» The economic problem: concerns how a society can satisfy the unlimited and competing wants

of individuals and the community with only a limited quantity of available resources.
 A matter of choice and priority; in choosing one option we must be deciding against another.
 The study of Economics is based around solving this fundamental issue.

» Utility: the satisfaction derived by individuals from the consumption of goods and services.
» Needs: those goods and services essential for everyday living and survival.
» Wants: those non-essential goods and services desired by individuals and the community.
 Unlimited; as soon as we have satisfied one want we will seek to satisfy another.
 Cannot satisfy all at once due to limited income; thus we must choose between our wants.
 Change over time; affected by certain factors e.g. age, income, technology, fashion trends.
 Can be recurrent (have to be satisfied over and over again in future; e.g. food, clothes).
 Can be complementary (naturally follows satisfaction of another want; e.g. petrol for a car).
» Individual wants: desires of each individual person; depends on personal preferences.
 Ability to satisfy individual wants is determined by one’s level of income.
» Collective wants: desires of the community; depends on preferences of community as a whole.
 Usually provided by various levels of government; funded by revenue from taxation.

» What to produce?
 No economy can satisfy all individual and collective wants due to limited resources.
 Must decide which wants (goods and services) to satisfy first and which to leave unsatisfied.
» How much to produce?
 Need to allocate limited resources efficiently to maximise the satisfaction of wants.
 Producing too much of a good wastes resources; producing too little leaves wants unsatisfied.
» How to produce?
 Must decide how to allocate resources in the production process.
 Most efficient production method using least resources will satisfy greatest number of wants.
» How to distribute production?
 In modern economies, each person’s share of total production depends on their income level.
 Must decide on equitable (even) or inequitable (uneven) distribution; equity vs. efficiency.

» Opportunity cost: the “real” cost of satisfying a want; not in money but the alternative foregone.
 Whenever we satisfy one want, we give up the opportunity to satisfy some alternative want.
 Arises due to limited resources; applies to individuals, business firms, and governments.

» Production possibility frontier: a graphical

representation of all possible combinations of the
production of two types of goods or services that the
economy can output at any given time.
 Demonstrates how opportunity costs arise when
individuals or the community make choices.
 Simple model (see right) assumes the use of existing
technology, a fixed quantity of resources, and that all
resources are fully employed in production.
» Production possibility schedule: the same numerical information in table format.

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» Factors affecting the production possibility frontier:
 New technology: may be able to develop more
efficient methods of production; can produce a higher
quantity of a good with the same resources.
 Represented (see right) as an outward shift of the
production possibility frontier.

 Increased quantity of inputs available for production:

e.g. through discovery of new resources or expansion of
population (i.e. labour force) through immigration.
 Represented (see left) as an outward shift of the
production possibility frontier.

 Unemployment: of either labour or production

inputs; indicates an inefficient allocation of resources
and thus that the total output of goods and services
is less than what it potentially could be.
 Represented (see right) as a shift in position with
regards to the production possibility frontier (the
frontier itself is not actually changed).

» For the production possibility frontier to be a linear

straight line, the economy must substitute between the
production of the two types of goods at a constant rate.
 Under real-world conditions this is not the case; the
production of one good becomes exponentially
more efficient as more resources are allocated to it.
 Thus (see left) the frontier is concave to the origin.

» Consumer goods: items produced for immediate satisfaction of individual/community demand.

» Capital goods: items used for production of other goods to increase future productive capacity.
» An economy focusing more on capital good production will experience greater long-term
economic growth; i.e. forego some wants now, can satisfy a greater number of wants in future.
» Economic choices made now have implications, whether positive or negative, for future economic
outcomes. This principle applies to individuals, businesses, and governments.

» Influenced by: age, income, education, future plans/expectations, family situation, personality, etc.
» Must decide on spending (satisfy short-term wants) vs. saving (raise long-term living standards).

» Must make choices on: price of products; production quantity; usage and allocation of resources
in production process (minimise costs, maximise efficiency); management of employee relations.

