SCSA Economics Economic knowledge and understanding

Since July 2023, the Australian economy has evidently been in the contractionary/economic downturn phase of the business cycle, with continuing falling rates of economic growth, with 2.1% GDP growth rate year ended for June 2023, and forecasted at 1.8% for the second half of the year, with this below trend growth the economy is in a downturn phase. This contraction phase is also evident in the falling consumer and business confidence indexes, which reduces the level of consumption, investment, aggregate demand and thus output/GDP.

AD Factor: Consumer Confidence

Consumer confidence refers to the level of optimism that households have regarding their future financial situation, employment prospects and the future state of the economy. In 2023, consumer confidence has remained at very low levels, which meant that consumers had a greater propensity to save rather than spend, which worked to reduce household consumption levels, lowering consumption, AD and thus leading to firms to respond to rising stock levels with decreased production volumes, reducing GDP and contributing to the downturn phase that the economy experienced in 2023.

AS Factor: Productivity

Explanation: Productivity refers to the level of output produced from a given quantity of inputs. Over 2023, labour productivity levels on average remained very low, whereby there were minimal increases in the output produced per hour of labour worked. This led to increased costs per unit of output for firms, reducing their ability and/or willingness to supply (AS reduced). Thus, as firms were less willing to make products available to the market, the level of output/GDP growth was reduced, contributing to the downturn phase that the economy entered in 2023. This is evident in the fall in GDP growth from 2.4% in March 2023 to 2.1% by June 2023.

The goal of strong and sustainable economic growth is to achieve the highest growth rate possible, consistent with strong employment growth, before running into excessive environmental, external and inflationary pressures. It is achieved at a real GDP growth rate of 3-3.5% p.a. If growth is below the target and not strong enough, there would be reduced derived demand for labour, as with lower levels of output there’s reduced need by firms to use labour resources to facilitate their production, thus leading to high levels of cyclical unemployment, which leads to greater social unrest, homelessness and crime rates, reducing non-material living standards. If growth is too high, such that is had become unsustainable, the excessive growth would thus lead to (if the economy was operating at/close to full capacity) capacity constraints and shortages. As aggregate supply begins to fall to keep pace with the growth in AD, these shortages in product and factor markets would place upward pressure on prices, thus exacerbating inflationary pressures, which erodes the purchasing power of workers with fixed wages, reducing their access to goods/services, worsening material living standards.

The headline rate of inflation includes the price movements of all goods and services included in the CPI, whereby if there were one off increases in the prices of energy such as fuel in the economy, this would, ceteris paribus, cause the headline inflation rate to increase. However, the underlying inflation rate ultimately excludes volatile/temporary price changes, including the one off energy prices increases. Thus, the underlying rate of inflation would remove the price increase from its calculation, and thus the underlying rate, ceteris paribus, would not change, leading to the headline rate of inflation being higher than the underlying rate.

Answers could include:

Economic policy objectives

• price stability
• full employment
• sustainable economic growth
• equitable distribution of income
• efficient allocation of resources.

Complementary objectives

• full employment and economic growth – expanding the economy requires the employment of more resources, including labour. This complements economic growth
• efficient allocation of resources and economic growth – as the economy expands, resources become scarcer and are used more intensively and efficiently.

Conflicting objectives

• price stability and economic growth – expanding the economy will increase competition for resources, increasing the cost of resources to meet additional demand
• and equitable distribution of income could reduce economic growth through increase in welfare payments
• equitable distribution of income - gains from economic growth are likely to benefit specific groups at a cost of others
• full employment and price stability – typically, during periods of full employment inflation is generally high. Inflammatory policies are often used during periods of full employment and counteract demand-pull inflation with higher cash rates or lower fiscal spending. As a result of lower aggregate demand, higher unemployment can be expected.

Answers could include:

Methods:

• labour productivity equals GDP per worker
• multifactor productivity equals output divided by all inputs – the growth in output caused by the growth in inputs.

Impacts:

• increased productivity decreases costs of production thereby achieving price stability
• increased productivity leads to increased economic growth, rising standard of living.
• higher wages from increased productivity can impact on standard of living and equitable distribution of income
• increased productivity may have negative impacts on employment in the short run. In the long-run, productivity increases incomes, leading to an increase in jobs, lowering unemployment
• increased productivity will result in higher government revenue which can be used to improve income distribution.

The model should show:

• a rightward shift in the AD curve
• a rightward shift in the AS curve;

Answer(s) could include:
Australian economy:

• reference to severe contraction (recession) and nature of demand and supply shock from exogenous factors particularly the coronavirus
• main economic indicators and how they have changed over the year: GDP growth, unemployment, inflation, investment, exchange rate, consumer spending etc.
• reference to industries hardest hit by contraction
• global financial crises and uncertainty
• effect of slowdown of global economic growth on local economy.

Monetary policy:

• reduction in cash rate by RBA and market interest rates - expansionary
• intended effect on consumption, investment and exchange rate via transmission mechanism
• aim to support aggregate spending and create employment
• role of multiplier effect.

Fiscal policy:

• range of significant stimulus payments to households and government policy support for businesses during time of collapsing consumer spending
• reduction in government revenue and increase in expenditure
• movement to a significant budget deficit from planned budget surplus
• role of multiplier effect..

AE model:

• 45 degree line, AE on vertical axis, Real GDP on horizontal axis
• parallel AE lines demonstrating impact of recession and policy effect
• increase in equilibrium real GDP to reduce deflationary gap.

Answer(s) could include:

Monetary policy:

• overall effectiveness is likely to be poor; no guaranteed increase in aggregate spending such as, cost of borrowing and asset prices channels
• interest rates were already very low, further reductions likely to have limited impact due to low consumer and business confidence
• household debt is high making it more likely households will seek to retire debt rather than borrow
• depreciation of Australian dollar will have increased net exports despite a significant fall in world growth
• significant effect time lag.

Fiscal policy:

• more effective because government spending can increase aggregate spending directly
• government expenditure multiplier likely to be low because of low MPC
• government reluctant to go into too much debt given experience post-GFC
• other criticisms relevant to success of policies implemented in 2020.

A number of factors effect both policies, i.e. multiplier effect, expectation, and crowding out effects.