all changes in the ASX (Australian Securities
Exchange)

Domesti c and global markets

 Dramatic increase in the participation of foreign investors in Australian markets

through increased lending and through increased foreign ownership of Australian
companies
 More opportunities for Australians to lend their surplus funds overseas or to invest in
companies overseas
 AU financial markets have become much more closely integrated over the past 3
decades
o ICT: ↓ communication cost, ↑ reliability/speed of electronic fund transfers
o Deregulation of financial markets (1980s)
 Foreign exchange markets: Movements of funds around the world (investing and
borrowing), increased when exchange rate was floated, and most exchange controls
abolished in 1983
o By April 2015: Daily transactions averaged US%136 billion
 Global debt markets: Economic development relies on foreign borrowing, mostly by 4
banks
o AU individuals: $1 trillion in loans to foreign entities
o AU: $2 trillion in outstanding foreign loans, usually by CBA, ANZ, NAB,
Westpac
 Benefits
o Access to foreign capital to invest in houses and businesses (would face
higher borrowing costs or might not be able to access finance otherwise)
o Opportunity to invest and earn returns from businesses overseas
 Disadvantage: Instability overseas is easily transmitted to AU, especially through
speculation

Regulation of financial markets

Defi niti ons

 Reserve Bank of Australia: AU’s central bank, in charge of conducting monetary

policy and to oversee the stability of the financial system
  Australian Prudential Regulation Authority: Govt. body responsible for supervision
and regulation of all authorised deposit-taking institutions (ADIs), life/general
insurance, and super funds
 Australian Securities and Investments Commission: Govt. body responsible for
corporate regulation, consumer protection, and oversight of financial service
products
 Australian Treasury: Advises the Government on financial stability issues, and the
legislative and regulatory framework for the financial system
 Council of Financial Regulators: Co-ordinating body for financial market regulation
that provides for cooperation and collaboration among its members (RBA, APRA,
ASIC, Treasury)
Council of Financial Regulators

 Informal body for financial market regulation that provide for cooperation and
collaboration among RBA, APRA, ASIC, and Treasury, allows sharing of information
and advice coordination
o 2008 Global Financial Crisis
 Produced joint Memorandum of Understanding
 Interim ban imposed by ASIC on short selling (lifted in 2009)
 Individual sells a share they do not own at the time of sale,
planning to buy later at a lower price and profit from any
decline in its value

Reserve Bank of Australia

 Conducts monetary policy, aims to achieve 2-3% I.R. while encouraging economic
growth
 Provides guidelines to foster the stability of individual financial institutions (enforced
by APRA), seeks to maintain long-term stability by avoiding/reducing risk of financial
crises
 Control of note issue: Sole issuing authority of Australian currency (Note Printing
Australia)
 Regulation of the electronic payments system by ensuring the efficiency and stability
of different payment methods, carried out by Payments Systems Board
 Holds exchange settlement accounts (w/other banks) which allow banks to settle
debts or by the banks to buy and sell securities from the RBA
 Responsibility for holding AU’s reserves of gold/foreign currency dealings,
o Provides funds (intl. payments/RB operations), oversees dealers in Foreign
Exchange
 Provides banking/financial agency services to the Commonwealth/State govt.
o Govt. can lodge excess funds w/RB, and obtain funds through Treasury bills
  RB is printing new money that the govt. needs
o Raises short and long term loans (Notes/Bonds) making interest payments,
and buying them back on maturity
 Publishes regular assessments of the state of the economy and financial markets:
Highly respected, significant influence on economic policy-making
Australian Prudenti al Regulati on Authority

 Encourages institutions to meet their obligation with clients

o ADIs: Deposit-holders can take back their deposit money when they want it
o Insurance companies can meet their policy obligations
o Superannuation funds can pay people who withdraw their savings
o Requires deposit-taking institutions to maintain a certain level of funds (risks)
 Sorting out institutions that experience financial difficulties (ADIs/Insurance/Super
funds)
o Ensures that policy/deposit-holders receive as much of their funds as possible
o APRA has right to intervene (range of investigative powers)

