7.

1 Introduction
Economic Growth

Involves an increase in the volume of G/S that an economy produces

over a period of time.

It is measured by the annual rate of change in real GDP

Economic growth =

Real GDP(current year) - REAL GDP(previous year)

REAL GDP (previous year)

100
1

The Australian bureau of statistics estimates Australias growth quarterly (every 3 months)
Year on year growth

Measuring growth in the current quarter against the same quarter in

the previous year.

Annual economic growth is calculated by measuring growth over the financial year.
There are a variety of different ways of measuring GDP because of different focuses of short and
long term economic policy makers.
The components of aggregate demand
Aggregate demand is based on the Economic theory which states that individuals act in the
present based on their assumption of the future conditions
Aggregate demand

Refers to the total demand for G/S in an economy.

AD=Consumption(C)+Investment(I)+Government Spending(G)+(exports-imports)
Aggregate supply

Refers to the total productive capacity of an economy. Also called

national income.

AS=Consumer spending by household + savings by household + taxation

The economy is in equilibrium when aggregate supply equals aggregate demand.
GRAPH
Influences on consumption
Consumption Vs saving

If a persons income increases they have more income to consume or save.

Thus factors such as wage rates and unemployment influence the overall levels of savings
and consumption thus altering AD

This also alters APS and APC.

Consumer expectations

Expectation of the future prices and the availability of G/S can alter AD and AS.
If people expect prices to rise quickly in the future, or higher real incomes or a shortage of
goods they tend to spend more in the short term and save less.

Conversely, if people expect lower real wages, lower prices of G/S and surplus of G/S they
will be in.

Interest rates

If the general levels of interest rates are high, this would discourage individuals from
spending and encourage them to save.

The opposite is true.

Distribution of income

The more equitable the distribution of income the higher the rate of spending. The opposite
is true.
This is because people on lower incomes tend to spend higher proportion of their income
than those on higher incomes.
E.G. A person earning $300 a week will need to spend a higher proportion of that income in
basic costs of living compared to a person earning $3,000.

Influences on investment
Investment in an important aspect on AD, making up 20% of it.
Cost of capital equipment

The lower the level of the cost of capital, the higher the levels of investment.

Factors affecting the costs of capital include: interest rates(if they are low, loans are cheaper),
changing Government policies which provide concessions for capital and the productivity of
Labour(high productivity means that Labour is a good substitute for Labour investments)

Business expectations

Business expectations about future prospects alter their willingness to invest.

The factors that affect business expectations include expected demand for their products,
general economic output, the discovery of new resources and inflation.

Influences of Government spending and tax

Government spending usually makes up between 20-25% of AD.

Government taxation usually makes up between 20-25% of AS.
Governments use fiscal policy to ensure a strong and stable rate of growth.

If they wish to increase it they will increase expenditure and/or decrease tax. The opposite is
true.

Influences on imports and exports

Imports and exports make up between 20-25% of AD.

If export revenue is equal to import spending then it neither adds nor subtracts from AD.
If export revenue is lower than import spending then this will represent a negative
contribution to AD-The opposite is true.
As Australia is often in trade deficit, exports take away from our AD.

Levels of imports and exports depend on the levels of domestic and overseas income,
respectively.
ERs also affect IR. E.G. If our ER is strong then our export demand will fall as their prices
become more expensive to overseas buyers, however demand for imports will rise as
Australian consumers experience increased purchasing power.

7.3 Changing levels of growth: multiplier process

I order to see how changes in AD effect the levels of economic activity we simplify the circular flow
of income to the first 3 sectors.
When investment exceeds savings AD is higher leading to increased growth. The opposite is true.
In order to better understand the relationship between these factors, the multiplier process is used.
Multiplier process

Measures the greater then proportional increases in national income resulting

from an increase in AD.

When there is a shock in the economy this will lead to changes in leakages and injections.
If injections increase, then there will be more income for individuals who consume more, which
continues to lead to growth.
Therefore this will have a multiplied impact on the national income.
However, this will not continue forever and the increase will begin to slow down, as some of the
extra income will be saved.
Thus the multiplier is the number of times that the final increase in national income exceeds the
initial increase in expenditure.
Multiplier measures the proportion that the growth of the economy caused by the initial in AD over
the initial increase in AD.
Hypothetical

Interest has increased by $10,000.

This means that national income rises by $10,000.
If MPC is 0.8, this means that $8,000 will be spent whilst $2,000 will be saved.
The $8,000 consumed is passed on to those who receive it as G/S payment.
Of that $8,000, 6,400 will be spent and $1,600 will be saved.
Cycle continues, but the amount extra consumed decreases each time.

Thus the size of the multiplier is given by:

1
MPS

OR

1
1 - MPC

Under the hypothetical situation the multiplier would be 1/0.2 or 5.

