Tim Dixon & John O'Mahony

The Market
Economy

Year 11 Economics
2020 EDITION
The Market
Economy
Year11
Economics Course

2020 EDITION

Tim Dixon
John O'Mahony
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Table of contents
TOPIC 1 INTRODUCTION TO ECONOMICS
Chapter 1 What Is Economics About?
1.1 The econo mic prob lem and the role of cho ices . .. . .... . .. . .. . .... . .. . .. .. .. 3
1.2 The product ion possibility front ier . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. .. 6
1.3 The future implications of choices . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. .. 9
1.4 The econo mic factors underlying choices .. . .. . .. . .... . .. . .. . . . .. . .. . .. .. . 11

Chapter 2 How Econom ies Operate

2.1 The product ion of goods and services .. . . . .. . .. . .... . .. . .. . .... . .. . .. .. . 16
2.2 The distribution and exchange of goods and services ... . .. . .. . .... . .. . .. .. . 19
2.3 The business cycle . . .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. . 21
2.4 An overview of the economy: the circular flow of inco me . ... ... ..... ... ... .. . 23

Chapter 3 How Econom ies Differ

3.1 The market economy .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. . . . 30
3.2 Austra lia: a ma rket economy w ith a role for government . . .. . .. . .... . .. . .. . .. 32
3.3 Compa ring econo mies . . .. . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. . . . 35

TOPIC 2 CONSUMERS AND BUSINESS

Chapter 4 Consumers in the Market Economy
4.1 Consumer sovere ignty . . .. . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. . 49
4.2 Decisions to spend or save . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. . SO
4.3 Factors influencing individual consumer cho ice . .. . .... . .. . .. . .... . .. . .. .. . 54
4.4 Sources of consume r income . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. . 56

Chapter 5 Business in the Market Economy

5.1 Business firms and industries . .. . .. . .... . .. . .. . .... . .. . .. .. . .. . .. . .. .. . 60
5.2 Product ion dec isions .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. .. . .. . .. . .. .. . 60
5.3 What business cont ributes to the economy . .. . .. . .... . .. . .. .. . .. . .. . .. .. . 63
5.4 Goals of the fi rm .. . .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. .. . .. . .. . .. .. . 64
5.5 Efficiency and product ion . . . . .. . .. . .... . .. . .. . .... . .. . .. .. . .. . .. . .. .. . 66
5.6 Investment , techno logical change and ethical dec ision making .. .. . .. . .. . .. .. . 71

TOPIC 3 MARKETS
Chapter 6 Demand
6.1 Factors affect ing market demand . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. . 80
6.2 Movements al ong the demand curve . .. . . . .. . .. . .... . .. . .. . .... . .. . .. .. . 82
6.3 Shifts of the demand curve . . . .. . .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. .. . 84
6.4 Price elasticity of demand . . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. . 87
6.5 Factors affect ing elast icity of demand . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. . 90

Chapter 7 Supp ly
7 .1 Factors affect ing market supp ly . . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. . 95
7.2 Movements al ong the supp ly curve .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. . 97
7 .3 Shifts of the supply curve . . . . .. . .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. .. . 98
7 .4 Price elasticity of supp ly .. . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. 100
7 .5 Factors affect ing elast icity of supp ly . . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. 101

Chapter 8 Market Equilibr ium

8.1 The concept of market equilibrium .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. .. 105
8.2 Estab lishing m arket equilibrium .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. 106
8.3 Changes in equ ilibrium . . .. . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. 107
8.4 The role of the market . . .. . . . .. . .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. .. 108
8.5 Government intervent ion in the marketplace . .. . .. . .... . .. . .. . . . .. . .. . .. . . 109
8.6 Competit ion and market power .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. . . 112
TOPIC 4 LABOUR MARKETS
Chapter 9 Labour Demand and Supp ly
9.1 The demand for labour .... . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 119
9.2 The supply of labour . .... . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 124
9.3 The Australian workfo rce .. . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 127
9.4 Extension: labou r market equilibrium . . .. . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 131

Chapter 10 Labour Market Outcomes

10.1 Wage outcomes . .. . .... . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 136
10.2 Trends in the distribution of income from work . .. . .. . .. . .. .. . .. . .. . .. .. .. 142
10.3 Non-wage outcomes .... . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 143
10.4 The costs and benefits of inequality ... . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 145
10.5 Unemployment . . .. . .... . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 148
10.6 The move ment away from full-time work .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 153

Chapter 11 The Changing Australian Labour Market

11.1 The role of trade unions .. . .. . .. . . . .. . .. . .. . . . .. . .. . .. . . . .. . .. . .. . . . . 158
11.2 The role of employer associations . . . .. . .. . .. . . . .. . .. . .. . . . .. . .. . .. . . . . 162
11.3 Australia's cur rent indust rial relations framewo rk . . .. . .. . .. . . . .. . .. . .. . . . . 164

TOPIC 5 FINANCIAL MARKETS

Chapter 12 Types of Financial Markets
12.1 The role of financial markets in the economy .. .. . .. . .. . .. .. . .. . .. . .. .. .. 171
12.2 Primary and secondary financ ial markets .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 172
12.3 Financial mar ket products . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 175
12.4 The share ma rket .. . .... . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 178
12.5 Domestic and global markets . .. . . . .. . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 182
12.6 Regulation of financ ial markets .. . . . .. . .. . .. .. . .. . .. . .. .. . .. . .. . .. .. .. 184

Chapter 13 The Money Market

13.1 Borrowers : the demand for funds . .... . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. .. 193
13.2 Factors affect ing the demand for funds . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. .. 194
13.3 Lenders: thle supply of funds . . .. . . . .. . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. .. 197
13.4 Money and money supp ly . .. . .. . . . .. . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. .. 198
13.5 Interest rates .. . .. . .... . .. . .. . . . .. . .. . .. . . . .. . .. . .. .. . .. . .. . .. .. .. 199
13.6 Domestic ma rket operat ions by the Reserve Bank . .. . .. . .. .. . .. . .. . .. .. .. 201
TOPIC 6 GOVERNMENT AND THE MARKET ECONOMY
Chapter 14 The Limits of Markets
14.1 Why governmen ts intervene . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. 210
14.2 Market failure in the provision of goods and services ... . .. . .. . . . .. . .. . .. .. 211
14.3 Market failure in income dist ribut ion . . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. 213
14.4 Market failure in externalities . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. 214
14.5 Market failure in the abuse of market power .. . .. . .... . .. . .. . . . .. . .. . .. .. 216
14.6 Market instabi lity : the business cycle .. . . . .. . .. . .... . .. . .. . .... . .. . .. .. 217

Chapter 15 The Role of Governme nt in Australia

15.1 The structure of govern ment . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. . . 221
15.2 The public sector . . .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. . . 224
15.3 The reallocation of resources . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. . . 226
15.4 The redist ribution of income . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. 229
15.5 Stabilisation and sustainable growth . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. 233
15.6 Public enterprises . . .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. .. 234
15.7 Other roles in the economy . . .. . .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. .. 235

Chapter 16 Government in Action

16.1 The Budget . . . . .. . .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. . . 241
16.2 Revenue and expend iture . . . .. . .. . .... . .. . .. . .... . .. . .. . . . .. . .. . .. . . 241
16.3 The impact of budget outco mes . .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. . . 244
16.4 Influences on government pol icies . . .... . .. . .. . .... . .. . .. . . . .. . .. . .. . . 246

SKILLS
Appe ndix A Key Economic Skills
A.1 Introduct ion . . . . .. . .. . .. . . . .. . .. . .... . .. . .. . .... . .. . .. .. . .. . .. . .. .. 254
A.2 Drawi ng and interpreting economics diagrams . . .. . .... . .. . .. .. . .. . .. . .. .. 256
A.3 Equations and calculat ions in econom ics .. . .. . .. . .... . .. . .. .. . .. . .. . .. .. 260
A.4 Interpreting eco nomic data and informat ion . .. . .. . .... . .. . .. .. . .. . .. . .. .. 261

Glossary 266

Index 283
Welcome
The Market Economy
You are standing on the scarring block of your study of econ omics, about to dive into a world
that uses special language, concepts and theories ro build a comp lex understandi ng of how
the economy works in the modern world. It's a daunting cask, there is a lot ro learn , and a
fair bit of it does not come naturally. It is, however, very rewardi ng.
Understanding economics will help you to unlock many of the mysteries of the modern world.
You will better understand rhe issues involved in making personal choices - what kind of job
to choose, what course co study, what to spend money on, and whether ro borrow or save. You
will better understand rhe forces around you - what makes indicators such as interest races,
share prices, unemploym ent and the Australian dollar move up and down. And you will better
understand the forces that shape our world today - making bett er sense of issues discussed in
the media every day, and how Australia firs into what we describe as rhe g lobal economy.
If it seems hard going at first, you should find chat study ing Economics gets easier as you
go along. In itially, you need ro understand the foundations and bu ilding blocks of modern
economies - the technical aspects of how markers work, how consumers make decisions
about what rh ey want, and how businesses decide what to produce. This is the main focus of
the Year 11 course and of this book. It is economics at the m icro level (the level of individual
agents and markets). Th e sign ificance of what you learn here may nor be immed iate ly
obvious, but once you have put th ese blocks togethe r the b igger p icture should become clear.
In the Year 12 course, rh e focus is on the big picture: how the g lobal economy works and
how governments manage rh e economy and choose between compet ing policy goals. This
is economics at the macro level. But ro understand rhe b igger picture of how economies
function in the real wor ld, you need a solid grasp of the foundat ions of economics. And that's
what this book is about .
T his is the twentieth editio n of The Market Economy, and we're as enthusiast ic about this
edition as we were for ,rhe first one back in 2001. T his textbook is a collaborative effort of a
whole team of economic researchers. Each year, rhe book is comprehens ively revised and
refined ro reflect feediback from students and teachers, as well as changes in g lobal and
domestic economic condit ions and developments in the econom ic po licy environment. Our
thanks ro all of rh e team involved in rh e production of rh ns rexrbook, borh for th is year and
previous years.

Back ,·ow (L-R ) : Ti m Di xon, Natalie Bake,;J oei Bank, Nicholas Kampe,: From row (L-R ):
Diana Hu (previomeditions)
, Zain Ahmed,RohanGarga,Joh12
O'Mahony.Not pictttred:Michael
Pahos and Lu ke Goidma·12.
 The text is divided into six Topics fo llow ing the structure of the
Year 11 Econom ics syllabus . Each Topic is introduced by a
page tha t includes the relevant Focus, Issues and Skills for that
Topic, reflecting the syllabus objec tives . This is fo llowed by an
introduc tion to each chapter w ithin the Topic .

•
Each Chapter concludes
with a 10-point Chapter Summary
and then Chapter Review questions . The
.---------- Chapter Summary is a good starting point
-
---- ---··---- for your notes on each chapter, and the
review questions are a great way to test your
understanding of the chapte r.

1----------------- - 010...,ry

Throughout the text you will find references

to useful websites relevant to that area of study.

•
K•Y Economic
Sl<ill•

A unique feature of The Market Economy is the

Appendix: Key Economic Skills, which gives you
t he opportunity to master the 26 skills of the Year 11
Econom ics syllabus. The Appendix covers three main
areas: drawing and interpreting econom ic diagrams,
equations and calculations, and interpreting economics
data and information. By work ing through this material
you w ill develop and reinforce the key econom ic skills.

The Market Economy Workbook Eighth Edition

The accompanying workbook The Market Economy Workbook Eighth Edition is a great
resource to further help you in your study of the Year 11 Economics syllabus.
This year we have added enhanced answers to the workbook answers, including
worked solutions for answers that require calculations and additional explanations for
answers that require you to demonstrate a deeper understanding of key concepts and
knowledge. These will allow you to not only confirm whether you arrived at the right or
wrong answer, but to understand why.
How to access answers to the Workbook
You can download the answers to the multiple-choice and short-answer questions in
the workbook by following these simple steps:
If you have The Market Economy 2020 Edition EBook:
After activating your code, you can find the workbook answers by clicking on the
'Explore resources' tab in your EBook.
If you don't have an EBook:
1. Go to: www.pearsonplaces.com.au
2. Login or sign-up {free)
3. Scroll down and click on 'Check out our library of free rescources' and click on
'Explore now'
4. Search for 'The Market Economy'
5. Click on 'Workbook answers' from the list.

*
We really hope that this t,ext makes your study of Econom ics more enjoyab le
and rewarding. The book is revised and updated each year to make sure it stays
sharp and contemporary .
 TOPIC

INTRODUCTION
TO ECONOMICS

Focus
The focus of th is topic is the need for
choice by individuals, businesses and
governments. Their decisions determine
the nature of the economy and create the
diversity of ec,onomies found in the world.

Issues
By the end of Topic 1, you will
be able to examine the following Skills
economic issues:
Topic 1 skills questions can ask you to:
■ Ident ify the opportun ity costs involved in
■ construct and interpret product ion
economic dec isions made by individuals,
possibility frontiers
bus inesses and governments at local , state
arnd national levels ■ dist inguish between equilibr ium and
diseq uilibrium situat ions in t he circular flow
■ Examine the ways that t he econom ic problem
of income mode l
aff ects individua ls at different income levels
■ explain how an economy might return
■ Examine the implicat ions of unemp loyment
to an equilibriium situat ion from a
arndtech nological change using product ion
diseq uilibrium situat ion
poss ibility frontiers
■ ident ify bias in media items on economic
■ Compare and contrast the ways that
issues affecting the local, state and
different econom ies deal with spec ific
national economies
problems or issues.
■ ident ify key features of an economy t hrough
analysis of a variety of informat ion types
and sources
■ work in groups to investigate aspects of
Econo mics Stage 6 Syllabus 2009 extracts © NSW Education
Standards Author ity f()( and on behaH of the Crown in right of the economics and econom ies.
Stat e of New South Wales, 2009 ; reproduced by perm ission .
 Topic 1

Introduction
Topic l introduces some essential concepts in the study of econom ics. You will find chat
in studying economics we continually come back to these core concepts .

Chapter 1 places rhe study of economics within rh e bigge r pictu re of huma n life.
Economics is essentially about how we solve the econom ic p rob lem of unl imited wants but
limited resources - that is, how we choose between alternativ es. Th is involves concepts of
opportu ni ty coses and production possibi lities . Th e three groups chat influence how we
make these choices are individuals , bus inesses and governments .

Chapter 2 exam ines how economies operate, as well as the process chat determin es how
econom ies produce and distribute goods and services. We exami ne rhe circula r flow of
income, a mode l that exp lains how the economy works by d ivid ing ir into five sectors and
explaini ng rhe income flows between each sector. Chapter 2 finishes with a brief discussion
of rh e concept of equi l ibrium, another essent ial economic concept.

Chapter 3 compares the different ways in which econom ies attempt to solve the
econom ic prob lem. We compare rhe characteristics of a market economy, where busi ness
and consumers determine what is produced, with a centrally p lann ed economy, where
governments mak e rhe decisions about production and distribution. Austra lia is a
mixed economy - one that combines a marker economy with some level of govern ment
intervention. We look at how Australia compares ro other econom ies in Asia across a range
of indicators, includi ng econom ic growth, qua lity of life, emp loyment and unemp loyment,
dist ributio n of income, enviro nmental sustainabi lity and t he role of government .

II
What Is Economics
About?

1 .1 The econom ic prob lem and the role of cho ices

1 .2 The production possib ility f rontier
1.3 The future impl icat ions of cho ices
1 .4 The econom ic facto rs underlying choices

1.1 The econom ic problem and

the role of choices
H istorically, experts in economics have wrestl ed wit h one fundamental issue
above all else: how co solve what we call the econ omic problem. Th at is, how
can a society sat isfy the unl imit ed wanes (of individuals or the comm unity) with
the limited resources available? It can be summ arised as follows:
The econom ic problem
• Our wanes are unl imi ted.
is about choices
• Resources are scarce - th at is, the resources we have to draw from to
sati sfy our wanes are lim ited.
• Since we canno t sati sfy all our wanes with our limite d resources, we must choose
betwee n th em .
• Th erefore, we need to rank our preferences - we wi ll choose our hig hest-preference
wanes, and leave some wanes un sati sfied.
Th e stud y of economics is essentia lly a bout attempti ng to solve th e economic prob lem -
trying to allocate our limited resources for t he sat isfaction of our unlimit ed and competi ng
wanes. It is a stud y of choices, in wh ich each decision we make involves choosing one
op ti on bu t decidi ng against an altern ative.

Understanding wants
People in all count ries need to obtain good s and servic es for their daily lives. Goods such as
food and shelter, and services such as health and education, are essenti al for our lives. Whil e
these are basic need s essenti al for hum an survival, individuals also w ant a whole range of
ocher goods and services to make their Iives easier, or give them p leasure. Econom ics assumes
that humans pursue maximum self-int erest , meaning that we have unl imited wanes and
lim ited means to satisfy them. Economi cs does not att empt to change the fact that we may
be greedy. Rather, it atte mpts to help us work our which wanes are our hig hest pr iority,
and how we can organise production in order to satisfy the maximum numbe r of our wanes.
I
The Market Economy 2020

Wane s can be d efined as the mater ial desires of indiv iduals or the commun ity. They are
items that p rovide some p leasure or satisfact ion when they are consumed. Economists say
that indiv iduals derive ut ilit y (which broad ly means sat isfaction or p leasure) from th e
consumption of goods and services. People have desires for the basic necessities of life,
such as food or she lter, wh ich we can furth er classify as n eed s, as well as for non-essentia l
items, such as a. home theatre system, an overseas holiday or expensive clothing.

Individ u al w ant s are the desires of each person. An indi vidual's desire depends on
personal p references, but can be influence d by broader social tre nd s. T he number of
ind ividua l wanes that can be satisfied di ffers from perso n to person, dependi ng on their
ability to purc h ase goods and services (that is, their level of income). Indiv idua ls who
have low incomes are affected by the economic probl e m more severely than those on high er
incom es. Peop le who have low incomes can satisfy fewer of their want s. Th ey may not
even be ab le to cover the cost of basic needs such as food, housing and clothi ng. Th e less
incom e a person has, the fewer wants they can satisfy.

Co llect ive want s are the wants of the whole commu n ity. What is desired wi ll depend on
th e preferences of the community as a whole - not only those of th e ind ividua l person.
Collective want s are usually p rovided by the govern ment . In Australia, local govern ment
provides collective want s for local neighbourhoods, such as parks, librari es and local
sport ing facilities. Seate governments provide most wants for the wider community, such
as hospitals, schools and a po lice force, whi le the Commonwea lth (or Federal) Govern ment
satisfies th e wa.nts of the entir e nation, such as a defence force. Governments p rovide
collective wants by using taxation revenue collected from the commun ity.

Our wants are u nlimit ed . As soon as we have satisfie d one want, we will seek to satisfy
anothe r one. Because our means of sat isfying wants are limite d (as a result of our limit ed
income) we cannot sat isfy them all at once. In othe r words, we cannot have everyth ing we
want . As a resu lt, w e mu st ch oos e b etwee n our wa nt s. T his means that some wanes
will be satisfied sooner at the expense of ot hers. Gen erally, the most p ressing wants will be
satisfied first. For example, we would satisfy our want for food before buy ing a new laptop.

Some wants wi ll be recurrent. Whe n we satisfy a want such as food, we are faced with
th e fact that we will have to satisfy th is want over and over again in the futu re. Furt her
examp les of recur rent wants incl ude newspap ers, clot hes and petro l. Othe r wants a.re
comp lementary. A want is said to be comp lementary if it naturally follows the initia l
satisfaction of another want . For instance, when you satisfy th e want for a car, you wi ll
also want petro l and car accessories.

Our wa nt s also ch an ge ove r tim e. As people grow older, the ir wants change . Th e factors
that affect these changes include age, income, tec hn ology and fashion. For example , a
one-year-o ld wa.nts a pram ; an eleven-year-o ld want s a video game console; a twenty -one-
year-old want s a car; and a nin ety-one-year-o ld may want a wheelchair. As your income
increases, you are able to afford more luxury goods, and you increase the range of wanes
that you can satisfy. Techno logy also int roduces new want s that people seek to satisfy. A
generation ago, most individuals did not own a mobi le p hone, whereas today they are an
almost universal possession.
 Chapter 1: What Is Economics Abo ut? I
The key economic issues
All economies - regard less of their type - must attempt ro answer the following quest ions:

1 What to produce?
Because of lim ited resources, no economy can sat isfy all individua l and collective wanes.
It must decide which wants ir wi ll sat isfy first and wh ich ir wi ll leave unsat isfied.
Therefo re, ir must decide what goods and services wi ll be produced.

2 How much to produce?

To allocate limited resources efficiently and maximise the satisfact ion of wanes, an
economy must make decisions about how much of each good or service ir will produce.
Whe n it produces coo much of a good, resources will be wasted, and when it p roduces
coo little , rh e wanes of some ind ivid uals will be left unsatisfied.

3 How to produce?
Having decided what and how much co produce, an economy must decide how co allocate
irs resources in the production process. It must look for the mosr efficient method of
p roduction char uses the least amount of an economy's resources so char rhe g rearesr
number of wanes are satisfied at any one point in time.

4 How to distribute production?

Havi ng produced a certa in range and qua nri ry of goods and services, an economy muse
dec ide on their distribution among tihe population. In modern econom ies, each person's
share of coral p roduct ion depe nds on t heir level of income. People on hig iher incomes can
afford co buy more goods and services than peop le on lower incomes, and the refore receive
a bigge r share of rota! production. Each economy must decide whether it wanes a more
eq u itab le (even) dist ri but ion of production or a more in equ itab le (uneven) distribution.
This is a difficu lt question because the re is often a confl ict between equity and efficiency -
more efficient systems may p roduce less equ itab le outcomes.

Opportunity cost
Whe never we sat isfy one want, we are g1v10g up rh e opportunity of sat isfying an
Opportunity cost
al ternative wane. The real cost of satisfy ing a wane is, therefore, not the money we pay
represents the alternative
for it, bur the nexr-besc alternative want char we have co forgo. Th is cost is known as rh e use of resources. Often
oppo rtun ity cost (it is also sometimes referred co as the eco n om ic cos t or real cos t). referredto as the real
cost, it represents the
Opportunity cosrs can be app lied ro the individual, the business firm and the government: cost of satisfyingone
want over an alternative
• The individual consume r, with [imited resources (represented by her limited income) want. This is also known
may have co choose between satisfying her desire for a car and an overseas holiday. as economic cost.
If she chooses the car, the real cost is the overseas travel that she has ro forgo.
• Th e business firm muse also make a choice in the allocation of irs scarce resources.
An ent repreneur who decides co produce a compute r gives up rh e opportunity ro
produce something else - such as elect rical app liances - with those resources.
• Th e government has limited resources chat ir can use ro satisfy commun ity wanes.
If the government allocates res,ources co constructing a new fleet of subma ri nes, ir
may be ar rhe expense of a new motorway or airpo rt.

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The Market Economy 2020

1 List TWO examples of each of the followi ng typ es of wants :

a) individua l wants b) collective wants .
c) recurrent wants d) comp lementary wants
2 Identify wh ich of the following are examples of opportun ity costs:
• paying $1200 for a new smartphone
• missing a rugby game to go to a music concert
• missing a work shift because the bus was late
• amalgam ating local cou ncils to expand the police force.
3 Explain how all societies face the economic prob lem, w ith reference to the four
key economic issues.

1.2 The production possibility frontier

The production possibilit y frontier can be used co de monsrrare how opporcuni ry costs
Production possibility arise when individua ls or rhe communi ty make choices. Th e production possib ility front ner
frontier is a graphical
(sometimes also known as the production possibil it y curve) shows the various com binations
representat ion of all the
possible combinations of rwo alternati ve products that can be produce d, given techno logy and a fixed quantity
of the production of of resources, whe n all resources are used to their full capacity.
two goods or services
(or two types of goods The following examp le of a production possibi lity front ier is based on a numb er of sim-
or services) that the plify ing assumptions, includi ng:
economy can produce at
• the econo my produces only rwo goods - oi l and leath er
any given time.
• the scare of techn ology is constant
• the qua nt ity of resources available remains u nchanged, and
• all resources are fully empl oyed .

