Economics All economic activity is directed towards the satisfaction of human needs and wants.

Needs refer to all the essential items that use individuals must have to survive e.g. food, clothing, water, shelter. Without satisfying these needs, we would die. Wants refer to all the goods and services that individuals, communities and countries desire. Economists say that individuals desire utility (satisfaction and pleasure from the consumption of goods and services. There are 2 types of wants: 1. Individual wants wants which are felt by the individual 2. Collective wants the wants of the whole community which are satisfied by the government through the provision of roads, parks, libraries etc. Characteristics of Wants 1. Unlimited wants are always unfulfilled and new wants arise every day 2. Competitive competition for the satisfaction due to limited income 3. Differing in importance limited income; requires us to satisfy urgent wants over less important wants 4. Changeable Wants that change over time 5. Complementary They complement each other. Cars and Petrol 6. Recurrent some wants require satisfaction again and again. E.g. Newspaper, Food etc. Resources A resource may be defined as anything which can be used to satisfy a want. Economic resources are all the resources that go into the production of goods and services. Economic resources must be: 1. Known 2. Accessible 3. Capable of being used in the production process 4. Useful in satisfying wants Types of Resources Economists divide resources into four main types: land, labour, capital and enterprise. All these resources are used in the process of producing goods and services, theyre referred to as the factors of production. Land comprises all natural resources of the earth. The income to land is rent, earned by landowners if they let others to use their land for farming or buildings. Labour refers to all forms of human effort, both physical and mental, which can be used in the production of goods and services. The income to labour can be wages, salaries, fees, commissions and other payments. Capital refers to those goods which have been produced for the purpose of assisting with the production of goods and services. It includes all buildings, machinery, tools, trucks, roads and railways. The three categories of investment are: 1. Investment in buildings 2. Business investments e.g. machines, stocks of unsold goods, tools 3. Government investments e.g. transport facilities, power stations, and schools. Net investment = gross investment (total investment) depreciation The income to capital is interest. When a business borrows money to buy its capital, it has to pay interest to the people it borrows from. Enterprise is the ability to organise and combine land, labour and capital for the purpose of producing and selling goods and services. This is performed by the entrepreneur who possesses the talent, drive and initiative to make decisions and bear the risks involved in running a business. Profit is the firms income after all the costs of production are paid. Characteristics of resources 1. Limited in availability resources are scarce in relation to the wants they are used to satisfy. 2. Capable of alternative uses e.g. most workers are capable of more than one type of task and an area of farm land may be used for growing a variety of crops or for grazing.

Key economic issues In any kind of economy, these 4 following questions must be answered: 1. What to produce? Because of limited resources, no economy can satisfy all individual and collective wants. Therefore, it must decide which goods and services will be produced 2. How much to produce? This question depends on the level of consumer demand. 3. How to produce? This question will be answered depending on the availability of resources and the level of technology. 4. How to distribute production? This question will be answered depending on the factor of incomes and the provision of welfare. What is economics? Economics may be defined as the study of the way in which mankind allocates its scarce resources in order to satisfy its unlimited material wants. Modern economics is based on 2 fundamental concepts: Choice Scarce The material wants of people can not equal to the supply of resources. Therefore, the problem of choosing between alternative wants is known as the economic problem. Opportunity Cost The necessity for economic choice means that the satisfaction of one want involves giving up another alternative want. This sacrifice is opportunity cost. Efficiency = producing the maximum possible output. This can be achieved when all resources are fully employed in a way that maximises production and minimises the cost of production. We can illustrate the economic problem, along with the concepts of opportunity cost and efficient resource allocation, with a production possibility model. This model makes the following assumptions: i) All resources are fully employed; ii) All resources are fixed in supply but can easily be transferred from production of one good to the production of another; iii) The level of technology is constant; iv) Society produces only 2 good: consumer goods and capital goods. Consumer goods are used by individuals and households to satisfy their present wants e.g. bread. Capital goods are the goods that assist in future production of goods and services e.g. tractors. A production possibility curve/schedule shows the maximum combination of 2 goods which society might produce at any one time. Expanding Resource Supplies Over time the volume of resources available to society tends to increase. The net result of an increase in the volume of available resources is that society is now capable of producing a greater output of goods and services. The increasing capacity of society to satisfy more of its wants with a greater volume of goods and services is called economic growth. Unemployment and the Production Possibility Curve Unemployment refers to the problem of the scarce resources. Unemployment indicates that there is an inefficient allocation of resources if the X is inside the production possibility curve and therefore the economy can not achieve a maximum satisfaction of wants with a minimum opportunity cost. Production Possibilities, Increased Resources and Technological Progress Technological advances lead to production of better goods and services as well as better methods of production. Technological progress improves the efficiency with which resources are used; therefore the same resources are still used. If there is an advance in production technology, the production possibility curve will move outwards.

The Future Implications of Choices In the long run, an economy which focuses more on the production of capital goods will increase its productive capacity and therefore experience a higher level of economic growth. The principle that economic decision making has future implications is true for individuals, businesses and government. For example: An individual may choose to forego a long overseas holiday and invest his time and money instead in further education. The individual is making a sacrifice now, foregoing some enjoyment, in order to increase his workforce skills and job options in the longer term. A business must choose to focus on one area of business activity over another. Businesses have a limited amount of entrepreneurial skill, labour, capital and other resources available and must therefore focus on products in which they are likely to have the greatest success. Businesses are likely to be most effective if they can identify where the next wave of business growth is likely to come from. For example, many businesses which invested in communications and information technology a decade ago have achieved extraordinary financial success. If a business only chooses to operate where people have already been successful, they may find that they have entered the market too late. The decisions of governments have very important long-term implications, both for the government and the nation. A government may choose to make its top priority to satisfy immediate wants. As a result, it may provide less funding in areas such as education, infrastructure and research and development. In the future, this government will experience slow economic growth. Economic Factors Underlying Decision Making Besides being influenced by consumers, firms and governments, decision making in an economy is also influenced by social, cultural, historical and other factors. Consumers a) Spending and saving A consumer may choose to spend or save all of his/her income, or spend some and save some proportion of income. An equation can be used to show the relationship between consumption, saving and income:

Y=C+S
Consumption can be expressed as:

C=Y-S
Saving can be expressed as:

S=Y-C
Where (C) stands for the consumption of goods and services in which income is not saved, (S) stands for savings in which that part of income is not consumed and (Y) is for income which is either gross or taxable income. Consumption is carried out to satisfy basic needs and wants. As income increases, consumers may increase their absolute value of consumption. Consumers on low incomes tend to consume more of their income. Therefore, they may save little or none of their income. Higher income earners have a greater capacity to save since they are more easily to buy necessities and luxuries, leaving some income for saving. Three main motives for saving: The transactionary motive for holding money balances was to finance cash purchases of goods and services (i.e. transactions) in the present; The precautionary motive refers to an individuals desire to have cash balances for precautionary income or purchases (e.g. to pay for unforeseen expenses); and; The speculative motive is the individuals desire to invest in shares, bonds, real estate or cash to earn a rate of return on the money invested. b) Work The type of work performed by the individuals will affect their decision making. Employment can be classified as professional, trade, semi skilled or unskilled.

The higher level of skills, education, training and qualifications required in a job > potential for higher income earned > higher potential levels for consumption and saving > higher standards of living. c) Education Education refers to the ability of people to increase their skills, knowledge and competencies through learning and training. Levels of education include the basic skills of literacy and numeracy acquired at primary and secondary school; trade or TAFE qualifications acquired through apprenticeship training leading to trades qualifications; and tertiary qualifications gained at universities leading to professional employment. d) Retirement Retirement is a time in a persons life where they cease full time work and receive superannuation or pension as an income. The way that retirement influences decision making is they force employers to contribute 9% of the employees gross wages to superannuation. e) Voting and Participation in the Political Process A pattern tends to form when it comes to voting in the political process, this is due to the economic circumstances that an individual is in which determines their political affiliations e.g. highly paid and skilled professionals might vote for the Liberal Party, believing in a well managed economy with more business opportunities for the self employed. Whereas a semi skilled individual and a member of a trade union because it a tradition workers party. Business Business is primarily run for the maximisation of profits. Profit is equal to the total revenue minus the total costs of production. Pricing is important as total costs must be covered and a surplus left for entrepreneurs to gain sufficient profit or return to stay in business.

Total Revenue = Price x

Prices are usually determined by production costs and the mark up or the return to the entrepreneur in terms of profits. This is known as cost plus pricing i.e.

Price = Costs + Mark Up

Production mainly involves the use of labour and capital as well as other resources. A business must decide on the most efficient combination of capital and labour to use. Producers try to maximise resources by allocating resources (land, labour, capital and enterprise) to their most highly valued uses. Price is influenced by the production costs, responsiveness of demand to price changes and the level of competition in the industry. Since labour costs (wages and salaries) represent over 70 % of production costs for most business and industrial relations, negotiation of wages and working conditions are important because they will determine the employees productivity and they will promote worker motivation and satisfaction. Safety Net System: AIRC Australian Industrial Relations Commission: Establishes minimum wages, conditions of work and types of work employers must pay and provide for employees. Government The federal government imposes and collect taxes from individuals and allocate funding into areas such as education, transport etc. Governments influence the decisions of individuals and businesses in 4 main ways: 1. Governments allocate resources through their spending in the provision of infrastructure. 2. The federal government attempts to stabilise economic activities through the conduct of economic policies e.g. the government may increase interest rates if it believes inflation is accelerating or it my budget for a larger surplus to raise public saving. 3. Governments play a distributive role by implementing taxation. 4. The federal government attempts to protective an individuals consumer rights and increase competition in the economy in order to raise efficiency and lower prices. Examples of government regulations that affect decision making of individuals and firms include: Price control, price regulation and price surveillance in certain markets and industries The provision of a framework of law and order for commercial dealings

The application of a national competition policy to protect consumer sovereignty and to ensure competitive conduct by firms in competitive markets Minimum wage legislation and the safety net of the award wage system to protect employees and their entitlements in the workplace Legislation to control environment externalities (such as pollution) through regulation, and the use of market based instruments such as fines, fees, taxes and licences.