Australian Securiti es and Investments Commission

 Monitors, investigates, and acts (individuals’ illegal acts, unethical investment

products)
Protect consumers against misleading/deceptive and unconscionable conduct
affecting financial products and services
 Crucial in lifting standards of corporate behaviour/maintaining confidence in
financial markets
o ‘Insider trading’: Company directors use non-public info to buy/sell shares
o Company executives failing to inform the market of price-sensitive
information
 Has hundreds of investigations underway: Paying fines, frozen assets, jail-time
 Does not prevent investors from making losses, nor does it prevent companies from
experiencing financial difficulties
Australian Treasury

 Main source of economic policy advice to the government: Budgets, taxes,

expenditure, monetary/labour market policy, market regulation
 Provides advice on regulations (financial markets, corporate practices, consumer
protection)
 GFC: Kept Govt up to date on AU/overseas development markets, best approach to
minimise the impacts of financial market disturbances

Borrowers
 Individuals
o Short-term: Purchasing a car, international travel, educational courses, credit
cards
 o Long-term: Mortgage for family home. Bank can sell it to regain debt if
defaulted (Security)
 Businesses: Need access to funds (expand production, invest in R&D, other special
projects)
o Raising equity (issuing equity) or debt (issuing bonds)
o Borrowing from deposit-taking financial institutions
o Investment in R/D (↑ production): Selling bonds/borrowing funds from F.I.
 Government: Raise the level of
economic activity
o Increase spending/tax cuts to
stimulate AU economy
o Funding major infrastructure
projects
o Can borrow from overseas
banks
o Government will hold some cash reserves (liquidity)

Factors affecting the demand for funds

Liquidity: The ease with which a financial asset can be transformed into cash so it can be
used as a medium of exchange
Moti ves

 Transactional: Day-to-day transactions, e.g. Purchases, regular payments for g/s

 Precautionary: Numerous unpredictable circumstances, emergencies
 Speculative: Possibility of making capital gains or losses
Financial innovati ons

 Increased use of technology: ATM, EFTPOS, online banking/payment systems

 Increased availability of contactless payment systems: ↓ 25%-time vs CC/DC
 Digital currencies: Bitcoin, directly exchanged for g/s

Lenders
 Individuals
o Lend money to banks in order to get a return on it (interest)
o Individuals could also invest in assets (property) or shares (risky!)
 Businesses: Possess strong cash flow and good profits
o May deposit its funds to get a return on interest
 Government
o Revenue exceeds spending: Paying off outstanding debts, maintain cash flow
 International: Important source of funds for domestic borrowers
o AU Govt. provided guarantee for all overseas borrowings by AU banks (no risk
in lending)
Financial aggregates measured by the Reserve Bank of Australia
 Characteristics of money
o Medium of exchange: Used to exchange G/S, resources
o Measure of value: Used to compare the relative value of G/S, resources
o Store of value, Measures value of G/S, resources over time
o Deferred payment: System of lending and borrowing
 Money Base: Measure the most liquid financial assets
 M3: RBA’s definition of the money supply
 Broad Money: Accurate measure of total money supply, but it takes longer to collect
the relevant statistics
 Credit: Allows payments for purchases to be deferred (no store of value), not
measure of money supply

Interest Rates
Interest rates: Cost of borrowing money expressed as a % of total amount
borrowed, or the rate of return (yield) on fi nancial assets or fi nancial
instruments, such as bonds

 Demand for funds curve represents demand for financial

assets by borrowers. They borrow more at lower interest rates
 Downward-sloping (Inverse relationship)
 Supply of funds curve represents supply of financial assets by
lenders. They supply more at higher interest rates  Upward-
sloping (Direct Relationship)
Equilibrium: Quantity of funds supplied by lenders = quantity of funds demanded by
borrowers
Reality: Interest rates not determined by normal interaction, but indirectly set by RBA. The
supply of funds (savings) tends to be unresponsive to changes in the interest rate (i.e. very
inelastic)
Lending Rates

 Financial institutions earn money by lending funds (savings deposits) to other

borrowers
o Borrowing rate: Rate of interest paid to those who deposit
 o Lending rate: Rate of interest that customers who borrow have to pay back
o Interest rate differential/margin: Lending rate > Borrowing rate  Profit
 Short-term securities: Loans w/maturity of less than a year
o Commonwealth Govt = Treasury Notes (13 or 26 weeks)
o Less risky, more liquid (easier to turn into cash) = Lower interest rate
 Long-term securities: Loans w/maturity of more than a year
o Commonwealth Govt = Treasury Bonds (5, 7, or 10 years) or Mortgages (25
years)
o Riskier, less liquid (harder to turn into cash) = Higher interest rate

