Economics Revision Sheet GDP, INCOME AND EXPENDITURE Learning objectives Pg.

391 Students should be able to: Explain how total production in an economy is measured. Discuss whether GDP is a good measure of economic wellbeing. Discuss the difference between real variables and nominal variables. Understand how the economic growth rate is measured. Discuss the importance of long-run economic growth and its impact on living standards. Use the economic growth model to explain why economic growth rates differ between countries. Key terms check list Black economy - Buying and selling of gods and services that is concealed from the government to avoid taxes or regulations or because the G/Ss are illegal. Business cycle Alternating periods of economic expansion and economic recession Capital Manufactured goods that are used to produce other goods and services. Consumption (C) Spending by households on G/S, not including spending on new houses. Consumer Price Index - computed to measure the changes in price level of consumer goods. Economic growth The expansion of societys productive potential. Economic growth is usually measured by the growth in real GDP. Economic growth model A model that explains changes in real GDP per capita in the long run. Economic growth rate - The rate of change of real GDP from one year to the next.

Real GDP io Current Real GDP Prev Real econ growth rate x1 Real GDP Prev iou
Expansion The period of a business cycle during which total production and total employment are increasing. Final good or service - A new G/S which is the end product of the production process that is purchased by the final user. GDP deflator A measure of the price level calculated by dividing nominal GDP by real GDP and multiplying by 100.

Nomina GDP GDP 100 deflator x Real GDP

 Government purchases (G) - Spending by federal, state and local governments on G/Ss. Gross domestic product (GDP) (Y) The market value of all final goods and services produced in a country during a period of time. Y= C+I+G+NX Human capital The accumulated knowledge and skills workers acquire from education and training or from life experiences. Inflation rate The percentage increase in the price level from one year to the next. Intermediate good or service a G/S that is an input into another G/S, such as a tyre on a truck. Investment (I) Spending by firms on new factories, office buildings, machinery and inventories and spending by households on new houses. Labour productivity The quantity of G/Ss that can be produced by one worker or by one hour of work. Long-run economic growth The process by which rising productivity increases the average standard of living. Macroeconomics The study of the economy as a whole, including topics such as inflation, unemployment and economic growth. Microeconomics - The study of how households and firms make choices, how they interact in markets and how the government attempts to influence their choices. Net Exports (NX) = exports imports Nominal GDP The market value of final G/Ss evaluated at current year prices. Per-worker production function The relationship between real GDO, or output, per hour worked and capital per hour worked, holding the level of technology constant. Potential GDP The level of GDP attained when all firms are producing at maximum capacity. Price level A measure of the average prices of G/Ss in the economy. Real GDP The market value of final G/Ss evaluated at base year prices. Recession The period of a business cycle during which total production and total employment are decreasing. Technological change The change in the ability of a firm to produce a given level of output with a given quantity of inputs. Transfer payments Payments by the government to individuals for which the government does not receive a good or service in return. E.g. pension

 Value Added The market value a firm adds to a product. GOVERNMENT EXPENDITURE GOVERNMENT PURCHASE Purchases do not include transfer payments.

Limitations of GDP GDP does a good job at measuring production, and provides an indication of wellbeing, but it is not flawless. GDP does not include: Household production: Goods and services people produce for themselves. Examples: Home cooking, cleaning, child care, gardening, maintenance. The black/cash economy The distribution of GDP is not captured in GDP measures income inequality. The value of leisure is not included in GDP. GDP is not adjusted for changes in crime and other social problems. GDP is not adjusted for pollution or other negative effects of production The complete circular flow

UNEMPLOYMENT AND INFLATION Learning Objectives p.470 Students should be able to: Define the unemployment rate and the labour force participation rate, and understand how they are calculated. Explain the economic costs of unemployment. Identify the types of unemployment. Explain what factors determine the natural rate of unemployment. Define the price level and the inflation rate, and understand how they are calculated. Use price indexes to adjust for the effects of inflation. Discuss the problems caused by inflation. Understand the difference between demand-pull and cost-push inflation.

Key terms check list Consumer price index (CPI) An average of the prices of the G/Ss purchased by the typical urban family of four. CPI= exp in current year/exp in base year x 100 Four sources of bias in the CPI may lead to it overstating the inflation rate. Substitution bias Increase in quality bias New product bias Outlet bias Cost-push inflation Inflation that arises as a result of a negative supply shockthat is anything that cause a decrease in the aggregate supply of G/Ss.

Cyclical unemployment Unemployment caused by a business cycle recession Deflation A decline in the general price level in the economy. Demand-pull inflation - Inflation that is caused by an increase in the aggregate demand for G/Ss and production levels are unable to meet this demand immediately. - Too little good chasing huge demand.