The Operation of an Economy An economy refers to the way in which a society is organised to solve the economic problem of scarcity of resources in relation to consumer wants. There are 2 types of economic systems: 1. The market or free enterprise economy which is based on a system of markets which allocate resources and allow private ownership of resources, the profit motive and free enterprise. 2. The planning economy which is based on government ownership of most resources and the allocation of these resources according government planning priorities. Both types of economic systems need to perform the functions of production, distribution and exchange. This involves answering 4 basic questions: 1. What to produce? production 2. How much to produce? production 3. How to produce? production 4. How to distribute? distribution and exchange How economies operate The production of Goods and Services Goods and services are the outcome of the production process. They are the products which satisfy our wants and needs. Goods are tangible things (things we can physically touch) e.g. food, cars. Services are intangible acts that are of benefit to us, such as receiving medical help. Factor of production any resource which can be used in the production of goods and services. The quantity and quality of a countrys factors of production can influence how wealthy or poor that country will be. High quality resources higher standard of living. Given that the supply of all these resources is limited, producers face an opportunity cost decision in determining how to use them in production. New resources may become known or useful in the production process, the size and quality of the labour force may change as educational standards, work and retirement patterns, and lifestyle choices change. Each of the four resources (land, labour, capital and enterprise) are limited in their supply, reflecting the problem of scarcity in economies: There are limits to the amount of natural resources available for production, whether land, fossil fuels or even clean air and water. Our supply of labour is also limited by our population size, labour market skills and peoples willingness to work. Our supplies of capital are limited by the extent to which governments and the private sector are willing to invest, as well as the level of domestic (or overseas) savings available for domestic purposes. The supply of entrepreneurial skills is also limited by the size of the population and a range of other cultural and economic factors, including most importantly the ability and willingness to innovate and take risks. In a market economy, decisions about how scarce resources are allocated in the production are largely determined by consumers in deciding how to dispose of their income. Firms are motivated by the aim of making a profit, and so they will combine resources with the aim of minimising their cost. Business firms can often use several different combinations of resources. Therefore the business must decide which combination of resources to use in the process of production. Depending on which factor is used in greater proportion, the method of production may be labour-intensive (where more labour is used relative to other factors) or more capital-intensive (where relatively more capital is used).

Production: What, How Much and How to Produce? Most societies and economic systems have a variety of land, labour, capital and entrepreneurial resources which can be used by producing goods and services. Since resources are scarce, 4 questions must be answered. These questions are: What to produce? How much to produce? How to produce? How to distribute? The what to produce question will be answered by the economic system responding to societys scale of preferences for certain goods and services over others. The how much to produce question involves the determination of the quantities good and services to be produced depending on the level and pattern of consumer demand. The how to produce question involves the method of production to be used. This will depend on the current state of technological progress and resource availability. The how to distribute question involves the distribution of the production of goods and services. The distribution of the production of goods and services depends on individual incomes. Characteristics of a market economy and a planned economy Market economy: Tend to have an uneven distribution of income because individual are free to accumulate income and wealth. The tax/transfer system in a market economy helps to redistribute income and make the distribution of income less unequal than if determined by market outcomes alone. Planned economy: Incomes are basically determined by the government and many prices are also set by government agencies. There is a more even distribution of income and the prices of basic foodstuffs, clothes, housing and utilities may be subsidised to make them more affordable for the majority of the population. How each economic system solves the economic problem Economic Decisions Market Economy What to produce? Determined by us How much to produce? Determined by consumer demand How to produce? Determined by resources To whom to distribute? Determined by income Planned Economy Determined by government Government planning Determined by government Determined by income and other factors

The distribution and Exchange of Goods and Services The total amount of goods and services produced in an economy is known as the Gross Domestic Product (GDP). One of the main functions of an economic system is to determine how to distribute and exchange the goods and services produced in an economy. Market economies provide people with income as a reward for their contribution to the production process. Workers income levels are influenced by how much they work, their skills and enterprise, educational qualifications and their bargaining power in wage negotiations with employers. These factors can influence the distribution of income between workers. The benefits of such a system of distribution is that if provides incentives for people to obtain better skills and work harder in order to improve their share of output, or to develop entrepreneurial skills and start their own business. The problem with this system is that it is unfair to those who cant contribute due to illness, age or disabilities. Therefore, governments redistribute money through taxation. Individuals and business use money as a medium for exchanging goods and services. This makes it easier for people to conduct transaction when only one party is interested in what others have to offer.

Resources and the Provision of Income Goods and services are a production from a combination of resources. These resources are sometimes called factors of production. Each factor of production receives a return or income as follows: Factor of Production Factor Income Return Land (Natural resource) Rent Labour (human effort) Wages/Salaries etc. Capital (machines and equipment) Interest Enterprise (risk taking behaviour) Profit The factor income returns paid to the owners of the factors of production are determined by the quantity and quality of each resource. They are paid as a reward for the use of production resources.

Disposable = Gross Income Taxation

The Provision of Employment and Quality of Life Employment may be categorised according to the main sectors of economic activity: Primary industry businesses are involved in a raw material extraction such as agriculture, mining, fishing, hunting and forestry. Secondary industry or manufacturing includes all those businesses (such as furniture and steel making, car assembly and clothing manufacturers) that process raw materials or inputs into usable products for consumers and other business. Tertiary or service industry includes all businesses involved in the retailing, wholesaling or distribution of goods and services to consumers. It includes retail shops, banks, supermarkets and cafes, and services such as banking, insurance and entertainment. The quality of life in an economy depends on the quantity and quality of both material and non-material goods and services in the economy and the community. The Business Cycle In market economies, economic activity occurs in cycles. These cycles form the business cycle which is characterised by 4 main phases: - phases - booms - recessions - depression (rarely occurs) In each stage of the business cycle, production, income, employment and the quality of life may be affected by changes in economic activity; In an upswing phase: expenditure, output, income and employment levels rise. Higher levels of tax collections by governments may finance increased spending on infrastructure, community services and improved environmental quality. In a boom phase: expenditure, output, income and employment levels reach a maximum as economy activity peaks. Shortages of labour and other resources may occur leading to inflation. In the downswing phase: expenditure, output, income and employment opportunities begin to fall as the economy slows. With less economic activity, there may be less demand for labour and therefore an increase in unemployment. In a recession: expenditure, output, income and employment opportunities are ate a minimum. There is rising unemployment and the government may use economic policies designed to stimulate economic activity. The Circular Flow of an Income Model Shows continual movement of goods and services, resources and money between sectors in the economy. Most Market Economy consists of five sectors.

Two Sector Model Based on the following assumption: Only has two sectors Households spend all of their income on goods and services All goods and services produced by firms are sold to households There is no financial sector, government sector or overseas sector

Because there is not overseas sector, there is no export, import or international money flow ---- this is said to be a closed economy.

<INSERT TWO SECTOR MODEL> There are four basic flows in the two sector model: Households provide productive resources (land, labour, enterprise) to business firm In return for supplying these resources, firms pay household income in the form of wages/salaries, rent, interest and profit. Business firms use the resources to produce hoods and services which they ten sell to households. In buying these goods and services households spend all of their income. Three Sector Model Financial Sector is added; Savings are added to the circular flow model Savings: are defined as the part of the income that is not consumed (i.e.: not spend on goods and services) - Saving is regarded as Leakage from the circular flow mode. A leakage (or withdrawal) is the part of an income that is received but not put back into the circular flow as expenditure. - Any leakage (in this case savings) causes a reduction in the size of the circular flow. Economist use the term: Investment the production and purchase of capital goods by business firms. Investment adds to societys capital stock. Thus investment expenditure leads to capital accumulation (capital Accumulation is necessary for a country to achieve economic growth). - Investment is regarded as Injections into the circular flow mode. An injection may be defined as an addition to the income stream. By investing, firms effectively pout money back into the circular flow. - Injections of investment expenditure will increase the level of income, output + employment for the economy as a whole. - Investment therefore, increases the size of the circular flow of income. Equilibrium in the circular flow model when leakages are offset by injections. - In the three sector model; Equilibrium will occur when Total Savings = Total Investment. - When the withdrawal of money from the circular flow by households, is equal to the injections of money in circular flow by business firms. <INSERT THREE SECTOR MODEL> Four Sector Model Government Sector is added; a) The government imposes taxes on households and firms b) The government undertakes expenditure of various kinds. Taxation represents a leakage from the circular flow. - Households pay income taxes (e.g. the amount of money which they have available for expenditure is reduced). - Reduction of expenditure on goods + services and on resources, the tax leakage reduces the level of income, output and employment for the economy as a whole. Government Expenditure represents an injection into the circular flow, when government spend on collective goods and services, the incomes of household will rise either directly or indirectly. - Government expenditure increases the size of the circular flow, and the levels of income, output and employment for the economy as a whole. Equilibrium occurs when sum of leakages = sum of injections. - SAVINGS + TAXATION = INVESTMENT + GOVERNMENT SPENDING - (S) + (T) = (I) + (G) <INSERT FOUR SECTOR MODEL> Five Sector Model Overseas Sector is added; - This becomes an open economy -Trades between Australia and other countries come in three forms: Imports, Exports, International Money Flows Imports is a leakage from the circular flow. - Households spend part of their income on imported goods + services; money is withdrawn from the

Australian circular flow because household income is not passed back into Australian Firm in the form of expenditure, instead expenditure of imported goods + services flows to overseas firms and households. - Money is withdrawn from the circular flow when Australian firms and household invest in other countries or EFFECT Increase in equilibrium level of Decrease in equilibrium level of CHANGE income, output and employment income, output and employment Changes in Decrease in Increase in Leakages S, T or M S, T or M Changes in Increase in Decrease in Injections I, G or X I, G or X when they pay interest to overseas households and firms who have taken investment in Australia. - Imports reduce the overall size of the circular flow. (i.e.: Increase Imports -> Decrease Income, output and employment). Exports is an injection into the circular flow. -When domestic firms exports goods and services, they receive payment from overseas firms and households. - The income of Australian households increase and money is injected back into the circular flow. - money is also injected into the circular flow when overseas firms and households undertake investment in Australia and when Australian households and firms receive interest and dividends payment as result of their investment overseas. - Exports increase the size of the circular flow. (i.e.: Increase Export -> Increase income, output and employment.) Equilibrium occurs when sum of leakages = sum of injections. - SAVINGS + TAXATION + IMPORTS = INVESTMENT + GOVERNMENT SPENDING + EXPORTS - (S) + (T) + (M) = (I) + (G) + (X) <INSERT FIVE SECTOR MODEL> Inequalities between total leakages and total injections will lead to increases and decrease in the level of income, output and employment for the economy as a whole. These fluctuations are undesirable and in The Australian economy, it is the federal government that ultimately bears the responsibility and controls these fluctuations. The table shows the effect of changes in all individual leakages and injections on the equilibrium level of income, output and employment economic activity). Types of Economic Systems The Planned Economy exists where the answers to the four questions are determined by central planning authority, which is usually government controlled. In a planned economy the government prioritises what is believe to be the needs of its citizens. Then through planning it prescribes the level of output required by each enterprise (business), and each enterprise then determines the methods of production it will use to meets it quota. Distribution of the goods and services is also determined by the government. Characteristics include: - Public Ownership of resources; - Limited economic freedom of the individual; - Centralised planning achieved through goals and plans. The Market Economy decisions are made by private individuals and firms with a minimum of government interference. Resources are privately owned and it is felt that individual self-interested and the profit motive will result in maximum benefit for society. The price mechanism, determined by the interaction of supply and demand, determines which goods are produced and in what quantity. Consumer Sovereignty means that consumers rule the market ensures efficient allocation of resources. Relative price factors of production will determine the methods of production used. Finally, who gets the goods and services is determined by a persons ability to pay for them. Individual income is determined by the price mechanism, which decides their share of production. The quantity and quality of resources provided by individuals to the market determine their income. A pure mark economy with government interference is known as laissez-faire (let it be). There is no such thing as a pure laissez-faire economy today.