A simple production possibility frontier

Oil 160 120 80 40 0 Given the above assumptions, we can
construct a productio n possibil it y schedu le.
Lea th er 0 20 40 60 80
Figu re 1.1 shows the production possibilit ies
Fig ure 1. 1 - Production possibility schedule for chat woul d resul t if all our resources
oil and leather
were used and were divided between the
prod uction of oil and leath er. By graphing
Oil (units) rhe dara in figure 1.1, we can consrru cr the
160 A prod uction possibility frontier in figure 1.2.

120 .........,C Th e produ ction possibility frontier shows

all the possible combination s of productio n
of oil and leather at a given point in time .

: Ij
o..____
20
......._
40
___
60
.
....._
80
__ _
We ma y choose ro produce only oil and
no leather (point A on the diagram), or
just leather and no oil (point B), or any
combi nation of oil and leather between these
Leather (units) rwo extremes. Society must choose whi.ch
combination is mosr desirable.
Figure 1.2 - Production possibility frontier for oil
and leather

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 Chapter 1: What Is Economics Abo ut? I
The production possibility frontier shows the maximum an economy can produce at a
g iven po int in time. All points on the front ier itself represent po int s at wh ich the economy
is operat ing at full productiv e capacity - chat is, all resources are fully e mp loyed. If th e
economy were produci ng at a point inside the curve, it wou ld be p roducing less rhan irs
maximum possib le ourput and resources wou ld not be fully employed.

Combination A Combination B

I I I I
m
I

Q <.t~ 40 cd ~ r5 J

l I_ I l I_

Ill El
20

Whe n society wants co change irs production combi nation, there is a cost involved - rhe
oppo rtu n ity cost. This can be illustrated by the following examp le. Assume char th e
economy is producing at point A on rhe production possibility fronti er (160 un its of oi l
and no leathe r) bur wanted co move ro point B (120 uni ts of oil and 20 un its of leat her).
In order co gee the 20 units of leather we would have co give up 40 un its of oil. Therefore ,
the opportun ity cosr of obtain ing the 20 un its of leather is 40 un its of oil.

We can calculate the opportunity cost of obta ining each indivi dual unit of leathe r by
d ividing up the 40 oil un its g iven up by rh e 20 leath er un its gained. Th u s, for each unit
of leathe r, we muse give up 2 units of oil. In othe r words, the opportunity cost of leather
is 2 units of oil.

New technology and the frontier

Ho wever, rhe production possibi lity
frontie r does not always remain rhe same. Oil (units)
With th e app lication of n ew te chn o logy, 200
we may be able ro develop more efficient
m et hods of pro duction. This might allow 160
us co produce a high er quantity of a _good
w ith the same resources. This can be 120
represented by an ourward shift of the
p roduction possibility fronti er. 80

Applying this co the previous exampl e, 40

an improvement in technology, such as
0 20 40 60 80
en hanced oil extraction methods, increases
Leather (units)
the maximum product ion level co 200
units of oil with the same level of resour ces Figure 1.3 - An improvement in the technology of
as before . Figu re 1.3 shows rh e new oil production
p roduction possibility fronti er.

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The Market Econ omy 2020

New resources and the frontier

Anything chat increases the availabi lity Oil (units)
of p roduct ion inputs wi ll change the 200
production po,ssibil icy front ier. Th is
includes d iscovery of new resources, or 160 '
'
an expansion of the popu lation th rough '
'
imm igration, which would increase the 120 '
'
'
number of people available for work. As ''
a result of these new inpurs, we wou ld 80
''
be able co p roduce more of both goods. ''
40 '
Thi s wou ld also push the production
possib ility froncier outward , as shown in 0 20 40 60 80
figure 1.4.
Leather (units)

Unemployment and Figure 1.4 - Impact of the discovery of

new reso urces
the frontier
Th e p roduct io n possibility front ier
Oil (units )
can shed light on what occurs when an
economy experiences unemp loyment. We 200
usually refer co unemployment as the
prob lem of a person being available for 160

work bur unable co find it. A simi lar

120
prob lem may occur nor just for people ,
but also for any input into the production 80
process. If any resources are n ot fully
employed, the fronti er itself would nor 40
change, bur we would change our position
in relat ion co ic. Our economy wou ld be 0 20 40 60 80
produci ng at a point somewhere within Leat her (units)
(or underneath) the p roduct ion possib ility
frontier, as shown by point A in figure 1.5. Figure 1 .5 - Unemployed (or underemp loyed)
resources

Thi s situat ion indicates chat we have an inefficient allocat ion of resources. We are not
achieving a max imum sat isfaction of wants with the min imum opportunity cost, which
would del iver an efficient outcome. Because the economy has resources that are not being
used efficiently in p roduct ion, the total output of goods and services is less than what it
could be. These resources would be "unemp loyed".

The shape of the Oil (units)

production possibility
frontier
In the analysis so far, the product ion
possibility front iers have been straight
lines. For th is co be the case, it muse be
possible co shift all resources between the
product ion of o.il and leather so that the
opportunity cost of producing leather is 0
constant (in other words, the economy Leather (units)

could substitute between the product ion of

the two goods at a constant rate).
Figure 1.6 - Concave prod uct ion poss ibility frontier

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 Chapter 1: What Is Economics About? I
In the real world , this is genera lly not the case. Some resources are bet 1C
er su ited co oi l
p roduction, and orhers ro leather - we cannot simp ly expect ro move resources from oi l
p roduction ro leather without any loss of p roduct ive capacity, and vice versa. Therefore ,
as: we move more and more resources inro rh e production of leather, rhey will become
less productive, wh ich will increase che opportu ni ty cosr of leather. When this is taken
into account, rhe proper shape of a production possibilit y frontier is drawn concave ro
the origin (as shown in figure 1.6) , bur rh e overall conclusions char have been discussed
remain the same.

1 A factory is able to produce a maximum of 1000 espresso machines or

2000 food processors . Construct a production possibility front ier and
calculatethe opportunity cost of producing one food processor.
2 Illustrate the effects of each of the follow ing situatio ns on a product ion
possibility front ier for oil and leather :
• the invention of a new oil drill
• an improvement in stitc hing techno logy
• an increase in a nation's intake of worki ng-age migrants.
3 Identify the change in the opportun ity cost of producing more units of leather
as an economy moves down to the right on the product ion possibility frontier
shown in figure 1.6.

1.3 The future implications of choices

In making economic choices roday, we
can influence economic outcomes in the Consumer goods
Cap ita l goods
future. In a genera l sense, an economy as and services are
a whole can choose between produc ing items produced fo r the
immed iate satisfact ion of
goods chat sat isfy consume r dema nd
individual and community
immediately (co nsumer goods ) and needs and wants.
goods chat will increase our productive
capacity in the future (capita l goods ),
su ch as machinery. Whil e capita l goods Capital goods are items
do not satisfy consumer wanes now, that have not been
they will allow us ro satisfy these wa.ncs produced for immed iate
0
in the future by expandi ng our abi l ity Consumer goods consumption but will be
co produce . Th e trade-off betwee n used fo r the production of
other goods.
p roducing consumer goods and capital Figure 1. 7 - The choice between consumer
goods is represented in figu re 1.7 . and cap ital goods

In rh e long run, an economy char focuses more on the production of cap ital goods wi ll
in crease irs productive capacity and experience a high er level of econom ic growth.
A country char is producing ar a hig her point on the frontier wi ll, in t he long term , be
ab le co sat isfy irs consumer wanes bett er than a counrr y ar a lower point on the frontier.
In effect, the country choosing co prod uce more capita l goods now is making the choice
co forgo satisfying some wanes today s,o it can sat isfy a greater numbe r of wanes tomor row.

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The Market Economy 2020

The principle that economic decision making has future implications is true for
individuals, businesses and govern ments. For exam ple:

• An individual may choose to go wirhour an overseas holiday or extravagant lifestyle

and instead take out a mor tgage and purc hase a house. Saving up for a deposit and
spendi ng Saturday afternoo ns with rh e real esta te agent will represent a significant
sacrifice for many ind ividua ls, only to be followed by years of scrimp ing ro pay
off rh e m ortgage. In rhe longer rerm, however, home ownership impr oves an
individual's financial securit y, as rh ey will no t have to pay rent and will also have
an asset chat they can pass on to their ch ildr en when rh ey d ie.
• A business muse choose ro focus on one area of business act ivity over anot her.
Businesses have a limited amount of labour, capita l, entrepre neurial sk ill and orh er
resources, so rhey mu st focus on the products in wh ich rh ey are likely to maxim ise
profit. Thi s involves a d ifficult assessment of wh ich areas of business activity rh ey
can be most successful in over the medium to longer term. Businesses are likely
to be mosr effective if rhey can identi fy where the next wave in business grow th is
likely to come from. For examp le, many businesses that invested in communi catio ns
and infor mation technology a decade ago have achieved exrraordi nary financial
success. If a business only chooses ro operate where orh er businesses have alread y
been successful, rh ey may find that they have entere d the mar ker too late and are
unable to obtain a competitive advantage.

The future implications of

education for individuals
One of the most important econom ic decisions made by individuals is
whethe r to invest in further educat ion beyond high school. While most
students would prefer to hang out at the beach or go on an overseas holiday
than be stuck in a classroom , many ch oose to sacrif ice some enjoyment
now in orde r to extend their educat ion and imp rove their workforce skills.
This should expand their job opt ions and may result in an increased income
in the future .
Recent evidence suggests that educat ion, particu larly tert iary educat ion, does improve
individuals' earn ing potent ial. Accord ing to the 2018 Graduate Outcomes Survey, new
graduates with a bachelor's degree are paid $61,000 a year in the ir first year. While th is
is 40 per cent below the average annual earnings for all Australian full-time workers ,
research shows graduates earn around 50 per cent more than those with only high
school qualifications. Dentistry graduates enjoy the highest median start ing salary
($83,700), followed by medicine ($73,000), soc ial work ($65,600), educat ion ($65,500)
and engineeriing ($65,000).
The survey also noted that university graduates enjoyed better job prospects .
Around 72.9 per cent of university graduates were able to find full-time emp loyment ,
compared to only 62.6 per cent of non-university graduates . The overall emp loyment
rate (including part-time work) was also notab ly h'igher at 87.2 per cent for university
graduates , compared to 81.6 per cent for non-graduates .
Furthermore, the comp letion of higher educat ion o r Vocational Education and Training
qualificat ion is increasingly a prerequisite for access to, and successfu l participat ion in,
the labour market. In 2018 the then Department of Jobs and Small Business forecasted
that 90 per cent of the 886,000 new jobs expected to be created by 2023 will require
a post -schoo l qualification.
A dec ision to invest in educat ion may mean sacrifice in the short te rm , but it will pay
off in the fut ure.

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 Chapter 1: What Is Econom ics Abou t? I
• Th e decisions of gov ernments have very important long- term implications, both
for governm ents th emselves and for the entire economy. A gove rnm ent may choose
to give th e highest priority in it s spendin g to satisfying immediate needs, such as
increased welfare benefits and health care. As a result, it may p rovide less fund ing
for other areas of expenditure, such as education, infrastructure , and research and
development . In the longer term , this is likely to result in a lower level of economic
growth, because the country will have a lower ski lls base in its workforce , less
inn ovation and weaker infrast ru cture (such as an inadequate tramporc system or
limited band width in it s communi cation s systems) . Th e d ifficulty for governm ents
is that in the short term it may be more pol itically popular to satisfy imm ediate
wants than to p lan for future needs.

1 List TWO examples of a capital good and TWO examp les of a cons umer good.
2 Describe the costs and benefits of prod ucing capital goods in an eco nomy.
3 Outl ine a poss ible future econom ic benefit for each of the follow ing c hoices:
• saving money in a bank account
• pursuing tertiary educat ion
• working beyo nd the reti rement age.

1.4 The econom ic factors underlying

choices
In the process of making economic cho ices, all participants in the economy must weigh
up a range of factors relati ng to their short- and long-te rm object ives. Th e following
section reviews some of the factors t hat affect the econom ic decision-ma!king process for
in dividuals, businesses and governm ents.

Individuals
The econom ic choices mad e by indiv idua ls are shaped by a variety of factors , incl ud ing
the ir age, income, expectat ions, future p lans and family circumstances. Personality factors
w ill also influence economic decision making; for exampl e, some people are keen to
embrace change and risk, wh ile ot hers will avoid risk and prefer securit y.

What ever the ir level of income, indiv iduals must make a choice abour how much of that
in come they wi ll save and how much they will spe nd . This will , of course , be influe nced
by the ir income level, as well as a range of other factors, such as age, the performance of
an y assets they hold and the ir expeccations of whether th eir income is likely to rise or
fall in th e future .

P[ans in relat ion to edu cat ion , work, family and retireme nt also p lay a substant ial role
in influenc ing economic decis ion makin g . The decision to undertake fu rther edu cation
may involve forgoi ng income for seve.ral years, although in most cases it w ill be rewarded
w ith hig her income in the longe r run. In the meant im e, the indiv id ual's abi lity to
consume wi ll be rest ricted by thei r lim ited income . When a coup le decides to sta rt a
fam ily, th ey may have to cur dow n o n personal expe nditure and one par tn er may have
to go wit hout an income , pe rhaps for several years. The decis ion to retire involves
adjusting to a much lower income w hen more free leisure time may give an individua l
mor e opportun ities to consume.

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I
The Market Economy 2020

Individuals also contribute ro economic decisionmaking by voting in elections. Economic

policy issues are a cent ral featur e of po lit ical deb:are in Aust ralia, and rhey are major
priori ties of govern ment prog rams and elect ion campaig ns. Political parties regularly
debate who is best ar managi ng rhe economy and the budget , and wh ich parry is most
likely co del iver lower levels of unemp loyment , inflat ion and inte rest races. Elect ions -
such as rh e 20 19 federal election - involve indiv idua ls making a choice about who co vore
for, and economic po licies, especially on tax and infrasrrucrure, sig ni ficantly influe nce
voti ng behaviour.

Business
Firms face choices in many aspects of th eir business operat ions. In pric ing its produces , a
business may choose a higher p rice, hopin g chat this will maximise profits and on ly have
a small impact on the level of sales. The pricing decisions that businessesmake are also
based on the ir market ing strategy - whethe r they are crying co sell a produce to the mass
mark et or targe t a more exclusive g roup of consum ers.

In makin g decisions relating co p roduct ion and resource use, businesses will seek co
min imise the ir coses and maximis e qual ity. This may sometimes involve difficu lt choices;
for examp le, a bus iness may face hig her costs in the pu rchase ofbeccer-qualicy equ ipme nt ,
bur the equip m ent may have a longer operat ing life and requ ire less maint enance.
Businesses will ge nerally choose the cheapest available resources, bur if the supply of a
cheaper resource is nor assured, rh ey may choose to pay slig htl y more for an input chat
has a more reliab le supply. Businesses may also need co conside r et hical issues, such as rhe
importance of the natura l environment. For examp le, a business may consider whether it is
willing to pay a higher price for using recycled paper rather than using non-recycled pape r.

Businesses can also face complex choices in how they manage indust rial relations issues.
Businesses can c hoose co emp loy people on wage levels sec by industr ial awards; rh ey can
negotiate wage agreements with the ir whole workforce; or they can negociace indiv idua l
contra cts with their staff. Th ey also face choices about whethe r rhey will encourage un ion
represent ation or involvement from emp loyees in d ecision making.

Government
Governments can have a significant influence over the econom ic choices of individu a ls
and business. Th is influe nce may include mak ing it less or more expensive co mak e
some choices. For example, by taxing cigaret tes more heavily, gove rnments attempt co
discourage ind ividua ls from smoki ng.

In more extreme situations, governments may seek to influence economic behaviour by

prohibiting certai n act ivities and imposin g heavy pena lties on chose who break the law.
For examp le, busi nesses operati ng in rhe same industry are prohib ited from meeting
cogecher co sec prices for their industry, because t his degrades competition and harms
che interests of consumers.

Equally, govern m ents may wish to encourage certa in econom ic activities and may provide
incentives for th em . For examp le, in order co encourage individua ls to join a private health
insurance scheme, the Austra lian Government p rov ides a cax rebate of up co 33 per cent
co low- and middl e-income earn ers for private health insurance payments, and imposes
che Medicare Levy Surcharge (a tax p enalt y) on hig her-income earners who do not cake
our p rivate heal th insurance. General treatm ent p r ivate health insurance coverage now
extends co 45 per cent of rh e popu latio n, compa red with 30 per cent before these po licies
were introduced.
The gove rnmen.r's influ ence on rhe economy is a result of both influencing the decisions
of individuals and busi nesses, and providi ng goods and services d irectly.

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 Chapter 1: What Is Economics Abo ut? I

1 Outline THREE economic factors that may cause people to increase their level
of saving .
2 Describe how each of the follow ing business strategies could maximise
business profits:
• raising the selling price
• lowering the selling price
• purchasing more efficient capit al goods
• offering higher salaries to staff.
3 Identify TWO examples of business activiti es that the government may wish
to encourage, and TWO business activities the government may want to
disco urage or ban altogether.

m
The Market Economy 2020

1 Eco nomics is concerned with addressing the economic problem of satisfying

unlimited wants with our scarce resources.

2 The economic problem means that we must make choices about how to allocate
limited resources. Therefore, we must give priority to some wants over others .

3 Each econom y must answer the following four basic questions:

• What to produce?
• How much to produce?
• How to produce?
• How to distr ibute produc tion?

4 Whenever we choose to produce or consume one product, we miss out on the

alternative p:roducts that could have been produced using those resources. This is
known as the opportunity cost .

5 The production possibility frontier is a simp le way of explaining opportun ity

cost. Assum ing that only two goods are produced, it shows that produc ing more
of one good requires us to produce less of the other.

6 Improvements in technology w ill cause the productio n possibility frontier to shift

outwards .

7 Changes in t he levels of resources w ill change the positio n of the production

possibility frontier , moving it outwards (when the level of available resources
increases) or inwards (when the level decreases).

8 If an economy is producing at a point below the product ion possibility curve, then
it is experiencing unemployment of resources.

9 Today's economic choices affect tomorrow's econom ic outcomes . If we choose to

satisfy a want today, we may not be able to satisfy a want in the future.

10 In choosi ng between satisfying present or future wants :

• Individuals must make choices between spend ing or saving. Spending
satisfies present wants while saving raises futu re living standards .
• Businesses must make choices about price , how much to produce , what
resources to use and how to manage their emp loyees.
• Governments can influence the choices of individuals and businesses
by affecting the cost of choices and ot her factors underlying their
decision-mak ing processes .

II
 Chapter 1: What Is Economics About?

•
-- - --- -- ~~ ~::..:=-..a
rev1ew
1 Explain what is meant by the economic problem.

2 Outline why economics can be described as a study of choices .

3 Define opportunity cost .

4 Explain how a production poss ibility front ier can be used to demonstrate the
concept of opportunity cost.

5 Identify why it is imposs ible for an economy to produce outs ide its production
possibil ity frontier.

6 Discuss the circumstances under which it wou ld be possible for the product ion
possibil ity frontier to shift outward.

7 Explain why we might find our economy producing at a level w ith in (or below) the
product ion poss ibility front ier.

8 Given the following product ion possibil ity schedule, construct a product ion
possibil ity frontier and answer the follow ing questions.

Hats 200 150 100 50 0

Tea 0 30 60 90 120

a) What is the opportun ity cost of obtaining the first 30 units of tea?
b) What is the opportun ity cost of obtaining one unit of tea?

9 Identify the kinds of opportun ity costs that the government might face in
attempt ing to satisfy community wants .

10 Define the fo llowing terms :

a) consumer goods
b) capital goods .

Extended response
Define the economic problem . Explain how individual consumers, business firms
and the government are all faced with the econom ic prob lem. Identify the different
econom ic factors that influence how each group seeks to address th is problem.

Ill

Factors of production
are any resources that
can be used in the
production of goods and
services . The
four main types are
natural resources (or
land), capi tal, labour and
enterprise.
How Economies
Operate
2.1 The production of goods and services
2.2 The distribution and exchange of goods and services
2.3 The business cyc le
2.4 An overview of the economy: the circular flow of income
2.1 The production of goods
and services
Goods and serv ices are the outcome of the product .ion process. Th ey are the products t hat
satisfy our wants and needs. Goods are tangi ble th ings such as food, cars and electro n ic
equipment, whi le services are intangible acts that are of benefit to us, such as receiving
medical help or watching a movie.
A factor of production can be defined as any resource that can be used in th e production
of goods and services. A factor of production, therefore , is simply another name for a
resource. Th e quant ity and quality of an economy's factors of production (or resources)
can influence h ow wealthy or poor that country w ill be. T hus, th e peop le in a countr y
with abundant, hig h-qualit y resources wou ld be better ab le to satisfy their wanes, and
they would have a much hig her sta n dard of living, or quality of life, tha n people in a
country with fewer, poorer-quality resources.
As outlined in Chapter 1, the supply of these resources is limited . Th erefore, producers
face an opportunity cost when they are decid ing how to use resources in the production
process. Over time , th is decision can be affected by th e availability of the factors
of product ion . For example, the size and quality of the labour force may change as
educat ional standards improve, and hig her investment in plane and machin ery would lead
to an increased availab ility of capita l. Alternative ly, environm enta l damage may reduce
the quantity of natural resources that can be used in the production process .
Th ere are four factors of production in an economy : natural resources, labour, capital and
enterpr ise. Th e return (reward) to the owners of th ese resources are rent , wages, interest
and profit , resp ective ly.
RESOURCE Natura l resources Labour Cap ital Enterpr ise
Rent Wages Interest Profit
 Chapter 2: How Economies Operate I
Natural resources
N atu r al r esou r ces include all nacurally occurring materials rhat are used in the
p roduction process (sometimes also called land as shortha nd for all natu ral resources). It
in cludes items such as soil, wate r, forests, min eral depos its and fishing areas .

The reward ro the owners of natu ral resources is called re nt . Th is use of the concept of
rent goes beyond rh e idea of renti ng property. It covers all the income .rewards derived
from the p roduct ive use of natural resources.

Labour
La b ou r is human effort, both physica l and menta l, used co produce goods and services.
The supp ly of labour for p roductio n depends on a numb er of factors, and these can change
over time. Th e size of a country's popu lation is obviously impo rtant in dete rmining how
mu ch labour is available. Popu lation s ize will be influ enced by birth rate, death rare, and
imm igra tion. Othe r factors rhar influence rh e availabilit y and qua lity of .labour resources
include the school leaving age, the ret irement age, social attitudes cowards the role of
women in the workforce, the availab ilit y of child care, educationa l standa rds and the
amount of on-the-job tra in ing .

W ages are the reward co the owners of labour. Again, economises use this term in a wider
sense than irs commo n usage . As wel.l as regu lar payments for a sranda rd working week,
the term wages includes executive salaries, commissions , fees for p rofessionals and the
earni ngs of self-emp loyed people.

Capital
Cap it al is the "prod uced means of p roduct ion ." This means rhac capita l goods are nor
p roduced for immediate consumption, bur co be used in the product ion of other goods
an d services. Examp les of capital include mach inery, cools, factories and computers.
These types of capital goods are gene rally owned private ly by indiv iduals or firms.
In frastructu r e (or social overhead capital) is another form of capital char is usually
owned by rh e commu ni ty as a whole. Infrastructu re includes roads, ra.ilways, bridges,
te lecommunications networks and schoo ls. Although most of this capita l is not owned
by businesses, its existe nce is viral for them co operate - for example, good roads are
necessary for the tra nsport of goods, and a reliab le power supp ly is necessary ro operate
machi nery. It is impo rtant co note char economises' definit ion of capital does not include
financial assets such as money, shares, stocks and bonds .

Capita l equipment can greatly increase the pr oduc tivity of other resources - that is,
how much output they can produce per factor of production per unit of time. Using
cap ital goods can increase the level of production from the existi ng workforce and natura l
resources, enabling us co satisfy more wanes than would otherwise be possib le. The amount
of capital available can therefore have a sign ificant effect upon the future earning capacity
of an economy.

Fu nds become available for entrepre n eurs th rough other people's savings . Ent repre neurs
borrow money char has not been spent by consume rs (known as the ir savfogs), which can
then be used co invest in capital goods. In effect, when consumers save mon ey rather than
spend it, they are shifting resources from consumer goods co capital goods.

The owners of capita l are rewarded by earning inte rest. When ent repreneu rs borrow the
excess savings in the economy, they pay inte rest on their loans. Th is inte rest is the p rice
of capital. Alcernarively, for chose firms and entrep reneurs who invest rh eir own surplus
funds in capital equipment, rh e interest rate they could earn if rh ey simply put the funds
in a bank account represents rh e opp o rtunity cosr of investing in capital.

