Topic 3 Economic issues Economic Growth Definition: Economic growth involves an increase in the volume of goods that an economy

y produces, or increases in real output or productive capacity over a period of time. Measurement Economic Growth = real GDP(current) Real GDP (previous) x 100 Real GDP (previous) 1
1.

GDP per capita = value of GDP per person Real GDP = nominal GDP (price x quantity) adjusted for inflation Real GDP = Nominal GDP x 100

CPI GDP: calculation of the total volume of goods that an economy produces Real GDP is the best measure of economic growth because it cancels out the effects of changes in prices and relates the actual change in production in the time period. Keynesian rational The equilibrium income (Y) is the level of income in the economy from which there is no tendency for change Y = C+ S E=C+I Y=O=E Equilibrium is where Aggregate Demand (C + I ) = Aggregate Supply (C + S) Y1 Y Income Expenditure Aggregate Demand Aggregate Demand 1 Aggregate Supply

Aggregate Demand The amount of expenditure in an economy Total demand for goods and services AD = C + I + GE + (X-M) Aggregate Supply The total available supply of goods and services in the economy Y=C+S+T There is an autonomous increase in an aggregate demand component (C+I+G+X-M), which increases demand for resources and thus increases income. Increased income

causes a multiplied level of change in national income, known as the multiplier effect whereby the economy will return to equilibrium (S+T+M=I+G+X) at a higher income. Economic growth occurs as there is an increase in consumption and production. Businesses reach maximum capacity and invest in new productive capacity because national income increases (induced investment) The multiplier effect A change in autonomous expenditure is redistributed within the economy In general, a change in expenditure will lead to a greater than proportionate increase In national income Shows the total change in national income, as the increased Autonomous expenditure travels through the economy, being saved and consumed, until worth 0 K= 1/MPS or K = 1/(1-MPC) MPS = S/Y In general, the multiplier in Australia is about 1.6x Sources of economic growth Aggregate Demand Consumption (60% of GDP) Consumer expectations Expectations about future rates of inflation, real incomes and general availability of foods The level of interest rates High rates means higher savings The distribution of income Greater equality of income distribution means higher rates of overall spending Income levels and consumption preferences Aggregate Demand Investment (21% of GDP) The cost of capital equipment Affected by changes in interest rates, government policies Labour productivity substitute labour for capital Allow existing resources to be utilised more efficiently Business expectations Expectations about future demand for their products Capital formation Raises productivity Aggregate Demand Government (22% of GDP) $42 billion stimulus package to pump prime the economy Spend on the education revolution and infrastructure Microeconomic reform achieved productivity growth through encouraging innovation, competition and the adoption of new technologies Aggregate Demand Exports Imports Terms of trade have improved Fluctuations in the $A Depreciation = improved international competitiveness, decreases export prices increasing AD Comparative Economic Growth with China Effects of economic Growth in Australia Benefits Living Standards Increased real GDP per capita

A higher disposable income means higher material living standards

Investment High consumer and business confidence Taxation revenue Growth dividend occurs due to bracket creep, (employees move into higher taxation brackets) Finance welfare and alleviate poverty as will as develop infrastructure in the economy Employment Generates additional employment due to increased aggregate demand Changes the nature of employment towards more highly paid and highly skilled jobs Research and development Leads to innovation, technological progress and increases in productivity. Inflation Demand pull inflation particularly when the economy approaches full capacity. Due to a wage price spiral Current consumption forgone Since capital accumulation and technology is needed to sustain economic growth, resources are required to be diverted away from current consumption Income distribution Benefits of economic growth often flow mainly to shareholders or company executives, rather than flowing more broadly to people through wage increases or improved public services

Costs

Structural unemployment May increase due to technological and structural changes in production Increased number of highly skilled jobs

Environmental impacts Detrimental when economic policy peruses growth above all other goals Can result in pollution, depletion of non-renewable energy sources and damage to local environment

External Stability Increased consumer and business spending results in a higher level of imports Causes an increase in the CAD Increased demand leads to increased imports