Characteristics are: - Private ownership of resources; - Freedom of enterprise; - Freedom of choice; - Self-interest and the profit motive; - Consumer sovereignty; - Price mechanism interaction of supply and demand to determine price; - Completion; - Limited government interference.

The Mixed Economy (Modified Market Economy) is characterised by a mixture of private enterprise (capitalism) and various degrees of government controls. Characteristics are similar to those of a market economy, but with greater government influence. Government perform four main tasks: TOPIC2: Consumer and Business Consumer Sovereignty consumers will ultimately decide what goods and services will be produce by exercising their freedom to choose what they buy and which wants they will satisfy. Consumers determine the answer to the question of what to produce and how much to produce. Production is geared to what people want therefore their wants can be satisfy. Based on consumers sending their signals to producers through demands of goods and services. Marketing Advertising and direct marketing greatly influence the spending patterns on consumers. Marketing strategies can be informative but most of the time the aim to manipulate the behaviour of consumers. This type of marketing reduces consumer sovereignty. Misleading or Deceptive Conduct Consumers can be tricked by false or dishonest claims about a product, leading them to pay for items they do not really want to buy. E.g. Weight Loss Programs, Health Products and Services. Planned Obsolescence Firms sometimes produce goods and services that wear out quickly or go out of date quickly; this is done to get consumers to make further purchases of the product Monopoly Behaviour When there is one seller of a particular good. Firms who have a monopoly over a product or service may restrict output in order to raise the price of their products, this also reduces consumer choice. E.g. Australia Post is a monopoly. The Disposable Income Equation Y=C+S Y Disposable Income C Consumption Expenditure S - Savings Important Implications 1. Increase C = Decrease S 2. Increase Y = Increase C + S Sources of Consumption Expenditure Their current disposable incomes Their past saving Borrowing money from Financial Institutions Average Propensities to consume and save Average propensity (tendency) to consume (APC) is the proportion (or percentage) of any given level of disposable income (Y) which is spent on consumer goods and services ( C). APC = C/Y Average propensity to save (APS) is the proportion (or percentage) of any given level of disposable income (Y) which is saved (S). APC = S/Y

The average propensity to save is known as the savings rate Since disposable income must either be spent of saved. APC + APS = 1

Factors that Influence the Decision to Spend or Save Cultural Factors Personality Factors Expectations of the Future Any Specific Future Spending Plans Tax Policies Availability of Credit Level of Income Age Marginal Propensity to Consume (MPC) is the proportion of each extra dollar of income which goes to consumption. MPC = C/Y Marginal Propensity to Save (MPS) is the proportion of each extra dollar of that is saved. MPS = S/Y Since each extra dollar of income earned must be saved or spent the MPC and MPS for an individual (or house hold) must sum up to be. MPC +MPS = 1

Factors Influencing Individual Consumer Choice Consumer Taste and Preferences Advertising Level of Income The Price of the Good or Service itself The Price of Substitute and Complement Goods The Role of Business in the Economy A business organisation that owns, rents and operates business equipment, hires labour and buys materials and other input. The firm organise and coordinates the purpose of producing and marketing goods and services. The relationship between resources and production Productivity refers to the relationship between the volume of goods and services over a given time period and the volume of resources used in their production.

Productivity = outputs inputs

per unit of time.

An increase in productivity means that outputs are growing at a faster rate than inputs. An increase in productivity therefore implies an improved (more efficient) use of available resources. Firms can improve their efficiency by capturing economies of scale. Economies of scale allow a firm to reduce its production costs as it expands its volume of production. A business can do this by operating more by operating more efficiently e.g. a business may be able to receive a discount by buying inputs in bulk. As such, it can increase output but reduce its costs. 2 types of economies of scale: 1. Internal 2. External Internal economies of scale

Internal economies of scale often accrue (gained) by a business when it can reduce its per unit costs as it increases its productive capacity. One of the main ways that a business can do this is through specialisation. External economies of scale External economies of scale occur when a firm experiences declining costs usually because it benefits from being part of a larger and important industry. Internal Economies of Scale Advantages The cost saving advantages that cause a firm to expand its scale of operations can be summarised as follows: By becoming larger, the firm is better able to take advantage of specialisation of labour by breaking up the process of production into different stages. A large firm will be able to invest in more capital equipment. A large firm can buy its raw materials in bulk, and bulk buying generally reduces the cost. A large firm can generally find a market for its by-products, whereas a smaller firm would have to discard it as waste. External Economies of Scale Advantages Increasing localisation of industry generally means that all firms in a particular region would enjoy certain cost-saving advantages, such as locating near a highly populated area with a supply of skilled labour, a plentiful supply of necessary inputs and a major consumer market. As an industry grows, all firms in that industry generally bring extra benefits. This could involve the government providing special research and development to help promote the industry. A growing, competitive and more sophisticated capital market would be of benefit to all firms as it could provide cheaper investment funds from a wide variety of sources. External diseconomies of scale - are the disadvantages faced by a firm because of the growth of industry in which the firm is operating, and are not the result of a firm changing its own scale of operations. How can a firm increase its productivity? Introducing new technology in the production process Reducing wastage of resources Changing work practices Specialisation Specialisation refers to the use of factors of production for only one purpose, rather than being used in a variety of ways. Thus the resource will be concentrated into the task or type of production to which it is best suited. Advantages of specialisation of labour include: Allows labour to become more highly skilled Avoids loss of time and effort as workers are not required to move from one type of task to another. Disadvantages of specialisation of labour include: Workers experience boredom associated repetitive tasks Workers become incapable of changing jobs because the skills they have acquired are very narrow. There is less personal contact with management Worker absenteeism creates problems of replacing key employees. 1. Localisation of industry (also known as specialisation of land) Localisation of industry occurs a large number of firms specialising in the same type of production situate themselves in a particular area.The localisation of industry results in lower costs. 2. Large Scale Production (also known as specialisation of capital) There is a tendency for firms to operate on a much bigger scale than ever before, making use of efficient, highly specialised capital equipment. There are many advantages available to large producers that are not shared by small producers. These advantages are referred to as internal or external economies of scale. Economies and Diseconomies of Scale In order to discuss economies and diseconomies of scale it is important to first analyse the productions costs of a firm over a period of time.

The Size of a Plant (firm) The size of the plant which the firm decides to build in the short run, will be determined by the level of output it chooses to produce. Regardless of its sales, the firm will try to produce any given level of output with the least costly combination of inputs. The LRATC is U shaped. Each level of output corresponds to a particular plant size. A movement from left to right along the curve not only indicates an increase in the level of out but also an increase in the size of the plant. Returns to scale - The term returns to scale refers to the ratio of outputs to inputs associated with any given plant size.

Demand 2 ways to talk about demand: Individual demand This is the demand for the product by an individual consumer/household. Market demand This is the demand for a particular good by all consumers or households. The Role of Prices in Market Economies Prices of goods and services serve a number of functions in market economies such as the following: Prices reflect the relative scarcity of goods and services. Prices act as incentives or signals for producers and entrepreneurs to take risks in organising the factors of production to produce the goods and services demanded by consumers. Prices are equilibrating devices in market. Changes in prices bring about equilibrium between demand and supply if they are in disequilibrium. Factors Affecting Market Demand The main factors affecting market demand: 1. The price of the good or service itself 2. The price of other goods and services 3. Expected future prices 4. Changes in consumer tastes and preferences 5. The level of income 6. The size of the population and its age distribution. Demand and the Price of the Product Demand Schedules The demand schedule is a table which shows the number of units of a good which will be purchased at various possible prices over some specified time period. There are 2 kinds of demand schedules: i) Individual demand schedule ii) The market demand schedule The Law of Demand This simply states that, as prices rise, quantity demanded falls, and as price falls, quantity demanded rises. Movements along the Demand Cycle Expansion and contraction in demand An expansion in demand occurs when quantity demanded increases, as a result of a fall in price. A contraction in demand occurs when quality demand increases as a result of a rise in price. Shifts of the Demand Curve The demand curve can move in one of two ways: An increase in demand: shown by a rightward shift. Consumers are willing to purchase more of the goods at each possible price than before. A decrease in demand show by a leftward shift. Consumers are willing to purchase less of the good at each possible price than before.

Types of demand elasticity Perfectly inelastic quantity does not change at all, in response to a change in price. Relatively inelastic a change in price leads to a smaller than proportional change in quantity demanded. Unitary elastic a change in price leads to the same proportional change in quantity demanded. Relatively elastic a change in price leads to a larger than proportional change in the quantity demanded. Perfectly elastic consumers are prepared to buy all they can at the going price. Changes in the quantity demanded have no effect on price. Factor Markets *When demand supply the market is equilibrium and there is a tendency for the price to change. *when demand > supply the market is in disequilibrium and there is a shortage and therefore prices will rise. *when supply > demand the market is in disequilibrium and there is a surplus and therefore prices will fall. The forces of supply and demand in an economy will determine prices to fall or rise. Calculating price elasticity of demand the total outlay (expenditure) test The total outlay method helps to identify where demand is: Relatively Elastic: Fall in price means total expenditure rises (opposite direction) Unitary Elastic: Fall in price means total expenditure remains constant. Inelastic Demand: Fall in price means total expenditure falls. Goods having a relatively elastic demand Luxuries Good having a large number of close substitutes (e.g. breakfast cereals) 3Goods having a large number of alternate uses (e.g. butter) Durable goods which can be repaired and on which expenditure can be delayed (e.g. TV) Goods occupying a relatively large proportion of total household spending (e.g. cars) Goods having a relatively inelastic demand Necessities (e.g. food) Goods having very few or no close substitutes (e.g. salt) Goods which are habit forming (e.g. cigarettes) Complementary goods used in conjunction with other, more expensive goods (e.g. petrol) Goods occupying relatively small proportion of total household spending (e.g. pencils)

Supply Supply may be defined as the quantity of a particular good which producers (or firms) are willing to offer for sale at a particular price, during some specified period of time. The law of supply states that as price rises, supply rises. Conversely, as prices fall, supply falls. Movements Along The Supply Curve Movements along the supply curve generally come about from about as a result of two main factors: 1. An expansion in supply comes about as a result of a rise in price of the good itself. 2. A contraction in supply comes about as a result of a fall in the price of the good itself. Expansions or contractions in supply involve a movement along the existing supply curve i.e. the supply curve does not move. Shifts of the Supply Curve The supply curve can shift in two basic ways: An Increase in Supply An increase in supply means that producers are willing to sell more of the good at each possible price than before. It also means that producers are willing to sell any given quantity at a lower price than previously.