II
I
The Market Econ omy 2020

Enterprise
Ent erp ri se involves organ ising the othe r factors of production (natura l resources, labour
and capita l) for rh e pu rpose of producing goods and services. It is rh e vita l ingred ient
char brings the production p rocess togethe r. The entrep reneu r makes the management
decisions concern ing all aspecrs of p roduct ion and bears rh e risk chat these decisions may
nor be the correct ones. Th e right decisions will mean a successful business, the wrong
ones may result in failure.

Profit is rhe return ro enterprise. Th is is not merely revenue earned minus actua l expenses.
Entrep reneurs are ent itled to receive rent for the 111se of any land chat they own in rh e
product ion process, wages as a retu rn for th eir work effort and int erest for any capita l
invested into the bus iness. Profit is rh e income received over and above these other
rewards. It is earn ed because the entrep reneu r sees up and runs a successful business
despite the considerabl e risk of failure.

Factors of production Output

g
d
Natural

~,· ~
Capital Enterprise

Fig ure 2 .1 - Comb ining natural resources, labo ur, cap ital and enterpr ise

Each of rhe four resources is limited in its supply, reflecti ng the p ro bl em o f scar c ity
in economies:

• T here are limits to rh e amount of nacura[ resources available for production,

including land, fossil fuels or even clean air and water.
• Our supp ly of labour is limited by our population size, labour market skills and
peop le's w illingn ess ro work.
• Our supp lies of capital are limited by the exte nt ro which governments and rh e
private sector are will ing to invest, as well as rhe level of domestic (or overseas)
savings availab le for investment.
• T he supply of entrep reneuria l skills is also lim ited by rhe size of rhe populat ion and
a range of orher cultura l and economic factors, includ ing - most importa ntly - the
abilit y and will ingness of individuals to innovate and take risks.
In a marker economy, decisions about how scarce resources are allocated in production
are largely determined by consumers' spending patterns. Firms wi ll respond to consumer
dema nd by obtai n ing the resources necessary ro produce rhe items consume rs want.
Motivated by the main aim of making a profit, fi.rms pay for the resources and labour
skills that are necessary to p roduce those goods and services that are in demand. Th erefore,
efficient indust ri es chat face growi ng consumer demand and highe r prices will be able
ro attract more resou rces. Furthe rmore, chose resources that are relat ively cheaper will be
more attractive for profit-maximisi ng firms.

II
 Chapter 2: How Econom ies Operate I
Business firms can often use several different comb inati ons of resource~. Therefo re, rhe
business muse decide wh ich comb ination of resources ro use in rhe process of production.
Dependi ng on wh ich factor is used in greater proport ion, the method of product ion may
be more labour-int ensive (where more labour is used relat ive co orher factors) or more
capita l-inte nsive (where relatively more capital is used).

1 Identify the major factor of prod uct ion used in each of the followin g act ivities:
• provid ing child care
• prod uct ion of motorcyc les
• managing a small business
• emu farming.
2 Describe ONE example of a cap ital good that wo uld increase the prod uctivity
of labour.
3 Outline how the problem of scarc ity affects the supply of land and rnatural
resources in the economy.

2.2 The distribution and exchange of

goods and services
Worki ng out how co distribute what an economy produces is difficu lt . We have co srrike
a b alance that provides rewards for investment, ent repreneurs and innovatio n, as well as
ensuri ng that everyone has an accepta ble qua lity of life.

T h e coral amount of goods and services pro duced in an economy in a g iven year is known
as Gr oss D om estic P roduct , or GDP . G DP also measures the coral income of a societ y
th at is received for t he production of goods and services. O ne of the main functions of an
economic system is co determi ne how co d istribu te and exchange t he goods and services
produced in the economy. Usually thi s involves assigning each indiv idual a certain level
of income, which comma nds for him or her a certai n proportio n of the our pur produced.
Ind ividua ls can then exchange th is income with others co obtain goods and services.

Mar ker economies do not attempt co d istribute output equally withi n societ y. Instead,
marke r econom ies pr ov ide p eo pl e w ith inc o me as a reward for t heir cont ribu t ion co rhe
produc ti on process. The owners of natura l resources, capita l or ent reprene u rial skill used in
pro du ction receive income based on the value of their input. Workers are pa id accord ing
co the value of their labour. The price that is paid for inp ut s deter mi nes rhe indiv idual 's
share of coral ourpu r and will gene rally depend on how scarce or hig hly demanded t heir
resources are. Rent of land in the centre of rhe city, or the labour of a high ly sk illed
ma nager, involves a larger sum of money because city land and soph isticated manage ment
ski lls are in high demand and scarce supply.

Fig ure 2 .2 shows rhe p ropor tion of coral income (or output) for Aust ralia n households
t hat comes from labour (called compe nsation of emp loyees) compared wiith the owners of
t he othe r factors of product ion . Over ithe past rwo decades, the distr ib ut io n of out put has
been relatively stab le, wit h the share of income received as wages being higher tha n it was
in. rhe 1980s, bur lower than ir was in the 1970s . Ar the same ri me, however, wages have
shru nk as a share of rhe overall economy, wh ile corpora te pro fit s have been increased - but
t h is is a different issue ro t he sources of household income.

m
I
The Market Economy 2020

% Gross income
70
Compensation of employees
- - - - - - · Oth er income
60

50

..._____ ...... ..."

... _, .,.-------✓
40

30 ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
1975 1980 1985 1990 1995 2000 2005 2010 2015 2019
Source : ABS cat. no . 5206 .0, Table 20 Household Income Account

Figure 2.2 - Distr ibutio n of tota l gross income

In add it ion , indiv idua ls do nor all receive rhe same level of wages. Workers' incom e
levels are infl uenced by how mu ch they work, the ir ski lls and expertise, educat ional
qua lifications and th eir bargaini ng power in wage negotiations with emp loyers. How
such factors can influence the d istribution of income between workers will be discussed
in more derai l in Topic 4, in our analysis of the labou r mark et.

Th e benefit of such a sysrem of distribution is th at it provides incent ives for peop le co

obrain bett er sknlls and work harder in order ro imp rove the ir share of output, or ro develop
ent repreneu rial ski lls and scare the ir own business. T his will impro ve rh e resource base
and encourage innovation and techno logical advanceme nt .

However, the problem with this system of distribut ion is char it can be unfair, part icularly
for people who are unable co contribute co p roduct ion because of illness, age or disabili t y.
T hose with less b argaini ng power may also be unab le co secure a fair return for thei r labour
input. T herefore, governm ents may decide co int ervene ro correct inequitab le market
outcomes and he lp people who would othe rwise not receive an adequate level of income .
In th is way, gove rnm ents can influence rh e d istribution of goods and services: in effect
by taking money from hig her-income earners through taxation and redistributing it co
lower-income earn ers through social securit y payments.

Individuals and businesses ge nerally use money as a m ed ium for ex c hang ing goo d s and
se rvices. T his makes ir easier for peop le ro conduce transactions when only one party is
int erested in what the other has co offer. In other words, the existence of money as t he
basis of exchange allows individuals co specialise in how they contribute co rhe product ion
process. Even local services such as babysitting, clean ing and home repairs are genera lly
paid for in cash rather than by the exchange of anothe r good or service. How ever, this form
of exchange can occur. Th e non-cash exchange of goods and services is known as ba r te r .
Barter ing was commo n in earl ier societies, but is rare in an advanced economy with. a
srab le currency. Nevertheless , in recent years there has been a small resurge nce of bartering
th rough rhe emerge nce of bartering cooperative g roups such as the Barrer Swap Austra lia
business. Th e Austra lian Tax Office gui delines nore that barter transactions are subject co
the same tax assessment rules as if you used cash or a cred it transaction; for example, you
may srill be liab le for GST or income tax if you were pa id in goods (inst ead of money).
Addir ionally, the emergence of new forms of currency such as the d igita l payme nt system
Bircoin has crea.ted new forms of non-cash exchange.

m
 Chapter 2: How Econom ies Operate I

1 Explain how the distribution of income in an eco nomy may influence the
distribut ion of outp ut.
2 Outline the role of factors of prod uction in the distribut ion of income .
3 Identify ONE disadvantage of a [b arter economy.

2.3 The business cycle

O n the basis of our discussion so far, we might assume that econom ies g row and change
The businesscyclerefers
in. a stab le pattern. In reality, th e level of economic activ ity - th e amount of goods and to fluctu ations in the level
services p roduced in a give n period o f tim e - is never constant. Mark et economies such of economic growth due
as Australia 's are su bject to a cycle of ups and downs known as the business cycl e (also to either do mesti c or
somet im es called the economic cycle) . Thi s is shown below in figure 2.3 . international factor s.

% GDP
6
5
4
3
2
1
0
-1
-2
-3
.,..
I{) r-,.. a,
m C') I{) r-,.. a, C') I{) r-,.. a, .,.. C') r-,.. co a,

~
C')
a, a, , cp
~0 ~0 :%
(0 (0 (0
(0

C\I
(0
I I
<:t
(0
co co co a,
I
co 0
I
C\I
a,
I I
a,
1
(O •
a, ,
I
co
a, 0 0
9
0 .,.. ~
co 6 .,..
"i II
(0 r-,.. co
.,.. .,...,..
a, a,
.,.. .,.. a,
.,.. a,
.,.. a,
.,.. a, .,.. a,
.,.. a, .,.., a,
.,.. 0
C\I
0
N
0
N
0
N
0
N
0
C\I
0
N
0
N
00
NN
Source: ABS cat. no. 5206.0

Figu re 2.3 - Australia's economic growt h performance

Over tim e, econom ies usually exper ience an overall trend of grow th in their output.
Ho wever, th ey are subj ect to a continuin g pattern where a period of st rong g rowth is
followed by an econom ic slowdown, in which th e level of economic activity often falls.
T h e economy may th en stay weak for some period of tim e before recoveri ng, gradually
achieving a faster level of economic growt h, peaking and th en slowing again. Although
Recession is the stage
th e performa nce of economies is rarely exactly the same as this mod el of the bus iness cycle,
of the busi ness cycle
in. broad terms the cyclical patt ern of grow th recurs in mark et economies. w here there is decrea sing
economic activity, defined
T h e cyclical patte rn of economic activity presents problems for a society. Cyclical as two consecu ti ve
flows cause sig nificant d isrupt ions for both individua ls and businesses. Durin g periods quarters (six mont hs) of
of econom ic downturn, known as rece ss ion s, firms usually postpone plans for new negative economic growth,
in.vestment , reduce their production and reduce th eir demand for labou r. As a result, that is, a fall in GD P.
emp loyment falls and many people can become unemp loyed.

II
I
The Market Econo my 2020

T he increase in unemp loyment has negat ive effects for consume rs. Fam ilies are forced to
rely on their savings and social securi t y pay ments ro meet expenses whi le th eir normal
sources of income have dri ed up. As those who have become unemployed reduce their
consumptio n, th e economy can contract further and more peop le may be put our of work.
As un emp loyment rises, more peop le fall below che poverty line. As living standa rds
fall, health pro b lems can rise, edu cationa l opporcuni ries may be disrup ted and social
prob lems such as cri me and suicide can increase. Togeth er, th ese effects will resul t in a
lower quali ty o f life .

Duri ng an economic uptu rn , rhe opposite is rh e case. A boo m in economic growt h is

associated wit h increased investm ent and p rodu ction . T his increases de mand for labour and
leads ro fall ing u nemp loyment levels. Th erefore, an econom ic uptu rn rends ro increase rhe
disposable incom e availab le ro mosr consumers, which may lead ro a furth er expansion of
the economy as consumption levels rise. An improve ment in qua lit y of life occurs du ri ng
an uptu rn as pove rty levels fall.

IMPACTS OF THE BUSINESS CYCLE

Recession Boom
Falling product ion of goods Increasing production of goods and
and services services
Falling levels of consumption Rising levels of consumpt ion
and investment and investment
Rising unemployment Falling unemployment
Falling income levels Rising income levels
Falling quality of life Rising quality of life

Because a p rolonged downt urn in the busi ness cycle can have such negative effects, one of
rhe main econom ic aims of gove rnment s is ro smoot h out rhe cycle. Gove rnm ent s step in
to st imulate economic growt h during periods of recession to restore the economy ro growt h
and improve emp loyment opportu niti es. In the longer term, gove rnm ent s also attempt
ro ensure tha t rhe economy can sustai n econom ic growt h for a longe r period of ti me to
avoid any major econom ic dow ntu rn . W hen the g lo bal financial crisis erup ted in 2008, it
provoked extens.ive debate about how governm ent s should respond ro the downtu rn in th e
global busi ness cycle. Around rh e world, governm ents made very large interve nti ons in
their econom ies to fig ht rhe threat of an extremely· severe recession . Th ese interventions
were generally regarded as successful in preventing a much deeper recession tha n what
occurred. In Aust ralia's case, a recession was avoided altogethe r. Figu re 2.3 shows tha t in
2019 Austral ia achieved its 28th year of consecuti ve economic g rowth, having avoided a
recession since 1991.

1 Outl ine the effect of a recessio n on each the follow ing:

• payme nts of unemp loyme nt benefits
• business investment plans
• income levels.
2 Identify the year in which the last recession occurred in the Austral ian economy.
3 Describe the economic effects of a boom in the business cycle.

m
 Chapter 2: How Economies Operate I
2.4 An overview of the economy : the
circular flow of income
Economists sometimes bui ld theorecical models t hat can help to describe features of
econom ic act ivity. An example of this is the five-sec to r ci rcu lar fl ow o f in co me m ode l,
wh ich descri bes the operat ion of the economy and the linkages between che main sectors
in. the economy.

T h e circular flow of income mode l is based on div idi ng t he economy inro five sectors, as
shown in figure 2.4 . A sector may be defined as a part of t he economy where t he participants
are engaged in a sim ilar type of economic activity. We can d ivide t he Austra lian economy
in.co five such sectors - ind iv id u als , bu sin esses, finan cial in st itu t ion s, g ov ern ment s
and int erna t io na l t r ade an d fin an c ial flow s.

•@\l@j8◄·················· Income rewards ·········

········
······•
•a\'hj•jffifj

Financial insitutions

i L.....T="".........
..► Governments ............
' '"'"'""~.......
L ............. Imports •····► International flows Export s .................;

Leakages Injections

Figure 2 .4 - The five-sector circ ular flow of income model

Individuals
T h is sector consist s of all individua ls in the economy. It is concern ed wit h their activities
in. earn ing an income and spend ing it on goods and services. T hese ind ividuals are t he
ow ners of prod uctive resources and the consumers in our economy.

Ind ividuals supp ly factors of prod u ction (inp ut s) such as labour and ent erprise to
busi nesses, wh ich t hey use to pro duce goods and services. As a reward for supp lying
resources such as labour and enterp rise to firms, ind ividuals receive incom es in rhe form
of rent, wages, int erest and profit.

Ind ividuals' income goes eithe r to spend ing on consu mptio n of locally pro du ced goods,
savings, paying tax or pu rchasing imp orts .

Businesses
T h is sector consists of all the business firms engaged in the prod uction a nd sale of goods
and services (apart from financial services, wh ich are included in the financial sector). It
concerns all their act ivities involved wit h buying factors of prod uction, and using them
to pro duce and sell goods and services.

II
I
The Market Economy 2020

Businesses depe nd on indiv idua ls to supply the resources needed for rh e producr ion
process, as well as rhe consumption of goods and services produced. Without individua ls,
businesses would not exist. Simi larly, indiv idua ls d epend on businesses ro produce rhe
goods and services that they demand , as well as prov ide rh e income ro buy chem. W irhour
businesses, indiv idua ls wou ld find it difficu lt ro surv ive. In othe r words, ind ividuals and
businesses need each other - th ey are inte rdepende nt .

It is important ro nore chat the circula r flow d iagram depicts the flow of money
betwee n indi viduals and bus inesses, rather than rhe flow of goods and services or
factors of production.

Financial institutions
T his sector consists of all those institut ions that are engaged in the borrowing and lending
of money. T hey act as rh e intermediaries between savers and borrowers of money. It
includ es organis.arions such as banks, bui lding societies, finance compa n ies, credit unions,
supera nn uation funds and life insurance compa nies.

Financial inst itutions are needed for individuals and firms to be able ro unde rtake saving
and investment. Financial inst itutions (somet imes a lso known as rh e capital ma rk et ) are
rhe third sector in our economy. T his sector is made up of all the financial intermediaries
chat accept savings (deposits) from individuals and lend chem out ro businesses for
investment purposes. Th erefore, rhe financial institutions perform rh e function of
mob ilising savings so chat they can be used for investment.
Leakages are the items
that remove money Sav ings represents a leak age from the circular flow, as savings involves money that is put
from the circular flow aside and withdrawn from the circular flow of income. Th is leakage leads to a reduction
of income, decreasing
in the size of the circular flow of income, wh ich a lso means a reduction in the level of
aggregate income and the
general level of econom ic
economic activit y. When individuals decide to save part of their income, this upsets rhe scare
activity. The three of equ ilibrium in the economy, and as a result rhe level of economic activity will change.
leakages are savings,
taxation and imports. Th e following examp le, based on figure 2.5, demonsrrares the effect of savings on the size
of the circular flow of income:

Value of Household Household Household

Year
output Sm income Sm expenditure $m savings Sm
1 1000 1000 1000 0
2 1000 1000 900 100
3 900 900 810 90
4 810 810 729 81
5 729 729 656 .1 72.9
Fig ure 2 .5 - The effect of savings on the size of the circular flow

• Year 1: Firms p roduce $1000 million worth of outp ut , wh ich gene rates $1000 mill ion
income to individuals , which they spend on consumer goods. Because at this
stage th ey save nothing, the value of output generated in rh e next rime period
(year 2) remains rh e same at $1000 mill ion .
• Year 2: Firms have produced $1000 mill ion worth of ourpur, which generates $1000
mill ion income ro indiv iduals . T his year, however, and in each subseque nt year,
indiv iduals decide ro save 10 per cent of their income. Th erefore, expenditu re
drops ro $900 million, and we have $100 mill ion of savings.
• Year 3: Because of reduced expenditu re caused by indiv idua ls saving part of their
income, firms cut back on production. Th e value of producrion in year 3 is now
$900 mill ion . Th is fall in production means that firms demand fewer resources
(for example fewer workers wi ll be emp loyed) and individua ls receive less

II
 Chapter 2: How Economies Operate I
income (income will drop co $900 million). As ind ividuals save 10 per cent of
this, expenditure will come down to $810 million and savings. to $90 mi llion.
Inject ions into the circular
T h is same scenario is repeated in subsequent years, with the leakage of savings causing a flow model of inco me
fa[l in expenditure on goods and services, a fall in production, a fall in the dema nd for are those flows of money
resources and a fall in income to the owners of chose resources. Left to itse lf, the leakage that increase aggregate
of savings will prog ressively reduce the size of the circular flow of in come (level of income and the general
level of econom ic activity.
economic act ivity) until it ceases co exist. In othe r words, our economy wou ld be faced
The th ree injectio ns are
wi th a cycle of falling expenditu re, falling p roduct ion , fall ing income and rising investment , govern ment
unemp loyment unt il it eventually collapsed . In order co stop this from happeni ng the re spending and exports.
muse be something to counteract the leakage of savings , namely an injec ti on of
in vestme nt (see figure 2.6) .
Increased investme nt
In fact, savings are essential if investment is co occur, allow ing the creation of new
capita l goods. The acts of saving and investing are vita l for the growt h and prosperity
of our economy. By forgoing some cur:rent consumpt ion of goods and services, we can Increased product ion
in vest in capita l goods and improve che future productive capacit y of the economy. of cap ital goods
T h is actua lly increases our stock of p roduct ive resources (capital being one of the
four factors of production) and allows us co p roduce an even greater volume of goods
Increased demand
and services in the futu re. for resources

I nvestment is defined as any cur rent expenditure chat is made in orde r to obtai n t
benefits in the future. For examp le, the pu rchase of new capital goods, such as Increased +-- Increased
machinery, by businesses is investment - firms muse make a capital expend iture demand for incomes
goods and
now in order co ga in profits in the future from the output the machine will help co
services
produce. Investment represents an inject ion into the circula r flow and , as such , has
t he opposite effect to a leakage - increasing the size of the circular flow of income Figure 2.6 - The effects of increasing
(and therefore increasing the level of economic activ it y). investment

When firms undertake investment expenditu re they increase the demand for capita l goods .
T h is stimulates p roduct ion in the firm s that produce them, who in tu rn demand more
resources. As more resources are employed, individuals' incomes wi ll increase, stimulating
a further increase in the demand for consume r goods and services, whic h in turn means
even more resources will be employed, and higher incomes generated . In other words,
spe nding on investment wou ld lead co rising expenditure, production, employment and
in come levels in the economy.

Overall, individua ls, businesses and financia l inst itutions together make up the private
sec to r in our economy.

Governments
In Austra lia, the government sector consists of the three levels of government -
Commonwea lth, state and local. Th e government sector helps co satisfy collective
(community) wanes such as roads, rai[ways, schools, hospita ls and defence. It obta ins th e
resources to do this by imposing raxe-son the othe r sectors in the economy.

T h e government p lays two major roles in th e circular flow of income. Firstly , it imposes
ca,ces on ind ividuals and businesses, and second ly, it uses this tax revenu e co undertak e
various government expenditures .

Taxation represents a leakage from the circular flow. When ind ividuals pay income tax,
t h is reduces the amount of money they have co spend on goods and services. Sim ilarly,
wh en the government taxes busi nesses, it reduces the funds availab le co pay for resources.
T h erefore, taxation wou ld cause a reduction in the level of economic activ it y, with falling
in come, output and emp loyment opportun iti es.

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I
The Market Economy 2020

For simpl icity, the leakage of taxation is shown in figure 2.4 as coming only from
indi viduals, even though the government does tax b usinesses as well. The reason for this
is that the ma jority of tax revenue comes from ind i.viduals.

Govern ment exp end itu re represent s an injection imo the circu lar flow for two reasons .
Firstl y, when the government spends revenue on collective goods and services, it p rovides
income to govern ment emp loyees, and emp loyees of the private busi nesses from which
it pu rchases goods and services. Secondly, the government uses part of its tax revenue to
make transfer payments such as pensions and un employment benefits , wh ich represent s
income to the recip ient s. Therefore , government expend iture wou ld cause an increase in
the level of econom ic activ ity, with rising income, out put and employment oppo rtunities.

This sector is al.so referred to as the p ub lic sec to r , and together with the private sector,
it makes up the do me sti c secto r in our economy.

International trade and financial flows

This sector covers all transactions that our economy has with the rest of the world . T hese
transactions include e xp ort s (goods and services produce d in Austra lia and sold overseas),
im po rts (goods and services produce d overseas and sold in Austra lia) and internati ona l
m on ey fl ows (financial transactions such as borrowing , lendi ng and income payme nt s
between Austra [ia and the rest of the world).

The internat ion.al trade and financial flows sector shows flows into our economy as an
injection , whi le any outwa rd money flow is regard ed as a leakage. In order to keep our
circu lar flow diagram simple , we on ly include impo rts and exports in relat ion to t he
int ernationa l sector , even though we do experience other internationa l money flows such
as borrowing, lending and income movements. Any other international money flows into
Austra lia can be regarded as having the same effect' as receipts for exports, and any ot her
money flows out, having the same effect as payments for imports.

Imp o rt s are goods and services produced overseas but sold in Australia. Payment s for
impo rts are regarded as a leakage from the circu lar fl ow because money is withdrawn from
the Austra lian e-conomy and paid to bus inesses overseas. Similarly, any other money flows
our of Aust ralia, such as lendi ng , or paying income overseas, wou ld constitute leakages
from our circula r flow.

Like all leakages , imports reduce the size of the circular flow, causing a decrease in t he
level of econom ic activ ity, with fall ing income, output , and emp loyment oppo rtu n ities .

Expo rts are good s and services produced in Austra lia but sold to overseas custome rs.
Payments for exports are regarded as an injection into the circular flow, because money
is paid to Austra lian businesses by consumers in ot her countries . This inflow of income
st imu lates product ion and emp loyment opportun it ies in Austra lia. Simi larly, any other
inflow of money from overseas, such as foreig ners lend ing or paying income to Austral ians,
would constitute an injection into our circular flow.