Unemployment Measurement Labour force: the section of the population o15 years of age and above who are employed in full-time or part time work(work for 1 hour or more each week), or are unemployed but are actively seeking work Labour Force affected by Population size (Population growth rate (%) = Natural Increase (%) + Net Migration (%) Level of net migraton Age distribution of population Labour force = employed + unemployed

Participation Rate: The percentafe of the working age population who are in the labour force (i.e. working or actively seeking work) Labour Force X 100 Working age population (15+) 1 Unemployment Rate: the proportion of people who are willing and able to work, actively seeking work, but unable to find it. As of April 10 at 5.4% Unemployed People X 100 Labour Force 1

Problems with the method used to measure unemployment: Underemployment Unemployment doesnt take into account the hours that person work for Many people are underemployed and would prefer to work longer hours Hidden unemployment Many people have given up seeking for work and are no longer classified as part of the labour force According to the Australian Council of Social services there are 1.4 million hidden unemployed people in Australia Trends Participation rates closely correlated with the unemployment rate and changes to the level of economic growth. As unemployment falls, participation levels rise as it is easier to fid work. This saw the participation rate rise from 63.4% in 1999 to 65.25% in 2009 as previously discouraged workers re entered the workforce

Participation rate growth from 61% to 65% from 1990 2008

Increasing female offset decreasing male The number of married femaes I the labour force The age of retirement The school retention rate The number of people in full-time post-secondary education The level of economic activity/growth Unemployment

Reduced 11% -4.5% between 1991-2007 April 2004 Skill shortages in healthcare, mining Increasing part time work through GFC Types of unemployment Institutional Unemployment is caused by a price floor or minimum wage This restricts the price mechanism, as social objectiveness favoured over economic Minimum Wage

Q of labour

Demand Side types of Unemployment Cyclical: Unemployment associated with the business cycle i.e. insufficient aggregate demand to provide the required derived demand for labour E ($) Yfull Ye AD AD1 AS Unemployment or deflationary gap

Yfull represents the full employment level of national income i.e. all who seek a job can find a job. Ye represents the inadequate level of national income that exists The unemployment gap represents the extant of or lack of demand for labour in the economy The movement of AD to AD1 is the solution to cyclical unemployment

Time Lag of 6 moths between a change in the level of economic growth and a change in employment levels known as the ratchet effect

Seasonal: unemployment based on the rapidly changing nature of some work e.g. fruit picker, ski lift operator, Christmas operator Supply Side types of Unemployment Structural Unemployment Structural changes within an economy (due to changes in technology or patters of demand) may lead to a mismatch of labour skills with the job vacancies provided. It takes time for workers to acquire new skills before they can fill the vacancies offered Skill Mismatch driven by: Industry closure Technologival change Inadequate education Main source of Australias unemployment

Long Term Unemployment Refers to persons unemployed for over 12 months (usually due to structural unemployment) Hard to reduce: Harder to be absorbed back into the workforce Normally dont possess the required skills Lose enthusiasm after numerous rejections Underemployment: Where a person is working in an industry and not utilizing specialist skills (e.g. o/s trained doctors as taxi drivers) OR Where a person is working less than the desired amount of hours Hidden Unemployment: Discouraged job seekers Those who may not be counted as part of the official unemployment statistics because they have given up looking for work. Frictional Unemployment: People moving between hobs or experiencing changing economic circumstances Result of normal market turnover and the imperfect flow of information between hob seekers and employers on the labour market.

Causes of Unemployment Cyclical Unemployment Cause Deflationary gap arises when total spending is insufficient to guarantee full employment of the economys resources Low AD means full employment cannot be produces there are fewer employment opportunities Okuns law (used to justify pump priming the economy) %Change GDP>%Change Labour force + %Change in Productivity (means that there will be a decrease in unemployment)

Unemployment is derived from GDP If it was equal unemployment would remain constant Structural Unemployment Cause Microeconomic Policy forces business to increase efficiency to compete; possibly reallocating resources, or causing labour capital substitution Tariff Removal Privatization of formerly public companies Deregulation of industries Market orientated Change Changes in tastes and preferences Globalization allows businesses to source foods from overseas Technological Change New products and new production methods, means that capital is substituted or labour. New skills are needed wile old ones are made redundant Inadequate Training and Investment Skills Shortages in trades people, nursing and chefs