A Decrease in Supply A decrease in supply is shown by a movement of the supply curve to the left. A decrease in supply means that producers are only willing to sell less of the good at each possible price than before. Price Elasticity Price elasticity: refers to how responsive supply is to a change in price: 1) Perfectly Inelastic Supply: Co-efficient = Zero. A change in price has no effect on quantity supplied. 2) Relatively Inelastic Supply: Co-efficient = In between Zero & One. A change in prince means there is a less than proportional change in quantity. Example: 10% Increase in Price = 2% Increase in Quantity. 3) Unitary Elasticity of Supply: Co-efficient = One A change in prince means there is a proportional change in quantity. Example: 10% Increase in Price = 10% Increase in Quantity. 4) Relatively Elastic Supply: Co-efficient = Greater than One. A change in prince means there is a greater than proportional change in quantity. Example: 10% Increase in Price = 10% Increase in Quantity. 5) Perfectly Elastic Supply: Co-efficient = (infinite) Firms are prepared to sell all they can at the going price but nothing at any other price. Market Equilibrium Market equilibrium is determined through the interaction of supply and demand forces. At any price below the equilibrium, the quantity demanded exceeds the quantity supplied and therefore there is excess demand (a shortage). At any price above equilibrium, quantity supplied exceeds quantity demanded and therefore there is excess supply (a surplus). Government Intervention In Markets Market failure is the reason the governments have to intervene in the market place. Market failure refers to the occurrence of the market forces creating unfavourable outcomes. The aim of government intervention is to achieve desirable outcomes; some ways that they intervene include: Price control schemes Price support schemes Externalities 1. Price Control Schemes Government fixes prices above or below the equilibrium if they believe that it is what the public wants. Price Ceiling This occurs when a maximum price for a good or service is set below the equilibrium. 2. Price Support Schemes Price Floor This occurs where the government sets a minimum price for a good or service below the equilibrium 3. Externalities Externalities are impacts or consequences of resource decisions that are not reflected in the price of the good or service being produced such as pollution. Governments can impose taxes on businesses, which increase the costs of production and reduce production levels.

Merit Goods: goods or services that the government believes are beneficial to society but they may not be produced in adequate quantities because the market is too small and there is little or no incentive for private production e.g. education. Public Goods: goods that private firms are unwilling to supply as theyre not available to restrict usage and benefits to those willing to pay for the good. In other words, they cant exclude people from using the good and thus the government provides this good e.g. national defence. Problem Market price too high Market price too low Market quantity too high [negative externalities] Market quantity too low [positive externalities] Market does not provide good or service Government Action Price ceiling Price floor Taxes Subsidies Government provides good or service Problem Reduces price, quantity shortages [Disequilibrium] Increases price, quantity excess [Disequilibrium] Increases equilibrium price, reduces equilibrium quantity Reduces equilibrium price, increases equilibrium quantity Government must collect taxation revenue to finance its supply of public goods

Varieties in Competition Market Structure Number and Relative Size of Firms Perfect competition Very large number, relatively small size Monopoly One firm only, often very large Monopolistic Large number, Competition relatively small size Oligopoly Few, relatively large

Type of Product

Entry Conditions

Examples

Homogenous (similar) Unique no close substitute Differentiated Differentiated or Homogenous

Very easy no entry barriers Blocked Relatively easy Significant obstacles preset

Fish markets, Fruit markets Australia Post Sydney Water Cafes Motels

Topic Four Labour Markets

The labour market refers to any situation which brings the buyers of particular skills, talents and abilities (employers) into contact with the sellers of these same skills, talents and abilities (employees). Demand for labour The services of labour are demanded only because they are needed for the firm to produce goods and services and make a profit. The demand for labour is a downward sloping curve. This indicates that as the price of labour (wages) fall, an individual firm will employ more labour. Factors Affecting Demand The output of the firm The most significant influence on a firms demand for labour is its level of output. If a firm is experiencing higher sales, it will increase production and therefore increase demand for labour. General economic conditions Aggregate (total) Demand refers to the total demand for goods and services within the economy. Higher rates of economic growth > falling unemployment levels and vice versa.

Conditions in the firms industry

Demand for a firms products

Changes in the demand for labour will occur as a result of fluctuation in the business cycle Time lag between firms observing a pick-up in the level of demand and raising their demand for labour. Firms tend to operate with excess capacity. They do not always utilise their resources and tend to accumulate labour so as not to have to train new staff when production picks up. When production does increase, firms can satisfy the higher demand, at least in the short run, by using their existing resources more efficiently and intensively. During a fall in aggregate demand it takes time for firms to notice that their sales are falling, cut back production and retrench some of their workers A change in the consumer tastes and preferences for different goods and services will see a change in the allocation of labour between different industries Increase in demand for an industrys products > increase in demand for labour Firms output is determined by its effectiveness in selling goods and services This is determined by the quality of its products, its customer service and its marketing efforts.

Productivity of labour The cost and productivity of labour will determine the extent to which a firm uses labour in its production. The productivity of labour can be defined as the output per unit of labour per unit of time:

Labour Productivity = Total Output Labour Generally, labour productivityInput depends on the quality of the workforce (including overall education, skill, health and desire to perform) and how efficiently labour can be combined with other factors of production in the production process. An increase in labour productivity can have either a positive or negative impact on the demand for labour, depending on whether aggregate demand increases or not. The more productive labour is > more good and services will be produced. If aggregate demand continues to rise > more labour employment to satisfy demands. Aggregate demand is unchanged and labour productivity is rising > demand for labour would decline. Because firms can produce the same amount of output with less labour. Falling aggregate demand and rising labour productivity > greater decline in the demand for labour.

In summary: more labour will be employed when labour productivity increases, but only when there is a sufficient increase in aggregate demand to warrant it. If firms substitute capital for labour > reduce demand for labour > output levels remain the same or increase. Cost of Other Inputs Firms must consider the cost of all inputs when choosing how much labour to employ as compared to capital. If the cost of labour is relatively high, firms will use more capital inputs in the production process, and less labour and vice versa.

A firms demand will respond more sharply to price changes when: It is easy to substitute between labour and capital Labour costs are a relatively high proportion of its total costs It is difficult for the firm to pass on increased labour costs in the form of higher prices to consumers. When comparing the cost of labour against the capital, firms must include both wages and labour on-costs/benefits such as sick leave. Other factors A firms demand for labour may also be affected by discrimination or prejudice on the part of some employers, or due to mistaken belief that members of certain groups in society are less productive workers. Firms must satisfy certain legal requirements when employing workers, such as giving them holiday leave and ensuring minimum occupational health and safety standards at the workplace. The supply of labour Factors affecting supply Pay levels The higher wage offered, the more people are willing to work. Other non-wage and salary incentives would also influence ones willingness to work. Working Conditions Attractive working conditions encourage a higher supply of labour to a workplace and vice versa. Firms may offer incentives such as generous holiday leaves which would increase peoples willingness to work. Education, Skills and Experience Requirements (Human Capital) The education, skill and experience requirements for some type of sales can limit the supply of labour. A country with relatively high levels of human capital is more likely to achieve low unemployment. Government spending on education and training will also influence the skill levels in the workforce. The Mobility of Labour
The supply of labour will be affected by its responsiveness to changes in the demand for labour in different areas and industries

Two types of labour mobility: Occupational Mobility refers to the ability of labour to move between different occupations in response to improved wage differentials and employment opportunities. Skills required for a particular job increase > more difficult labour to move into that occupation. Geographical Mobility refers to the ability of labour to move between different locations in response to improved wage differentials and employment opportunities. Factors that limit geographical mobility include: The costs of relocating, including travel, transportation and real estate costs. The personal upheaval associated with moving, such as breaking ties with family and friends.

The Labour Force Participation Rate People may decide not to participate in the workforce because they want to undertake further study or take care of family; or They think they are unlikely to find a job or would rather rely on other forms of income. Labour Force Participation Rate (%) = X 100 Labour Force

Working Age Population Other Factors Supply of labour may be restricted as a result of government policy decisions or the collective action of those providing labour within an industry. Higher participation rate > increased living standards Government can limit the supply of labour to particular occupations by imposing certain qualification and license restrictions e.g. builders. The Australian Workforce The Australian workforce can be defined as that section of the population who are 15+ years who are working or actively seeking work. Included In the Workforce Persons aged 15 Employed for at least one hour a week On paid leave, strike or on workers compensation Unemployed actively seeking and available for work Not Included in the Workforce Children under 15 years. Full time, non working students above 15 years Retirees People performing full time domestic duties Without a job but not available or actively seeking work

The Australian workforce can be divided into 2 categories: 1. The employed a person is defined as being employed if they have more than one hour of work per week. 2. The unemployed a person is defined as unemployed if they are currently available for work and are actively seeking work. The size and quality of the workforce is affected by 3 main factors: a) Population size b) The age distribution c) The labour force participation rate Population Size Sets the limit to which the workforce can grow The larger the total population, the greater the potential workforce Population growth influenced by 2 factors natural increase and net migration. Natural increase refers to the excess of births over deaths in the population over a period of a year. Net migration refers to the excess of permanent new arrivals to our country over permanent departures over a period of a year. Age Distribution The greater the proportion of the population in the 15-65 age group, the greater the potential for a larger workforce.

Full time workers are employed people who usually work 35 hours a week or more. Part time workers are employed people who work more than 1 hour but less than 35 hours a week. Labour Market Outcomes Labour market outcomes refer to the performances of the labour market in terms of wage and employment levels. Wage outcomes refer to the following: The rate of wages growth The distribution of wages and salaries The forms of labour income e.g. fringe benefits The relative differences between these wage levels, according to income groups, occupational groups, age, gender and cultural background. Wage Outcomes
Average Total Earnings Nominal Wage Real Wage Inflation measures the average weekly gross rate of pay to all employees is the pay received by employees in dollar for their contribution to the production process not adjusted for inflation measures the actual purchasing power of money wages the sustained increase in the general level of prices over a period of time, usually one year this is commonly measured by the percentage change in the consumer Price Index (CPI)

Differences in Wage Outcomes Wage differentials between different occupations People are generally rewarded for working in occupations that require a higher level of skill and a longer period of training. They will not spend their time and money acquiring education unless they are confident that they will receive higher wages when employed or some other substantial benefit. If occupational mobility is high, supply of labour will be high, less need for employers to raise wages to attract labour and vice versa. Wage differentials in the same occupations Wages also differ for workers in the same occupation, reflecting the various degrees of experience. Employers find it difficult to attract labour to isolated locations, and generally have to pay higher wages to do so (geographical mobility). The productivity of labour will influence wage rates paid. Enterprise bargaining employees often gain higher wages at the individual enterprise level in exchange for taking steps to increase their productivity. The capacity of the firm to pay also influences wage outcomes. More profitable firms have a greater capacity to pay for higher wages. Age Income levels are low in the earlier years of working life. Highest when people are 25-64. Income levels decline as people get older and need to rely on aged pensions. Gender

Discrimination by employers against certain groups in our society means that people in some groups have fewer job opportunities and less access to higher paid jobs, leading to lower earnings.