Like all inject ion s, exports increase the size of the ci.rcu lar flow, causing an increase in t he
level of econom ic activ ity, with rising income, output and emp loyment opportun it ies.

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 Chapter 2: How Economies Operate I
Equilibrium Equilibrium occurs in the
circular flowof income
Eq u ilibrium occurs in rhe circular flow of income when rhe sum of all rhe leakages is equa l
when the sum of allthe
co rhe sum of all rhe injections roa n economy (see figure 2 .7). T here are th ree leakages: leakages is equal to the
savings , taxatio n and imports, and th ree injections: investment, governme nt spending sum of allthe injections in
and exports. an economy.
D isequ ilibr iu m occurs when there is an inequa lity between coral leakages and roral
in ject ions in an economy. The economy tends co move cowards equ ilibr ium , and as this
process occurs , the re will be a change in the level of income. The possible outcomes are
summarised as follows:

• Whe never coral leakages are greater than rota ! inj ecti o ns there will be a downturn
in rhe level of econom ic activity , with falling incomes , fall ing production and rising
unemployment. In the circu lar flow model, as the level of econom ic activ ity falls,
roral leakages from rhe economy will also fall as consume rs have less. income ro save,
ro spend on imports or ro have co llected as raxes. T herefore , leakages and injections
will eventually be equa l and the economy will again be restored co equ ilibrium , but
at a lower level of income in rhe circular flow.
• Whenever rota! inj ect ions are greate r than coca! leakages there will be an uptu rn in
the level of econom ic activity, wirh The circular flow of income will
rising incomes, rising production be in equilibrium when:
and rising employment. In rhe
circular flow mode l, as rhe level of Savings Investment
economic activity increases, coca! + Taxation =+ Gov ernment expenditure
leakages from rhe economy will + Imports + Exports
also increase, as consumers have
more income ro save, co spend on
imports or co have collected as taxes.
Therefore, leakages and injectio ns
( Leakages ) =(Injections)

will eventually be equal and the Figure 2.7 - Equilibrium

economy will again be restored ro
equi librium, but at a highe r level of income in rhe circular flow.
T h e government can have a sign ificant influe nce on the circular flow in rhar it can change
t he levels of taxation and government revenue, and therefo re man ipulate rhe size of roral
lea kages and injections and rhe overall level of economic act ivity. In so doing , it is possib le
for the government co offset any undesirab le outcome from the inequality of savings and
in.vestment or internationa l trade and financial flows . It can srimu lare t he economy by
increasing injections in relat ion co leakages, or dampen the economy by increasing leakages
in. relat ion co injections.

1 Explain how a high level of savings in an economy might reduce economic

act ivity.
2 Assume that the Aust ralian econo my has a low level of savings and a high
level of invest ment. Outline TWO ways in which th e economy might remain in
equilibrium (without changing the levels of saving or investm ent).
3 A hypothetical economy contin ually experiences an excess of import spending
over the sale of its exports. Describe the effect on the level of economic
act ivity in this economy.
4 Explain how changes in the circular flow of inco me w ill lead to fluctua tions in
th e business cycle.

II
The Market Economy 2020

1 Business firms comb ine the factors of production to prod uce goods and
services. Goods are tangib le items for consumpt ion, whereas services are
intangible acts that are of benefit to consumers.

2 The four main factors of product ion are:

• natural resources or land, which earn rent
• labour ., which earns wages
• capital , which earns interest
• enterprise , which earns profit .

3 Market economies distribute goods and services based on the individual's

contr ibution to the product ion process: the larger the contr ibution, the greater
amount of output received.

4 Modern mar'ket econom ies use money to exchange goods and services between
people. Non-cash exchange can also take place , where a good or service is
directly traded for another good or service. This transact ion is called bartering .

5 Market economies are subject to recurring fluct uations in the level of economic
activity, known as the business cycle , which affects income levels, emp loyment
opport unities and quality of life in an economy. Despite this cycle, the overall
trend over time in an economy is generally towards increased outp ut.

6 The circular flow of income model is a the oretical model that describes the
operation of the economy and linkages between the main sectors in
the economy .

7 The five sectors in the circular flow of income model are:

• individuals
• businesses
• financia l institutions
• governments
• internat ional trade and financial flows .

8 The private sector consists of individuals, businesses and financial institut ions.
The government sector represents the public sector in our economy, and
comb ined w ith the private sector, makes up the domestic sector .

9 Leakages represent all the outflows from the economy (savings, taxation
and imports) and injections represent all the inflows into the economy
(investment, government spending and exports) . When the sum of all the leakages
in our economy is equal to the sum of all the inj ections, we say that the economy
is in equilibrium .

10 Whenever there is disequilibrium there will be a change in the level of economic

activity. It w i II increase when injections exceed leakages and decrease when
leakages exceed injections . Therefore, by altering its contribution to leakages
and injections , the government has a large degree of influence over the level of
economic activ ity.

II
 Chapter 2: How Econom ies Operate

•
-- - --- -- ~~ ~::..:=-..a
rev1ew
1 Explain the econom ic meaning of the fo llowing terms:
a) natural resources
b) labour
c) capital
d) enterprise.

2 Briefly describe how goods and services are distributed in a market economy .

3 Define the term business cycle , and explain the impact of changes in the
business cycle on output, emp loyment and quality of life in the economy .

4 Identify whether the fo llowing flows are leakages or injections :

a) imports d) taxation
b) government expenditure e) exports
c) savings t) investment.

5 Explain what is meant by financial institutions . Outline their role and give THREE
examples of such institutions.

6 Outline the relationship between savings and investment and discuss why they
are important for the future growth prospects of the economy.

7 Based on the circular flow model, explain what the government would do if it
believed that:
a) economic activity was too low
b) economic activity was too lhigh.

8 Apart from receipts for exports, identify what other money flows into Australia
would also be regarded as inject ions.

9 Identify what is meant by equilibrium .

10 Explain the effect on the circular flow of income when:

a) total leakages exceed total injections
b) total injections exceed tota l leakages.

Extended response
Using a diagram, outline the main f eatures of the five-sector circular flow of income
model of the Australian economy . Exp lain how leakages and injections influence the
level of economic activ ity. Examine how the government can influence the level of
economic activ ity.

II
 How Economies
Differ

3.1 The market economy

3.2 Australia: a market economy w ith a role for government
3.3 Compar ing econom ies

3.1 The market economy

In a pure mark e t eco n om y, all major economic decis ions are made by ind ividuals and
priva te firms m ocivared by self-interest . Unde r th is system , most econom ic resources are
owned by the private sector, and peop le are able co seek wealth wirhouc rhe governme.nc
interve ni ng or affecting t heir business acriviries. Ot her names used co describe t his system
are capiral isr, free ente rprise and laissez-faire.
T he market economy is often cont rasred co a c e ntra lly planned economy. Under a
cent rally p lann ed system, govern ment p lan ners ma ke econom ic decis ions, and there is
liccle scope for ind ividual choice co influe nce rhe economy . Pub lic ownership of facrors
of production a llows the govern ment ro allocate resources as ic sees fir . In the past,
Russia, Easte rn Europe and Chi na followed rh e pla nn ed economy model, but ic is no
longe r pursued by any ma jor economy.
It is impo rtant ro nore rhac just as no fully planne d economy exists , th ere is no examp le
of a pu re market economy in the world today. Proba bly the closest examp le is found in
eighteenth- and early nineceenth-cenrury Eng land , when there was an almost complete
absence of gove rnm ent int ervention in economic activ it y. Th is is known as the laissez-
faire approach (wh ich can be tra nslate d as "Jee th ings be"). Th e main weakn ess of th is
system was rhar ic allowed some people (th ose wh o owned and cont rolled rh e means of
pro duction) ro become extre mely wealthy, wh ile rh e majorit y were exploited and had
very few opporruni ries co gee out of poverty . l e was also vulnerable co a volatile cycle
of boom and bust. T hese obvious faults led co modificat ions co rhe laissez-faire system ,
with gove rnme nt s p laying a greater role in econom ic decision making with out goi ng as
far as cent ral p lann ing.

Characteristics of a market economy

The market system

Product market is the A market is a n etwor k of buyers and sellers seeking ro exchange a par ticular pro du ct
interaction of demand for ac a certain price . In a free-marker economy, the re are markers for all the goods and
and sup ply of the outputs services prod uced, as well as for rhe resources chat p roduce rhem .
of production , that is,
goods and services . In rhe mar kers for goods and services, known as p roduce marke t s, the buyers are t he
consumers, and they conscicure rhe dema nd for p roduc es. Th e sellers are rhe businesses,
and their output decisions make up rhe supp ly of prod uces. Price becomes very imporra.nc
 Chapter 3: How Econo mies Differ I
here because it will affect rhe level of consume r dema nd as well as supply by rh e businesses.
Consumers want ro buy at rhe lowest possible price so that they can sat isfy more of their
wants, whereas firms want ro sell at t he highest possible price so that rhey make as much
profit as possible. In the marker economy it is th is market, or price mechani sm, char brings
supp ly and demand rogerher to dete r mine rhe price for each good and service (the price
at wh ich goods and services are actually bought and sold).
We can illusrrare the p ri ce mec h an ism with the following example. Because of
Price mechani sm is
unexpected ly sunn y weather, the demand for sung lasses increases. This wi ll force up the
the process by wh ich
price of sung lasses as consume rs compete ro buy rh e limited srock. Because they can now the forces of supply
sell th eir product at a highe r price, manufacture rs of sunglasses will be encouraged to and demand inte ract to
produce more . This shows how rh e price mechanism conveys the wishes of consumers (in determine th e marke t
t h is case ro produce more sunglasses) to the producers th rough a movem ent in price. A price at which goo ds and
dec rease in rh e dema nd for sunglasses wou ld have the oppos ite effect. Ir wou ld lead to a services are sold , as well
as the quantity produced.
lowering of rh eir p rice, and th erefore a fall in the production of sunglasses.
Changes in demand and supply in the product market wi ll also influence supp ly and
Factor market is a
demand in rh e fac to r ma rket, wh ich is rhe marker for factors of product ion . For example,
market fo r any input
g iven the increased consume r demand for sunglasses, produce rs will need extra factors of
into the producti on
production ro increase supply (inputs such as plast ics, meta ls and skilled labour). In order process, including natural
to attract resources away from orher areas of production, rh e manufactu rer will have ro resources, labou r, capital
offer highe r prices for them (for insta nce, offer highe r wages ro labour). In th is way the and enterprise.
price mechanism also influences the way in which resources are allocated in the economy.

Private ownership of property

Individua ls have the right to own the means of production (or resources) and can use these
to der ive income and acqu ire wealth . They also have the right ro sell t h eir p roperty or
transfer ownership to someone else under whateve r cond it ions rh ey choose.

Consumer sovereignty
Consumer sovereignty
Consumers play a very important role in the market economy. They are free ro choose refers to the manner
how rh ey will spend the ir income in order ro satisfy their wants. T herefore, consumers in which consum ers,
through market demand,
wi ll ultimately decide what goods and services will be produced by exercising their
collectively determine
freedom to choose which wants they will satisfy. Businesses will produce whateve r goods what is produced and the
and services are in demand. This con cept is known as co n su me r sove r e ig n ry, because quant ity of prod uction.
consumers determ ine rhe answer ro the quest ion of what ro produce and how much should
be produced.

Freedom of enterprise
In dividua ls have rhe right to use rh eir resources as rhey choose. This means that
ent repren eurs are free to set up profit-making acriviries and
have the right ro determin e what goods and services they
produce and how they will unde rtake char production.
Workers are free to choose their occupat ions or, for
th at matte r, whether they work or nor.

Competition
Compet itio n is the force that allows rhe pr ice
mecha n ism to work effect ively. Competit ion
means ther e are large numbers of buyers and
sellers . T his ensu res char no single buy er or seller is
big enough on irs own ro influence the mark et pr ice
so as to have an advantage (or g reater bargaini ng

II
I
The Market Econo my 2020

power) over the other players. In a pure free-market economy, a large num ber of produce rs
Competition is the
compe te wit h each othe r in every industry. In a less competitive market, it is possib le for
pressure on business
firms in a market a few large businesses charging higher prices to make excessive profits ar the expense of
economy to lower prices rhe consumer .
or improve the quality
of output to increase
their sales of goods and
services to consumers.
1 Identify TH REE examples of product markets in the Australian econom y.
2 Predict the likely change in the price of cinema tic kets in the fo llowing
situations:
• an increase in the number of people watching movies
• a decrease in the price of online movie down loads
• an increase in the number of cinemas in Australia.
3 Discuss the benefits of competition for consume rs.

3.2 Australia: a market economy with a

role for government
No economy in rhe world today is purely marker based, or rotally planned . Instead,
all economies co nta in elements of both economic systems. Th ey are the refore referred
to as mixed economies. We can define a mixed economy as one where rh e decisions
concerning production and d istribution are made by a comb ination of mark er forces and
government decisions. Each country attempts to find the best mix of relying on marker
A mixed economy is
an economic system forces and gove rnment intervent ion in attempting ro solve rhe economic problem . Since
where the decisions rhe 1980s, there has been a clear trend among mix ed economies away from government
concerning production intervention and cowards relying on market forces, although the g lobal financial crisis of
and distributionare made rhe late 2000s p rompted a level of governm ent intervention in the finan cial system char
by a combination of
few countries had seen before.
market forces and
government decisions. We can use the examp le of Australia as a mixed economy ro see why rh e governme.nr
chooses ro interve ne in rh e free operation of marke t forces.
Firstly, rh e government intervenes in production because the free market does nor always
prov ide rhe mosr efficient alloca t ion o f re so urce s for the economy as a whole. Th ere
are thr ee consid erations here:
• Some necessary goods and services may not be provided unde r a pu re marker system.
For examp le, Australia has hisrorically had a government-owned and operat ed
railway system. Government int ervention was necessary because when the system was
estab lished, no private ent erpr ise was willing and ab le to prov ide the huge capical
outlay, or undertake rhe risk of providi ng such a facility. Th e private sector will often
nor provide collective goods and services, such as parks, roads or national defence.
Governments provide those goods that are beneficial to rhe whole com munit y and
for wh ich it would nor be pract ical ro charge on an indi vidua l basis.
• It is sometimes bette r for essential goods and services ro be provided by govern ment,
rather rhan being left to private individua ls. For example, for reasons of security an d
int ernal stabi lity, ir is safer ro have a defence force in rh e hand s of rh e governme.nr
than to have a system of p rivate armies.
• Markers do not always operate freely, competitive ly or in rh e best interests of t he
economy as a whole. Th e gove rnment prov ides regulations ro prevent produce rs
from exploiting consumers with mis leading .information or by agreeing with their

II
 Chapter 3: How Economies Differ I
competitors co raise prices . Th e governm ent may also legislate co ban the production
of undes irable goods and services (for examp le, illicit drugs or internet ga mblin g)
and ensure adequate safety standards for all produces sold on rh e market .
Second ly, the gove rnm ent interve nes in the di str ibuti o n of output (income) because rh e
free mark et will not necessarily provide a socially desirable or fair distr ibut ion . This is
done in two ways:
• Social we lfare payments: U nd er the price mechanism alone, there wou ld be
no income earned by chose who did not contribut e ro the production process. In
othe r words, there would be n o prov ision mad e for the elde rly, t he unemp loyed
or the chronica lly sick . In Australia , rh e governm ent overrid es the mark er forces
and redis rribur es income by taxing peop le on higher incomes more heavily, and by
makin g social welfare payme nt s ro rh e members of society who do not cont ribute
to th e p roduc tion process. Examples of social welfare payments includ e disabi lity
pensions, age pensions and unemp loyment benefits.
• Pr ogressive income tax: Th e governm ent also causes an overall redistribution
of income in order ro achieve a more equitab le (even) shari ng of produced
ourpu r. Ir does this through che use of a progressive income tax system. Und er
such a system , high-income earners are taxed at hig her margi nal races and pay
propo rrionarely more tax rhan low-income earners.
Finall y, as we saw in Chapte r 2, rh e mark er economy is subjec t ro the flu ctuations of
th e business cycle. Governm ents ofte n int ervene throu g h the imp lemencati on of macro-
economic (counter-cycl ical) policies in order ro smooch the effect s of the cycle and reduce
th e proble ms of insufficient or excessive economic activity. Governm encs also intervene
dur ing tim es where th ere is a th reat of major economic or financial problems, such as when
th e credit crisis in 2008 brought the g lobal finan cial system close to cornapse.

WHY GOVERNMENTS INTERVENE IN THE MARKET ECONOMY

Resource allocatio n • to provide important goods and services that would not
otherwise be provided by the private secto r
• to restrict product ion of harmful goods
Income distr ibution • to create a fairer society and look after people
Economic stability • to smooth out sharp fluctuat ions in the econom ic cyc le
• to ensure stability in the economy and the financial system

• Private prope • Public ownership

• Free enterprise • Regulation
• Social welfare payments
• Progressive taxation

Australia's
ed econo((''i
tniJC

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I
The Market Econ omy 2020

How the mixed economy aims to solve the economic

problem
In a mixed economy like Austral ia's, th e answers to rh e four important questions - what
ro produce, how much to produce, how ro produce, and how p roduct ion will be shared -
are primari ly dete rmined by the operation of markers. However, governments int ervene
to a limited extent ro modify certa in mark et outcomes. Th e government can interve ne in
marker outcomes in several ways.

What to produce?
T he g overnmernr can influe nce what is produced in many ways. The government can be a
produce r itself. Ir can prov ide collective goods and services such as schools, roads, bridges
and a defence force, as well as competing di rectly with p rivate enterprise and p rovid ing
certa in consumer goods and services (for exampl e, ABC te levision and radio services). Ir
can encourage some forms of p roduct ion th rough subsidies, tax incentives or start-up
funding. It can also limit, or even p rohib it, rh e production of goods chat it conside rs
undes irable , such as illicit drugs .

How much to produce?

Governments can influe nce the scale of p roduct ion in many ways. The governme nt can
limit the production of some goods or delivery of some services. For examp le, state
governments reg ulate rhe numbe r of taxi licenses tihar are issued ro taxi drivers, in order
ro ensure rhe safe and reliable transpo rt services and viability for business operato rs,
Merit goods are goods although this is. being challenged by the g rowth of competitive ride sharing companies
and services that are not such as Uber, O la and Bolt. Governme nt s can also encourage greate r provision of certa.in
producedin sufficient goods and services that are desirable, but would otherwise be under-provided. These are
quantity by the private somet imes refer.red to as m er it goo d s, and examp les of government po licies ro p romote
sector because individuals
the ir production include government subsid ies for che arts (th eatre, opera, film, fine art s)
do not place sufficient
value on th em.
as well as for edu cation and renewab le energy. Th e government can encourage Australian
produce rs competing with foreigners ro increase output by impos ing protectionist trade
po licies, including import restrictions and taxes on goods and services ente ri ng Austral ia,
or by granti ng subsid ies (cash payments or lower taxes) ro Austra lian p roducers.

How to produce?
T he government can influence the cost of factors of p roduction and how those factors are
used in rh e product ion p rocess. For examp le, industrial relatio ns laws provide a framewo.rk
for setting min imum wage levels and work ing conditions in d ifferent industries,
influen cing labou r coses. Furth ermore , laws chat regu late the behaviour of firms , such as
safety rules, environmenta l controls and the prohib it ion of child labour, wi ll mean that
firms will not always be able to choose the cheapest method of production.

How to distribute production?

Many government pol icies affect how p roduct ion is dist ri but ed throughout societ y.
Highe r-income earners pay more of th eir incom e in tax, and th is mon ey is redistributed
ro lower-incom e earners th rough welfare. T his changes the dist ribut ion of production
chat would p revail if incom es were determ ined ent irely by mark et forces and the price
mechanism. In add it ion, the government may intervene in factor markers for redistribut ion
purposes; for example, by imposi ng a minimum wage in rh e labour market .

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 Chapter 3: How Econo mies Differ I
INTERVENTION OR INTERFERENCE?
The role of government in the economy is hotly debated . If you listen to the language of
peop le opposed to the government, you may hear government intervention described as
bureauc ratic interference , a red tape nightmare and socialism. On the other hand, those
who support the role of government may speak of giving people a fair go , decent minimum
standards , basic rights and the need to protect individuals from the dog eat dog brutality
of unchecked market forces . This language reflects the very different perspect ives that
different people and groups bring to the debate on what role governments should play
in a market economy.

1 Ident ify FOUR examples of governme nt intervention in a mixed eco nomy.

2 Define the term merit good, and identify TWO examp les of a merit good of
w hic h the government may enco urage prod uct ion.
3 Outline how the government might interve ne if large compa nies engaged in
misleading advert ising.

3.3 Comparing economies

To unde rsta nd how t he Austra lian economy operates and how well it has perform ed, we
need to compare it wit h othe r econom ies. Traditio nally, Aust ralia has been compa red with
ot her advanced indu strialised econom ies in Europe and N ort h America and wit h Japan
(t hat is, th e members of th e O rganisation for Econom ic Co-operatio n and Development).
T h is approach reflects Austra lia's historic and cultura l ties wit h Europe and the impor tance
of an economy's level of indus t rialisatio n to othe r econom ic out comes, such as living
sta ndards and patte rns of emp loyme nt.
Whi le Australia's relat ionships wit h othe r advanced economies remain sig nificant, it is
in creasing ly important to also understa nd th e Au stral ian ec on om y w ithin t h e Asian
ec on om ic regio n . Th ere are many reasons for analysing Austra lia withi n its regional
cont ext:
• Australia's t rad ing relat ionships are main ly wit h Asian economies, with over two
thirds of Austra lia's exports des ti ned for the econom ies of Ch ina, J apan, ASEAN
and Sout h Korea.

• Australia's relatively stro ng perfor mance thro ug h t he g lobal down tu rn of the late
2000s - which battered the economies of Europe and N orth America - high lighted
how Aust ralia's economic fortu nes are linke d to the fortu nes of Asian economies
more tha n to ot her advanced econom ies.
• R ising living standards in Asia and th e sh ift towards market -orie nt ed economies
in th e regio n in recent decad es make for more mean ingfu l comparisons and
econom ic analysis.
T h e economic regio n of Asia is home to a very div erse gr oup o f economi es . It includes
th e full spect rum of econom ies from large, powerfu l economies like Chi na and J apan to
sm all island econom ies like Tonga and Vanuatu. Asia includes wealt hy economies like
Sout h Korea and less-developed econ om ies like T imor Leste. Asia incl udes some of th e
fastest -growi ng economies like India and slowest -growi ng econom ies like J apan . Asia is
ho me to several former cent rally pla nn ed economies like Vietn am, wh ile a lso being home

II
I
The Market Econ omy 202 0

co some of the mosc p ro-market economies in the world, includi ng Singapo re and Hong
Kong. Th e process of industr ialisation across the Asian region has d iffered marked ly
between indivi d ual economies .
In compa ring Australia with orher Asian economies it is important ro recogn ise t he
divers it y of different Asian economies. Austral ia is more similar ro some Asian economies
on some econom ic indicators, and more simi lar co other economies on orher ind icators.
Th ere is no sing le Asian economy, nor is there a typica l Asian economy.
We will compa re Austral ia's economy wirh orhe .r Asian economies across five areas:
economic growth and the qua lity of life; employme nt and unemployment; d istribution of
income; environ menta l susta inability; and the role of governme nt in health care, educatio n
and social welfare. Because of how international o.rganisacions categor ise count ries, our
comparisons will be scrucrured around th ree types of Asian economies: advanced economi es
like J apan; the n ewly industria lised econom ies of Sourh Korea, Singapore, Ho ng Kong and
Taiwan ; and Em erging and Developi ng Asia, which takes in other sign ificant economies
such as China, India and Indo nesia.