Participation rates An increase in the participation rate will tend to increase unemployment More people who previously were not looking for work (and were not classified as unemployed) start actively seeking employment) Productivity Low productivity encourages employers to use capital in preference to labour in production Increases in productivity also mean that the same level of output can be produced with fewer workers

Cost of Labour Wages are established above market rates catering for future inflation (award wages through trade unions) Demand for labour is lower. Capital may be substituted for labour or alternatively employment may be rationed leading to unemployment QD QS Quantity Wage

Unemployment is created, with the Award Wage reducing demand. Unemployment represents QS-QD

The Natural Rate of Unemployment (Non-Accelerating Rate of Unemployment) The rate of unemployment that is considered full employment in the labour marker including seasonal, structural, hard-core, frictional The level of unemployment that exists when cyclical unemployment is zero It represents the supply constraint of the economy (the limit of labour resources that the economy can use) Currently it is between 4-5% in Australia Unemployment Inflation Long Run Phillips Curve Short Run Phillips Curve

Short Run Phillips Curve (SRPC): Indicates that there is a trade-off between the rates of inflation an unemployment (Decreasing unemployment, increases inflation) Raised aggregate demand, raises demand for labour whilst producing inflation Long Run Phillips Curve (LRPC) Once the natural rate of unemployment is reached, there is no longer a trade off between inflation and unemployment Illustrates the limit of AD based polices to reduce unemployment Further stimulation by the governmenta reduction in private sector spending by the crowding out effect of higher I.R (demonstrates by the vertical Phillips cure) Any increases in AD will only produce inglation as all cyclical unemployment is exhausted The skill mismatch means that even though there is demand for labour, the pool of unemployed workers does not fall. Costs of Unemployment Economic Costs

Living Standards Unemployment reduces the production of both consumer and capital goods Less consumer goods, leads to a reduction in current living standards and rates of economic growth Less capital goods, decrease our future capacity to produce goods and services

Opportunity Cost Unemployment means that the economys resources are not being used to full capacity Operating inside of the production possibility frontier

Lower total output means lower household incomes and expenditure, which may lower sales and profit Loess of potential economic growth as not all resources are fully utilized

Skills Decline Unemployed will lose their labour market skills, self esteem and experience, will become les employable

Taxation Revenue Falling incomes associated with unemployment will generate less tax revenue Greater transfer payments misallocate government income towards unemployment benefits, lab our market programs and training Social Costs

Social Costs Severe financial hardship and poverty, increased levels of debt, homelessness and housing problems, family tensions and breakdown, boredom, increased social isolation, crime, erosion of confidence and self esteem, loss of work skills Increased inequality Unemployment occurs more frequently among lower income earners in the economy, such as the young and unskilled

Groups Affected by unemployment Youth (15-19 years) Often lack the required training, education, skills and experience In 2009, 15.4% for males and 21.2% for females

Indigenous Australians Unemployment rate of almost 20% (4 times national average)

Age related unemployment Older workers have greater difficulty in finding work once they have lost a job Find it difficult to maintain the required skills and knowledge Remain unemployed for a longer period of rime A person aged 35054 is unemployed for an average 57.8 weeks, compared with 31.8 weeks for 20-24 year olds

Geographic Location Urban areas generally have slightly lower unemployment rates than non-metropolitan areas In 2004, the figure were 52% urban compared to 6.2% rural

Occupations

Semiskilled or unskilled occupations had unemployment rates of 710% in 1998 compared to rates of 1-5% for managers, professionals and trades people

Relationship between productivity and unemployment Productivity the level of output produced per unit of labour in a unit of time Okuns law Relationship between economic growth, productivity increases, labour force changes and unemployment As productivity increases and economic growth and labour force remain constant unemployment increases Unemployment is a lagged indicator economic growth means that hidden unemployment reenters the labour force Inflation Inflation: A sustained increase in the general level of prices over time Formula Inflation Rate = Current Inflation Previous Inflation x 100 Previous Inflation 1 Headline Measures the rate of change of the Consumer Price Index The CPI summarises the movement in the prices of a basket of goods and services (weighted according to their significance for the average Australian household) Total Inflation within an economy Underlying Excludes one off occurrences core inflation and real costs Seasonal factors Interest rate changes A new government tax Trends Microeconomic policy, RBA targeting managed low inflation 2005-2007 saw heavy inflationary pressures peaked at 5% Higher oil prices Higher house prices (5%p.a.) Tradable prices inflation raise 1.3% 2009 inflation steadied Despite heavy stimulus, low consumption kept low inflation 1.4% Causes AS Demand Pull Inflation Expenditure AD