Ethnic and Cultural Background Those born overseas tend to receive higher weekly income levels than those born in Australia. Migrants from non-English speaking countries have lower income levels than those born in Australia. Lack of understanding of the language leaves the non-English speaking migrants unable to obtain better paid jobs even if they have the equivalent skills and experience of their Australian-born counterparts. Non-Wage Outcomes Many employers receive additional benefits such as sick leave, holiday leave and other fringe benefits. These are known as non-wage outcomes. Different types of non-wage outcomes include: Salary packaging. Employees receive a company car, laptop etc. Bonus cash payments. These come about as a performance bonus, either based on the companys profit performance or the employees individual work performance. Flexibility for employees in work patterns. Employees may be given time to study, extra paternal leave etc. Trends in the Distribution of Income from Work In the 1980s, the prevalence of the award wages system ensured that differences in wage outcomes both between and within occupations were smaller. Negotiations between employers and employees have created a much greater difference in wage outcomes for both different industries and individuals. Emerging industries that require skilled labour are likely to pay higher wages than declining industries that are experiencing falling demand for their goods and services. Income Distribution Within Occupations Recent years have seen an increase in the dispersion of earnings within occupations and among employees with the same skill levels or educational qualifications. Another contributing factor is the declining level of union membership in Australia. High rates of union membership create more similar wage outcomes in an occupation, but as union influence has declined there has been greater variation in wage levels. The costs and benefits of an inequitable distribution of income Economic benefits of inequality Income inequality > increase in productive capacity of resources > increase in real GDP per capita. Incentive effects The labour force is encouraged to increase education and skill levels If those with higher qualifications and skills receive higher income rewards, new entrants and participants in the labour force will be encouraged to improve their education and skill levels. Income inequality > increase in the quality of the labour force. The labour force is encouraged to work longer and harder The potential to earn higher income produces an incentive for workers to work longer hours or to work overtime.

Workers will only be willing to give up leisure time in order to work longer hours when they feel the extra income is more valuable than their leisure time. Increased output is rewarded through higher pay > improved labour productivity.

The labour force becomes mobile A more mobile labour force > more efficient allocation of resources > higher rate of economic growth Entrepreneurs are encouraged to more readily accept risks Income rewards for entrepreneurs is necessary to encourage them to take risks associated with business. If they did not receive extra rewards for risk taking then > fewer entrepreneurs and businesses > lower rate of economic growth > fewer jobs > reduced productive capacity in the economy. Potential for higher savings and capital formation Higher income earned, the greater the proportion of income that will be saved and vice versa. Greater income inequality should encourage increased savings in the economy because of the greater number of higher income earners. Economic costs of inequality Overall utility is reduced Generally felt that inequality in the distribution of income reduces the total utility or satisfaction in society. Based on the assumption that people on higher incomes gain less satisfaction from an increase in income that people on lower incomes. Reasoning is that as more of a good is consumed it will prove progressively less utility to the consumer. Consumption and investment is reduced Poorer people spend a higher proportion of their income than richer people. Thus less income will go towards consumption. This leads to lower economic activity, employment, investment and living standards. Expenditure on conspicuous consumption Inequality in income distribution creates a class of higher income earners who spend a large proportion of their income on conspicuous consumption, which is a consumption of expensive goods and services purely for the purpose of displaying wealth e.g. expensive cars/clothes. Lower income earners might try to emulate conspicuous consumption to lift their status, rather than spending their money on more necessary goods or services. Less work and work efficiency Inequality in income distribution causes relative poverty. Reduces educational opportunities and lowers self esteem. May result in people not working to their full capacity or not working at all.

Welfare support Places demands on government spending as a large number of people on low incomes may require government assistance. Social costs of inequality

Problems associated with social class divisions Class divisions can result in tensions between people and between different regions. Wage disputes between workers and capitalists, in which workers try to improve their income level, are a common cause of dispute. These divisions can lead to social and economic upheaval Poverty There are many Australians who live in relative poverty. This leads to misery for those in poverty and tends to trap families into a vicious cycle of low incomes and few economic opportunities. High poverty levels also tend to be associated with high levels of crime, suicide, disease and reduced life expectancy. Unemployment Unemployment Rate = Number of unemployed Total labour force Types of Unemployment Cyclical unemployment Structural unemployment Seasonal unemployment Frictional unemployment Hard Core unemployment Hidden unemployment Long term unemployment Underemployment x 100 1

Results from the ups and down of the business cycle. During a downturn, firms respond by cutting back production levels and laying off workers. Occurs because of a mismatch between the skills demanded by employers and those possessed by unemployed people. Occurs because of the seasonal nature of some jobs (such as touristrelated jobs) and during periods of the year when new school leavers enter the job market Occurs as people change jobs it usually takes some time to move from one job to another Refers to those individuals who might be considered unemployable because of some personal characteristic such as mental or physical disability Refers to those individuals who are not counted in the official unemployment figures ( they have given up actively seeking work or have gone back to school) Refers to those individuals that have been out of work for a period of 12 months or more. Refers to those individuals who have part-time jobs but would like to work more hours per week.

The Move Away From Full Time Work The labour market has been undergoing changes over recent years. The main change in work practices is the shift away from full time work towards more work structures which give businesses flexibility e.g. part time work, casual jobs, outsourcing, individual contracts and sub-contracting. Part time employment Part time workers are employed people who work more than 1 hour but less than 35 hours a week. Casual employment is when employees have occasional work hours that dont follow a set pattern. The 90s saw a shift towards part time and casual employment. Several factors help to explain this shift, these include:

Some employees prefer part time work to satisfy non work commitment e.g. family, study Part time work my be a preferred lifestyle choice Improvements in communication technology make it possible for people to work in more flexible arrangements

Labour Market Institutions The relationship between employers and employees is known as industrial relations. The Industrial Relations System involved the laws, institutions and processes established to resolve conflict between employers and employees. The Role of Trade Unions A trade union is an association of workers, which aims to advance the interests of its members by improving their wages and working conditions. Trade unions bargain collectively on behalf of their members, thereby increasing bargaining power of individual workers in wage negotiations. They use industrial actions such as strikes to support their claims for higher wages or working conditions. Occupational Unions Industrial Unions General Unions Draw their members from people of the same occupation e.g. Electrical Trades Union Cover workers in a particular industry regardless of the type of work they do e.g. Transport Workers Union Cover a whole range of workers with many different skills across various industries e.g. The Australian Workers Union.

Most unions are joined with the Australian Council of Trade Unions (ACTU). The ACTU has several roles today: It provides a national union movement voice when proving input into Safety Net Review Wage Case. Play a key role in major industrial relations disputes. Is the voice of the union movement on key industrial relations issues e.g. enterprise bargaining. Unionisation levels have declined because of: Increasing casualisation of the workforce in the services sector where union presence is low. The decline in manufacturing employment, a traditional stronghold of unionism The decentralisation of wage determination A general fall in confidence in the union movements ability to deal with industrial issues. Trade unions can influence labour market outcomes in 2 ways: By restricting the supply of labour to only unionised worker, this will cause a shift in the supply curve to the left, forcing up wage rate. Reduces the quantity of labour employed to only union members. By attempting to raise wage levels above market equilibrium. If the award wage for an occupation is raised, the supply curve of labour may change, creating a wage floor. However at the wage rate, supply of labour exceeds demand and thus leading to unemployment. Employment Contracts

These are agreements made between an employer and employee on an individual basis. They generally favour the employer. Contracts offer employer a number of benefits: They provide the greatest flexibility for changing pay and working conditions to the individual circumstances of the firm and employee. At the end of the program, the employer has no obligation to provide work or redundancy payment. Outsourcing is another form of employment replacing full time work. Outsourcing (or subcontracting) occurs when an organisation pay businesses to perform a function, which it doesnt regard as a core part of its business focus, For example, governments leaving their information technology operations in the hands of private companies. Advantages of outsourcing: It aims to improve efficiency because it allows the organisation to focus on its area of specialisation It tends to create shorter term employment arrangements because workers only work until they complete the job. Sub contracting is a method of labour contracting which is more common in certain industries such as building. Sub contractors are private companies that work for large contractors, but charge their own wage rates and provide for all the costs of employment e.g. taxation, superannuation etc. Role of Employer Associations Employer Associations represent employers in similar industries. Employer Associations seek to have a collective voice on industrial relations to protect the interest of their member in negotiation with trade unions. Employer Associations: Make employer submissions at the annual Safety Net Review Case Make employer submissions over industrial relations issues such as unfair dismissal laws. The Federal Government and Industrial Relations Structures The federal government has the constitutional power and responsibility to resolve nation industrial disputes. State and Federal industrial tribunals set minimum wages and working conditions for a range of occupational awards at both state and federal level as a means of providing a safety net for workers on minimum wages. Tribunals hold hearing and may be called upon to conciliation or arbitration services. Introduction of Workplace Relations Amendment Act 2006 > AIRCs power to adjust the federal minimum wage and working conditions was handed over to the Australian Fair Pay Commission (AFPC) The federal government creates legislations to establish procedures for wage negotiations and working conditions. The Role of Industrial Tribunals The main role that these tribunals play is to resolve disputes between employers and employees. The key role of the Australian Industrial Relations Commission (AIRC) has been to resolve industrial disputes through conciliation and arbitration. Conciliation is the process in which the tribunal provides a mediator who tries to help the disputing parties to reach an agreement.

Arbitration occurs when an industrial tribunal or court makes a rule that is legally binding on all parties. The Courts role is to interpret and to enforce AIRC decisions. The courts role is important because the AIRC is not a court, and therefore its decisions and determinations are not automatically enforceable in the same way as the courts would be. The Workplace Ombudsman enforces the legal obligations of employers, unions and employees. The role of the Ombudsman is to ensure that agreements are implemented, and that employees receive their minimum pay entitlements. The Workplace Authority promotes individual contracts and reviews contracts.

Topic Five Financial Markets

Financial Markets The financial markets play key role in the economy as the market allows both savings and investment, which are the basic elements necessary for economic growth. Price is determined by the interaction of demand and supply Financial markets affect how we act and interact in the economy. The Financial Sector The financial sector comprises all those institutions involved in the borrowing and lending of money and in the provision of related services. Institutions such as banks, building societies and credit unions are called financial intermediaries. The process is bringing together the funds from a large number of lenders who have a surplus of money and make them available to borrowers who have a deficit of money is called intermediation. The flow of funds from savers to borrowers can be described as indirect or intermediate financial flows. They are indirect because the savers have no direct contact with the borrowers. The role of financial intermediaries When financial intermediaries borrow funds from the surplus sector (lenders), they pay this sector a certain agreed rate of interest. When they lend these funds to the deficit sector (borrowers), they charge interest. Interest Differential the difference between the rate of interest paid to savers and the rate of interest charged to borrowers. This is used for running expenses of the financial intermediary as well as providing profit. The Structure of Financial Markets They play an important role by providing a return for those in the economy who have savings or excess funds and by making funds available to those who need additional money. Consumers tend to be the net savers in a market economy, and the businesses the net borrowers. Sources of savings: The proportion of household incomes that are not spent on consumer goods is saved. Businesses can save by not distributing part of their profits to their owners. When the government budgets for a surplus it means that it is accumulating savings. Australians can borrow funds from overseas. In this way they get access to foreign savings.