Factors infl uencing interest rates

 D capital goods: ↑ Demand for investment = ↑ Demand for borrowing = ↑ Interest Rates
 Level of savings: ↑ levels of savings = ↑ supply of loanable funds = ↓ Interest Rates
 Liquid funds: ↑ Demand for investment = ↑ Demand for borrowing = ↑ Interest
Rates
 Inflationary expectations:
 Govt budget: ↑ Spending = Budget deficit = Borrower in financial markets = ↑
Interest Rates
 Intl interest rates: ↑ intl. rate = ↑ returns = ↓ supply of loanable funds = ↑ Interest
Rates
 RBA buying/selling securities: Affects supply of funds in short-term money market in
order to set the cash rate (influences the interest rates on short-term loans and
longer-term loans)
Domesti c market operati ons
Actions by Reserve Bank in the short-term money market to buy/sell securities, either
outright or through repurchase agreements in order to influence the cash rate and general
level of interest rates
Cash rate: Interest rate paid on overnight loans in the short-term money market

 Exchange Settlement Accounts: Banks and some NBFIs hold a certain proportion of
their funds with the RBA to settle payments with other banks
o ANZ costumer uses cheque to buy g/s from NAB business, Funds from ANZ 
NAB
o No net impact on money supply (one bank gains funds, another loses funds).
Some banks borrow from banks w/surplus funds in order to settle their daily
transactions
 Short term money market: Where banks borrow/lend money for their ES accounts
 Expansionary monetary policy: Buys securities, deposit funds (bank buys back at later
date)
o ↑ supply of funds = ↓ cash rate (price of borrowing)
 o Lowers cost of borrowing for banks  Lower lending interest rates for
customers
o Encourages consumption + investment spending  Higher level of economic
activity
 Contractionary monetary policy: Sells securities, withdraws funds
o ↓ supply of funds = ↑ overnight cash rate of interest
o Increases cost of borrowing for banks  Lower lending interest rates for
customers
o Deters consumption + investment spending  Lower level of economic
activity

RBA sells securities RBA buys securities

Shortage of borrowable funds Excess of borrowable funds

↑ Cash rate ↓ Cash rate

↑ market interest rates (banks ↓ market interest rates (banks

maintain profit margins) maintain profit margins)

Consumers/Businesses pay more Consumers/Businesses pay less

on existing debts, New borrowers on existing debts, New borrowers
find it harder to borrow funds find it easier to borrow funds

↓ Consumption and investment ↑ Consumption and investment

spending spending

↓ Economic Activity ↑ Economic activity

Topic 6: Government and The Economy

Government intervention in the economy
Provision of goods and services

 Market failures:
 Public goods: Firms are not willing to supply this type of good, the government provides
them
o Non-excludable: Cannot restrict usage/benefits to those willing to pay  free riders
o Non-rival: One person’s enjoyment does not diminish potential for others to enjoy
o Examples: Clean air, health care, street lighting, national defence, and public parks
 Merit goods: Under-produced goods (individuals do not value these goods enough)
o Subsidies for arts (theatre, opera, film, fine arts e.g. Sydney Opera House)
o Health care: Operating most hospitals

Inequality in the distribution of income

  Disadvantaged groups: Those with low education levels, migrants from non-English speaking
backgrounds, Indigenous Australians, and single parent families
 Relative poverty: Those whose standards of living is substantially lower than the average
(level of income below 30% of avg. earnings)
 Inequality: Child in a low-income family v. wealthy family (education/job opportunities)
o Parents are less-educated: cannot help with homework
o Financial pressures: may not be able to fund until end of high school/university
o Individual may not study further due to large student debt  low-paid jobs
 Role of the government: Improves social mobility
o Improve opportunities for people in disadvantaged groups
 Universal access to free education until the completion of high school
 Special educational assistance programs and scholarships
 Living allowances for students
 Measures to help mature-age people enter higher education
o Welfare state: Comprehensive benefits system to create a more equal society
 Aged pension, unemployment benefits, free access to health care, subsidised
access to other government services e.g. transport and housing
 AU welfare state
 Grew throughout second half of 20th Century due to ageing
population, higher levels of unemployment, an increase in single
parent families, and higher numbers of students in tertiary education
 1980s: Backlash (too generous) due to belief that people who make
no contribution should not be entitled to government benefits
Externalities in the environment