Inflationary gap

National Income Yf Y Y full denotes full employment the economy is at maximum productive capacity as all resources (L, L, C, E) are fully utilized At Y the economy has exceeded full capacity Aggregate Demand Exceeds Aggregate Supply leads to an inflationary gap Too much money chases limited resources. Consumers auction up the price of goods and services (as there is limited available), while businesses auction up the price of resources Consequently demand pull inflation Cost Push Inflation

Price Level Aggregate Supply

P1 P Real GDP Aggregate Demand Real GDP1 Real GDP A decrease in aggregate supply caused by increase input costs (higher costs of production), to remain competitive these costs are past on to theconsumer causes a new equilibrium, established at a higher price and a lower output of real GDP The economy experiences a contraction in real GDP (less economic growth) and a rise in inflation cost shocks Increased wages Increased interest rates Raised resource costs Imported Inflation Inflation transferred to Australia through international transactions Caused by either A rise in the price of imports The depreciation of the Australian dollar Inflationary Expectations

Consumers and Business perceptions of future inflation based n past and current rates of inflation. Such will try and protect themselves If employers expected future increases in their costs of production, they may raise prices in order to cover the expected costs, resulting in inflation If employees expect a certain level of inflation, they are likely to factor this inflation into their wage claim, leading to cost-push inflation Inflationary Effects Households Purchasing Power - wages Potential wage price spiral to mitigate inflation exaggerating effects Reduction in real purchasing power distorts economic decisions Savings and investment decrease Producers are uncertain about future prices, costs and profit. Less willing to invest Consumers spend in the short term, as purchasing power reduced over time Unemployment In the shorter term, there is an inverse relationship between inflation and unemployment Illustrated in the Phillips curve However may cause stagflation Income distribution Lower income earners often find that their incomes do not rise as quickly as prices More likely to have fixed incomes, and les likely to have income indexed for the rate of inflation. Firms Resource allocation Investment and resources reallocated to avoid inflationary pressuresdue to the rising cost of production Exchange rate High inflation is a major cause of depreciation, due to decreased international demand Exporters lose export market as international competitiveness declines International Investment International investors are reluctant to invest their funds in a high inflation economy Reduces international competitiveness. Imports become domestic substitutes corroding CAD Government Taxation revenue Inflation raises nominal income, causing bracket creep, where more and more people movie into higher tax income brackets and hence pay more in taxation Interest Rates Higher inflation requires contractionary policy

Deflationary Effects Fall in the general level of prices

Consumption delayed for future price falls Idle capacity form Collapse in asset prices, wealth is destroyed and consumption expenditure is lower, leading to a recession Investment is reduced, reducing national income and creating a potential deflationary spiral

Role of Price (Why solve inflation?) Prices allocate resources to different alternative uses send a signal to the owners of resources that more resources are required in the industry. Prices distribute incomes Prices ration goods and services between households cast a vote in products markets Relationship between inflation, unemployment and economic growth Stagflation Philips curve inverse relationship between inflation and unemployment Cost- push inflation both inflation and unemployment rising at the same time Experience in Australia in 1970s as OPEC restricted oil supplies = cost shock Stagflation Typically low rates of economic growth were also causing falling demand for labour Resulted in the need for microeconomic reform to generate low inflationary growth. Demand- pull inflation Unemployment is a derived demand and a lagged indicator Phillips curve Environmental Management Ecologically Sustainable development Development that meets the needs of the present generation without compromising the ability of future generations to meet their own needs Brundtland Report - 1987 Intergenerational equity This means that current economic growth and development should not result in long term damage to the environment or depletion of scarce resources Resource use and exploitation If the rate of harvest (use of resources) > rate of regeneration = extinction Renewable resource Can be sustained despite useage and usually encompass all biologival resources in the environment E.g. fish Non-renewable resources Cannot be sustained with increasing usage as their supply is finite and may be exhausted E.g. coal Definitions Private costs