Discouraged workers People who are available for work but have not looked for a job during the previous four weeks because they believe no jobs are available for them. Efficiency wage A higher than market wage paid by a firm to increase worker productivity. Enterprise bargaining Wages and working conditions negotiations between employers and unions or employers and employees at the workplace level.

 Frictional unemployment Short-term unemployment arising from the process of matching workers with jobs. Hyperinflation Extremely rapid increases in the general price level. Inflation The sustained increase in the general level of prices in the economy. Inflation rate The % increase in the general price level in the economy from one year to the next. = CPI g year CPI p year/CPI p year x100 Job Services Australia A national network of private and community recruitment agencies that find jobs for unemployed people and other job seekers. Labour force The sum of employed and unemployed workers in the economy. Labour force participation rate The % of the working age population in the labour force = labour force/ working age population x 100 Long-term unemployed Those in the labour force who have been continuously unemployed for a year or longer. Menu costs The costs to firms of changing prices. Natural rate of unemployment The normal rate of unemployment, consisting of structural unemployment + frictional unemployment. Non-accelerating inflation rate of unemployment (NAIRU) The level of unemployment below which the rate of inflation will rise. Price level A measure of the average prices of G/Ss in the economy. Producer price index (PPI) An average of the prices received by producers of G/Ss at all stages of the production process. Seasonal unemployment Unemployment due to factors such as weather, variations in tourism and other calendar related events. Structural unemployment Unemployment arising from a persistent mismatch between the skills and characteristics of workers and the requirements of jobs. Under-employed workers people who work part-time but would like to work more hours. Unemployment rate The % of the labour force that is unemployed = Number of unemployed/labour force x 100 Consequences of unemployment Monetary cost Loss of potential output Loss of skills reduce employability Burden to the working population Non-monetary costs include:

Personal, family & social problems associated with unemployment Long term unemployment Welfare dependence

- Real interest rate = nominal interest rate inflation rate - Real wage growth rate = nominal wage growth rate inflation rate MONETARY POLICY Learning Objectives p. 506. 536 Students should be able to: Define money and discuss its functions. Discuss the definitions of the money supply used in Australia today. Explain how financial institutions create money. Overview the financial system in Australia and discuss the role of the Reserve Bank of Australia. Define monetary policy and describe the main goals of monetary policy in Australia. Describe how the Reserve Bank of Australia affects interest rates. Explain how monetary policy affects GDP and how the government can use monetary policy to stabilize the economy. Explain how monetary policy may affect the four components of aggregate demand; consumption, government purchases and net exports Assess the arguments for and against the independence of the Reserve Bank of Australia. Key terms Asset Anything of value owned by a person or firm. Broad money M3 + deposits into non-bank deposit-taking institutions holdings of currency and deposits of non-bank depository corporations, such as finance companies, money market corporations and cash management funds. Cash rate The overnight money market interest rate. Commodity money A good used as money that also has value independently of its use as money. E.g. gold Contractionary monetary policy The use of monetary policy by the RBA to increase interest rates to reduce inflation. Credit Loans, advances and bills provided to the private non-financial sector (individuals and firms) by all financial institutions. Currency Notes and coins held by the public less holdings of coins and notes by banks and the RBA. Demand deposits Also current deposits , these are deposits in financial institutions that are transferable by CHQ, by debit cars at EFTPOS terminals and through electronic transfer between accounts. They are called demand deposits because they are available on demand, and are repayable on demand in notes and coins.

 Expansionary monetary policy The use of monetary policy by the RBA to decrease interest rates to increase real GDP. Fiat Money Money, such as paper currency, that is authorized by a central bank or government body and that does not have to be exchanged by the central bank for gold or some other commodity money. Inflation targeting Conducting monetary policy so as to commit the central bank to achieving a publicly announced level of inflation. M1 The narrowest definition of the money supply, which includes all the paper money and coins, that is in circulation (what is not held by banks or governments) plus the value of all demand deposits with banks. M3 M1 + all other deposits with domestic and foreign-owned banks operating in Australia, including certificates of deposits, term deposits a d deposits with banks from building societies, credit unions and other authorized deposit-taking institutions. Monetary Policy The actions the RBA takes to manage the availability of cash on the overnight money market hence interest rates to pursue economic objectives. Monetary targeting Conducting monetary policy to control the size and rate of growth of the money supply. Money Assets that people are generally willing to accept in exchange for G/Ss or for a payment of debts. Open market operations The RBA purchasing or selling financial instruments such as Commonwealth Government Securities and private binds and securities, either by outright purchase or sale or by the use of repurchase agreements. Reserve Bank of Australia The central bank of Australia Reserves Deposits that a bank keeps as cash in its vault or on deposit with the RBA. Repurchase Agreement The RBA offer to buy (or sell) Commonwealth Government Securities and other eligible financial instruments, from banks or other authorized financial dealers, provided the same banks or dealers are prepared to repurchase (or resell) them at a future date, often in a few days time, at a price agreed at the outset. Simple deposit multiplier The ratio of the amount of deposits created by banks to the amount of new reserves. Total Deposit created = initial deposit/r Money multiplier K = total deposit created/initial deposit K= 1/r r= reserve ratio