 Externalities: External costs and benefits that private agents in a market do not consider in
their decision-making process. Positive = Benefits, Negative = harmful effects
 Negative externalities in Australia
o Contribution to increased carbon dioxide and global warming (fossil fuels)
o Transformation of land (clearing/excavations)
o Land degradation (soil salinity/erosion)
o Water pollution: Detergents and industrial output

Monopoly power

 Formation: Costs involved in producing, distribution, and marketing may be high

o Small number of firms (oligopoly, monopoly)
o Restricts its production in order to charge a higher price and maximise its profits
o Focus more on advertising, brand packaging, and product differentiation
 No real benefit for consumers (instead of reducing prices)
 Ways which firms may abuse their market power
o Monopolisation: Eliminates existing competition (temporary price cutting)
 Govt owned monopolies: Protects consumers
o Price Discrimination: Same type of g/s at different prices, e.g. peak/off-peak
telephones, concession prices for movie tickets
 Charging different prices to different consumer according to their
willingness and capacity to pay
o Exclusive dealing: Exclude retailers from dealing with other competitors
  Competition and Consumer Act 2010: Suppliers are prohibited from
imposing on their customers an obligation not to purchase g/s from other
suppliers, strictly enforced by the Australian Competition and Consumer
Commission
o Collusion and market sharing: When firms get together and agree on a pricing and
market-sharing agreement that reduces effective competition (criminal penalties)
Fluctuations in economic activity

 Business cycle: Fluctuations in the level of economic growth

(domestic/international factors)
 Severe fluctuations w/out government intervention
 Boom: Excess demand for g/s  Inflation
o Distort business decision making
o Reduces consumers’ purchasing power
o Increase in interest rates
 Recession: Shortage of demand for g/s
o Increase in unemployment
o Business failures
o Other economic/social problems
 Govt: Economic stabilisation: Strong and stable level of economic
growth while minimising the harmful effects of inflation and
unemployment
o Macro (Fiscal and Monetary): Impact on the whole economy
 Excessive growth: Spend less, increase taxation, raise interest rates
 Recession (stimulate growth): Spend more, tax cuts, low interest rates
o Micro (Competition/Trade Policy)
 Improve work practices/productivity levels (individual firms/industries)
 Promote structural adjustment

The role of government

Functions of the 3 levels of government and their constitutional powers

 Australian Constitution: Law making powers, restrictions on what Federal and State
government can and can’t do, only able to act under constitutional “hands of power”, what is
not covered by Federal goes to the state
 Commonwealth: Overall responsibility for the economy, has the most
influence on economic performance, responsibility of defence, funds
health and education
 State: Play important roles in developing infrastructure, delivering
government services and fostering regional development, runs health
 Local governments: Minor role, local community facilities and roads
Public Sector

 Public Sector: The parts of the economy that are owned/controlled by the government
 o Commonwealth, state, and local governments
o Public enterprises, e.g. Sydney Water Corporation, Rail Corp, and Australia Post
 Total Public Sector Outlays: The proportion of total annual expenditure by all levels of
government compared with the expenditure for the whole economy
o Increased steadily in the second half of the 20th Century (after WWII)
o Within a range of 35-42% of GDP for the past three decades (small compared w/
EU)
 Composition of government spending: Less infrastructure, more social welfare payments and
community services e.g. health care (Transfer Payments: back to households)
 Proportion of AU employees in public sector (Usually in proportion to public sector outlays)
o Decrease since 1985: Contracting out many of their activities to the private sector
 Role of public sector
o Change in approach to economic management
 1940s-1970s: Influence of Keynesian economics (More spending  full
employment levels), more active role in influencing economic performance
 1980s: High tax levels and excessive borrowing, privatisation
 2008 GFC: Govt started having a more pro-active role, large short term
increases in government spending and borrowing to stabilise the business
cycle and support financial institutions at risk of collapse
o Provision of government services
 Should provide improved standards of health care, education, other services
 Concentration of population in larger towns/cities; Community services,
such as police, water and sewerage, roads, recreational facilities etc.
o Growth of social security: Welfare benefits and programs
 Age pension, widows’ pensions, child support payments, unemployment ben.
 Welfare state: Comprehensive social security programs
 Reduce taxation levels + Reduce budget deficits = More constraint on
government spending
Economic functions of the Australian Government
Reallocation of resources
 Types of taxes
o Direct: Paid by individuals/firms, e.g. income, company, capital gains
o Indirect: Attached to a good or service, e.g. sales, duties
 Demerit goods (tobacco/petrol): Discourage/deter their consumption
 Example: Carbon tax in 2012 (reduce carbon emissions)