» Can influence choices of individuals and businesses by: affecting cost of products (e.g. taxation);
prohibiting undesirable practices (e.g. imposing fines as penalties); encouraging desirable
activities (e.g. by providing rebates); providing public goods and services directly to community.

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» Goods and services are the outcome of the production process; satisfy our wants and needs.
 Goods: tangible items from which we derive utility. Services: intangible acts of benefit to us.
» Factor of production: any resource that can be used in the production of goods and services.
 Quantity and quality of an economy’s factors of production can influence its living standards.
 Limited supply of resources; producers face opportunity cost in deciding how to utilise them.

» Natural resources (land): all resources provided by nature that are used in production process.
 Includes: soil, water, forests, mineral deposits, fishing areas, etc.
 Rent: $ rewards to owners of natural resources; derived from their productive use.
» Labour: human effort (both physical and mental) used to produce goods and services.
 Supply and quality of labour depends on: population size (i.e. birth/death rates, immigration),
school-leaving age, retirement age, social attitudes, standards of education and training, etc.
 Wages: $ rewards to owners of labour; includes regular salaries, commissions, fees, etc.
» Capital: items that are to be used in the production of other goods and services.
 Can be owned:
 By individuals or firms: private goods (e.g. machinery, tools, factories, computers, etc.).
 By community: public infrastructure (e.g. roads, utilities, telecommunications, etc.).
 In economic terms, capital does not include financial assets (e.g. cash, shares, bonds, etc.).
 Using capital equipment can greatly increase productivity and efficiency of existing resources.
 Interest: $ rewards to owners of capital; price of borrowing savings to invest in capital goods.
» Enterprise: involves bringing the other factors of production together in the production process.
 Entrepreneurs make vital management decisions concerning all aspects of production.
 Profit: $ rewards for enterprise; over and above rewards from other factors of production.
» Easy way to remember the four factors of production: CELL (capital, enterprise, land, labour).

» Each of the factors of production is limited in supply, reflecting the economic problem of scarcity:
 Natural resources limited by what is available in the surrounding environment.
 Labour limited by: population size; labour market skills; people’s willingness to work.
 Capital limited by: investment from private sector and government; level of savings available.
 Entrepreneurial skill limited by: size of population; ability and desire to innovate and take risks.
» In a market economy, the allocation of resources in production is largely in response to consumer
spending patterns. Firms obtain the necessary resources to produce items that are demanded.
» Firms may use more labour-intensive or capital-intensive combinations of resources in production.

» GDP (Gross Domestic Product): total market value of all final goods and services produced in an
economy over a period of time. Also measures the total income of a society from its production.
» Market economies do not attempt to distribute output equally within society; instead they reward
people with income based on the value of their input/contribution to the production process.
 Provides incentives to obtain better skills and work harder to improve one’s share of output.
 Improves the resource base; encourages innovation and technological advancement.
 Can be unfair for those unable to contribute to production (e.g. too old, ill, disabled, etc.).
 Those with less bargaining power may be unable to secure a fair return for their labour input.
» Governments may intervene to correct inequitable market outcomes and help the disadvantaged.
 Aim to influence the distribution of goods and services; take money from higher income
earners through taxation and redistribute to lower income earners as social security payments.
» Over the past three decades, Australian distribution of output has become more skewed towards
owners of non-labour production inputs; i.e. the share of income received as wages has declined.
» Money is generally used as a medium of common value for the exchange of goods and services.

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» Business cycle (economic cycle): fluctuations in the level of economic growth over time, due to
either domestic or international factors. Levels of activity in a market economy are never constant.
 Economies usually experience an overall trend of growth in output; however the business
cycle is characterised by alternating periods of strong growth and economic slowdown.
» Recession: stage of the business cycle where there is decreasing economic activity.
 Defined as two consecutive quarters of negative economic growth (i.e. fall in GDP).
» Boom: stage of the business cycle where there is increasing economic activity and growth.