Reasons for borrowing: Consumers borrow when their demand for goods and services exceed their current funds. Entrepreneurs borrow to fund the expansion of their businesses. The government becomes a borrower of funds when it budgets for a deficit. Australian financial institutions can lend money to overseas borrowers. Primary and Secondary Markets Primary Financial Facilitate the creation of financial assets, known as securities, Markets which can be sold into the economy. If a business wants to raise funds it can borrow money by issuing debt securities or sell new shares. The money received from investors goes directly to the company Secondary Financial Involve transactions with financial assets that have already Markets been issued on a primary market some time in the past Companies whose securities are traded on the secondary market do not receive any money from these transactions. Securities any form of financial instrument, including shares and bonds, which represent negotiable financial value. Financial Institutions Finance Obtain most funds by borrowing from the general public through the companies issue of debentures and unsecured notes. Provide mainly short to term medium term loans to households and businesses Merchant Borrow on a short term basis from companies with surplus fund, and Banks lend these funds to other large corporations for business expansion purposes and government agencies. Credit Unions Non-profit, co-operative organisations whose members belong to a particular trade, industry, profession or area. Provide an institution where these people can make regular deposits, and borrow money on a short-medium term basis. Permanent Accept deposits fro the public and provide funds mainly for home building loans societies They can now also offer other personal and business loans Interest rate controlled to some degree by State governments Mortgage Offer home loans to consumers at rates which are highly competitive Originators with banks. Bundle loans up and sell them as securities to investors. Life Insurance Obtain funds in the form of premium from their policy holders. Companies Use these funds to buy income producing assets such as shares, debentures etc. Profits are paid to policy holders as well as being used to purchase additional income producing assets Superannuatio Receive the contributions of employees and employers and invest n funds them in different types of assets in order to provide retirement income for the contributors. Unit Trusts Raise money by selling holdings (units) in the trust to the public.

Funds can be used to purchase shares, property, government securities as well as other assets.

Financial Market Products Consumer Credit Allows consumers to purchase consumer goods and services in advance of actual payment Most common type of consumer credit is the credit card Other major forms of consumer credit are personal loans offered by banks and credit unions. Housing Loans Offered by banks, as well as mortgage originators such as Aussie Home Loans. Long term loans to purchase property. Requires periodic repayments with interest Business loans Form of debt, which allow business to begin or expand production of goods and services. Small businesses typically borrow funds from finance companies and banks. Larger companies tend to borrow from merchant banks as well Bond Markets Bonds are a written record of debt The borrower sells a bond in return for a loan The holder of a bond receives interest payments and the final payment Bonds can be sold in the secondary market. Markets for longer term securities where lenders receive regular fixed payments from the issuing institution, and finally receive the coupon payment (face value of the bond) at maturity. Bonds usually issued by a small number of companies and banks Short Term brings together people and businesses with temporary shortages or Money Market surpluses of funds debt securities have a maturity date of less than one year surplus can be invested for a short period of time hoping itll create profit that can be loaned to people who need it Share Markets provide an avenue for the trade of shares and other financial products. Financial contracts to trade in other financial instruments, such as bank bills, Futures at a later date for a certain price. Allow investors to avoid against adverse movements in interest rates or share prices Foreign Market for buying and selling of foreign currencies. exchange/FORE X market Regulation of Financial Markets Before the early-mid 1980s, the Reserve Bank of Australia (RBA), acting on behalf of the government, had very powerful direct controls over the banks. The RBA could tell the banks: How much they could lend To whom they could lend What rate of interest they could charge These controls had banks being inflexible when it came to offering a service to customers.

As a result, many people began to turn away from the banking sector to the non-bank financial institutions (NBFIs) such as finance companies. The Campbell Report and the Martin Report came to the conclusion that it was time to abolish direct controls over the banking system. Consequences of financial deregulation: Less distortion in the allocation of resources in the economy, as market forces of supply and demand now determine who gets the borrowed funds. Increased competition > encouragement for innovation and efficiency in the financial sector Reckless lending during the 1980s which had large corporations bankrupt. Three major regulators under the new regulatory structure: The Reserve Bank of Australia (RBA) The Australian Prudential Regulation Authority (APRA) The Australian Securities and Investments Commission (ASIC) The Reserve Bank of Australia Australias central bank It does not provide banking and other financial services for the public It influences and regulates the activities of the rest of the financial system to ensure that financial markets operate smoothly, efficiently and in manner that is consistent with the objectives of the Federal Government Implements government economic policies e.g. monetary policy Aims to advantage the people of Australia Provides prudential for all authorised deposit-taking institutions (ADIs) such as banks, superannuation funds etc. Encourages behaviour by institutions that will ensure they are able to meet their obligations to the people who place their money with them. APRA has the role of sorting out the institutions financial position and ensuring that deposit-holders receive as much of their funds as possible, if ADIs etc. Are experiencing financial difficulties. Protects consumer in the Australian financial system. Possesses power to monitor, investigate and act in situations where the integrity of the financial system has been undermined by illegal acts. Role is to supervise all aspects of companys behaviour including formation, registration and reporting Also responsible for monitoring Australias securities industry and markets such as the Australian Stock Exchange.

Australian Prudential Regulation Authority (APRA)

Australian Securities and Investments Commission (ASIC)

The Functions of the Reserve Bank Control of the note - The RBA is the sole note-issuing authority in Australia. issue - Acts as agent for the Federal Treasury in the distribution of Australian coins Bankers bank - Acts as a banker to the individual banks - Holds accounts for trading and savings banks.

Banker, agent and adviser to the Federal Government Lender of last resort Custodian of Australias international reserves Conduct of Australias monetary policy -

Accounts are used by the banks to settle debts among themselves, to meet daily and seasonal changes in their customers demands for cash and sell government securities Provides short-term funds for government Acts as an agent for government by issuing Commonwealth securities to the banking system. Acts as an adviser for Federal Government, advises on things such as the issue of government securities, interest rates etc. Should unforeseen circumstances leave financial institutions short of funds, they may borrow from the Reserve Bank. RBA charge high interest rates in order to encourage these institutions to keep sufficient funds and to discourage them from seeking central bank credit except in emergencies. Holds Australias means of international payment, specifically gold and various foreign currencies. Monetary policy controlling the supply of money and the general level of interest rates. Influences the borrowing and the lending activities of institutions.

Borrowers: The Demand for Funds Main borrowers: 1. Individuals 2. Businesses 3. Governments Individuals Borrow money for personal purposes Most commonly for family home Also borrow for short term purposes such as a car, holiday etc. Businesses Borrow to expand production, invest in research and development. Can be done by issuing shares or by borrowing from a financial institution Governments Borrow to raise the level of economic activity Also to increase its spending or give tax cuts May also borrow if they are engaged in major infrastructure projects e.g. 2000 Olympic games Factors Affecting the Demand for Funds Benefit of holding money is liquidity Benefit of purchasing assets is that you can earn a return on them Motives for people to prefer money rather than investing in financial assets: Transactions People have day to day transactions in which they need money motive including regular payment for goods or services Shares or bonds are not an acceptable form of payment

Precautionary motive Speculative motive

There are numerous unpredictable circumstances and emergencies for which people need to have liquid funds Buying financial assets carries the probability of capital gains or losses If the price of shares or bonds goes up, the individual will make capital gains, otherwise they make capital losses. If individuals expect the value of financial assets to fall they will try to sell their financial assets and convert them into money.

Financial innovation can alter peoples demand for liquidity. In recent decades, many alternative forms of accessing funds or making payments have emerged, such as ATMs. This means that people do not need to hold high volumes of liquid funds for day-to-day transactions. Liquidity the ability to access money Lenders: the Supply of Funds Main lenders: 1. Individuals 2. Businesses 3. Governments Individuals Place deposits in institutions, in effect, loaning money to that institution to get a return of it. Businesses A successful business may be achieving a very strong cash flow and good profits, and may not have immediate plans for expansion or buying out another. Governments Can pay off outstanding debts from the past or maintain positive financial balances. How do Financial Institutions Attract Borrowers? By offering loans to households or firm (wanting to borrow money at terms that these borrowers will consider favourable). These terms may include duration of the loan, size and frequency of repayments, security requirements etc. Financial intermediaries must balance 3 considerations involved in attracting sources when making lending decisions. These include: 1. Returns 2. Risk 3. Liquidity Returns They must charge borrowers a higher rate of interest on loans than it pays savers on deposits Rates allow shareholders of the financial intermediary to make a profit, while at the same time remaining competitive with other kinds of financial institutions. Risk

They seek to minimise the risk involved with money They want to sure that the funds they lend will be repaid in full plus interest. Therefore they try to attract credit worthy borrowers. The higher the risk, the greater the interest charged.

Liquidity They must have enough liquid assets available to meet the legitimate demands of their customers as required. How do Financial Institutions Attract Lenders? In deciding wether to lodge their savings with any given financial institution, savers will consider 3 basic factors: 1. Returns 2. Risk 3. Liquidity Returns Most important factor influencing the decision to lend money is the rate of interest/return. Higher returns given by financial intermediaries will attract more lenders. Lenders tend to be concerned not only with the money value of their interest receipts but with their purchasing power as well. For this reason, economists distinguish between nominal interest rates and real interest rates. Nominal rate of interest is measured in terms of the face value of money received by the lender. Nominal Rate of Interest = Interest paid X 100 Funds borrowed 1 Real interest rate measures the purchasing power of interest receipts. Real Interest Rate = Nominal Interest Rate Inflation Rate If the real rate of interest offered by financial intermediaries is low relative to the returns on other assets (such as houses or land), these institutions may experience some difficulty in attracting lenders.

Risk Holding funds with financial intermediaries involves a certain risk factor Risk in this case is the possibility that money lodged with these institutions will not be repaid. Lenders try to minimise the risk or loss by holding their savings with financial institutions which offer security and safety for their funds. The greater the risk of loss, the greater the interest rates financial intermediaries are willing to pay. Liquidity Lenders are always concerned with the problem of access to their funds Financial intermediaries offer lenders a variety of assets, each with its own particular degree of liquidity. The liquidity of any given asset depends mainly upon its maturity. Maturity is the period of time which must elapse before lenders can get their money back without loss of interest. Assets with a long maturity date are far less liquid than assets with short maturity dates. Financial intermediaries prefer to borrow on a long term basis. This allows them to plan their lending activities more effectively. But the longer the period of loan, the greater the sacrifice of liquidity for the lender.

Financial intermediaries offer higher interest on long term loans to encourage lenders to lend money on a long-term basis. Interest represents compensation for the loss of liquidity.