 Types of expenses
o Funding: Arts (Unprofitable)
o Grants: Start-up businesses/new growth industries (may lack access to finance)
o Subsidies: Telecoms (Broadband in regional areas are not profitable)
o Cash payments: Private employment search businesses (help unemployed find jobs)
 Provision of goods and services
o Basic infrastructure (roads, railways, public transport, electricity, postal, telecoms)
o Considered to be inefficient: Sell businesses to private sector (privatisation)
Redistribution of income
 Taxation
o Tax base: The items that are taxed (income, wealth, consumption)
 o Average rate of tax (ART): The proportion of total income earned that is paid in the
Tax payable
form of tax ×100
Total income
o Marginal rate of tax (MRT): The proportion of any increase in income that must be
paid as tax. Therefore, it represents how many cents in each extra dollar earned that
∆ Tax payable
must be paid to the government ×100
∆ Total income
 Tax types
o Progressive: Higher income earners would pay a greater proportion of their income
as tax than lower income earners (ART rises as an individual’s income increases)
o Regressive: Higher income earners would pay a smaller proportion of their income
as tax than lower income earners (ART falls as an individual’s income increases)
o Proportional: All income earners pay the same proportion of their income as tax
(ART remains constant as an individual’s income increases)
 Social welfare payments: Redistribution of taxation revenue to lower income earners
o One-third of govt expenditure (considerable impact upon distribution of income)
o Payments are often means-tested (High incomes/large amount of assets) = Ineligible
o Types: Unemployment/family benefits, aged/disability/single parent pensions
o Largest single area: Age pension (financial security in addition to their super)

Government business enterprises

 Government business enterprises: Businesses owned and managed by a government at either

the Commonwealth or state level
 Recent trend: GBEs are being privatise (sold off to the private sector)
o Medibank Private, CBA, Qantas, Telstra, TAB, State Bank of NSW
 Corporatisation: When the government encourages public trading enterprises to operate
independently from the government (improve efficiency and profitability)
o ↓ govt. interference in operations (managers = independent and accountable)
 Competition: Pressure on business firms in a market economy to lower prices or improve the
quality of output to increase their sales of g/s to consumers
o Significant improvements in both prices and productivity in a number of industries
 Electricity/telecommunications industries
 Remaining GBEs: AU Post, State rail/bus/ferries, Utilities (Water/Gas), R&D institutions

Stabilisation of economic activity

 Fiscal: The manipulation of government spending and taxation to influence the budget
 Monetary: Actions by the RBA, influencing the level of interest rates and the supply of money,
which influences overall level of economic activity, inflation, and unemployment
o Tight: Slow down level of economic activity (upward pressure on interest rates),
reducing demand for money and dampen consumer/investment spending
o Loose: Increase level of economic activity (downward pressure on interest rates),
increasing demand for money and increase consumer/investment spending
Competition and environmental policies
 Competition policies: Ensure the efficient operation of markets
o Efficient use of resources, ↓ production costs/consumer prices, product innovation
 o Government wish to achieve a situation where markets are contestable
o Barriers to entry are kept to a minimum
 Consumer protection
o Ensure fair business conduct (prohibitions and impositions of penalties)
 Price fixing, misleading advertising, price discrimination, mergers
o Competition and Consumer Act 2010 and ACCC
 Environmental protection
o Non-renewable resources: Inputs to production where the stock of the resource is
permanently depleted in the process of production and consumption
o Renewable resources: Inputs to the production process that replenish themselves
 Supporting alternative energy sources
 Incentives to reduce the use of fossil fuels
o Climate change: Air and water pollution (coal + oil  CO2)
 Carbon tax: $23 per tonne on large companies
Federal Budget
Commonwealth Government Revenue