 Falling production of goods and services.  Rising production of goods and services.
 Falling levels of consumption and investment.  Rising levels of consumption and investment.
 Falling levels of employment.  Rising levels of employment.
 Falling levels of income.  Rising levels of income.
 Falling quality of life and standards of living.  Rising quality of life and standards of living.
» This cyclical flow of activity causes major disruptions; governments aim to smooth this out by:
 Stimulating economic activity during periods of recession to assist growth and recovery.
 Ensuring the economy can sustain long-term growth to avoid any major economic downturns.

» Five-sector circular flow of Income

income model: describes the
operation of an economy and the
linkages between its main sectors
(individuals, businesses, financial
Expenditure on goods and services
institutions, governments,
international trade). Savings (S) Investment (I)
 Sector: a part of the
economy whose participants
Taxation (T) Expenditure (G)
are engaged in similar types
of economic activity.
 Depicts flow of money Imports (M) Exports (X)
between sectors, not the flow
of goods and services or
factors of production. Leakages Injections

» Leakages: flows that result in money being removed from the circular flow of income.
 Causes a decrease in aggregate income and general levels of economic activity.
 Three types: savings (S), taxation (T), imports (M).
» Injections: flows that result in money being added to the circular flow of income.
 Causes an increase in aggregate income and general levels of economic activity.
 Three types: investment (I), government expenditure (G), exports (X).

» Individuals: consists of all individual people in the Australian population.

 Concerns their activities in earning an income and spending it on goods and services.
 The main consumers in an economy; also the owners of productive resources.
 Supply factors of production as inputs to businesses; rewarded by receiving incomes.
 Income goes towards spending on consumption of goods, savings, taxation, or imports.
» Businesses: consists of all business firms engaged in producing and selling goods and services.
 Concerns their activities in buying and using factors of production in the production process.
 Businesses and individuals are interdependent; need each other to survive.

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» Financial institutions: consists of all organisations engaged in borrowing and lending of money.
 Include: banks, building societies, finance companies, credit unions, superannuation funds, etc.
 Act as intermediaries between individuals and businesses looking to save and borrow money.
 Accept deposits from individuals; mobilise and lend to firms for investment purposes.
 Saving (leakage) and investment (injection) vital for growth and creation of new capital goods.
» Governments: consists of federal, state, and local levels in Australia.
 Impose taxes (leakage) on individuals and businesses; reduces levels of economic activity.
 Government expenditure (injection) on provision of collective wants and transfer payments as
income (e.g. pensions, unemployment benefits); increases levels of economic activity.
» International trade: consists of all transactions occurring between Australia and other nations.
 Imports: goods and services produced overseas but sold to Australian consumers (leakage).
 Exports: goods and services produced in Australia but sold to overseas consumers (injection).
 Other outwards and inwards monetary flows represent leakages and injections respectively.
» Private sector: individuals + businesses + financial institutions. Public sector: governments.
» Domestic sector: private sector + public sector. International sector: foreign trade.

» Equilibrium: occurs in an economy when the sum of all leakages equals the sum of all injections.
 Savings + taxation + imports = investment + govt. expenditure + exports; S+T+M=I+G+X.
» Disequilibrium: occurs when there is an inequality between total leakages and total injections.
 Leakages exceeding injections results in a downturn in levels of economic activity.
 Injections exceeding leakages results in an upturn in levels of economic activity.
» Economies will generally tend to balance themselves out and naturally move towards equilibrium.
» Governments can intervene directly by changing levels of taxation and government expenditure,
manipulating the total size of leakages vs. injections and hence overall levels of economic activity.

» Market economy: all major economic decisions are made by individuals and private firms.
 Actions motivated by self-interest; people able to seek wealth without government interfering
or affecting their business activities. Most economic resources owned by the private sector.
 Also known as a capitalist, free enterprise, or laissez-faire system.
» Centrally planned economy: government planners make all economic decisions.
 Little scope for individual choice to influence the economy; public ownership of factors of
production allows government (usually under communist regime) to allocate resources at will.
» Neither pure market economies nor fully planned economies exist in the modern world.