Expenditure incurred by consumers or producers in giving up a part of their money income in purchasing resources, goods or services Private benefits Profits made by producers selling goods and services and the utility gained by consumers through satisfying their own needs and wants Social Costs Are imposed on or borne by society as a result of private actions Social benefits Accrue to society as a results of private actions Price Mechanism The interaction between demand and supply, to reach an equilibrium price and quantity of production Solves the problem of scarcity In market economics Price to the consumer Represents relative value Communicates information to the supplier Price is a rationing device Price to the producer Shown through profit Determined by costs of production Increase in price more resources allocated to the production Price and Cost MSC MPC MPB

Ps Pm

Qs Qm Quantity MPB (Marginal private benefit)= Benefit from an additional unit of consumption MPC (Marginal Private cost) = cost of extra good or service MSC (Marginal Social Cost)= total cost to society of an extra unit produced Pm too low to allow for sustainable use of resources PS price at a sustainable level The price mechanism considers private cost of production but not social costs of production Public vs Private goods Private goods are excludable and rival, transferrable Public goods are non-excludable and non-rival

An item that private forms are unwilling to supply as they are not able to restrict usage and benefits to those that are willing to pay for the good E.g. air, oceans

Definitions Non- excludable It is not possible to prevent people who are unwilling to pay for it from obtaining it Fully accessible to everyone Non-rival No matter how many people consume them, the benefits available to others will not be reduced One persons consumption does not reduce the amount available to everyone else Free Riders Non-paying users of a good Market Failure Less than optimal allocation of resources around the economy Public goods Environmental goods are public, meaning that they are non-excludable and non-rival Inability to set a price No price means no control over demand: Free riders and the tragedy of the commons Exploitation Accelerated extinction of non-renewable goods Non- enewable: harvest is greater than renewal

Property Rights Price mechanism only accounts for private costs and benefits Price mechanism does not take into account social costs (externality) The total cost or gain accruing to society from a particular activity may not be registered reflecting a misallocation of resources Does not take into account future demand for goods, which may not be satisfied because resources have been destroyed Quantity Qs Qm Ps Pm MPC MSC MPB Price and Cost

A B Externality

B= ecologically sustainable price and quantity A = unsustainable level of resource use Externalities The costs or benefits to the environment and society tht are not included in the price of exchange between the producer and consumer Leads to a misallocation of resources Factors that lead to externalities Private costs of exchange are too low The environment is a public good lacks property rights Human nature individualistic Examples Pollution (impurities that reduce environmental quality) Environmental Management Policies Carbon Pollution reduction scheme Garanaut report 2008 Rudd proposed a carbon pollution reduction scheme has delayed this Proposition- give property rights to carbon Various enterprises are given fixed permit numbers or pollution. Failing to adhere requires payment of fine Internalized the externality Costs exceed price of new capital promote research and development OP represents income reallocated to Government for research and cleaning Business may pass on the costs, reduce real income or cut workers to remain competitive Demand O Q P Price of carbon Fixed Supply Quantity of Permits

Direct Ban Forced closure of industry E.g. CFCs Rebates and Subsidies Income and resources directed towards environmental friendly power production $AU 1.4 billion on solar panels over 6 years Quotas Ration: lesser form of direct ban Rate of renewal exceeds tate of harvest E.g. 5620 tonne tuna fishing limit Excise Tax Internalised economy Dissuade consumption and reallocates investment and resources Marginal Social Costs unkown Tax Price and Cost Quantity Qs Qm Ps Pm MPC MSC MPB

Conflicts of Ecologically sustainable development Impact of economic growth on ESD There is often a trade off between high growth in the short term (associated with high immediate living standards) nd long term growth Growth draws upon natural resources Excessive consumption raises the rate of harvest for renewable and non-renewable resources Depletion and damage to scare resources Illustrated by an inwards shift in the product possibility curve: there are physically less resources for future growth Also, the unsuitable disposal of waste products associate with growth reduces environmental quality e.g. air pollution or land and soil degradation (farming, mining), and prevents long term use of the environment Reduced quality of life with lesser environmental enjoyment