 Income tax (Individuals and companies)

o Personal: 47%, PAYG system, deducted regularly, progressive in nature
o Company: 17%, 30% of net profit, Fringe benefits tax (1% of revenue)
o Superannuation: 2% of revenue
 Goods and Services Tax (10% to most items sold in AU), 15% of total tax collection,
allocated to local and state governments
 Excise/Custom Duties: 9% of revenue, quantity of a product (Petrol, diesel, tobacco, alcohol)
 Other: 1% of revenue, miscellaneous taxes/charges/fees/fines imposed
 Non-tax: 7%, profits from GBEs, interest/dividends/royalties
Commonwealth Government Expenditure

 Social security and welfare: Largest outlay, transfer payments aimed at redistributing income
from taxpayers to welfare recipients, such as the elderly and unemployed
 Education: Funding to UNIs, VET providers, govt/non-govt primary and secondary schools
 Health: Funding of Medicare and the Pharmaceutical Benefits Scheme, public hospitals
 Infrastructure: Roads, rail, ports, communications networks
 Environment and ecologically sustainable development: Investment in clean energy and low
carbon emission technologies, energy efficiency measures
Types of budgets

 Surplus: Planned government revenue > Planned government expenditure

 Balanced: Planned government revenue = Planned government expenditure
 Deficit: Planned government revenue < Planned government expenditure
Government Fiscal Policy Stances

 Expansionary: Reduction of taxation revenue/increase in government expenditure

(infrastructure and social welfare)
o Creating either a smaller surplus/bigger deficit
o Higher inflation
o Aim to increase the level of economic activity by stimulating AD
  Contractionary: Increase of taxation revenue (people won’t have a lot to spend) /decrease in
government expenditure
o Creating a larger surplus/smaller deficit
o Decrease in inflation
o Aim to decrease the level of economy by dampening AD
 Neutral: No overall effect on the level of aggregate demand and economic activity

Automatic stabilisers

 Policies that act automatically to counterbalance (stabilise) the trend in the level of economic
growth
 The two main stabilisers are progressive income tax and unemployment benefits (social
welfare)
 Increase in level of economic activity: Increase in income levels, rise in taxation revenue, fall
in unemployment (more jobs created), reduction in government expenditure on unemployment
benefits. Therefore, budget outcome is increase in surplus and a decrease in deficit.
 Decrease in level of economic activity: Decrease in income levels, fall in taxation revenue,
rise in unemployment (less jobs), increase in government expenditure of unemployment
benefits. Therefore, budget outcome is decrease in surplus and an increase in deficit.
 Changes in the budget are the result of:
o Automatic changes in the budget due to economic activity (cyclical components)
o Government changes to revenue and expenses (structural changes); this is the main
driver of the fiscal policy
Influences on government policies in Australia

 Political parties
o Proposed law must be supported by a majority in both the Lower House and the
Upper House (House of Representatives and the Senate)
 Businesses: Significant voice in government policy decisions
o Political parties rely on large donations to fund election campaigns
o Lobbyists represent individual companies and their specific interests
 Tax, regulation, privatisation, outsourcing of g. services, spending programs
 Unions: Largest organisations by membership (declined membership since 1970s)
o Represent interests of their members, Consultations with government
o Public debates, issuing reports on matters that affect members’ interests
o Specific interests in labour market policies, specific industry policies, and measures
that affect the interests of people on lower incomes
 Environmental groups/organisations: Advocate for environmental protection
o Conduct research, provides education information
o Lobbies governments/companies that have implications on the governments
o Environment has now become a mainstream issue for economic policy makers
 Welfare agencies: Represent the most disadvantaged people in the community
o Participate in government inquiries and lobby government ministers
o Use media to put their message across and pressure the govt.1  influence policies
 The media
 o Determines which issues will receive coverage and how issues are presented to
public
o Heavy criticism: Change plans, positive media coverage: Pursue, even if they are of
limited benefit

LABOUR GOVERNMENT- Main focus on social welfare and look to increase this welfare
LIBERAL GOVERNMENT- Main focus on businesses, economy