Therefore the total increase in income generated by the 10,000 increase in AD=5x10,000=50,000

The multiplier process also works for decreases in AD. For example, if investment decreased by
$10000, the multiplier would work in reverse, leading to a $50000 decrease in national income

The larger the MPS, the lower the multiplier will be, as increased savings lead to lower levels of
investment and spending.

As can be seen, an increase in investment has a multiplied effect on the level of national income.
This is why governments attempt to exercise some control over the level of spending in the
economy

7.4 The effects of economic growth

Whilst growth is an important objective for economic management, it has both positive and negative
impacts on a country
Living standards

Living standards will increase as real wages rise and people gain more disposable income.
Furthermore, growth means that governments have more money to boost spending in areas of
healthcare and education, further increasing living standards

Employment

Unemployment will decrease as businesses have more income to pay workers

Additionally wage rates will increase
The nature of jobs that are available will change. As an economy grows, there will be increased
demand for labourers in high wage and high skilled jobs

Inflation

As wage rates and the level of spending rise so will inflation

This is particularly true if spending continues to rise when the economy is close to full capacity and
AS cannot keep pace with AD
A major aim of government policies is to maintain a stable level of growth, in order to ensure that
excess inflation resulting from growth does not cause the economy to take a sharp dive

External stability

As incomes increase, people will demand more imports

The increased demand for imports will lead to a worsening terms of trade which can lead to a
larger CAD
Thus high levels of growth pose a risk to the external stability of an economy

Income distribution

Whilst growth leads to leads to increases to increased disposable incomes for people in an
economy, the wealth is not always spread equally
Growth often favours certain individuals more than others (e.g. Shareholders, business executives
benefit more from growth then others)
Thus this can lead to an increase in an economies internal level of inequality

Environmental impacts

Growth often impacts negatively on the environment

As growth increases, so does industrial output, which means higher levels of pollution, thereby
contributing to increased damage to the natural world

7.5 Recent economic growth trends

A market economy is subject to periods of boom and recession
Recession

A recession is a decrease in the overall level of economic activity,

defined by a decrease in the level of economic growth over two
consecutive quarters

Macroeconomic policies

Macroeconomic policies are government policies which affect the

whole economy and are designed to minimise fluctuations in the
business cycle

Macroeconomic policies are designed with the goal of lowering inflation and UE, whilst maintaining a
stable level of growth
Between 1991 2008 Australia experienced its longest period of sustained growth at an average of
3.6%, higher than the average of other advanced industrialised nations at 2.7%
The GFC ended this when the Australian economy contracted 0.5%, however we were able to avoid
two consecutive periods of negative growth (recession)
Australias sustained growth between 1991 and 2008 can be attributed to several factors including:

The overall stability of conditions in the global economy which included low inflation, low U/E
and stable macroeconomic policies.

An improvement in our terms of trade which lifted domestic incomes and aided growth. Our
ToT rose by 47% and has led to a 13% boost to our national income over the last 8 years

Our economic management has focused on maintaining a stable level of growth by keeping
inflation in the 3-4% range

The government has shown commitment to use fiscal policy to either boost or dampen growth
during times of need. E.g. the governments expansionary policy in the 09-10 budget
prevented us from slipping into recession

The RBAs strong focus on using monetary policy to maintain inflation between 2-3%

Sustained low inflation in the mid 1990s helped keep interest rates low which encouraged
business and consumer spending which bolstered growth

The increase in asset prices (shares, property) boosted the wealth of households and
encouraged greater borrowing and consumption. This is known as the wealth effect

Productivity growth in the 1990s reached 2.6% which boosted growth. Furthermore, the use
of microeconomic policies bolstered productivity thereby increasing growth

New technologies have raised productivity and efficiency in many sectors. This is aided by
Australias quickness at accepting these new technologies

Australia's extended period of sustained growth reflects a mix of domestic and external influences
along with positive structural changes and effective macroeconomic policies.
As Australia becomes more closely integrated with global economy, it will become increasingly
subject to the global rate of growth.
In the long term Australia's economic challenges fall into the "3P's" productivity population and
participation.
The labour force participation rate is tipped to fall in the next few years due to an ageing
population.

7.6 Policies to sustain economic growth

A major aim of the governments economic policy is to promote sustainable growth.

The government uses macroeconomic policies to stabilise growth.

The government uses fiscal policy to alter growth.

If growth is leading to dangerously high inflation, the government will increase tax and/or
decrease spending. The opposite is true.

The RBA can use monetary policy to influence growth. If growth is causing high inflation they
will boost interest rates to dampen demand and stabilise growth.

Monetary policy is the most important tool in stabilising growth.

Macroeconomic policy is aimed at smoothing out fluctuations in the business cycle in the
short to midterm

Microeconomic policies increase AS by ensuring that the economy maintains a stable level of
growth.

Macroeconomics supply side

Macroeconomics demand side.

STATS
GDP = $1.116 trillion
GDP PC = $46,278 AUD
Inflation = 2.9%
Growth = 2.9%
UE = 5.3%
Labour force 11.44 million