Unsustainable development Economic Growth Inward shifts of the product possibility frontier Unemployment Structural change: resources are exhausted shifting production materials Quality of life Reduced quality of lift rthrough reduced environmental enjoyment External Stability Australian growth commodity based. Resource exploitation shifts PPF inwards, reducing exports and requiring imports to satisfy demands Inflation Cost Push: raised input prices raise production costs, which are passed onto consumers Income Distrbution Relative Poverty. Greater proportions of poor persons income spent on needs Water, food

Relationship between the external cost to the community, amount of pollution abatement and the cost of reducing pollution PAC MEC Amount of pollution abatement i.e. the reduction of pollution External costs to the community i.e. social cost or negative externality ($) Cost of reducing pollution or abatement costs ($) A

MEC = marginal external cost the line traces out the cost of pollution to the economy

PAC pollution abatement cost The cost of reducing pollution E.g. new technology, permits Point A The optimum leve of pollution abatement Where the cost of reducing pollution is equal to the benefit to the environment and society of the ower level of pollution Explanation of Diagram Cost benefit analysis A behaviour should be changed only to the point where the cost of changing behaviour is equal to the benefit of the change in behaviour This is represented by Point A Assumption All costs of production are known We can measure the benefits of lower levels of pollution The costs of reducing pollution can be calculated There is a direct relationship between money spend on pollution reduction and benegit ot society

Income Distribution Income: the value of benefits received by individuals during a period in return for their factors of production (land, labour, capital and enterprise) or as a transfer payment from the government Wealth: the net value of real and financial assets owned by individuals at a particular point in time. Quintile: 20% groupings of a population Lorenz Curve Illustrates income distribution Graphs data on income shares for equal groupings od the population Enables for a comparison between the income received and the income recipients The Lorenz curve lies below the line of perfect equality

A shift to the right represents increased inequality, whilst a shift to the left represents increased equality

Gini Coefficient A mathematical expression of the degree of income inequality It is the are between the line of perfect equality ad the Lorenz curve Gini Coefficient = Area A/ (Area A + Area B) A gini coefficient of 0 is perfect equality A gini coefficient of 1 is complete inequality Source of income Wages and salaries Income derived form the supply of labuor 55-65% of total household income Property Income Returns on factors f production (profits, dividneds, rent and interest) 20-30% of total household income Transfer payments Payments received whereby nothing is given directly in return e.g. social security 10-15% of total household income Other Superannuation Sources of wealth Link between wealth and income People with little wealth usually have low incomes Income generates wealth and wealth generates income Dwelling capital Includes land, houses and home units 59% of total household wealth in 2004

Business Capital Includes shops, offices, factories and farms Accounted for 37% of total household wealth in 2004 Consumer Capital Includes, cars, boats, furniture, appliances and jewellery Accounted for 3.5% of total household wealth in 2004 Other Investment in government securities Australian investment overseas Holdings of cash denoted as money base Dimension and Trends to Income and Wealth Gender Female Earnings represent 78% male earnings Reasons for this Greater percentage of women working part-time (32%) compared with men (23%) A younger age structure among full time female workers Lower educational qualifications for older women Occupational bias (with women under-represented in managerial/ administration positions) Less overtime Duration and continuity of unemployment, (due to women normally acting as the primary caregiver) Age Lowest income age bracket is 15-24 years Less experience and education Highest income age-bracket is 35-44 years Occupation Training increases, supply decreases Male professionals earn $1700 per week whilst laborers earn $800 p.w. Ethnic Background English speaking migrants: highest Non- English speaking migrants: lowest Indigenous Australians earn considerable less than non-indigenous Australians Family Structure Couple with no dependent children Median income $704 Couple with dependent children median income $659 Single Parent Median income $446 58% wealth from allowances Single Person Median Income $535 p.w

Benefits of Income Inequality Economic Benefits Incentive effect Reward of higher wages and improved living standards encourages employees to:

Undertake higher education, training and skills acquisition Work longer, harder hours improving labour productivity Labour mobility (occupation and geographic) due to relative wage flexibility, which helps to allocate labour more efficiently