Economic growth and quality of life

By world standa rds, Australia is a midd le-sized economy wirh a relat ively small popu lation
(jusr 25 m ill ion people), and an economy char sics just outside of the world's cop 10,
measured by Gross Domestic Produce. Within the Asian economic regio n, however, t he
Austral ian economy is more sig n ificant , being the fifth largest. As shown in figu re 3.1,
Asia's two largest econom ies are China and Japan, followed by rhe four midd le-sized
economies of India, Aust ralia , Korea and Indo nesia. Reflecting the increased importance
of Asian econom ies, all six of these economies are members of rhe Group of 20, which
brings togethe r rh e world's largest and most important economies . Th e G20 is an
impo rtant grouping wirhin the g lobal economy, in part because it is more representative
rhan rh e older G7 group, which includes only one As ian economy, Japan.
Th e Asian economi c regio n has been rh e worl d 's
GDP, US$
fastes t-g row ing econo mic regio n since rh e Country
billion, 2018
Second World War. Followi ng Japan 's rapid
indusrrial isarion in rhe 1950s and 1960s, a 1 China 13,4 07
second wave of new ly in du str ialise d econ omies 2 Ja pa n 4972
ach ieved rapi d economic growth over rhe 3 India 2716
1970s and 1980s . The Asian "riger" econom ies 4 South Korea 1619
of South Kore-a, Singapore, Hong Kong and
5 Australia 1418
Taiwan pu rsued g rowth srraregies that relied
on comper irive labou r coses and g rowing export 6 Indones ia 1022
markers, particularly for manufactured goods, 7 Taiwan 589
co achieve rapid industrial isation. The process 8 Thailand 487
of industrialis a tio n , which cook centuries in Hong Kong
9 363
some European economies, was achieved in th ese
10 Singapore 36 1
economies over only a coup le of decades. As
capitalist economi es, the tige r econom ies' success Source: IMF WorldEconomic Outlook
Database, April 201 9
cont rasred with rhe relat ively slower economic
development of rhe regio n 's commu n ist and Figure 3 .1 - Size of economies in Asia
centrally planned econom ies over the same period.
Recent decades have seen a th ird major phase of econ omic development in Asia. Emerg ing
and Developing Asian econom ies, which, unde r the Int ernacional Monetary Fund (IMF),
include China, Indo nesia and Ind ia, have experienced rhe fastest growth, with an average
ann ual economic growth of 7 .6 per cent over the past th ree decades . T he other advanced
economies in As ia - Hong Kong SAR, Taiwan Prov ince of China, Singapore and Kor ea
(which were at one time called "newly industrial ised econom ies") - have had an average
growth rare of 5.5 per cent over the same period, whi le rh e Japanes e economy has

II
 Chapter 3: How Econo mies Differ I
slowed co just 1.7 per cent per year. This reflecrs che face char in che process of economic
development, the period of induscri.alisacion creates a period of very rapid economic
growth , bur once industrial isation has occurred, the race of economic grow th slows down.

- - - - • Austra lia Newly industrialised Asian econom ies

-- Japan Emerging and Developing As ia

15

12
,,
I \
I \
/ \
9

6 I \ I \
\ I' I \
/ , ', , ' ,", / 1, '4\ \ / , .,,-~ , ........
3 \__ - ✓_........... :::-;.,--::;:

?::r:-r:-,
0

-3

-6 0 co 0 sat <O a:, 0 sat <O co 0 <O C:00')0

.. "'
,- C\I
.. ..
~ ~ g: "'
8l g: g: 8l 8 "'
8 8 8 8 0 "' 0 0
,- ,- C\J C\I C\I
00000

Source: IMF World Economic Out loo k Database , Ap ril 20 19 'fo recast
"' "' "' "' "' "' "' "' "' "' "' "' "'

Figure 3.2 - GDP growth, selected econom ies

Figu re 3.2 shows economic growt h uends across Asia for more tha n three decades. l e
sh ows chat Emerg ing and Developing Asia has experienced scrong and cons istent economic
growth , and th e newly indust rialised economies have gradua lly slowed , wh ile Japan 's
economy has had very weak growt h for the past two decades. Economises call it convergence
wh en less developed economies g row faster co "catch up " co th e development levels of
wealthier countri es. Figure 3.2 also sh ows th e severity of th e Asian financial crisis in th e
lat e 1990s, and how the Japan ese and. newly industr ialised economies were more affected
by the g loba l downturn of the lace 2000s than the large developing econom ies, such as
Ch ina and India.
Ho w does Australia's economic grow th performance compare with the rest of Asia?
Aust ralia's trajectory has been very d ifferent because it achieved industr ial isation and hig h
living standa rds before the Second World War, so it has not experienced rapid economic
growth in recent decades. Austra lia's average ann ual economic growth of3.2 per cent over
t he past three decades is slowe r th a n most eco n om ies in As ia (bur faster than most
ad vanced economies around the worl d). As shown in fig ure 3.2, after severe downturns
in the early 1980s and early 1990s, Austral ia has achieved relat ively stab le economic
growt h. Austra lia's conti nued g rowcih during the Asian financial crisis suggested chat
Aust ralia was less integ rated with newly indust rialised economies. However, continu ed
growt h d uring th e g lobal downturn of the lace 2000s hig hlig ht ed the greate r importance
of conditions in China and India than in Europe or North America for Austra lia's futu re
economic performance.
Whi le economic size and growt h m ig ht cell us which economies prod uce the biggest and
smallest output s, they do not cell us how economic outcomes for individuals in chose
countri es compare. For th is, we muse examine living stand ar ds . GD P per capita is a
m easure of living standards chat cakes the financial value of all goods and services produced
by a nation in a year and divides th is by the roral popu lat ion . Accordin g to this measure,
Aust ralia has the second-hig hest stan dard of living in the Asia region at US$49,961,
be hind Singapore (US$52,96 1) and ahead of Hong Kong (US$43,681) , New Zealand
I
The Market Economy 2020

(US$39,427)and Japan (US$38,894). Ind ividua ls in th eseeconomi es have l ivi ng scandards

that are, on average, eight or n ine ti m es high er th an the average citize n in ot her Em ergi ng
and D evelopi ng Asia economi es, w here GD P per capita is US$6586 a year.

ALL EGGS IN THE CHINA BASKET?

In 2019, Austral ia entered its 29th year of unbroken econom ic growth , having sustained
112 quarters without entering a techn ical recession. This extended period of consecutive
growth is one of the most resilient growth records among advanced econom ies. A large
part of Austral ia's economic fortunes have been derived from the economy 's close
economic links with emerging market econom ies in Asia , particularly China. During the late
2000s financial crisis, Australia's fortunes deteriorated . However, the timely introduct ion of
a US$570 billion stimulus package by Chinese policymakers resulted in a sharp rebound in
Chinese econom ic activity. As a result of this, Australia's export volumes were maintained,
helping Australia achieve growth of just over one per cent during the financial crisis while
other advanced econom ies contracted sharply. The deepening in financial and trade ties
with China has helped Australia during macroeconom ic shocks . Currently, annual two-way
trade between Australia and China exceeds US$200 billion. However, relying so heavily on
China has a downs ide as well. By the late 2010s, the slowdown in China was threatening
to drag the Australian economy into recession for the first time since the early 1990s.
China's slower growth rate - with growth rates forecast by the IMF to be 6.0 per cent
in 2020, from 6.2 per cent in 2019 - reduced some commod ity prices and demand for
Australian exports , highlighting how Australia relied on China to underpin its exports and
econom ic growth in the past decade . This has prompted debate about whether Australia
needs to do more to diversify its export base and trad ing relationships .

Human Development
Q ual ity of life is a m easure of welfare based on more than just economic output per
Index (HDI) is a measure capi ta. Ot her factors i nclude the gua lit y of heal th care, educational oppo rtun ities and
of economic development cl imate. On these issues, Au stralia scores well. T he qua lit y of life enjoye d by Auscral ia.ns
devised by the United is am ong th e hig hest in th e world. Th e H uman Deve lopment I n dex , a popu lar but
Nations Development narr ow measure of qual it y of l ife that cakes into account incom e, life expectancy, adUL lt
Program. It takes into
lit eracy and educational levels, ranked Australia th i rd i n the worl d , behind on ly Norway
account life expectancy at
birth, levels of educational and Switzerland, and ahead of all econom ies in A sia. Ot her econom ies wit h relatively hig h
attainment and material levels of develop m ent are those th at also have h igiher living standards - New Z ealand,
living standards (as Japan, South K orea and Singapore (see figure 3.3).
measured by Gross
National Income per GNI per Human Life
capita). Mean years
HDI capita Development expectancy
Country of schooling
rank (2011 PPP$, Index (value, (years,
(2015)
2017) 2017) 2017)
3 Australia 43,560 0 .939 83.1 12.9
7 Hong Kong , China (SAR) 58,420 0 .933 84.1 12.0
9 Singapore 82,503 0 .932 83.2 11.5
16 New Zealand 33,970 0 .917 82.0 12.5
19 Japan 38,986 0 .909 83.9 12.8
22 Korea (Republ ic of) 35 ,945 0 .903 82.4 12.1
57 Malaysia 26 ,107 0.802 75.5 10.2
86 China 15,270 0 .752 75.4 7.8
116 Indonesia 10,846 0.694 69.4 8.0
116 Vietnam 5859 0.694 76.5 8.2
130 India 6353 0.640 68.6 6.4
Source: IMF World Economic Outlook Database, April 2019
Figure 3.3 - Human Development Index, selected countries

II
 Chapter 3: How Econo mies Differ I
Some aspecrs of gual icy of life cannot be as easily measured as che components of che
Huma n Development Index. Austral ia's high gua lity of life extends beyond statistics to
its favourab le social conditions. Australia has a temperate climate and an enviable relaxed
lifesty le. Austral ia has a high degree of cultural diversity, with a qua rter of the population
born overseas. Australians enjoy po litical and religious freedoms that compare favourably
wi th many countries in Asia. Internac ional surveys of the world 's cit ies consiste ntly race
Aust ralian cities like Sydney and Melbourne as being amongst the most desirable cities
in the world in which to live.

Employment and unemployment

Au stra lia's unemployment rate of 5.2 per cent in m id-2019 was above m ost economies
in Asia. Wh ile official unemployment rates were around the same level in Indo nesia
and the Phi lipp ines, they were lowe r in the fast-g rowing Chinese economy , as we ll as
in othe r economies including Japan , Korea, Singapore and Thailand.

% ----- Australia
12 -- Japan
Indonesia
--Ch ina
10 - - - - - Newly industrial ised
Asian econom ies

6
-_- ______
,-;-
---
4

0 0 C\J -st <O co 0 C\J q- <O co 0 C\J -st <O co 0 C\J -st <O coO>O~C\IM~
co co co co co
~ ~ ~ 8 8C\J 8C\J 8C\J 8C\J 0C\J C\J T"""T"""C\IC\IC\IC\IC\I
en en en en en $ ~
$ C\J
0 0C\J 0C\J 0000000
C\IC\JC\IC\IC\IC\JC\I
Source: IMF Wo~d Economic Outlool< Database, April 20 19 ·fo recast Year

Figu re 3 .4 - Unemployment rates , selected economies

Figu re 3.4 high lights the different t rends in unemp loyment rates acro,ss econom ies in
Asia. The genera l upwards tre nds in unemployment in Ch ina and J apan is a stark contrast
to Austra lia, which has experienced declini ng unemp loyment since the early 1990s (after
much higher unemployment during the 1980s and early 1990s). Indones ia's unemployment
race increased for most of the decade following the Asian financial crisis of the late 1990s
but has fallen in recent years.
Em p loyment patt er ns in Austra lia are simi lar to chose of most advanced economies, with
t he majority of peop le employed in services industries such as retai l trade, real estate and
business services. Industries like manufacturi ng and construct ion cont in ue co provide a
substant ial numbe r of jobs, with employment in agriculture much smaller than it was
in prev ious decades.
T h ese emp loyment patterns are sim i lar in other regiona l econom ies like J apan, which,
like Austral ia, has less tha n five per cent of jobs in agriculture and almost three-qua rters
of the labour force emp loyed in services. Many Asian economies chat are st ill in the
process of indust rialisation have muc h smaller service sectors but continue co see a large
port ion of thei r workforce concent rated in agriculture, for examp le, Indonesia , which has
4 1 per cent of its labour force emp loyed in farming and fishing indust ries. In the coming

II
I
The Market Economy 2020

decades, rh e process of mass urbanisation is likely co continue in many Asian economies,

wh ich will see a substantial po rtion of peop le move from rura l co urban centres co seek
work in industry and services sectors.

Distribution of income
As we saw earl ier in th is topic, how income is distr ibuted in an economy is very important.
Even if an economy has a high average GD P per capi.ta, if income in the economy is mai n ly
received by a sm all g roup of peop le, other people in the economy may sri ll suffer from
very low standa rds of living. In gene ral, pu re marker economies tend ro have an unequal
distr ibut ion of income because chose who have ownership of resources and who have t he
most skills receive a g reater share of income rewar ds rhan chose who do nor have resources
such as land, cap ital or skilled labou r. Equally, agricultura l deve loping econom ies can also
have a very unequal d istribution of income because of rh e div isions betwe en rural and
urban populations and the concentration of land ownersh ip amongst wealthier groups in
society. W ithout government intervention, the process of industrial isation can worse n
inequal ity as one part of society becomes much weal thier while orher pares of society ga.in
very little, or even become worse off. Mixed economies with a greate r role for governme.nt
in redistributing income co poorer groups tend co be more equa l.

,::- 0,
~ ~

~ ·I ~
-~ ..
.~ 0
C
...J

~~ <5i

I ) Less
equal
45 50

So urce : Solt , Frederick . 20 19. "The Standard ized World Income Inequal ity Database ".
Working paper . SWIID Version 8.1, May 20 19.

Figure 3.5 - Income inequality, selected econom ies

In general, the economies of Asia have g reater levels of inequa lity rhan the deve loped
economies of Eu rope . Figure 3.5 shows char industrialised economies withi n Asia such as
Japan, New Zealand and Australia have a relative ly equa l distr ibut ion of incom e (as measured
by the Gini Index, a measure of inequality char is a number between Oand 100, with lower
numbers indicating a more equa l distr ibutio n of income). Fiercely pro-ma rket economnes
like Singapore and Hong Kong have only a small role for gove rnm ent in redistributing
income, and therefore have a more skewed distr ibutio n of income. Othe r economies in Asia,
including China and India, are also relatively unequa l societies in part icular due ro rhe
gap betwe en poorer rura l areas and wealthier urba n areas.

Environmental sustainability
Over recent decades, enviro nmenta l sustainabi lity has been an increasing ly important pa rt
of modern econom ies. Whethe r development is compat ible with the natura l environme.nt
is now a key pare of economic decision making in ma.ny countries. Austra lians mostly think
of thei r country as having superio r environmenta l qua lities compared with other econom nes
in the region, including less water and air pollut ion, more nat ional parks and more efficient
industr ial p rocesses. In severa l respects, this is true. Th e p rocess of indusrria lisarion in
Chi na, for example, has created enormous enviro nmental damage, with severe levels of air
pollution, poisoned river systems and widespread health prob lems arising from exposure co
po llut ion and tox ic chemicals. By compariso n , Austral ia has a much cleane r environment .
However, for an industrialised country Austral ia's. enviro nmental sustainabi lity is sr.ill
relat ively poor. Consider the following:

II
 Chapter 3: How Econo mies Differ I
• Austra lia has a very poor record of p rese rv ing biodive rsity despite being one of
on ly 17 "megadive rse" nat ions in the world and being home to mo re species rhan
any other developed country. In rhe past rwo centuries, over 50 birds and mammals
have become ext inct in Austra.lia, which means Austra lia has been responsib le for
one-thi rd of the species exti nctions char have occurred in the world during that
period. In add it ion, a further 1700 animals and p lanes are listed by the Austra lian
Government as being at risk of exti nction.
• Austra lia makes relatively good use of irs wate r r esou rces, as measured by water
p1·od11ctivit
y - US dolla rs of economic output per cubic met re of freshwate r used.
According to a recent estimate by the World Bank, Austral ia's water producriviry
of US$78 per cubic metre of water is higher compared ro Korea (US$31), New
Zealand (US$28) and rhe average water product ivity of all coun tries withi n rhe
Ease-Asia and Pacific region (US$17).
T h e most sign ificant enviro nmental issue facing Austra lia and the Asian region is cl im ate
c h a nge, also known as global warming, related ro rhe emission of g reenh ouse gases, such
as carbon dioxide (CO 2), n itrous oxid e (NO) and metha ne (CH 4 ). Emp ir ical evidence in
rocenr years suggests chat the impacts of climate change , specifically globa l warming,
are becomi ng more visib le. Eighteen of rhe 19 warmest years on record have occurred
sin ce 200 1, with 20 16 being the hottest year on record according ro the US Nationa l
Ocean ic and Atmospheric Adm inistration . Meanwhi le, ice th ickness in rh e Arct ic region
has decreased 40 per cent since the 1960s, and extreme weathe r event s are occurring
wi th greater frequency. The Un ited Nat ions Intergovernmental Pane l on Climate
Change est imates char increased greenhouse gas emissions could lead to average g lobal
temperatu res rising by betwee n 1.0 and 5.4 degrees du ring this centu ry un less action is
taken to reduce carbon emissions. The consequences of rising temperatur es could include
rising sea levels, more severe and unp redictab le weather events, and increased threats to
globa l econom ic growth, food securi t y and huma n health. Some of the econom ies most
vul nerable to rhe impacts of climate change are in Asia because of exte nsive low-lying
coasta l areas and the regu larity of extreme weathe r events.
Achiev ing internat ional agreement ro reduce g reenhouse gas em issions is d ifficult and
takes sig ni ficant rime. However, afte r several years of impasse, at rhe 20 15 UNFCCC in
Paris , a historic agreement was negotiated with representatives from nearly 200 count ries,
to keep "rhe increase in global average temperatu re to well below 2°C above pre-industria l
levels" - the benchmark scienr isrs believe is necessary ro p revent rhe most dangerous
impacts of climate change . The agreement, wh ich became effective in Novembe r 2016,
was sign ificant because for the first time, it included rhe participatio n of developing
nations such as China and India, as we ll as the United States, which refused ro ratify rhe
Kyoto Protoco l (though the US subseque ntly rook steps to withdraw un der rhe Trump
ad ministration). In contrast to rhe Kyoro Protocol, the Paris Agreem ent has greater
in-bui lt mechan isms for transpa rency and review processes, with the intention of increased
globa l scrutiny to further encourage count ries ro meet their respective cont ribut ions to
globa l emiss ions reduct ion . As of 2019, the re were 196 countries who were signatories ro
t he agreement, and 183 countries that had ratified the agreement (including Australia).
Australia is implementi ng domest ic pol icies to reduce g reenhouse gas em issions with
t he ult imate goal of reducing carbo n emissions to 26-28 per cent on 2005 levels by
2030, bu ilding on the p revious goal of reduc ing carbon em issions by five per cent of
2000 levels by 2020 . T he system of carbon pric ing introduced in 2012 was abol ished in
2014 and was replaced by "Direct Action" init iatives , includ ing an Emissions Reduction
Fund chat prov ides grants ro bus inesses for projects that lower carbon emissions. One of
t he arguments in favour of Australia. reduci ng irs g reenhouse gas emiss ions is that our
em issions per person - almost 17 ron nes of carbon dioxide - are among the highest in
t he world, and are around 50 per cent more rhan Japan and Korea and more than 70 per
cent above the average in advanced economies (see figure 3.6) .

Ill
I
The Market Economy 2020

Australia 115.4
Korea, Rep. 111.6

Singapore 110.3

Japan I 9.5
New Zealand I 7.7
Ch ina I 7.5

Hong Kong I 6.4

East Asia & Pac ific I 5.8
0 5 10 15 20
Tonnes per capita

Source : World Bank , World Development Indicators 20 18

Figure 3 .6 - Carbon dioxide emissions, selected economies

In high lighting the environmental challenges facing Australia , ic is important to recognise

chat all econom ies in Asia also face un ique prob lems and th ere is no single measure of
environm ental sustainab ility. For example, Indonesia is a sig ni ficant contributor to clima te
change because of the destruction of ics forests. China 's emissions of carbon dioxide w.ill
have a major impact on che world's climate in coming decades. India has some of che most
po llured cities in the world owing co poor urban p lanning and outdated infrastructure
chat has nor kept pace with che influx of people m oving to urban centres . Even sma ll
island economies of South- East Asia are leaving sig n ificant environmenta l impacts from
the ir econom ic develop ment, by polluting the ocean through industr ial waste and sea
litter . Both domestic policies and greater global cooperation will be requ ired to address
che many enviro nmental issues affecting Asia.

The role of government

A major quest ion facing any society is che extent co wh ich the government should be
involved in econom ic act ivity. Governments can be directly involved in what an econom y
produces and how it is produced by operating government-owned busi nesses, sett ing
price levels, or imposing othe r ru les and reg ulations . Less direct act ions can include taxes,
subsidies and orher measures co encourage resources co move from some sectors in t he
economy co orhers . Finally, the role of government is also often measured by its role in
prov iding key serv ices, including health care, education and social welfare.
For most of the second half of the twent ieth century, che role of government in Asian
economies was shaped by whether they were mar k e t eco n om ies or p lann ed eco n omies .
Marker econom ies were concentrated in Ease-Asia and included Japa n , Korea, Singapore
and Indones ia. Plann ed economies were concent rated on the Asian continent and includ ed
Chi na, Vietnam, India and Cambodia. Over the past th ree decades, che divisions betwe en
the types of economies have become less sign ificant. Plann ed economies like Chi na
and Vietnam have reduced government cont rol over economic decision maki ng, and
marker forces of supply and demand have played a g reater role. Over the same period,
the governments of market economies have used a range of interventions to promote t he
development of competitive export sectors and rap id industria lisation .
Between these two competing economic models, Auscralia's economic system has always had
more in commo n with the ma r ket eco nomies of East-Asia. During che Cold War, which
pitted capitalise countries against communise coun t ries, Australia was firmly all ied with
capitalist countries like Japan and Korea. Austral ia's economy has always been governed
pr imari ly by mark et forces, especially in key sectors like agr iculture, mi ning, construction
and manufacturing. As a mixed economy, there has also been a role for government in
certain service in dustries , including telecommunicat ions, aviation, banking and insurance.
Bur even in chese sectors, recent decades have seen a reduced role for che government
through pol icies of de r egula tio n and pr ivatisat ion of government-owned businesses.

II
 Chapter 3: How Econo mies Differ I
T he Index ofEconomic Freedom - comp iled by Washingto n-based chink tank rhe Heritage
Foundation - uses 10 indicators such as p rivate p roperty rights, govern m ent regulation
of the economy and spending on welfare and othe r services co assess rh e d egree co which
governments intervene in rhe operat ion of the market . Th e 20 19 index raced Aust ralia
as rh e fifth "free-esr" economy in the world, behind Hong Kong, Singapore and New
Zealand, which are well known for the ir commitment co free markets, bur ahead of J apan
and South Korea. By contrast, two Asian countries received the lowest freedom racing
("repressed"), Timo r-Leste and North Korea.
An other way of comparing rhe role of government in Australia with chat in other count ries
is co consider the percentage of GDP spent by the government and collected in taxation
revenues. Higher levels of government spe ndin g gene rally ind icate a greate r role for
government in rhe economy. General government expenditure in Austra lia was 3 7 per cent
of GDP in 2018. Th is is similar co (or slightly below) most other advanced economies,
including Japan (also at 37 per cent), and it is well above the average for rhe rest of Asia.
Government spending averages 20 per cent of GDP in the ASEAN-5 economi es and
29 per cent for Emergi ng and Deve[oping Asia. In orher words, compared with most
Asian economies with lower living standards, Austra lians pay more in tax and receive
mo re benefits and services from the ir government .
A useful way of comparing the role of government in d ifferent economies is co examine
t he provis ion of health and educat ion services. Austra lia has a well-establ ished system of
universal h ealt h car e known as rhe Medica re system. This is in stark contrast co most
deve loping economies in Asia, whose publ ic health systems are relatively undeveloped,
and where some rely on p rivate healcih care. As shown in figure 3. 7, pub lic spendi ng on
health care in Australia is high compared with most economies in Asia, at just over six
per cent of GDP . Austra lia's belief in a srrong government role in rh e prov ision of healt h
care is shared by most industrialised economies, including Japan , although in recent
years th ere has been a greater emp h asis on p rivate ly funded health care in Austra lia.
Many develop ing economies in Asia are strugg ling with rh e d iseases of poverty, caused by
poo r water and san itation, alongside emerg ing "lifestyle" diseases associated with greater
prosper ity, such as obesity, diabetes and card iovascular diseases. Many Asian countries
also face serious respiratory d isease prob lems in rh e long term because of high races of
sm oking. In Austra lia, rh e male smok ing race in 2016 was 17 per cent, compared with
around 50 per cent in Ch ina, Korea and Vietnam (and around 70 per cent in Indonesia).