» Market system: a network of buyers and sellers seeking to exchange products at a certain price.
 Product market: the market for goods and services that are the outputs of production.
 Factor market: the market for input resources that are the factors of production.
 Price mechanism: the process by which forces of supply and demand interact to determine
the market price at which goods and services are sold, and the quantity that is produced.
 Influences interactions between buyers and sellers in both product and factor markets.
» Private ownership: individuals have a right to own factors of production; can use them to derive
income and acquire wealth. Also have a right to sell these resources or transfer their ownership.
» Consumer sovereignty: the manner in which consumers, through collective market demand, can
exercise freedom of choice to determine the type and quantity of goods and services produced.
» Freedom of enterprise: individuals have the right to use their resources as they choose; they are
free to establish profit-making activities and determine what goods and services they produce.
» Competition: the presence of multiple firms in an economy selling similar goods and services.
 Large number of buyers and sellers; places pressure on businesses to lower prices and
improve quality of output in order to increase their sales of goods and services to consumers.
 Creates a more level playing field; allows the price mechanism to work effectively.

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» Mixed economy: an economic system where decisions concerning production and distribution
are made by a combination of elements via both market forces and government intervention.

» Free markets do not always provide most efficient allocation of resources for economy as a whole.
 Some necessary goods and services may not be provided under a pure market system.
 No profit-driven private enterprise would be willing to risk huge capital outlay required
for most collective wants and shared infrastructure; governments provide these instead.
 It is sometimes better and safer for essential goods and services (e.g. a national defence force)
to be provided by government rather than being left in the hands of private individuals.
 Markets do not always operate freely, competitively, and in the best interests of the economy.
 Governments provide regulation and legislation to protect consumers from exploitation.
» Free markets do not necessarily provide a socially desirable or fair distribution of output.
 Social welfare payments: overrides market forces by taxing people on higher incomes and
redistributing this to people who do not or cannot contribute to the production process.
 Progressive income tax: aims to achieve a more equitable distribution of produced output;
high-income earners pay proportionately more tax to government than low-income earners.
» The free market economy is subject to fluctuations as a result of the business cycle. Governments
intervene to smooth the cycle and counteract threats of insufficient or excessive economic activity.
» Australia’s mixed economy system essentially operates under a combination of:
 Market forces: private ownership, freedom of enterprise, consumer sovereignty, competition.
 Government intervention: public ownership, regulation, social welfare, progressive taxation.

» What to produce: governments can greatly influence what goods and services are produced.
 Provide collective wants as well as competing directly with private enterprise.
 Encourage production of some goods (e.g. by subsidies) while limiting or prohibiting others.
» How much to produce: governments can influence the scale of production in many ways.
 Regulate production and delivery of some goods and services to ensure long-term viability.
 Merit goods: goods and services not produced in sufficient quantity by the private sector
because, although desirable, individuals do not place sufficient value on them (e.g. the arts).
 Assist local producers competing with foreign business (e.g. by placing import restrictions).
» How to produce: governments can influence cost, allocation, and use of factors of production.
 Industrial relations laws set out minimum wage and working conditions in different industries.
 Regulations on firms may prevent them from choosing the cheapest method of production.
» How to distribute production: governments can affect how production is distributed in society.
 Redistribution of income (social welfare payments; distribution of production not only
determined by market forces); intervention in factor markets (e.g. minimum wage for labour).

» Australia is a relatively small economy, largely due to our small population of ≈22 million people.
» GDP per capita: equals GDP ÷ population; fairer assessment of an economy’s proportional size.
th
 Australia’s GDP per capita was US$37,302 (2009); ranked 11 among advanced economies.
» Economic growth: occurs where there is sustained increase in an economy’s productive capacity
over time; commonly measured as the percentage increase each year in the country’s real GDP.
 Australia’s GDP grew by an average of 2.9%/year from 2000-2009.