Entrepreneurs Accept risks more readily with potential profit Greater innovation, technological advances, and employment opportunities Capital formation High income earners save greater proportion of income which can fund capital Greater productivity of labour, increase in the output of goods and services, hence leading to higher living standards Reduces reliance upon foreign capital by providing domestic savings

Social Benefits Unrealistic: May arise if inequality promotes a desirable social structure Whereby relative productivity of individuals within society was reflected by their financial position, so that the more productive and individual was, the wealthier they would become

Economic Costs Welfare support Welfare payments reduced government spending on capital goods, place a tax burden taxpayers, and may deteriorated the governments fiscal position Economic growth reduced Lower consumption (due to lower MPC): lower aggregate demand Reduced economic activity, employment, investment and living standards

Social Costs Poverty and social problems Inequality of income causes relative poverty Inequality of opportunities in terms of health, housing, education and employment Increased levels of crime, disease and reduced life expectancy (police resources) Social class divisions Social and economic instability through class tensions E.g. wage disputes between workers and employers Democracy may be undermined Wealthier members of society have greater political influence

Polices to reduce income and wealth inequality Social security aged pensions, family assistance, sole parent pensions Reforms to income tax brackets Widening income bands, lowering tax Income tax rebates for low income earners

Saving exemptions Reductions in capital against tax Increase in minimum wage by Fair Work Australia by $26 p.w. However, the more flexible enterprise bargaining has meant that represented labour has higher than average wage increases than unskilled, unorganized and unrepresented labour (migrant women) Wage growth for these workers is 1-3% compared to 4-5% for represented workers

The social wage Transfer payments made by federal court Unemployment benefits, family assistance, disability pensions Provision of Medicare Minimum wage First home buyers grants Nation Building and Job Plan Hospital reform package These policies are MICRO in nature

External Stability CAD as a percentage of GDP Chronically negative 2002-2008 averaged 5.8% GDP. This fell to 3.75% GDP in early 2009 before an expected rise to 5.5% GDP by 2009/10 The CAD is considered unsustainable If it exceeds the growth rate of the economy Servicing cost of external liabilities is greater than the growth in income or output Formula CAD/GDP ratio = CAD x 100 GDP 1 Net foreign debt as a percentage of GDP Refers to foreign debt assets (debt lending by Australians to foreigners) minus foreign debt liabilities (debt lending by foreigners to Australians). Keep below 40% Formula Net foreign debt/ GDP ration = Net Foreign Debt x 100 GDP 1 Gradually rising from 47.9% (2004-2005) GDP to 58.5% (2008-2009) Net foreign liabilities as a percentage of GDP Net foreign liability is equal to net foreign debt and net foreign equity Total value of assets in Australia such as land, shares and companies in foreign ownership minus the total vale of assets overseas, owned by Australians Formula GDP Ration = Net foreign liabilities (debt + equity) x 100 GDP 1 The current Account Covers external transactions that are not reversible

Consists of Net goods (X-M) Net services (tourism and education) Net income (earnings on investment i.e. rent, interest, profit Net current transfers Causes of a High CAD The savings/ investment Gap The capital and financial account drives the Cad Aggregate Demand = Aggregate Supply C + I + G + x-M = C + S + T Cancelling put consumption and putting likes together X-M = S-I + T-G External Balance = private sector debt + Public sector underlying balance CAD = S/I Gap + net PSUB In 2004 national savings was 18% of GDP, while investment was 24% of GDP Since investment leads to economic growth via the multiplier effect, no government wants to slow down investment This lack of domestic savings means we rely on foreign savings Australian residents then pay interest, rent and dividends on foreign equity and foreign debt and this leads to the deficit on the net income of the current account Recently exaggerated through huge fiscal stimulus.

The yields on Investment in Australia (structural) Yields refer to the rate of return in cash 9interest rates, shares/equity (dividend yield) and real estate (rentals) Since Australias interest rates (4-5%) are relatively high compared with the USA and Japan (0-3%), non-residents are encouraged to ld to Australia (foreign debt) or invest in Australia (foreign equity) This is seen in the large net income deficit of the current account (approx. 70% in 2009) In structural terms, this net income deficit is the underlying problem of the current account deficit.