Public spe nding on he alth and educa tion (% of GDP)

Korea, Rep.

■ Heal th
■ Ed uc at ion

0 5 10 15 20

Source: World Bank, World Development Indicators, 2018. Note: Figures may not add due to rounding.

Figure 3. 7 - Government expenditure in hea lth care and education

At a pri mary and secondary level, there is universal free education in Austra lia, as in most
orher advanced econom ies. Around one-third of stu dents here atte nd p rivate schools.
T h e government prov ides most educationa l services in Austra lia. Th e vase majori ty of
universities in Australia are publ ic. Neverthe less, Austra lian university stu dents now pay a
substa nti al share of the cost of th eir educat ion , although rh e actua l payme nt of chose coses

II
I
The Market Econo my 2020

can be deferred u nder the H ig her Educar ion Cont ribur ion Scheme, which allows students
ro defer payme nt for unde rg raduate un iversity courses unti l rhey find emp loyment .
Many Asian economies have simi lar basic features. of the ir educat ion systems. Usuarny,
this includes compulsory prim ary schooling, wit h most schools being run and funded
by rhe governme nt . Schooling usually becomes volunta ry during high school years, with
an increasing sh are of fund ing comi ng from pr ivate sources. A high level of education is
cu lturally significant in many Asian countries, and int ernationa l surveys of maths and
science education suggest char educat ion systems are part icularly srrong in Singapore,
Korea, J apan and other Ease-Asian count ries.
Australia's governme nt funding of edu cation is above average compa red with Asia n
nat ions. As shown in figur e 3.7, pub lic spendi ng on edu cation account s for around
five per cent of t he economy, which is more tha n most orher economies in Asia. For som e
countries, lower government spending on educatio n reflecrs a greate r reliance on p rivate
cont ributions to edu cation expenses. In Japan and Korea, for examp le, there are large
private educatio n sectors, especially for high schoo ls. In developing count ries, however,
lower public spe nding on educatio n simply reflects the greater competition for scarce
government resources. T hey also face a more basic set of educat ion challenges, includ ing
raising literacy levels and extend ing educatio n ro large rural popu lat ions.
As with several other aspects of rh e economy, Australia's soc ial w elfare system p rovides a
level of assistance much g reater than that in most Asian count ries. Th e pu rpose of welfare
in Australia is to ensure a minimum standa rd of living for people who are unabl e to wo.rk
or are looking for work . Welfare benefits includ e unemp loyment benefits, the age pension,
disability support payments, family payme nt s and pa id marerniry leave. Compa red with
many Asian econ omies, Austra lia has an extensive system of social welfare.
Australia's pub lic expenditure on elderly and disab led pens ions is high by region al
standa rds . Ar 4 .2 per cent of GD P, spend ing on pe nsions is higher rhan in economies as
diverse as Korea (3 .0 per cent), Ind onesia (0 .8 per cent ) and Ind ia (1.3 per cent). J apan
has much higher spend ing in this area (9.4 per cent ), reflecting its older popu lat ion and
greater reliance on pub licly funded pensions .
As more economies in Asia become ind ustr ialised, ir is likely char demands for social
welfare in those countries wi ll increase. By contrast, rh e trend in Australia is towards
restricti ng social welfare, by righr eni ng eligibi lity. Almost all social security payme nt s,
includ ing age pe nsions, are subject ro a "means test", lim iting benefit s for people with
orher sources of in come or assets. Unemp loyment benefits have been tied to participation in
"Work for the Do le" community projects and requi rement s to seek work. Superannuat ion
is increasing ly funding the needs of peop le in reti re ment, eith er fully or in part replacing
rhe role of the rr-adirional age pension. With an ageing popu lation, Australia faces growing
pressures to sustain its system of social welfare in comi ng decades so that taxes do not
need ro rise, wh ile ensur ing adequate resources for orher government priorities such as
health care, educatio n and infrastructure p rovision.

1 Identify wh ich economies in Asia are of a similar size to the Australian economy.
2 Discuss the d ifference between standards of living and q uality of life w ith
reference to these indicators in Australia and at least ONE economy in Asia .
3 Describe the distr ibutio n of income and environmental sustainability in Australia
and in TWO econom ies in Asia .
4 Co mpare the role of govern ment in the Australian economy to ONE economy in
Asia for the provision of health care, education and social welfare.

II
 Chapter 3: How Economies Differ

1 In a market economy , most econom ic decisions are made by p rivate individuals

pursuing their self-int erest. The market economy is characterised by private
ow nership of property, freedom of enterprise, consumer sovereignty and a system
of compet itive markets.

2 Eco nomies can be placed at so me point along the spectrum betw een the
extremes of a centrally planned economy and a pure market economy. However,
most economies are closer to, the market economy model th an to the centrally
planned model.
3 The main diffe rences in market economies relate to th e extent of government
intervention in the economy and the degree to w hich corpo rations take into
acco unt wider social interests in their decision making.

4 Australia is a mixed economy , where th e decisions co ncern in g product ion

and distri bution are made by a comb ination of market forces and governme nt
decis ion making.

5 Government intervention occ urs in a market economy for th ree main reasons: to
reallocate resources, to redist1ribute income and to stabilise th e eco nomy from the
effects of th e business cycle.

6 Eco nomic growth is measured by changes in Gross Domestic Product (GDP) .

Gross Domestic Product (GDP) per capita measures the total value of goods and
services produced by a nation, divided by its pop ulat ion. Australia has a high
standard of living compared w ith most econom ies in Asia.

7 The quality of life in an econom y is co mmonly measured by th e Human

Development Index , w hich measures income , life expectancy and educational
levels. Australia ranks second in the w orld by th is index .

8 The degree of inequality in the distrib ution of inco me in Australia is similar to

industrialised Asian economies such as Korea and New Zealand. Higher levels
of inco me inequality exist in developing economies such as China, India and
Malaysia.

9 In recent decades , government s have paid greater attention to th e issue of

environmental sustainability , w hich involves using resources at a rate that
can be maintained over the long term without depleting the natural environment.

10 Government in Australia has traditionally played a major role in providing health

care, education and welfare. Although the role of government in each of these areas
has to some extent been reduced in recent years, it remains greater than in many
Asian economies.

II
The Market Economy 2020

1 Exp lain how the market economy attempts to so lve the econom ic prob lem.

2 Explain how the centrally planned economy attempts to solve the economic
problem.

3 Discuss the role played by the price mechanism in a market economy.

4 Exp lain what is meant by a market , and outline the two basic types of markets.
Discuss how these two market types are related .

5 Define the term mixed economy.

6 Briefly examine the main prob lems with leaving a market economy to funct ion by
itself withou t any government intervention .

7 Discuss the ways in which the government can intervene in the economy to
improve econom ic outcomes.

8 Ident ify whet her Australia is a market , mixed or centrally planned economy.

9 Outline the reasons for differences in economic growth trends in Australia and
econom ies in Asia.

10 Discuss the ,extent to which the Australian Government is involved in the health
care system . How does th is differ from other countries?

Extended response
a) How does Australia compare to other economies in Asia, in terms of :
• econom ic growth and quality of life
• employment and unemployment
• distribution of income
• environmental quality.
b) Define what is m eant by an economic system . Exp lain how Australia 's econom ic
system attempts to solve the economic prob lem. In your answer, use specific
examples to demonstrate how the government intervenes to affect the operat ion of
free-market forces .

II
 TOPIC

CONSUMERS
AND BUSINESS

~- - Focus
The focus of this topic is an investigation
of how consumers and businesses make
decisions about the choices they face,
recognising that, in a market economy,
they are motivated largely by self-interest.

Issues
By the end of Topic 2, you will
be able to examine the following -- - Skills
economic issues:
Topic 2 skills questions can ask
■ Examine t he impact of income on the you to:
spend ing and saving decisions of individuals
■ analyse the impact of changes in consumer
■ Assess the extent t o which consume r income levels on the types of product ion
sovereignty is achieved in a vari'ety of markets with in t he economy
■ Investigate the relative significa nce of the ■ explain t he role of firms in solving the
various sources of incomes in Austra lia econom ic prob lem.
■ Work in groups to investigate t he factors
leading to change in a particular industry.

Economics Stage 6 Syllabus 2009 ext racts© NSW Education

S tandards Aut hority for and on behalf of the Crown in right of the
S tate of New Sout h Wales, 2009; reproduced by permission.
 Topic 2

Introduction
Boch indiv idua ls and busin esses with in rhe marker economy are driven by self-int erest,
yet understa nding how self-inte rest affects our economic d ecisions is no simple matt er.
We must gain an accurate picture of what ind ivid uals and firms believe the ir self-interest
ro be, as well as how their interests are affected by the economi c condit ions around chem.
Once we do th is, we wi ll have a much clearer picture of ,che actions of individuals and
firms in the market economy .

Chapter 4 exam ines che role of consumers in a market economy who buy goods and
services ro satisfy th eir needs and wants. We analyse the ro le of individual income and
age in influencing consu mers' decisions to spend and save. Chapter 4 concludes with a
discussion of the sources of consu mer income .

Chapter 5 exami nes the role of busi ness in the market economy - how businesses make
th eir production decisions and how businesses contribut e to the economy by boosti ng
econom ic g rowth and prov iding indiv idua ls with emp loym ent and income . We exam ine
rh e goals of busi nesses and how firms can maximise th eir profits . Finally, we consider the
impact of investment, cechnological change and et hical decision making on businesses in
a mark et economy.

II
Consumers in the
Market Economy

4.1 Consumer sovereignty

4.2 Decisions to spend or save
4.3 Factors influencing individual consumer cho ice
4.4 Sources of consumer income

4.1 Consumer sovereignty

O ne of rhe main assumptions in a marker economy is that consumers dete rm ine what is
pro du ced. Consumers will ultimately decide what goods and services wi ll be produced
by exercising their freedom ro choose what they buy and wh ich wanes they wi ll sat isfy.
Business firms will pro duce whatever goods and services are in demand. This concept is
known as consumer sovereignty because consume rs determ ine the answer to the questions
of what ro produce and how much shou ld be produced . This is also one of the great
srrengrhs of rh e marker economy because production is geared ro what peop le wane and
t heir wanes are sat isfied.
Consumer sovereig nt y is based on consumers sending signals ro produce rs through their
demand for goods and services. Where the ir demand is high relative ro supply, p rices
wi ll rise. Producers will rh en notice char higher profits can be made by p roducing those
ite ms for which deman d is greatest. As a result, they wi ll shift resources inro those other
form s of pro duction. Consumer sovereig nty can th erefore determ ine how resources are
arnocared in an economy.
T h rough rhe operation of consume r sovereignty, consumer income levels determ ine rh e
types of p roduct ion that occur in an economy. As an economy becomes more prosperous
and income levels rise, demand for luxury goods increases, and so does rh eir production.
T h us, as an economy experiences an upturn and consumer incomes rise, rh e production
of goods such as sports cars and designer clothing will increase. Similarly, production of
t hese items will go down in an economic downturn.
However, consumer sovereignty is nor absolute. In rhe rwenry-firsr-cenrury marker economy,
there are several aspects of business conduct char can reduce rhe sovereignty of consumers:
• Marketing : Advertising and di rect marketing exert a powerful influence over rh e
spending patterns of consumers. Th e impo rtance of marketing ro rhe funct ioni ng of
marker economies has grown su bsranr ially in recent years. Whi le some mark eting
strategies are inform ative, most strategies p lace a strong emphasis on und erstanding
their target consumer in order ro manipulat e their behaviour . Ma rketers condu ct
extensive research inro rh e wants, interests, desires and fears of consume rs, and they
use rhis as the basis for both mass mark eting (such as in the popu lar media) and
d irect marketing (such as rargered Facebook, Insragram, Google search and web
browser advertising as well as m ore trad itional ema il and d irect mail approaches).
Consumer sovereignty is d imi nished by manipulative or deceptive mark eting
practices .
I
The Market Economy 2020

• Misleadi ng o r deceptive co n d u ct: Consumers can be deceived by false or

dishonest claims about a pro duce, leading chem co pay for items chat they do not
really wane co buy. This is especially commo n among claims over "fresh food ",
weig hr -loss and anri-aging produces, investment schemes, baldness creacmenr s and
orher health produces and services.
• P lanned o b so lescence : Firm s sometim es produce goods chat are designe d co
wear out quickly or go our of dace, in order co encourage consu mers co make
furthe r purchases in the future . By empha sisi ng the importa nce of keeping up
with the latest fashions and mosr recent produces , firms can manipu late peop le co
buy a p roduc e more often than rh ey wou ld otherw ise. For examp le, motor vehicle
man ufactu rers change th eir designs regularly co encourage peop le co buy a new car
and avoid driving someth ing chat might look out of dace, even if ir cont inues co
functio n effective ly.
• Anti-competiti ve behaviour: Firm s chat op erate in mark ets where th ere are few
orher sellers can also dimi nish the ability of consume rs co choose what they really
want . Fo.r examp le, businesses may manufa cture electronic devices so chat on ly
the compan y's brand of accessories, such as p ower supp ly cords and batteries, are
compati ble. Thi s may nor be necessary for the opti mum performance of rh e device,
wh ich cou ld work just as well with cheaper ge neric brand s of accessories, bu t it can
be a srracegy co reduce consumer choice.
Economises debate rhe extent co which th ese factors dimini sh true consumer sovereign.ry
and create a degree of business sovereig nty. Some crit ics argue chat a great deal of consumer
demand for goods and services is generated by deceptive market ing practices chat manip ulate
peop le's fears and insecuriti es. Others argue char these practices are a natural part of rhe
marker economy and, despite these patterns of business conduct, consumers still ulti mate ly
choose for themse lves what they buy.

1 Explain how cons umer sovereignty determ ines patterns of product ion in
an econo my.
2 Outline THIREE examples of business pract ices you have observed that reduce
consumer sovereignty.
3 Propose a. government policy to protect consumer sovereignty against
misleading or deceptive conduct.

4.2 Decisions to spend or save

In overall terms, after consu mers have received income and pa id their tax, they make a
choice co eit her spend or save rhe remain ing mon ey. Thi s is expressed in rhe following
equatio n:
Y=C+S
Where:
Y Disposable (after tax) income
C Consumption expenditu re
S Savings

This equatio n means chat , for a specific level of income, any increase in consu mpti on will
cause an equa l reduc tion in rhe level of saving, and si mi larly, a rise in saving will bring an
equa l reduction in consu mpti on. It also ind icates char any change in rhe level of income
will result in a change in the levels of both consumptio n and savings.

m
 Chapter 4: Consumers in the Market Economy I
T h e proport ion of an indi vidua l's income that is sp ent on consumption is called rh e Averagepropensity to
average pr opensity to consume (APC) . The proportion of an indiv idua l 's income that consume (APC) is the
is saved is kn own as rhe average propensity co save (APS). Because each do llar of an proportion of tot al
ind ividual's d isposab le income muse be spent or saved, the APC and APS muse sum ro 1. income that is spent on
consumpt ion.

C s
y=APC y=APS
Average propensity
Where: APC = Average propens ity to consume to save (APS) is the
APS = Average propens ity to save proport ion of tot al
income that is not spent
but is saved for futu re
Figure 4 .1 shows the level of savings for a range of high-, middl e- and low-income economies.
consu mpt ion.
T h is includes savings by households, !businessesand governme nt s. Whi le those economies
with higher per capita incomes rend to save a greate r propo rti on of the ir income, th e
re.lationship between income and savings levels is weak ar an economy-wid e level.

GDP per capita Gross saving

Country
(US$ , 2018) (% GNI , 2018)
Luxembourg 114,341 33
Norway 81,807 34
Un ited States 62,641 19
Australia 57,305 22
Japan 39,287 28
Brazil 8921 15
South Africa 6340 14
Indonesia 3894 33
India 2016 31
Burund i 275 6
Source: World Bank, World Development Indicators 2019
Figure 4 .1 - Income and savings levels, selected countries

A variety of factors influ ence the decision about whether ro spend or save, includi ng :
• Cu.ltur al factors: For exampl e, in some Ease Asian economies p eople rend to save
more of th eir income rhan people in orher indu str ialised economi es, and previous
gene rations tended to save mo re rhan people today.
• P ersonality fac to rs : Some people are mor e cautious and prefer ro have savings in
case of any future need, wh ile others are more easygoing and woul d rath er enjoy
the imm ediate benefits their mon ey can brin g .
• Confidence and future expectations: When consumers are wor ried about rh e
economi c outloo k , they are mor e likely to exercise caution and increase their
savings . On rh e orher hand , if chey are confid ent about the futur e and expect their
income to rise, they are more likely to increase their consumption and save less.
In some instances, a change in consumer confid ence may not be linked to actua l
changes in economic outloo k . For examp le, recent research from the Reserve Bank
of Austra lia identifi ed patterns of consumer spend ing in relatio n ro a change in
governm ent at elections, find ing that consumers who vored for the winn ing party
were more opt imi stic about economic conditions and were more likely ro increase
their consumpt ion than consumers who vored for the losing parry.
• An y sp ecific future spendi n g p lans : Individua ls mig ht save mor e if they are
p lanni ng a major expense in th e futu re, such as a holiday or pur chasing a car.
• Tax po lic ies: Th e tax system can influe nce an indi vid ual 's patterns . of consumption
and savings by makin g it more attracti ve to save (such as th rough lower taxes
on supera nn uation savings) or ro spend (such as throu g h t he abo lition of
consumption taxes).

m
I
The Market Econ omy 2020
The consumption
function is a graphical
representation of the
relationship between
income and consumption
for an individu al or
an econom y. It is
usually upward sloping
with a gradient less
than one, and with a
positive y-intercept.
Marginal propensity
to consume (MPC) is
the proportio n of each
extra dollar of earned
income th at is spent on
consumpti on.
Marginal propensity
to save (MPS) is the
proport ion of each
ext ra do llar of earned
incom e t hat is not spent ,
but saved for fut ure
consumptio n.
II
• Ava ilabi lity of cred it: Spendi ng is likely co be highe r if credit is readi ly availab le,
as th is creates a new source of money for expenditu re. Furth er, indiv iduals are less
likely ro save if they feel confident chat rhey will be able co access credi t easily in
the future.
In overall terms, however, the two most sign ifican t factors char influence a consume .r's
decision co spend or save are their leve l of in come and age.
Income
As inc ome rises, peop le tend co save a
Consumption ($) higher p roportion of the ir income; chat
300 is, APS rises and APC falls. Consumers
on lower incomes spend proport ionate ly
250
mo re of the ir d isposable income rhan
200 peop le on higher incomes. As incom e
rises, peop le do not need ro spend as
150 much of their income on essential items.
For examp le, a person with a d isposab le
100
income of $300 per week might have
50 co spend it all on basic coses of living,
whereas someone receiving $3000 per
0 .___ .,___ ...__ ...__ _.__ _.__ .......
_ _,
50 100 150 200 25 0 300 week m ight comfortab ly save 50 per
Income($ ) cent of rhac income . The consumpt ion
function diagram shows rh e relationsh ip
Figure 4 .2 - The consumption function betwee n income and consumptio n for a n
individua l. As income rises, so coo does
the level of consumption . Howeve r, even ar very low income levels, indiv idua ls tend co
have some posici.ve level of consumpt ion, say $50 per week, which may be financed through
credi t or existing savings . As income rises, say from $200 co $300 per week, consumpt ion
also rises, from $150 co $200 . Howeve r, because income rises faster than consumpt ion, rhe
average propensity ro consume falls. In the example in figure 4.2, APC falls from 0 .75 co
0.67, and APS rises from 0.25 ro 0.33 as income ri.ses from $200 ro $300 .
To comp lete the srory, econom ises have also developed terminology around rhe concept
of a person 's propensity (or tendency) co consume or save for each extra dollar they earn .
• The ma rgi nal pr opens ity co co n su m e (MP C) is rhe p roport ion of each extra dollar
of income chat goes co consumption (and is che slope of the consumpt ion funct ion
in figure 4 .2).
• The m arginal pr ope nsity co save (MP S) is the p roporr ion of each extra do llar of
income rhac is saved.
MPC = change in ~o~sumption MPS = change _in_saving
change in income change in income
Since each extra. dolla r of income earned must be eithe r spent or saved, rh e sum of MP C
and MPS for an indiv idua l (or househo ld) muse always be one . Therefo re:
I MPC + MPS = 1 I
In our simp le examp le in figure 4 .2, borh rh e MPC and rhe MPS remai ned constant whe n
income increased (char is, rh e consumption funct ion was a straight line with a gradient
of0 .5). In realicy, as a person's income rises, their m arginal prope nsity co consume tends
co fall and rheir marg inal p ropensity co save tends ro rise. T herefore, the consumption
function rends co become less steep as income rises.
 Chapter 4: Consumers in the Market Economy I
T h e relat ionsh ips exp lained on rh e p revious page also app ly ro rhe economy as a whole.
In general terms, as a count ry's national income rises, the overall level of savings in rh e
economy should rise at a faster rate. (Like many economic relationsh ips , this does not
always work. Th e Un ited States is one of the richest nat ions in the world, yer its savings
level, 19 per cent as a percentage of GNI as of 2018 (see figure 4 .1 ], is relatively low.)

Age
Age also pla ys a role in savings and consumption patt erns . An indiv idual"s income scream
and propensity to consume and save are not constant throughour th eir life. According ro
t he simple consumption theo ry, an in dividual or a househo ld wou ld cons ume a constant
proportion of th eir income each period . T his is clearly nor the case. Individuals and
households rend ro smooch thei r consumption - if they exp ect ro earn a very hig h level of
incom e th is period and very low or no income in th e following period, they are likely ro
save up arou nd half th eir income th is p eriod so as ro have a reasonably constant standard
of living in both periods .
Over rh e course of our lifetime, our consumpt ion and savings behaviour moves th rough
several patt erns. Wh en peop le are youn g, th ey rend to receive lower levels of income
because rh ey lack ski lls, experience and ed ucation. Th erefore, they rend co spend mosr of
t heir income and save very littl e - in fact rh ey would often rend ro dis-save (or borrow)
in order ro finance their educat ion . How ever, once peop le scarr workin g, and especially in
middl e age, th eir incomes rise, and rh ey wou ld tend to consu me a smaller proportion of
t heir income, as th ey start saving and accumu lati ng assets for ret irement . In ret irement,
people no longer earn income from the ir labour, and they consume out of past savings
and wealth, or rely on gove rnment p ension benefits.
T h is way of looking ar a household's consumption behaviour can explain why ind ivid uals
on hig her incomes tend ro have a lower average propensity to consume compa red
wi th lower-income earners. We can exp lain th is by saying that ind ividua ls who are on
hig her incomes would rend ro save mor e to pay past debts and accumulat e assets for
ret irement, whereas low income earne rs must use a hig her propo rtion of the ir income on
t he consumption of day to day necessit ies such as food and living expenses. Thu s, as an
indi vidual grows older, their average p ropensity to consume init ially falls (as th eir income
rises) and the n subsequently rises again after ret irement.
T h is theory of consumption behavio ur is often referred to as th e life-cycle th eory of
consumpt ion . Figure 4.3 shows what an individua l 's income, consumption and savings
pa tt erns wou ld look like during their lifet ime, according ro th is th eory.

Consumption,
Income

School Work Retirement

Figure 4. 3 - Life-cyc le theory of consumpt ion

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I
The Market Economy 2020

1 Dist inguish between average propensity to consume and marginal propensity to consume.
2 Consider a person earning $2000 a week who consumes $1200 of their income. Suppose that
w hen they receive a 25 per cent pay rise, their consumpt ion rises to $1400 a week . Calculate
the following :
• their average propensity to consume at their new income level
• their average propensity to save at their new income level.
Now suppose that this person decides to halve the amount of time they spend at work
so they can complete a part-time university course . Their income falls to $1000 a week .
Assuming they have a constant marginal propensity to consume , calculate the fo llowing:
• their new level of consurmption
• their new level of saving.
3 Explain how and why savings levels tend to change over the course of a person's lifetime .
4 If high-income earners tend to save a larger proport ion of their income than lower- income
earners, identify which economy 's average propensity to consume would be higher - one with
a relatively equal distributi on of income , or one w ith a very unequal distribution of income .