 Money creation = credit creation = deposit creation FISCAL POLICY

Learning Objectives p.560 Students should be able to: Define fiscal policy. Explain how fiscal policy affects GDP and how the government can use fiscal policy to stabilise the economy. Explain how the multiplier process works with respect to fiscal policy. Discuss the difficulties that can arise in implementing fiscal policy. Explain how the federal budget can serve as an automatic stabiliser.

Key terms Automatic stabilizers Government spending and taxes that automatically increase or decrease along with the business cycle. Autonomous expenditure Expenditure that does not directly depend on the level of GDP. Budget deficit The situation in which the governments spending is greater than its tax revenue. Budget surplus The situation in which the governments expenditures are less than its tax revenue. Contractionary fiscal policy Involves decreasing government purchases or increasing taxes. A decrease in government purchases will reduce the increase in aggregate demand to reduce the rate of inflation. Crowding out A decline in private expenditures as a result of an increase in government purchases. Cyclically adjusted budget deficit or surplus The deficit or surplus in the federal governments budget if the economy were at potential GDP. Discretionary fiscal policy When the government is taking actions to change spending or taxes to achieve its economic objectives (fiscal policy) Expansionary fiscal policy Involves increasing government purchases or decreasing taxes. An increase in government purchases will increase aggregate demand directly because government expenditures are a component of aggregate demand. Fiscal policy Changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives, such as high employment, price stability and healthy rates of economic growth.

 Induced expenditure Expenditure that depends on the level of GDP. Marginal propensity to consumer (MPC) The amount by which consumption spending increases when disposable income increases. Multiplier The increase in the equilibrium real GDP divided by the increase in autonomous expenditure. Multiplier effect - The series of induced increases in consumption spending that results from an initial increase in autonomous expenditures. Supply side policies Fiscal policies that have long-run effects by expanding the productive capacity of the economy and increasing the rate of economic growth. These policy actions primarily affect aggregate supply rather than aggregate demand, shifting the long-run aggregate supply curve to the right. Tax wedge The difference between the pre-tax and post-tax return to an economic activity. Limitations of using fiscal policy to stabilise the economy. Timing lags Recognition lag: the time it takes policy makers to ascertain there is a problem to be addressed. Legislative lag: the time it takes to have policy approved by both Houses of Federal Parliament. Implementation lag: the time it takes to implement the policy, and for the policy to take effect. Crowding out INTERNATIONAL TRADE Learning Objectives p.607 Students should be able to: Discuss the importance of international trade to Australia. Understand the difference between comparative advantage and absolute advantage. Explain how countries gain from international trade. Discuss the sources of comparative advantage. Analyse the economic effects of government policies that restrict international trade. Evaluate the arguments for and against government policies that restrict international trade. Key terms Absolute advantage The ability of an individual, firm or country to produce more of a G/S than competitors when using the same amount of resources. Autarky A situation in which a country does not trade with other countries. Comparative advantage The ability of an individual, firm or country to produce a G/S at a lower opportunity cost than other producers. Dumping Selling a product for a price below the cost of production.

 Exports G/Ss produced domestically but sold to other countries. External economies Reductions in a firms costs that result from an expansion in the size of an industry. Free Trade Trade between countries that is without government restrictions. Globalisation The process of countries becoming more open to foreign trade and investment. Imports G/Ss bought domestically but produced in other countries. Open economy An economy which exports a large proportion of its output and/or has few or no barriers to international trade. Opportunity cost The highest-valued alternative that must be given up to engage in an activity. Price floor A government guaranteed minimum price for producers, which is usually above the free market equilibrium price. Protectionism The use of trade barriers to shield domestic firms from foreign competitors. Quota A numerical limit imposed by the government on the quantity of a good that can be imported into a country.

Tariff A tax imposed by a government on imports.

 Terms of trade The ratio at which a country can trade its exports for imports from other countries. Voluntary export restraint An agreement negotiated between two countries that place a numerical limit on the quantity of a good that can be imported by one country from the other country. World Trade Organization (WTO) An international organisation that enforces international trade agreements. Why dont we see complete specialisation? 1.Not all goods and services are traded internationally. 2.Production of most goods involves increasing opportunity costs. 3.Tastes for products differ.