The Money Supply and Interest Rates Money acts as: A medium of exchange where goods, services and resources are exchanged for money A measure of value used to compare the relative value of items A store of value used to measure the value of goods, services and resources over time A method of deferred payments allows the system of lending and borrowing Money Supply is the amount of quantity of money which exists in the economy at any given point in time. Five monetary aggregates which can be used as a measure of the money supply in the economy M1 - Defined as currency + current deposits held with all banks M3 - Defined as M1 + all other deposits held with banks Broad - Defined as M3 + (NBFI deposits NBFI deposits in banks) Money Money - Defined as Currency + Bank deposits with RBA Base Credit - Includes loans and advances by financial intermediaries + total bank bills outstanding Interest Rates Interest is the price paid for borrowed funds. Rate of interest is determined by the demand and supply of loan funds Demand for Loan Funds The demand for loan funds comes from borrowers. Interest rates rise > cost of borrowing increases > demands for loans contract and vice versa. Supply of Loan Funds The supply of loan funds comes from savers. Interest rates rise > more willingness for households to save because they receive a greater rate of return and vice versa. The Influence of Interest Rates on Economic Activity Increase in interest rates > reduction in economic activity Interest rates rise > reward for savings increase > households stop spending and start saving and vice versa. Savings is a leakage from the circular flow. Interest Spread or Margin = Lending Rate Borrowing Rate Lending rates is the rate of interest that banks or financial institutions charge borrowers. Borrowing rates the rate of interest that banks or financial institutions are prepared to offer savers. Factors which influence the general level of interest

The demand for capital goods(investment)

Level of savings in the economy The demand for money

Inflationary expectations International Interest Rates

Stronger investment demand > higher demand for borrowing by firms seeking to finance their capital expansion > upward pressure on the level of interest Either an increase in the real wage rate, making capital relatively cheaper compared to labour, or an increase in the level of economic activity, whereby firms need to expand capacity to satisfy stronger demand > stronger demand for capital goods by firms. Higher level of savings means that there is an increased supply of loanable funds, which should put downward pressure on interest rates. If individuals have a stronger preference for highly-liquid funds, they might forgo buying securities, and instead choose to hold their funds in bank deposits or in the form of currency This would mean that the supply of loanable funds is lower and have an upward pressure on the rate of interest Inflation reduces the value of money and financial assets If inflation is expected in the economy, lenders would require a higher interest rate to be paid to compensate for the risk of a loss. Higher expected inflation > higher nominal interest rates The level of world interest rates has a significant impact on domestic interest rates. If the domestic rate of interest was lower relative to overseas, domestic lenders would seek to invest their funds overseas, reducing the supply of loanable funds, putting upward pressure on interest rates.

The Role of the Reserve Bank in Determining Cash Rate (Domestic Market Operations) Domestic Market Operations (DMOs) refers to the purchase and sale of second hand (i.e. previously issued) governments securities (Treasury notes and Treasury bonds) by the Reserve Bank, for the purpose of influencing interest rates. The Reserve Bank, by altering the interest rate (or cash rate) can influence the demand for money causing a change in the money supply and the overall level of economic activity. The Reserve Bank can carry out DMOs in 2 ways: 1. Domestic Market Sales (contractionary or tight monetary policy) 2. Domestic Market Purchases (expansionary or loose monetary policy) Domestic Market Sales If the Reserve Bank sells treasury notes or bonds to the public, the supply of bonds on the market will increase. A fall in the price of bonds > increase in their yield and interest rate. The level of deposits held with the banking system will fall as households and firms withdraw cash to pay for the bonds. This will cause the money supply to fall. Domestic Market Sales have a contractionary effect on the economy because the high interest rates encourage saving, dampen consumer and investment spending and therefore reduce the level of economic activity. Money supply also falls. Domestic Market Purchases If the Reserve Bank buys treasury notes or bonds from the public, the demand for bonds will increase.

A rise in the price of bonds > decrease in yield and interest rate The level of deposits with the banking system will rise as households and firms deposit money they received into their accounts. This will cause the money supply to rise. Domestic Market Purchases have an expansionary effect on the economy because the low interest rate encourages consumer spending and investment. Therefore, increases the level of economic activity. Money supply will increase. The Role of the Share Market in the Economy Shareholders Main reason for investors to purchase shares is to gain a stake of any company profits and to make capital gains from increases in share prices. Owning shares also gives investors the right to vote for a companys board of directors and ultimately decide how the company will act to maximise the wealth of shareholders. Proportion of profits received by company will be returned to shareholders. These payments are known as dividends. As the company grows, the value of the company increases and share prices rise. For shareholders, the possible gains from holding shares are almost limitless. If the value of their shares continues to increase, the shareholder may sell at any time to make a gain. The risks of being a shareholder are limit. If a company loses money or closes due to business failure, shareholders only lost the amount they invested in shares. Companies When a company decides to list itself on the stock exchange it must set about offering its shares to the public for the first time. This process is called a float. It is often beneficial for a company to float itself to access funds for investment without having to earn these funds as profits or having to borrow them from a financial institution. A company can access further equity funds at any time by issuing an approved prospectus for the release of new shares. Issuing new shares reduces the control existing shareholders have over the company, as they will own a smaller proportion of the company. A companys share price is set by the market forces of supply and demand and reflects factors such as confidence in management, previous earnings, expected earnings and general economic conditions. A low share price can expose the company to a possibility of a takeover. The economy as a whole Share market values are often an indicator of a countrys economic conditions. Rising share prices generally suggest that the economy is enjoying good conditions and vice versa. When individual shareholders expect economic prospects to improve they will invest more in order to maximise profits. The share market is often described as the barometer of an economy, as it is a useful guide to both the confidence and strength of the economy as a whole. A downturn or upturn in the share market can be measured by the All Ordinaries Index, which measures changes in the overall value of companies listed on the Australian Stock Exchange (ASX). By comparing the changes in the ASX with changes in a countrys economic growth rate, we can see that the market generally rises and falls in line with a countrys economic prospect.

Share market also acts as a method of allocating resources to different types of production. The share price will be higher for firms in industries that shareholders expect will experience high growth

The Impact of Share Market Activities Investment Share market encourages more efficient investment in the economy. The problem with people saving their money in the bank is that they are left with limited, low benefits. A healthy share market will encourage individuals to purchase shares with their additional income, as these offer the potential for higher returns. A healthy share market also ensures that shares have a much higher liquidity, which makes them more desirable. Debt Companies can pay off debt in one of two ways debt financing or equity financing. Debt financing involves borrowing money with the obligation to repay that money. Equity financing involves selling ownership in the company in order to raise funds. Companies choose to float as the funds they gain do not need to be repaid. This is unlike debt, which must be repaid regardless of a companys success or failure and which requires regular interest payments. A company that decides to float on the share market will avoid debt, and as a result, the overall level of debt in the economy is likely to be lower. Asset Prices Because investors have limited funds, they will choose to invest in assets that have a greater return. When an asset is doing well, demand for the asset is likely to increase, raising its price. Speculators buy lots of share to drive up the price of the asset; more speculators y the same shares (believing that the price will go up further); the extra demand forces the price up further, and so on. This creates a speculative bubble, in which share prices are driven by speculation rather than real financial performance. The Business Cycle Downturns in the share market are often associated with falling growth rates in the economy. Economic conditions influence share prices, but share prices also influence economic conditions. Market experiences downturn > shareholders feel less confident about their economic expectations > may encourage shareholders to save instead of consume > economy slows down. Downturn in economic conditions > discourage investors from buying shares > fall in share prices.

Topic 6 Government and the Economy

Government Intervention in the Economy Australia has a 3-tiered structure of government: Commonwealth/Federal Government which has the overall responsibility for managing the economy. It has the most influence on economic performance. The State government which play an important role in delivering government services, fostering regional development and developing infrastructure. Local government

Why do governments intervene in markets? The free operation of market forces does not always achieve the most desirable economic and social outcomes. Consequently, the government intervenes and modifies the operation of the price mechanism in order to achieve: A better allocation of resources A more equitable distribution of income Greater economic stability The general fault of markets is that unfortunately they only consider private economic interests and not the broader social interests. The challenge is to find the right balance. Too much government intervention may stifle innovation, efficiency and growth. Too little intervention may cause instability, inequity and a lack of basic community facilities.

The main reasons therefore why governments intervene in the operation of markets is because of market failure. More specifically: 1. Market failure in the provision of goods and services 2. Market failure in income distribution 3. Market failure in externalities 4. Market failure in the abuse of market power 5. Market instability Market Failure in the Provision of Goods and Services Public good is a type of market failure because you cant stop people from using it even if they dont pay for it. Public goods will always attract free-riders who benefit without contributing towards their costs. One persons enjoyment of a public good does not diminish the next persons enjoyment Markets may sometimes produce an inadequate quantity of an item, such as health care or art. Demerit goods items which are harmful such as alcohol, tobacco. These items have negative effects; their production and sale may be restricted or heavily taxed. Governments provide a range of collective goods and services which benefit the whole community. Governments may maintain ownership of monopolies such as railways because of concerns that private owners would have monopoly power and consumers would little choice but to pay whatever price the monopolist set for their good or service. Free markets tend to produce substantial inequality in the distribution of income Often this inequality will worsen over time, because one people become wealthy, their wealth tends to multiply. Governments act to reduce this inequality by providing greater opportunities for low income earners by providing: Education assistance programs/scholarships Living allowances for students Subsidised health care/transport /housing Pensions/unemployment benefits Imposing minimum wages (award wages) An exchange in the market economy will often affect people other than those involved in the transaction. These are known as

Market Failure in Income Distribution

Market Failure in Externalities

Market Failure in the Abuse of Market Power

Market Instability

externalities. Positive externalities are externalities that are very good for third parties. Negative externalities are externalities that cause harmful effects. These are an example of market failure. Negative externalities are of great concern in relation to the environment, because generally environment spill over effects are negative e.g. pollution. Examples of negative externalities in Australia include: The transformation of land which occurs because of land clearing Land degradation through increased soil salinity and soil erosion Water pollution from detergents and industrial output Atmospheric pollution. The costs involved in producing, distributing and marketing goods and services will only allow a small number of firms survive. This may create a market structure where there is imperfect competition In this market situation, the market will produce an inefficient quantity of goods at a higher price A monopolist will often restrict their production in order to charge a higher price and maximise their profits. Oligopolists may find that engaging is risky, so instead of reducing prices, they will compete with advertising, brand packaging and trying to make their product look different activities which hold little real benefits for consumers. Some of the ways in which firms may abuse their market power include: Monopolisation occurs when a firm uses its dominant market position to eliminate existing competition, or prevent new firms from entering the market. Price Discrimination occurs when a firm sells the same type of good or service in different markets at different prices. Exclusive dealing occurs when a firm sets conditions for supply which excludes retailer from dealing with other competitors Collusion occurs when firms get together and agree on a pricing and market sharing arrangement that reduces effective competition between them, and tends to inhibit the entry of new competition into the market. A free market system is likely to experience severe fluctuations in the level of economic activity. This makes it very hard for the government to achieve its goal of sustained economic growth. Free market forces can bring on boom periods where excess demands for goods and services causes inflation and this can bring about severe economic problems. High inflation and excessive imports can force interest rates to rise which can then cause a downturn in economic activity and potentially recession. Recessions increase unemployment and cause a wide range of economic and social problems. Governments use 2 stabilisation policies macro economic and micro economic policies. Macro economic policies help to smooth out major fluctuations in the economy cycle in order to help the economy achieve a sustainable rate of economic growth. The main macro-economic

policies include fiscal policy and monetary policy. Micro economic policies focus on certain areas of the economy and are intended to help improve productivity levels in individual firms and industries, efficiency levels etc.