4.3 Factors influencing individual

Utility is the satisfaction
or pleasure that
individuals derive from
the consumpt ion of
goods and services.
consumer choice
In addition co th e decision about whether ro save or spend, the consume r must decide
how co spend t heir money. We have an almost end less range of ways ro spend our money.
Economises assume that in their expenditur e decisions consumers aim co maximis e their
uti lity, or well-be ing . Achieving high er utility m eans that an individua l has satisfied
more of his or h er wanes. In aimin g ro maximis e uti lity, or the level of sat isfaction of
the ir wanes, consumers have ro choose wh ich goods and services co buy, and in this choice
they are constrained (or limited) by rhe marker prices of goods and services and their
level of incom e. The demand of each consume r for a particular good or service is known
as individual demand.
The main factors affecting the consumer's expend iture choices are:

1. The level of income

A person's incom e level is one of the main influ ences on an indiv idua l's spending pattern.
As individuals earn higher incom es, they tend co choose ro buy more items , and items of
high er qua lity. Th e range of goods or services char m ight be pu rchased by an investment
banker on a salary of $300,000 a year would be quite different from rhar of a pens ioner wino
is living off an income of $30,000 per year from rhe age pension and their superannuat ion .
For examp le, an overseas holiday might increase rhe pensione r's level of uriliry , bur t he
pensioner may nor have enough incom e ro satisfy tihis wanr .
Anoth er factor rhat may influence consumption is house p rices. Rising house prices makes
peop le feel weal thier - the so-called "wealth effect" - which makes rhem more likely
ro spend money. In 2019 , rhe Governor of the Reserve Bank of Australia cited research
showing char a 10 per cent increase in housing wealth raises the level of consumption lby
1.5 per cent in t he long term.

2. The price of the good or service itself

In considering wheth er or not to purchase a good, consume rs must decide whethe r or
nor they are willing co pay the nominat ed price for rh e item, g iven their level of incom e.
Some goods are considered necessities for dai ly life, and peop le will need ro buy rhem
regard less of pr ice changes. For example , if the price of basic food increases, people w.ill
m
 Chapter 4: Consumers in the Market Economy I
not reduce thei r demand for food greatly, because they need it for surviva l. (Gou rmet
foods like caviar or oysters, however, are hard ly necessary for surv ival and would be more
respons ive ro pr ice changes.) In contrast, consume rs are likely co reduce rhe ir demand for
orher goods , particularly luxury items , as price increases.

3. The price of substitute and complement goods A substitute is a good

that consumers may
T he quantity of a good demanded ar a.ny time will be affected by the p rices of other goods. choose to buy in place
Consumers consider some goods co be close su bs titu tes , such as butter and margarin e or of another good, such as
tea and coffee (consumers are able ro substitute one for the orher). If rhe price of margarine butter and margarine or
rises, consume r demand for butter, which is a substitute, will also tend co increase. tea and coffee.

On the other hand some goods are considered co be com p lem ent s and consumers rend ro
pu rchase them together. Possible examp les include iPhones and iPhone cases, cars and perrol,
A complement is a
an d surfboards and wee suits. If the price of an iPhone falls, we would expect an increase in
good that is used in
consumer demand for iPhones as well as for their complements, iPhone cases. conjunct ion with another
good . For examp le, petrol
4. Consumer tastes and preferences wou ld be a complement
of cars.
An othe r major influence on a consume r's decision on how co spend the ir money is their
castes and preferences. An individual will decide ro purchase chose goods and services that
g ive chem the highest level of uti lity or personal sarisfaccion. Generally, we assume that
a higher quantity of most goods increases consumer ut ility. However, some goods and
services will give an individual consumer higher sarisfaccion than orhe rs. For example,
a consume r who has a p reference for fru it juice and who disl ikes soft drinks will rend co
spe nd more on juices and consume relative ly fewer soft dri nks.
Some goods may in fact subtract from consumer sat isfaction. For example, if a consumer
wh o disl ikes classical music were co purchase a ticker co the symphony, th is wou ld reduce
the ir uriliry (they ga in no extra satisfactio n for th e ticker) and they will probab ly not value
t he purchase. Consume r tasres and preferences can be changed by exper imentation and
learning (a consumer who disl ikes classical music may change th eir mind after seeing a
mov ie chat uses a Mozart symphony as irs backg round mus ic).
As co n sum er tas tes a nd p refer en ces change over time, so coo will the demand for
pa rticu lar goods. For example, clothing rhar is coming into fashion will face an increase in
dema nd, while consumer demand for cloth ing that is going our of fashion will decrease.
Innovation and tec hn olog ical pr og r ess lead ro consumers demandi ng new and better
produces at rhe expense of superseded ones. For exampl e, global sales of lapcops and tablets
were more than three times th e sales of desktop computers in 2019. Australians now spend
a much high er proportion of their income on communicat ions than in rh e past, reflecting
t he explosive growth of mobile telephony, use of the int ernet and cheaper call coses. As
of J u ly 20 18, there were 14.7 million internet subscri bers in Aust ralia , according ro rh e
ABS Internet Activ ity Survey. Ten years before, less rhan half rhat numbe r of Australians
were intern et subscr ibers, reflecting rh e change in consume r behaviou r in response co
cochnological change.

5. Advertising
Adver tising can have a major impact on individual consumer choice, .sometimes even
crea ting dema nd for a part icular good or service where none existed before . Peop le are
saturated with adver tising all day long , from pop-up ads on rh e internet, p hone calls from
te lemarkete rs, SMS advert ising, seeing billboards on the st reet or ar railway stations , ro
read ing messages on other people's clothing. Advertisi ng and marketing represent major
act ivities in a modern marker economy. In Austral ia, billions of do llars are spent every
year on advertisi ng. Advertising can mak e demand for goods and services less responsiv e
ro price increases by bui lding consumer loyalty ro particu lar brands over rime.

II
I
The Market Econo my 2020
Social welfare payments
are payments made to
increase th e incomes of
indiv iduals or families in
need of ass istance by the
government ; fo r example,
unemploym ent benefits
and family allowances.
II
1 Identify TWO pairs of subst itute goods and TWO pairs of co mplement goods .
2 Explain, us ing examp les, ONE facto r influencing ind ividual consumer cho ice.
4.4 Sources of consumer income
Consume rs gai n their income from a variety of sources. Consu mer income main ly comes
as a retu rn for resources such as labour, land, capita l and ent repreneu rial in itiative . T hese
resources are also known as the factors of pro du ct ion. Consumer income can also com e
from the gove rn ment in rhe form of social welfare.
Returns to factors of production
Consume r incom e can be defined as the rewards ro tihe owners of the factors of pr odu ctio n .
Consume rs receive income from the sale of t hese factors of p roduc ti on . T hese are:
• Wages fr om lab ou r : T his is the main source of income for consum ers. It comes in
the form of wage or salary pay ments for labour when consumers participa te in rh e
labour ma rker . It also includes non-wage income such as fringe benefits, emp loyer
cont ribu cions to supera nn uat ion, and workers' compensat ion payme nt s.
• Rent fr om land: Many consumers own land tha t becomes a source of income when
iri s rented. For example, consumers may own an investm ent prope rty rhar generates
property income.
• I ntere st fro m capi tal : Returns from the owne rship of capital are a sig nifica.nt
source of consu mer income. People wit h greater wealt h tend to enjoy a much highe r
income level, because wealth creates ongo ing income through returns from owni ng
capita l. For most consu mers, th eir ownersh ip of capita l occurs indi rectly throug h
supera nn u atio n and othe r investm ent funds or through the ownership of shares .
Th ey may earn int erest on savings held in cash management accounts or bonds .
Many Austral ians now own shares in compa.nies such as Telst ra, Woo lwort hs and
the Comm onwealt h Bank , which earn them d ividends each year.
• Pr o fit fr o m e ntrepreneurial skill s: A su bstanti al nu mber of Australians are
involved in operat ing busi nesses, especially sm all busi nesses. If rhe bus iness makes
a pro fit , t his income is considered a return for th eir use of entrep reneu rial ski ll.
Social welfare
A sig nificant propo rtio n of household income in Austral ia is received by way of social
security or social welfare, known as tra nsfer paym ent s, as figu re 4.4 indicates . T his is
income collected throug h taxati on and rhen transferred from governm ents ro consume rs.
More than a th ird of gove rnment revenu e is used to make these social welfare payment s.
Examples of these tra nsfer payme nt s include :
• Assistance to t he aged : For people who are over 65 years of age and retire d from
work ing.
• Fam ily p aym ent s: For families with childre n , means teste d accordi ng to their
income level.
• Disabili ty sup port paymen t : For people who are not able to work because of
personal factors such as phys ical illn ess.
• U n empl oy ment be n efit s: For peop le who are seeking work but unab le to find it .
 Chapter 4: Consumers in the Market Economy I

Transfer payments 9% Wages and salary 56%

Rent from ownership

of housing 9% ~

Returns to
enterprise 10% __.

Business profits and

capita l investments 11% Source: ABS cat . no. 5206.0

Figure 4.4 - Sources of househo ld income, 2018- 19

T h e aim of social welfare is ro provide a m in imum income safety net, allow ing consumers
ro pu rchase the basic necessiti es of life. In rimes of economic downturn, gove rnments
somet im es raise transfer payments in order ro increase consumer demand and help
economic growth ro pick up.
Fig ure 4 .5 demonstrates rhar government social welfare spend ing p rovides income ro
a wide range of peopl e in the community. Despite common perceptions rhar a large
percentage of welfare spendi ng goes ro unemp loyed peop le, they only receive around
six per cent of the welfare budg et. In rhe 20 19- 20 Budget, coral social security and welfare
spe nding was $180 bi llion . Th e most sig n ificant dri vers of this welfare spendi ng are rh e
as.sistance ro the aged and assistance co peop le with disabi lities.

Assistance for
Indigenous Australians 1% ----\ Other welfare programs 1%
General administration 2% ': ,~\
Assistance to veterans _ _ _ ...,..
\;;
and dependants 4%

Assista nce to the -- - - Assistance to

unemployed the aged 39%
and the sick 6%

Assistance to peop le -
w ith disabil ities 26%

+---Ass istance to families

with children 2 1%
Source: Budget 20 19-2020 , Budge t Pap er No. 1, Statement 6, Commonweal th of Australia

Figure 4 .5 - Commonwea lth socia l welfare expenditu re 2019 - 20

1 Explain how returns to factors of product ion provide inco mes for cons umers.
2 State the THREE most significant social welfare payments in the A ustralian
economy.

II
The Market Economy 2020

1 In a market economy, consumers decide what goods and services will be

produced by exercising their freedom to choose their purchases. This concept is
known as consumer sovereignty .

2 Consumer sovereignty can be reduced by certa in forms of business behaviour

including market ing, misleading or decept ive conduct, planned obsolescence or
anti-compet itive behaviour.

3 All income in the economy must be saved or consumed. This is shown by the
equation: Y = C + S.

4 The pattern of consumer savings can be influenced by a variety of factors

including culture, an individual's personality, expectat ions, future spending plans,
tax policies and availability of credit. However, t he two most important influences
are individuals' income and age.

5 Higher-income earners tend to save proport ionally more than lower-income

earners - they have a higher average propensity to save (APS) and a lower
average propensity to consume (APC). As income in the economy increases,
the level of both savings and consumpt ion tend to rise, but savings usually rise
faster than consumption.

6 The consumption function diagram shows the relations hip between

consumpt ion and income for an individual. The slope of the consumpt ion functio n
gives the marginal propensity to consume (MPC) , the proportion of each
extra dollar of income that goes to consumpt ion .

7 The life-cycle theory of consumption states that consumers save according

to their stage of the life cycle, where most of a person's savings occur while they
are of work ing age. Dis-savings occ ur before w ork begins and after retirement.

8 Individual demand is defined as the demand of each consumer for a particular

good or service. Factors influencing individual consumer choice include the
level of income, the price of the good itself and the price of substitutes or
complements, consumer tastes and preferences, and advertising.

9 Income is derived from the sale of the fo ur factors of prod uction: natural
resources, labour, capital and enterprise. Their respect ive returns are rent, wages,
interest and profits.

10 The government may provide social welfare to supplement an individual's income

or provide a basic standard of living in the absence of any income. These are
called social welfare payments .

II
 Chapter 4: Consumers in the Market Economy

•
- - --- -- ~~ ~=--=----
review
1 Discuss what is meant by cons umer sovereignty and the extent to wh ich this
principle operates in our eco nomy.

2 Explain how changing levels of income influence an individual's dec ision to spend
or save.

3 Calculate the average prope nsity to consume and average prope nsity to save for
the following individuals:
• Miriam, who has a weekly income of $450 and consumes $400 per week
• Stephen, who receives an annual income of $70,000 and saves $10,500
per year.

4 Draw a co nsumption function diagram based on the information in th e

following table.

Income($) 0 100 200 300 400

Consumption ($) 100 150 200 250 300
Calculate the marginal propensity to consume and th e marginal prope nsity to save.

5 Explain the effect that age has on an individual's consumption and savings patterns.

6 Consider how savings patt erns might be affected if an eco nomy was to
experience an econo mic down turn .

7 Distin guish betwee n a substitu te good and a complemen tary good. Explain how
a change in th e price of a substitute good might affect th e individual demand for
an item.

8 Give an example of how changing consumer preferences have influenced demand

for a good or service in recent years.

9 Outline the main sou rces of income for Austr alian households.

10 Explain what is meant by social welfare payments and th eir import ance to
Australian households.

Extended response
Explain the factors that influence an individual's demand for goods and services. Discuss
the role that advertising and marketing play in influencing consumer demand. Outline
government policies that might be used to encourage individuals to increase their savings.

m

Industry is the collection
of firms involved in making
a similar range of items
that usually compe te with
each othe r, such as the
financial services industry
or the car industry.
.,
Business in the
Market Economy
5.1 Business firms and industries
5.2 Production decis ions
5.3 What bus iness contr ibutes to the economy
5.4 Goals of the firm
5.5 Efficiency and product ion
5.6 Investment , techno logical change and eth ical dec ision making
5.1 Business firms and industries
Businesses occupy a central role in the economy. Essent ially, a business firm is an
organ isation involved in using entr epreneuria l ski lls to combin e factors of product ion to
produce a good or service for sale. An indu stry consists of th ose firm s involved in mak ing
a simi lar range of items tha t usually compete wit h each ot her. For example, we speak of
the motor vehicle industry , th e publishing industry and the pharmaceut ical ind ustry.
Business firms a re the major production un its in ou r economy, and their size, behaviour
and performan ce influence our overall productive capacit y. Because of th eir importa nce, we
need to gai n som e understa nd ing of how they function. In particular we look at how th ey
make productio n decisions, what they contr ib ute to the economy, the main objectives of a
firm, how th ey achieve efficiency, and how they are influenced by external develop ment s
such as new tech nologies .
5.2 Production decisions
What to produce
Th e first decision for someone operati ng a busin ess is what to produce. Several factors
may influence a business operator's decision:
• Th e sk ill s and experience of the busin ess operator. A person is likely to be most
successful operatin g in an ind ustry that th ey know well , where they und erstand
the dema.nds of consu mers, th e nature of production, how to maintain quality and
so forth, and where th ey also may have personal conta ct s.
• Ind ustries where th ere is strong consumer demand . An entrepre neur is more like ly
to be attracted to an industry where rapid grow th is being experienced, because
they are mor e likely to find opportunities co expand the business. For exampl e,
the minin g boom of th e 2000s saw many peop le create an almost instant fortu n e
from minin g investm ent s. Ho wever, ot her busi ness operators will sometimes go to
 Chapter 5: Business in the M arket Eco nomy I
decl ining areas of rhe economy, where businesses may be poorly run or undervalued
and the re are oppo rtu n ities co consolidate chem into more efficient businesses .
• Specific b u siness opportu n ities. An indiv idua l migh t find a specific bus iness Niche market is a
opportunity chat is particularly attractive. For example, they may fin d a region chat segment of a mass market
does not have a particu lar kind of busi ness, or th rough family or contacts they may for a good or service
have an opportun ity co develop a business in which rh ey might noc otherwise have that can be defined by
the specific tastes or
had an int erest . Alternati vely rh ey may find a n ic he market by focusing on the
characteristics of the
castes of a specific ser of customers, such as legal services for informati on techno logy target customers.
compani es.
• Th e amount of capi tal requ ired ro stare rh e bus iness. For many entr epreneurs, Capital is the
access co capital is a constraint in starti ng up a busi ness. Small ibusiness owners manufactured products
commo n ly mortgage th eir house and orher assets in order co start up th eir firm . used to produce
An entrep reneur is likely to be attracted co a business that has lower srarr-up costs, goods and services,
common ly described as
as this may min imise the ir risk.
the "produced means
O nce a firm has initially decided what ro produce, ir is likely ro cont inue produc ing chat of production".
ite m. How ever, a business char is com mitt ed ro expansion will regu larly review its produce
lines and look for opportun ities co expa nd int o ot her areas (and replace less p rofitab le
produce lines). Th e more a business ge es ro know its field of operations, rhe more likely
ir is co find opportun it ies chat may not have been obvious in rh e begi nn ing .

How much to produce

Ha ving decided what co produce, a firm muse next decide how much ro prod uce. Th is will be
based on its assessment of rhe level of consumer demand and irs ability ro convert char demand
into sales of its items. If ir produces coo much, rhe unsold goods may spoil, bur if ir produces
coo littl e, it may harm relationships with potent ial customers. A business may comm ission
market research co determine rhe likely sales levels of specific items; th is information may
also be useful ro help it determine what price levels would be appropriate.
In the ir initia l operations, firms can face a difficu lt decision in determi n ing how much
...Yes, I know that
co produce. For those firms chat requi re large p rod uct ion run s in orde r ro maxim ise Tasmania only has
efficiency, rhe p ressure co produce a la rge quant it y of output may conflict with a lack of 500,000 people, but if we
access ro capital. On the orher hand, some bus inesses may be able co respo nd quick ly produce a million 'Glad to
be a Tassie' T-shirts, we'll
co the level of demand, such as a cafe chat may only need ro add extra sta ff and save on product ion
purchase more supp lies. costs ... Don't worry,
Raj iv, I'm sure they 'll all
Th e quest ion of how much co produce is most d ifficult when a firm scan s want to buy five each!
up or when it introduces a new product line. In orher circumstances,
firms are generally ab le ro anticipate market dema nd reasona bly well by
observi ng past trends. Estab lished bus inesses will never th eless find .it
d i fficult co antic ipate the impact of changes in externa l condit ions on
con sum er dema nd (such as a change in weat her conditio ns increasing
demand for sun g lasses).

How to produce
Ha ving decided on irs produce s and quant ities of p rod uct ion , a business mu se next decide
how co p rod uce. Th e production process involves com bin ing a range of resources (known
as inputs) in order co create goods and services (known as outp ut s). A firm 's decision about
how ro p roduce depends upon the relative efficiency of rh e four factors of p rod uct ion
(natura l resources, labour, capita l and ent erprise), which can change over time, as shown
in the diagram overleaf. Firms will choose the combinat ion of factors of production chat
is mosr efficient .

II
I
The Market Economy 2020

New resourcescan be
discovered and new
technology can improve
the productivity of
natural resources.
,._,"I
education and
training can increase
the productivity of the
nation's workforce.

Natural resources can A decline in the birth rate

be diminished or an ageing of the
through exploitation, population will reduce
such as overfishing or the quantity of people
deforestation. available to work.

Businesses increasethe The supply of entrepreneurs-

economy's capital stock
through investment in goods
that are used in the
production process.
the innovators and risk
takers - will increase
under favourable political
and economic conditions,
providing opportunities
to make high profits. .- ,,..,..-..

An uncertainenvironment - such as
Over time, old capital will political instability or economic
wear out and become downturn - will
obsolete. This discarded generally reduce
(or worn out) component the willingnessof
of capital is known as individuals to
depreciat ion. innovate and
take risks.

The Sharing Economy

In recent years the emergence of the sharing economy has challenged trad it ional
bus iness mode ls where companies produced goo ds and services for consumption by
ind ividual consumers. In the sharing economy , dig ital platfonms like Uber and Airbnb
have di rectl y connec ted t he owne rs of cars, houses and othe r asset s w ith peop le who
want a lift , somewhe re to stay, or the use of a lawnmower fo r the afternoon. Shar ing
economy bus iness mode ls now play an importa nt role in markets alongs ide tradit iona l
bus inesses like tax is and hotel companies .
Some level of households sharing assets wi t h others has been part of t he economy
for cent uries, but d igita l platfo rms have mad e it a lot more convenien t by improv ing
informat ion flows, lower ing t ransact ion cos ts and faci litat ing
better rating syst ems that ind ividuals can trust. And wh ile it 's
called "sha ring" , it is very ser ious bus iness - its ma rket va lue
in October 2019 was US$49 billion. Othe r examp les of digital
platfo rms d irectly connec t ing buyers and sellers inc lude th e
on line trad ing webs ite eBay , and the Sydney - based AirTasker,
wh ere ind ividuals pay others to do everyday tasks from pet
mind ing, to having someon e wa it in a queue on the ir beha lf .
The sharin g economy opens up whole new ways to answer
the econom ist 's ques t ion : "How to produc e?"

II
 Chapter 5: Business in the Market Economy I

1 Outline the factors that an entrepreneur must cons ider when deciding what
good s or servic es to produce.
2 Describe the effect of the follow ing fact ors on a fi rm's decision of how much
to prod uce:
• popu lati on growth
• increased number of firms in the ind ustry
• reduced availability of storage space
• dec lining consumer demand over time.
3 Explain why a firm might choose a higher proportion of capital than labour in its
prod uct ion process.

5.3 What business contributes to

the economy
T h e performan ce of individual business
firms has a major impact on the Capital goods
performa nce of an economy. A health y,
growi ng p rivate sector will generare a
hig her race of eco no mic g rowr h an d a
st ronger revenue base co fund rh e services
prov ided by gove rnm ent s. For exampl e,
one of the main reasons for the st ronge r
growth races in the West Australian and
Qu eensland econom ies in the decade ro
2014 was the extent co which firms
in. chose scares are concent rated in rhe
0 Consumer goods
min erals and resources industries. Globa l
demand for min erals and resources fuelled
Figure 5 .1 - An increase in the economy's
large price increases for Austra lian expo rts productive capac ity
such as coal, iron ore, nickel, zinc and
copper, and ensured chat th ese resource-rich srace econom ies susrained faster g rowt h races
tha n chose of orher states such as New South Wales, Victoria and Tasman ia, which have
a sma ller proport ion of firms in min erals and resources industries .
Growing businesses also emp loy more people and reduce the incidence of un e mp loym ent .
For examp le, the grow th of business and financial services, and the i.nformacion and
com mu n ications technology sectors , resulted in much faster job creat ion in the Sydn ey
region in recent years, wh ile unemp loyment races in small er citi es such as Wollon go ng
and N ewcastl e have been hig her.
Businesses can also cont ribute co reg ional development. Th e rapi d growt h of Austra lia's
wi ne industry has add ed co tou rism and econom ic development in areas such as rhe Hunter
Valley in N ew South Wales, rh e Barossa Valley in Sourh Austral ia, and the Margaret River
region in Western Austra lia. Th e benefits of regiona l developme nt can include improved
road and transport services, better com municatio n links and greate r access ro facilities
such as bank ing and shops.

II
I
The Market Economy 2020

Finally, g rowth in indiv idua l businesses also increases an economy's p rod u ct ive cap ac ity
over time, as show n in figure 5 .1 on page 63. Th is wou ld be reflected in an ourwa.rd
shift in the produc t ion possib ility fronti er, wh ich was d iscussed in Chapte r l. T he reSUL
lt
of increasing the nation's product ive capacity is that an economy will be able to provide
improved living standa rds for its popu lat ion .
G iven the substant ial cont ribution that indiv idua l firms can make to a country's economic
grow th and productive capacity, it is not surprisi ng that govern ments offer significa.nt
assistance to encourage the development of new businesses. Commo nwealth and state
governments pr ovide a range of business assistance programs that offer informat ion , cash
payme nt s, train ing, and even help with specific activities such as overseas marketing. T his
reflects the benefits that the success of ind ividua l fir ms can offer to an entire economy:

1 Desc ribe TH REE benefits of stro ng business growth for th e broader econ omy.
2 Outline TWO ways a business might increase its own productive capac ity.