» Australia’s current rate of unemployment is 5.3% (March 2010); well below OECD average of 8.6%.
 Unemployment levels are often higher in regional areas than in cities and urban locations.
» Australia’s youth unemployment rate is 8.9% (2008); low compared with OECD average of 12.6%.
» Majority of Australians employed in service industries (e.g. hospitality, retail); ≈20% in industry
(e.g. manufacturing, mining); <5% in agriculture. Reflects international labour distribution trends.

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» HDI (Human Development Index): a measure of economic development devised by the UN.
 Considers life expectancy, education, literacy, and material living standards (GDP per capita).
 Australia’s HDI is ranked second-best in the world (2009) behind Norway.
» Australia’s population includes ≈4.7 million people born overseas (2010); high cultural diversity.
» Australians are among the highest ranked users in the world of telecommunications technology.
» Australia’s cost of living is relatively low; about average compared to other industrialised nations.
» Over half of Australian employees work >40hours/week; relatively high by international standards.

» Australia’s natural resources are a major part of our economy and constitute most of our exports.
 Unusually rich deposits of coal, gold, diamonds, uranium, copper, iron ore, aluminium, etc.
 Large agriculture industry capable of feeding ≈80-100 million people per year.
» The sustainability of our use of environmental resources is a major economic and social concern.
 Governments are focusing on how to preserve supplies of natural resources in the long-term.
» Australia has often failed to provide adequate environmental protection by global standards.
 We have a very poor record of preserving our native species and biodiversity from extinction.
 Only ≈10% of land is protected as nature reserves; below average for high-income countries.
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 Our water productivity (economic output per m of water used) is well below global averages.
» Climate change is currently most significant environmental issue facing Australia and the world.
 Australia produces 19 tonnes/person of CO2; well above some other industrialised countries.
 We have ratified Kyoto Protocol; other domestic policies to reduce greenhouse gas emissions.
 However, ≈80% of our electricity supply is still reliant on non-renewable energy sources.

» Shareholder model of capitalism: individuals and firms encouraged to freely pursue self-interest;
relatively limited role for government (may provide basic health, education, and welfare services).
 Most decisions left to market; corporations pursue profits in interests of their shareholders.
 Also known as the Anglo-American market economy model.
» Stakeholder model of capitalism: government has a more activist and interventionist role;
provide many services and are seen as essential to maintaining an adequate standard of living.
 Governments act where motive of making profits fails to provide important community wants.
 Businesses are expected to act in the interests of all who will be affected by their decisions.
 Also known as the Continental European market economy model.
» Australia has increasingly moved towards the shareholder model since the 1980s; however
governments still play a role in economic regulation and provision of certain goods and services.
» Australia is ranked by Index of Economic Freedom (2009) as third-most free economy worldwide.
» Australia is a relatively low-taxed economy with a smaller role for government; the percentage of
GDP collected as taxation revenue and spent by government is well below typical OECD levels.
» Australia’s level of public ownership of services (e.g. utilities, transport, telecommunications) has
fallen substantially in the past two decades; reflects recent worldwide trends towards privatisation.
» Responses to the 2008 global financial crisis led to an increased economic role for government.
» Australia has a well-established system of universal health care (Medicare); governments bear the
majority (about two-thirds) of the burden of financial spending to provide health care.
 This is not unusual; however in some countries private spending funds most of health care.
» Australia has universal free primary and secondary education; mostly provided by government.
 Vast majority of Australian universities are public; unlike the USA and some European nations.
 Australian government funding of education is below average for industrialised nations, due
to higher levels of private funding for both secondary and tertiary education institutions.
 Australia’s overall education expenditure is 5.7% of GDP; around the same as OECD average.
» Australia’s welfare system provides a greater level of assistance than USA but less than in some
European countries. Recently, many economies have been tightening eligibility rules for welfare.
 Aimed at ensuring a minimum standard of living for those unable to work or looking for work.
 Mutual obligation: those on benefits should contribute to society (e.g. “Work for the Dole”).

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