HSC Topic Three – Economic Issues

ECONOMIC GROWTH ............................................................................................................................................. 6

• aggregate demand and its components: Y = C+I+G+X–M ................................................................... 6
• injections and withdrawals (I+G+X; S+T+M) ...................................................................................... 7
• the simple multiplier: k = 1/(1–MPC) ................................................................................................... 7
• measurement of growth through changes in real Gross Domestic Product ........................................... 8
• sources and effects of economic growth in Australia ............................................................................ 9
• increases in aggregate supply – improvements in efficiency and technology ....................................... 9
UNEMPLOYMENT ................................................................................................................................................ 12
• measurement ........................................................................................................................................ 12
– labour force .......................................................................................................................................... 12
– participation rate .................................................................................................................................. 12
– unemployment rate .............................................................................................................................. 12
• trends ................................................................................................................................................... 13
• types and causes................................................................................................................................... 13
• non-accelerating inflation rate of unemployment (NAIRU) ............................................................... 16
• main groups affected by unemployment ............................................................................................. 18
• effects of unemployment – economic and social costs........................................................................ 19
INFLATION ......................................................................................................................................................... 20
• trends ................................................................................................................................................... 21
• causes ................................................................................................................................................... 21
• positive and negative effects................................................................................................................ 23
EXTERNAL STABILITY ....................................................................................................................................... 23
• measurement ........................................................................................................................................ 23
• trends ................................................................................................................................................... 25
• positive and negative causes and effects ............................................................................................. 26
DISTRIBUTION OF INCOME AND WEALTH ......................................................................................................... 28
• measurement – Lorenz curve and Gini coefficient .............................................................................. 28
• sources of income as a percentage of household income .................................................................... 28
• taxation, transfer payments and other assistance ................................................................................. 29
• sources of wealth ................................................................................................................................. 29
• dimensions and trends, according to gender, age, occupation, ethnic background and family structure
29
• economic and social costs and benefits of inequality .......................................................................... 31
ENVIRONMENTAL SUSTAINABILITY .................................................................................................................. 33
• ecologically sustainable development ................................................................................................. 33
• private and social costs and benefits – externalities, market failure ................................................... 34
• public and private goods – free riders ................................................................................................. 35
• environmental issues: .......................................................................................................................... 35
– preservation of natural environments .................................................................................................. 35
– pollution, climate change..................................................................................................................... 35
– depletion of renewable and non-renewable resources. ........................................................................ 36

5
Economic growth

• Economic growth is the increase in the value of goods and services produced in an
economy over a period of time.
• It is experienced during an upswing and boom of the domestic business cycle.
• It is measured by increasing Gross Domestic Product (GDP) which is equal to GDP =
C + I + G + (X – M)

• aggregate demand and its components: Y = C+I+G+X–M

• C = DOMESTIC consumption of domestic goods and services. This means the

spending of domestic citizens in the country. This is different to consumption of goods
and services by foreigners which would be counted as X and not C. it is also different
from M which is consumption of FOREIGN goods and services by domestic
consumers. Domestic consumption represents 60% of Australia’s GDP.
• I = investment. This can be domestic or foreign investment.
• G = government expenditure.
• X = export revenue
• M = import spending. From Year 11, import spending is a leakage out of the circular
flow of income by the overseas sector. This is why it is subtracted from the income Y
or GDP equation.
• Together, (X – M) is called the trade balance. When recorded on the balance of
payments, it is called the balance on goods and services.
• How did we get the equation Y = C + I + G + (X – M)? Well, GDP is the value of
goods and services produced in the economy and Y is national income. The value of
goods and services the economy produces is equal to the amount of income that the
economy generates as a whole so C + I + G + (X – M) = GDP = Y.
• Also, the amount of income the economy generates is also indicative of the level of
demand in the economy. This is because increasing demand will increase consumption
of goods and services, and this will generate more income for the economy. So AD is
also equal to GDP and Y à AD = C + I + G + (X – M)
• Now, economic growth is made up of two components: aggregate demand (AD) and
aggregate supply (AS).
• AD = the total volume of spending in the economy.
• AS = the total volume of output in the economy.

6
• injections and withdrawals (I+G+X; S+T+M)

• Investment (I), government expenditure (G) and export revenue (X) are injections into
the circular flow of income via the finance, government and overseas sectors,
respectively.
• Savings (S), taxation (T) and imports (M) are leakages out of the circular flow of
income via the finance, government and overseas sectors, respectively.
• Increased injections will increase economic growth as I, G and X are added to the
GDP equation.
• Increased savings and taxation decreases the disposable income households are able to
consume via the equation Y = C + S + T à C = Y – S – T.
• Increased leakages decrease economic growth. M is subtracted from the GDP
equation.

• the simple multiplier: k = 1/(1–MPC)

• The multiplier effect is when an increase in aggregate demand leads to a greater than
proportional increase in national income.
• Consider a situation in which one person consumes. Their consumption represents a
unit of demand for goods and services which will increase the derived demand for
labour. Consequently, labour will acquire a job and earn more income as businesses
respond to the increase in demand for their goods and services. Labour will then be
able to consume their higher income. Therefore, one person’s consumption or
aggregate demand led other people to consume and increase their aggregate demand.
Since national income Y = C + I + G + (X – M), this shows that one increase in
aggregate demand caused national income to increase by even more.
• The simple multiplier k is equal to 1/(1 – MPC). Since MPC + MPS = 1 and MPS = 1
– MPC, the simple multiplier k is also equal to 1/MPS.
• To calculate the change in national income, use the equation DY = kDAD. In
economics, the symbol D means ‘change in.’ Therefore, the change in national income
is equal to the product of the simple multiplier and the change in aggregate demand.
• FROM NOW ON, WHEN EXPLAINING ECONOMIC GROWTH, ALWAYS
REFER TO THE MULTIPLIER EFFECT.
• An increase in C, I, G or (X – M) induces a positive multiplier effect on economic
growth and a decrease in C, I, G or (X – M) induces a negative multiplier effect on
economic growth.
• The multiplier effect is illustrated using the Keynesian inflationary gap diagram
below.