Public Sector Consists of Commonwealth, State and Local Governments, as well as government authorities such as Sydney Water and Australia Post. Two important indicators that can demonstrate the size of the public sector, and how this has changed over time are public sector outlays (spending) as a percentage of GDP and public sector employment as a percentage of total employment. Total public sector outlays shows the proportion of total annual expenditure by all levels of government compared with the expenditure of the economy as a whole. Over time, governments have tended to spend less on infrastructure, while spending more on welfare support and community services such as health care. Employment levels in the public sector have declined, even though the public sector outlays remain around the same level. This is because governments have given out many of their activities such as road building to the private sector, and as a result, people are performing these jobs as private sector contractors and not as public sector employees. A change in approach to economic management After the Second World War, governments in industrialised countries adopted a more active role in seeking to influence the economys performance. This reflected the Keynesian theory which argued that government spending could accelerate economic activities and help it achieve full employment levels. However, government lost support for this approach and changed their policies. Governments were seeking to reduce their spending, high because government spending would require high tax levels and excessive borrowing from the private sector. Economic Growth As the economy has grown and living standards have improved, voters have had higher expectations of government, believing that governments should provide improved standards of health care, education etc. Governments have also been required to deal with problems created by economic growth, including pollution. The growth of social security The number of people relying on welfare payments grew substantially as unemployment rose from the mid 1970s. Due to overall ageing of the population, governments have made superannuation compulsory. Political pressures to reduce taxation and economic pressures to eliminate budget deficits have resulted in reduced government spending. Governments have tightened access to welfare benefits and introduced superannuation to reduce peoples future reliance on the aged pension. The Reallocation of Resources When the government reallocates resources, it changes the pattern of production in the economy. It directs resources towards the production of some goods and services that it considers desirable, and away from other it considers less desirable.

The government can bring about these changes in 3 main ways: 1. Taxation or spending 2. Regulation 3. Production of goods and services Taxation or Spending - The government can influence the price of goods and services, and thus influence consumer demand, through taxes and other charges levied on producers - Taxes add to costs, they can have the effect of diverting resources away from certain types of economic activity and vice versa. - By changing prices, tax policies may change the pattern of consumer demand and this will indirectly change resource allocation. - Governments can either choose direct or indirect tax to achieve their resource allocation goals. Direct Tax paid by individuals or business firms on which they are levied. They cant be passed onto someone else e.g. income tax. Indirect Tax levied on individuals and business firms, but they can be passed on to someone else e.g. GST. - Government spending is a direct means of shifting resources into a particular area of the economy where the government feels that the market does not allocate sufficient funds to that sector. - The mains items of spending which influence resource allocation include: Infrastructure Labour market assistance Industry assistance Public sector agencies e.g. Australian Securities and Investments Commission Regulation - The government uses its regulatory powers to influence the conduct of firms with the aim of avoiding market outcomes which disadvantage consumers, particularly in situations where firms have excessive market power. - The Trade Practices Act 1974 (cth.) is designed to reduce situations where sellers have acquired an unreasonable amount of market power, and are able to exploit the consumer. - By establishing rules about business conduct and providing a legal system, governments can give business people confidence that the contacts they sign can be enforced. - Regulation can also improve the flow of information to consumers and businesses. Government Production of Goods and Services - Governments sometimes involve themselves directly in the production process to achieve a better resource allocation by operating their own enterprises. - Through direct involvement in the market, governments were though better able to provide important goods and services to a larger number of people at a lower price. - It was widely felt that governments were inefficient in operating their businesses, and that this inefficiency ultimately added to costs for average consumers. - As a result, governments have largely sold their businesses to the private sector (process known as privatisation). The Redistribution of Income While the market mechanism will generally produce more efficient outcomes this will often occur at the expense of greater social inequality. The government mainly redistributes income through the taxation system and social security payments. Personal income tax provides the majority of tax revenue for the government. Tax is collected at the Commonwealth, State and Local government levels but the majority of tax is collected by the Commonwealth (80%).

Progressive, Regressive and Proportional Taxes In a progressive tax system, the marginal rate of tax (MRT) increases as taxable income increases. In a regressive tax system, the marginal rate of tax decreases as taxable income increases. In a proportional tax system, the marginal rate of tax does not change as income changes. Generally speaking, a regressive tax system tends to disadvantage low income earners because they could pay a higher marginal tax rate compared to these on higher income. Stabilisation of Economic Activity Market economys major problem is that it is often unstable Sustaining economic growth can result in higher living standards Monetary policy tends to operate as the main stabilisation policy. Higher interest rates can restrict excessive growth, while low interest rates tend to encourage spending and investment, lifting the growth rate. When using economic policies, economists tend to distinguish between expansionary policies (loose policy) and contractionary policies (tight policy)

Monetary Policy The type of monetary policy pursued by the federal government will depend largely on the economic circumstances at a particular point in time. Monetary policy attempts to stabilise the economy by controlling the money supply and interest rates. a) Expansionary (Loose) Monetary Policy If the government wished to increase economic activity, it will do so by loosening monetary policy This would involve the RBA undertaking domestic market purchase This would put downward pressure on interest rates which would encourage higher levels of consumer and investment spending, increases in production and lower levels of unemployment. End result would be an increase in economic activity. b) Contractionary (Tight) Monetary Policy If the government wished to slow down the level of economic activity, it could do so by tightening monetary policy. This would involve the RBA undertaking domestic market sales This would put upward pressure on interest rates which would dampen consumer and investment spending, decrease production levels and increase unemployment. End result would be a decrease in economic activity Fiscal Policy Fiscal policy attempts to stabilise the economy through government spending, taxation and borrowing. The government has a choice between contractionary fiscal policy and expansionary fiscal policy. Public Enterprises

There has been a clear shift towards minimising the role of government in the economy, and the governments direct role in production has been substantially cut back. Most of the government-owned companies that have not been privatised such as Australia Post, have undergone a process of corporatisation. This is where enterprises are forced to act as private business enterprises, with the removal of government interference from their operations. The main remaining government business enterprises are: Australia Post State rail, bus and ferry authorities State electricity Utilities such as water Research and development organisations Educational institutions Increased levels of competition have seen prices fall significantly.

Taxation Policies Taxation is a compulsory payment made to the government by an individual or business. The major goals of government taxation policies are to: Raise taxes in order to provide necessary funds to pay for the public goods and services that it provides. Influence the level of economic activity Influence the allocation of resources in the economy Influence the overall distribution of income in the economy. Tax Terminology Tax Base Items which are taxed Direct Paid by the individuals or businesses on which they are levied. They cannot be Tax passed on to someone else e.g. income tax. Indirect Taxes which are levied on individuals or business firms but can be passed on to Tax someone else e.g. GST Impact The impact of tax refers to the person/ firm, on which it is initially imposed. and Incidence of tax refers to the person/firm on which the tax finally rests on. incidenc e of tax Progressive Tax System Regressive Tax System Proportional Tax Tax Threshold Marginal Rate of Tax Average Rate of Tax Tax avoidance Tax evasion Horizontal equity Vertical equity Higher income earners pay a greater percentage of their income than lower income earners. Lower income earners would pay a higher percentage of their income than higher income earners. All income earners would pay the same percentage of their income as tax. First income level at which an individuals income begins to be taxed. Income earners who receive less than this income level pay no tax. The tax paid on the last dollar earned as a percentage of that dollar. Refers to the percentage of total income that must be paid in the form tax. The legal minimisation of tax payable. The illegal minimisation of taxable income. Persons who earn the same income should pay the same amount of tax Persons with greater income can afford to bear a greater tax burden and should pay proportionately more tax than those who earn a lower

income Other Roles in the Economy Governments also have other, smaller functions in the economy that aim to make markets produce better outcomes in the long term. These include ensuring a maximum level of competition in the economy, protecting consumers from unfair business conduct, and protecting the natural environment. Competition Policy - A major aim of government policy relating to business firms is to ensure that markets operate efficiently. - Governments aim to promote workable competition in Australian industry. - Government policies assume that competition will produce a more efficient use of resources, lower production costs, lead to product innovation, and lower prices for consumers. - Sometimes it is necessary to reduce the number of firms in an industry - The remaining firms can then produce on a larger scale and achieve the lowest possible long run average costs of production. - Entry barriers to industries should be kept to a minimum by eliminating practices that restrict potential competition. - The Australian Competition and Consumer Commission (ACCC) monitor competition policy and uphold consumer protection legislation. Consumer Protection - Consumer interests are protected through the Trade Practices Act and the ACCC. - The aim of trade practices legislation is to ensure fair business conduct by prohibiting practices that restrict competition and imposing penalties on firms that breach these guidelines. - In some cases, such as financial services, consumers are given stronger protections because of the significant risks of consumers losing large amounts of money if their finances arent protected. Environmental Protection - Environmentalists argue that at the current rate of energy consumption, resources will be depleted within a matter of generations. - The government can contribute towards sustainable energy use by supporting alternative energy sources and giving incentives to reduce the use of fossil fuels. - Externalities are another major concern regarding environmental issues. These involve atmospheric and water pollution. Climate change is now regarded as the greatest environmental threat in the world, with devastating consequences for future generations. The Federal Budget The federal government has the most power to influence the level of economic activity. The main way the government tries to achieve its economic objectives is through Fiscal Policy. There are two main components of fiscal policy structural component and the cyclical component. a. Structural component refers to explicit changes in government spending or taxation policies. b. Cyclical component refers to changes in government spending and/or revenue which are caused by changes in the level of economic activity. The federal budget is a statement which sets out the spending, taxing and borrowing plans of the Commonwealth Government over the forthcoming financial year.

Three budget outcomes: Balanced budget occurs when T = G Surplus budget occurs when T > G Deficit Budget occurs when G > T Contractionary Fiscal - Occurs when government spending is reduced either through Policy higher taxes or reduced government spending or a combination of the two e.g. a budget deficit is reduced, or a surplus increased - The effect is to reduce the total level of economic activity and would be used to reduce spending, growth and inflationary expectations. Neutral Stance of - Implies a balanced budget. G = T Fiscal Policy - Government spending would be fully funded by tax revenue Expansionary Fiscal - Involves an increase in government spending either through Policy lower taxes or increased government spending or a combination of the two e.g. existing budget deficit would be increased or a budget surplus reduced. Automatic Stabilisers Even without deliberate decisions by government to change its policies, the level of revenue and expenditure change in response to changing economic conditions. Automatic stabilisers policies that operate automatically to counterbalance the trend in the level of economic growth and to stabilise the economy. Two automatic stabilisers progressional income tax system and unemployment benefits. Their operations can be illustrated by the following situations: An increase in the level of economic activity: when the economy is growing, income levels increase, leading to arise in taxation revenue for the government > unemployment falls, reducing government expenditure on unemployment benefits > contraction in aggregate demand. A decrease in the level of economic activity: in times of recession, income levels fall > fall in taxation revenue > unemployment rises, increasing government expenditure on unemployment benefits > aggregate demand expands.