The price elasticity of Demand for Exports The price elasticity of demand refers to the sensitivity of buyers to a change in price Price elastic means buyers and sensitive Price inelastic means buyers are relatively insensitive to price changes A substantial amount of Australias exports are low value added agricultural products There are numerous competitors wit Australian wheat exporters, so if Australian whet prices increase then our buyers will look to the USA, Canada and Europe . Price elastic On the other hand, Australian demand for high value added imports is price inelastic Should price increase due to a depreciation in the $A Australians will spend more to buy less

The income Elasticity of Demand for Imports Australias demand for imports is aggregate demand elastic This means as Australian aggregate demand increases, demand for imports grows at a faster rate As aggregate demand increases this leads to an increase in national income via the multiplier effect, which leads to an increasing demand for imports. This is sometimes called the income elasticity of demand for imports As for exports, an increase in incomes overseas will not result in a large increase in demand for agricultural products If incomes overseas increase, consumers tend to buy better quality food rather than more, so out exports tend to be income inelastic

Comparative Economic Growth In cyclical terms, when the domestic economy grows faster than the world economy or the economies of Australias trading partners, import demand tends to outstrip export demand The goods balance deteriorates, adding to an existing current account deficit.

Terms of Trade Australias vulnerability Australia Is vulnerable to the terms of trade since it is very reliant on mineral exports for earning export income The price and income elasticity of demand for such commodities tends to be quite inelastic This means that a fluctuation of price will affect revenue BOGS balance recorded 1.4% surplus in December 08 as terms of trade balance improved 68% Combined with law consumer confidence which saw imports fall, CAD reduced Causes of High Net Foreign Debt Persistent CAD Required financing through overseas debt and equity borrowing Long term depreciation of the Australian dollar Increased debt servicing loans for the foreign debt denominated in foreign currency loans Decline in domestic funds due to low borrowings There was an early shift to debt financing after deregulation The outflow of investment from Australia

Effects

Debt Trap scenario (perpetuating cycle) A high CAD requires and inflow of foreign funds (either foreign debt or selling Australian assets to foreigners) to finance CAD With a larger foreign debt, servicing costs become greater These interest payment constitute a large part of the income debits that flow out on the current account Threat would exist ig Australia was unable to attract a reasonable level of investment Susceptibility to Exchange fluctuations

Valuation effect on debt

Debt sustainability problems As debt increases; it becomes increasingly difficult to service he debt Australia cannot sustain a growth rate in excess of 5% if the CAD rises to over -5% of GDP (if the increase in CAD is greater than the rate of economic growth) has average 4.5% over the last two decades Since the debt servicing obligation becomes greater than the capacity of the economy to increase its income The interest payments on the debt will progressively take up a greater proportion of our CAD Results in decreased investment spending This reduces Australias standard of living and the growth potential of the economy However, Pitchford thesis suggests if debt/ equity borrowings are put into income generating assets, debt is irrelevant Since Public sector debt is 8% of net foreign debt while private sector debt is 92% Increase in Australias international credit rating High net foreign debt is seen as a significant risk to an economies future performance Credit rating downgrading Great capital outflows Hence, it may increase the cost of borrowing through higher interest rates High interest costs hamper capital formation

Contractionary policy May require contractionary policy to reduce CAD

Policy to Reduce CAD Monetary Policy Inflation management maintaining import competitiveness Fiscal policy The budget directly relaties to CAD and the net income Aggregate demand = Aggregate supply C + I + G + X- M = C + S + T Cancelling out consumption and putting likes together X-M = S-I + T-G Fiscal consolidation has historically eliminated public sector debt More savings can be used for private sector investment reducing reliance on foreign investment Recent stimulus has worsened the Cad raising PSUD and the savings and investment gap Twin Deficit theory Reduction of budget deficit government borrowing less more domestic funds available for the private sector there is domestic borrowings and dont need to go overseas reduces foreign debt reduction in CAD

Microeconomic Reform Superannuation Compulsory 9% p.a. to reduce low national savings Deregulation, privatization Raise competitiveness and export markets