5.4 Goals of the firm

Th e objectives of the firm can be viewed as tihe moti ves of the ent repreneu r (or
ent repreneu rs) who own and run the firm. Th ere a.re a numbe r of objectives that a firm
can pursue in its day-to -day operations - it may try to maximis e profits, sales or g rowth,
or it may simply engage in satisficing behaviou r.

Maximising profits
Maximis ing p rofits - maki ng the biggest possib le profit, or the smallest possib le loss -
Profit motive refers to
is recognised as the main objective of most firms . Profit is the d ifference between t he
the process by wh ich
a business seeks to
firm 's tota l revenue (output sold mu ltip lied by price) and its coral costs of production.
maximise prof it by In fact, we will see later when we examin e the the,ory of business firms that econom ists
using th e lowest- cost generally assume that the desire to maximise p rofits guides the behaviour of all firms .
comb ination of resources Although profit maximisat ion is th e main objecti ve of most bus inesses, firms may have
and charging t he highest other objectives.
possible pr ice.
Meeting shareholder expectations
Th e main responsib ility of compa ny directo rs, who make decisions for a business firm, is
to serve the inte rests of shareho lders. Th is is a legal responsib ilit y govern ing th e operation
of corporations in Australia, and it is the overriding concern of most business managers.
Compa ny d irecto rs are chosen to represent shareho lde r int erests on boards, and so they wi ll
generally aim to meet the expecta t ions of their sha reholders . Sometimes this will create
tensions because the re may be a confl ict betw een actions that maximise share price and
div idends in the short term, but are like ly to reduce th e firm's value in the longer term .
Shareho lders are often int erested in maxim ising short -term returns on their investme nt .

Increasing market share

Because th e ent repreneu rial function of larger businesses coday is generally split betwee n
rhe owners (sha reholders) and paid managers, rhe goal of profi t maximisation may nor
always be rhe hi g hest priority . Th e shareho lders rake on th e function of risk. Th ey risk
the ir capita l and seek maximum p rofit as rhe reward for rhis risk. On rhe orher hand, t he
paid manage rs take on rhe organisationa l function and may seek increased salaries, power
and prest ige as t heir rewards. T heir perce ived managerial abili ty, and rhus th eir rewards,

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 Chapter 5: Busi ness in t he M arket Eco nomy I
may be more depe ndenr up on increasing sales cacher than maxim ising p ro fits. As a result ,
t here may have co be a compr om ise becween rhe objecti ves of p rofir maximi sation and
in creasing marker share.

Maximising growth
An oth er mot ive of management may be ro maxim ise rhe rate of growth of th e firm 's assecs.
In th e long run , a large r asset base should allow a bu siness ro achieve h ig her profits. It
can also brin g management oth er rewards, such as hig her salaries and p rest ige. However,
a s trategy of maximi sing g rowth can sometim es lead co a business failure .

Starbucks - the perils of ~--

maximising growth, not profits ~
The wo rld's largest coffee cha in, Starbucks , has over 27,300 stores in 78 count ries and
had revenue of over US$24 billion in 2018 . After rapid expansion in the United St ates in
the 1980s, it went international in the 1990s, opening a new store every single wo rkday
throughout the decade . While Starbucks was highly successfu l in some countr ies, the
Aust ralian ventu re was a lesson in the comp lexities of globa l bus iness. By focus ing on
rapid growth , Starbucks failed to understand that Australia's market for ca.fes was more
competit ive and mature than Ame rica's, w ith better -quality coffee , soph ist icated small
bus iness operators and st rong loca l custome r loya lty. It lost money and had to close
most of its stores . By 2016 , the cha in had closed all but 23 of their Austra lian stores
compared w ith its peak of 84 in 2008 . The Australian franch ise for St arbucks has now
been taken over by the owne rs of ?-Eleven, the Withers Group , who relaunched the
Starbucks brand w ith a strategy focused more on areas popu lar w ith touris ts and large
retail shopp ing centres . By 20 19 t his strategy had seen the tota l number of Starbucks
stores in Australia expand to 49 .

Satisficing behaviour
Sat isfic ing be h aviour means th ar a firm does nor atcemp t ro max im ise any parti cular
Satisficing behaviour
obj ect ive, bur cacher seeks co ach ieve w har it regards as an adeq uat e level of atcainm ent in
is the idea that firm s
each area. For examp le, a firm may seek co earn a sarisfactory level of profi t (an acceptable will attempt to pu rsue a
rare of recurn on investm ent for sharernolders) cacher rhan maxim ising p rofos . T his may be satisfactory level in all
in. rhe firm 's interescs in th e long run , because excessive pr ofirs may invite n ew compe cirors goals (profit max imisat ion,
in.co rh e indust ry, or may p rovoke rh e governm ent ro impose regu lati on on th e ind uscry. sales maximisation etc.)
rather than maximi sing
Sometim es firms may aim for non-fina ncial out comes - for example, newspaper pr oprietors
any single goal.
have often soug ht poliri cal influ ence or social p restige cacher th an purel y maximising
pro fits. A small but growing number of businesses operate as socialenterprim,with th e goal
of posi t ive social or environm enral im pac c, such as recycling or gree n energy businesses,
and businesses char emp loy hig her n umb ers of peop le who have di sabifo ies, have been
homeless or have recentl y arr ived as refugees.
W hile pr ofit maximi sat ion may nor n ecessarily be rh e overridin g objecrive of all firms,
wh en we analyse rhe pr icing and oucp uc policies of firm s operatin g und er d ifferent marker
srruc cures, we assum e rhi s ro be rh e case.

1 Descr ibe why lowering prices mig ht be beneficial for ach ieving the goa ls of a firm .
2 Ident ify TW O examples of bus inesses t hat you th ink hav e been suc c essfu l in
meet ing t heir goa ls. Exam ine w hich goa ls yo u th ink are t he most im portant to
eac h bus iness.

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The Market Econ omy 2020

5.5 Efficiency and production

Productivity
Once a business firm has decided co supp ly certain goods ro rhe marker , its next challenge
is co de liver rh e good or service at a minimum cost. An essentia l part of minimis ing coses
is ro be as efficient as possib le in rh e production process, an aim reflected in rh e concept
of p roducr iviry. Pr odu ct ivity refers co how much we produce with a give n qua nt ity of
Productivity refers to the
quant ity of goods and resources, per u ni t of time.
services the economy An increase in productivity can be defined as an increase in ourput per factor of production
can produce with a given
(input), per unit of time. Increasing productivity ns desirable because ir means char rhe
amount of inputs, such as
capital and labour. firm is mak ing mo re efficient use of irs limited resources. Increased product ivity allows a
firm ro satisfy a g reater number of wanes using the same level of resources.
It is impo rtant ro avoid confusion betw een rh e terms p1·od11ctio11 and productivity.
Pr odu ct ion refers ro the coral amount of goods and services produced . We can increase
production by increasing the amount of resources we use, or working chose resources for
a longer period of time . For example, ir is possible for a paving cont ractor co increase rhe
amount of pav ing completed each day by work ing longer hours or by employ ing more
labour ro help.
To increase p roduct ivity, we need more than just an increase in production - we need co
increase production proport ionately more tha n the increase in inputs of resources. For
example, if a concrete pavi ng concracror can more tha n doub le rhe area paved when she
doubles rh e am ount of labour used, then the re has been an increase in p roduct ivity - more
is being p roduced per unit of labour per un it of time . This means that the resources are
being used more efficiently.
T here are substa nti al benefits co the economy when firms use resources more efficiently . .In
a ge neral sense, because we are ab le ro produce more goods and services with our exist ing
resources, our overall livi ng sta n da rd s increase (in orher words, rhe economy is able co
satisfy more wanes). Econom ises generally recogn ise rhar, in rh e long term, improveme nt s
in productivity are the key ro increasing living stan dards in a count ry.
Producriviry comribuces co an improvement in our srandard of living in several ways:
• Less was tage of ou r scarc e r esou r ces: Because we are using our resources more
efficiently, we are ab le co produce more wit h a g iven quantity of resources.
• Lowe r produ ct ion cos ts and hig h er p ro fi ts for th e bus in ess fir m: Because
each factor of production can p roduce more .in any g iven rime period, it coses less
co produce the same qua nt ity of goods and services.
• A lowe r in fla tio n rate: Because of lower production coses, firms do not have co ranse
the prices of the goods they produce and may even be able co reduce these p rices.
• H ig h er i nc o m es: Since labour is more productive, firms can afford ro pay beccer
wage races co workers without increasing prices.
• I mp rov e d inte rn at ional com pet it ive n ess o f Au st rali a's indu st r ies: Increased
productivity compared with foreign businesses wi ll make Austral ian goods more
compet itive on local and int ernational markets .

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 Chapter 5: Bus iness in the Market Economy I
Specialisation and productivity
O ne of the major ways busi ness firm s can increase th eir p roducriviry is sp eciali sat io n ,
wh ere the factors of p roduc t ion - labour, natura l resources and capita l - are used more
intense ly for a smaller number of prod uctio n processes. Figure 5.2 describes how
spec ialisation can occur in relat ion co these three factors of pro duction.

TYPE DEFINITION EXAMPLE

Division of labour
(spec ialisation of labou r')
Occurs when bus inesses The assemb ly-line approach
break down their production to car product ion, where
process into a number of each worker comp letes a
sub -processes , allowing small tas k in the cons truction
labour to spe cialise in of each vehic le .
a particu lar part of the
process , and thus avoiding
the time and effort of moving
from one process to another.

Location of industry Occurs when a large number The concentrat ion of

(spec ialisation of
natural resource s)
of bus inesses advanced techno logy
that produce s imilar goods indust ries in the Macqua rie
and serv ices congrega te Park industria l area in
in the same area to Sydney's north-west.
reduce production costs
by sha ring common
infrastructure requirements.

Large-sca le production Occurs when bus inesses A large wine producer

(spec ialisation of capita l) grow so large they can that uses spec ialised
use hig1hly spec ialised mach ines to b ottle ,
cap ita l equipment in the ir cork and labe l wines .
product ion process.

Figure 5 .2 - Types of specialisation

Internal economies and diseconomies of scale Internal economies of

scale are the cost saving
In many situations, firms are ab le ro reduce t heir per-unit coses of produc t ion as t heir advantages that result
outp ut increases. In particu lar, manufacturing businesses often require a very high level froma firmexpanding
of output before they can compete wnrh orh er firms . its scale of operations.
Theyoccur when a firm's
T h e concept chat a firm needs co achieve a large scale of production in orde r ro m inimise output level is below the
coses is kn own as interna l economi es of scale . Econom ies of scale are experienced when technical optimum.
average coses per uni t of pro duction fall as rhe size of output grows. Ave rage cos t is rhe
pe r-unit cost of produc ti on, obta ined by div id ing the coral cost of prod ucing a certain level
of out put by rhe coral quantity produce d . Assum ing char the re is adequate dema nd for rhe Interna l diseco nomies
outp ut, the manufacture r will conti nue co expand the business, wh ile the firm can lower of sca le are the
cost disadvantages
t he per-uni t p roduc ti on coses because t his wi ll increase the firm 's overal l profitab ilit y.
(spec ifically, the increase
A firm cannot conti nue co g row and benefit from falling per-unit coses of p roduc ti on in marginal costs per
ind efini tely. It will eventually reach rhe point where coses of productio n wi ll scare co rise unit)faced by a firm
as a result of the firm
because of certa in d isadvantages associate d with becomi ng roo big. Th ese d isadvant ages
expanding its sca le of
are known as internal di seconomi es o f scal e. Mose of the factors chat cause d isecono- operations beyond a
m ies of scale are related ro management p roblems. As rhe size of the busi.ness grows, certain point. The firm's
m.anagement may not be able to efficiently organise all areas of the business, slowing output level is above the
dow n the prod uctio n process and increasing coses. technical optimum.

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The Market Economy 202 0

INTERNAL ECONOMIES OF SCALE

The cost-saving advantages that result from a firm expand ing its scale of operations can
be summarised as fo llows :
• By becom ing larger, the firm is better able to take advantage of spec ialisation of labour
by breaking up the process of produc tion into diffe rent stages.
• A large firm w ill be able to invest in more efficient cap ital equipment.
• A large firm can buy its raw materials in bulk, and bulk buying generally reduces the
per-unit cost of these inputs (also known as eco nom ies of size).
• A large firm can generally find a market for its by- products , whereas a smaller firm
would have to discard them as waste . For example, a large-scale furnitu re manufacturer
might be able to sell its timber off-cuts to a trophy manufacturer, whereas a small-scale
enterprise wou ld have to dispose of them.
• A large firm can put resources into research and development, which can expand
new produc t ion lines, and further reduce per- unit cos ts in the future by imp lementing
improved produc tion techn iques. A larger firm can invest in human cap ital, improving
the skills of its labour force through training prog rams that are spec ifically tailored for
the firm's needs .
• Larger firms usually find it easier and cheaper to raise finance for business expansion.

Where has productivity growth gone?

Aft,er decades of strong product ivity growth in Australia, recent data shows a
significant slowdown in various measures of the product ivity of businesses.
The Produc tivity Comm ission's annual Product ivity Bulletin found in 2019
that labour produc tivity, output per hours worked , had not grown at all in the
prev ious year. That compares with histo rical growth rates of almost 2 per
cen t per year. Falls in product ivity had been seen in many sectors , including
farm ing, mining, construction, transport and retail trade . The latest numbers
co ntinued a trend of weaken ing produc tivity growth since 2013.
IFM Investors Chief Economist Alex Jo iner said product ivity growth in
Aust ralia has fallen fo r six out of the last nine quarters. Dr Joiner said the
dece leration of product ivity growth is bo th hurting the broader economy
and supp ressing wage growth , arguing that "reduc ing regulatory barriers,
meaningful and fair tax reforms, encourag ing investment in techno logy and
investing in skills and educat ion" will delliver improved living standards over
the long term.
The current weakness in labour produc tivity can be partly attributed to a
marked slowdown in investment in cap ital, so much so that the ratio of
cap ital to labour has fallen, known as "cap ital shallow ing" (as opposed to "capital
deepening"). This is of particular concern because the way techno logy is changing
people's sk ills means that without new investment, workers become less productive.
With the RBA running out of room to cut interest rates below the historic low of
0.75 per cent in 2019, RBA Governor Philip Lowe has encouraged governments to
invest in infrastructu re that not only stimulates the economy in the short term but
also improves its growth potent ial in the long term .
Australia has a different industria l structure to most developed econom ies,
with weaker capab ilities in high value- added manufacturing industries such as
aerospace , automotive design and compute r des ign. Australian manufacturing is
orientated towards lower value- added manufact,uring. Nonetheless, the Product ivity
Comm ission notes there is likely to be scope for c atch -up for some industries. Given
the widesp read dispersion in product ivity levels ac ross otherw ise compa rable firms,
improved d iffusion of existing techno logies and knowledge offers a cost- effective
way fo r Aust ralian firms and indust ries to narrow the gap with global leaders.

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 Chapter 5: Business in t he Market Economy I
INTERNAL DISECONOMIES OF SCALE
The disadvantages that cause per- unit product ion costs to increase once a firm
expands its size past a certain point can be summar ised as follows:
• Management can lose touch with the day-to -day running of the firm and inefficiency
can increase.
• The large size of the firm may lead to dup licat ion and paperwork (red tape can bog
down the dec ision -making process).
• Problems arise in workplace relations because management no longer know the staff
persona lly. Management would be increasingly unaware of the prob lems and issues
faced by different workers on the product ion floo r. This can increase the tension in
the relationsh ip between employers and employees , and lead to misunderstandings
and workplace d isputes.
• Generally speaking , there is a decrease in managerial and admin istrative effic iency,
wh ich tends to overshadow the advantages of being large, and leads to an increase
in the per-unit production costs of the f irm.

T h e relationship between p roduct ion costs and internal economies and diseconom ies of
scale is shown in th e long-ru n average cost (LRAC) curve (figu re 5.3).

Cost per unit

LRAC

Technical
optimum

Internaleconomies Internaldiseconomies
of scale of scale
0 X Output

Figure 5. 3 - The long-run averagecost curve

• As the firm increases the scale of its operations up to outp ut leve[ X , its per-u n it
prod uctio n costs are declinin g, as revealed by the falling LRAC curve of the firm.
Th e firm can continu e to cake advantage of internal economies of scale up to this
po int .
• If the firm increases its scale of operatio ns past output level X, its per-unit production
costs start to rise, as revealed by the rising LRAC curve of th e firm. Past thi s po int ,
interna l diseconomi es of scale will now outweigh interna l economies of scale. Technical optimum is
the most efficient level of
• Point X represents the most efficient level of productio n for the firm (sometim es known production for a firm. At
as the technical optim um ). At t his point , average costs of product ion are at the lowest this point, average costs
of production are at their
possible level. Thi s is the point where the firm has taken maximum advantage of internal
lowest possible level.
economies of scale, without having to suffer excessive internal diseconomies of scale.
On this basis, the firm should contin ue to grow up to point X , but not past it.

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I
The Market Economy 2020
External economies of
scale are the advantages
that accrue to a firm
because of the growth
of the industry in which
the firm is operating. They
are not the result of the
firm changing its own
scale of operations.
II
Learning by doing Cost per u nit
A bene fit of cont inuous ly repeating LRAC 1
production processes is that a
firm gets more practice - and can
Technical
become more efficient at comp let ing optimum
the same tasks in the product ion
process over t ime. Learning by
do ing , as it is known , results in a
downward shift of the firm 's long-run
average cost curve - meaning lower o Output
per-unit product ion costs at each
level of outpu t (see figure 5.4). Figure 5.4 - Learning by doing
External economies and diseconomies of scale
In add it ion to factors relat ing to a firm's own p rodu ction p rocess, t here are oth er cost
advant ages and d isadvantages th at can affect a bus iness that lie comp letely outside its
cont rol and occur regardless of a firm 's level of p rodu ction . Th ese are known as exter n al
eco n om ies an d external d iseco n omie s of scale .
EXTERNAL ECONOMIES OF SCALE
Externa l econom ies of sca le are cos t- saving advantages that accrue to a firm because
of outside influences , and are not the result of the fi rm chang ing its own sca le of
operat ions . They can be summarised as fo llows :
• Increas ing loca lisation of industry genera lly means that all firms in a part icu lar reg ion
wou ld enjoy certa in cost -saving advantages , such as locating near a highly popu lated
area w ith a supp ly of skilled labour, a plentiful supp ly of necessary inputs and a major
consumer marke t.
• As an industry as a who le grows , all firms in that indust ry generally der ive some
extra benefits . This cou ld involve the governmen t prov iding spec ial research and
developmen t to help promote the industry. For instance , the CSIRO has deve loped
new stra ins of disease-res istant , high -yielding whea t , wh ich benefit all wheat farmers ,
both big and sma ll. Likew ise , private enterpr ise m ight also be w illing to prov ide
research and deve lopment , as well as other benefic ial serv ices (such as transport) to
a grow ing industry.
• A grow ing , competit ive and more soph isticated cap ital market wou ld be of benefit to
all firms as it cou ld prov ide cheaper invest ment funds from a w ide variety of sources .
On t he ot her ha nd, cost d isadvant ages may accrue to a g rowing firm because of outside
influ ences, which are known as exter n al d iseconomies of sc ale .
 Chapter 5: Business in the Market Economy I
EXTERNAL DISECONOMIES OF SCALE
External diseconom ies of scale usually result from the growth of the industry in which
the firm is operating, but they can also result from rapid growth across the entire
economy . They are not the result of the firm changing its own scale of opera tions and
can be summarised as follows:
• The growth of industry causes increased pollution. For examp le, in China, rapid
indust rialisation, comb ined with weak environmental controls, has cont ributed to
huge problems with air pollution in several major cit ies. The pollution prob lems are External diseconomies
so severe that they are cont ributing to illness and premature deaths, and requiring of scale are the
occas ional closures of facto ries and restrictions on driving , with harmful effects on disadvantages faced by
business. a firm becauseof the
growth of the industry
• The trend towa rds increasing the concentrat ion of indus try and people in exist ing in which the firm is
urban areas can eventually cause• transport bottlenecks. This can inc rease operating, and they are
the transport costs of all fi rms. For examp le, the growth of Tokyo has caused not the result of a firm
extraordinary increases in property prices, fo rcing many Japanese people to changing its own scale of
live fa r away from urban cent res. This has meant that hund reds of thousands of operations.
commute rs spend several hours t ravell ing to and from work each day .
• As an industry grows, the cost of a firm's raw materials can rise, as the increasing
demand forces up their price. This is especially likely to occur if there is only a very
limited supp ly of these resources.

1 Descr ibe the benefits of increased productivity fo r an eco nomy.

2 Outline and expla in, using examples, the THREE different types of special isation
of the factors of production.
3 Compare and co ntrast internal economies and diseconomies of sca le.

5.6 Investment, technological change

and ethical decision making
T h e business environ ment in the twenty-first centur y is highly competitive and
fast-changing. Business managers need to be alert to th e opportunities offered by trends
like globalisatio n and new technolog ies like the int ernet. Th ey also need to understand
ec:h ical decision mak i ng and what impact their business has on ibroader society,
especially on the natura l environ ment . Th ese forces have sig nificant i mp lications for Ethical decision
making is when
how businesses operate in the marker economy. Th e following section examines some of
business decisions about
t he implications that techn ological cha nge and ethical decision makin g have for several production methods,
aspects of business conduct . employment and other
matters are made taking
into consideration the
Production methods impacts on broader
Techno logical change and innovatio n have increased the prod uctive capacity of th e society and the
environment, and not
economy by maki ng it possible to use existing resources more efficientl y. Investment in simply to maximise profits
te<:hnology has led to radical changes in th e methods used to produce goods and services. for the firm.
For example, a large numb er of firms, such as car manufacturers, have computerised many
aspects of the production process. Th e impact of technological change on production
m eth ods has varied from firm to firm . Ho wever, in many cases it has led ro lower costs,
in creased efficiency, a reductio n in the size of th e workforce and the possibility of larger
production run s.

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I
The Market Economy 2020

ETHICAL DECISION MAKING

Recent years have seen many scandals involving dishonesty and
abuses by businesspeop le that have prompted huge fines.
Cheating on fuel emission tests by German car manufacturer
Volkswagen was estimated by the end of 2017 to have cost it
A$45 billion in fines and vehicle refits globally. In 2017 ,
Australian regulators imposed a $25 million fine on Japanese
shipping company Nippon Yusen Kabushiki Kaisha, wh ich
colluded with other shipping lines to reduce competit ion in the
car import business and maintain their market shares. Austra lia
has seen its fair share of corporate scanda ls. The 2018 Banking
Royal Comm ission into the misconduct of Austra lia's largest
financial inst itutions is reported ly set to cost the big four banks
over $2 billion in regulatory costs to try and clean up the mess
caused by years of wrongdo ing.
Such cases have prompted calls for business managers to embrace more ethical dec ision-
mak ing processes , so that business decisions take into account the impacts they have on
broader society and do not just aim to increase prof its for shareholders. Business ethics
is not just about abiding by the law, meeting contractua l ob ligations, and treating customers
well to build relationsh ips - it is about going above and beyond what is required by the
law, and ta king into account social interests in dec ision making. Board members and
decision makers must therefore maintain the bus iness's "social license" to operate .
Unethical decision making may damage the reputat ion of the business, as well as impact
revenue and profits . Increasingly, consumers , cit izens, governments and even a business's
employees expect that a business will be driven by not just the profit motive, but a broader
social purpose.
A wide variety of business decisions can be affected by business ethics, such as what to
produce (is it eth ical to produce tobacco that can cause lung cancer?), how to produce (is
it ethical to use contractors in countries like China where workers are paid very low wages
and work in unsafe factor ies?) and how to market goods and services (is it ethical to make
exaggerated claims about a product?). The pressure on businesses to increase profits can
often result in corporat ions engaging in unethical behav iour, and this has resulted in a
greater focus on the role of ethics in business dec ision making. Corporate soc ial
respons ibility or "triple bottom - line report ing" programs also aim to encourage more
ethical decision making.
In a globalising economy, ethical decision making is also playing a greater role in product ion
methods , with some businesses taking account of social interests that may not directly
contr ibute to increased profits. Ethical decisions are espec ially important when businesses
have global sup ply chains and are involved in product ion processes in developing countries,
where they can potentiallycut costs by paying workers low wages, or using chemicals or
production methods that are not allowed in deve loped econom ies.
An environmental example of an ethical business decision might be a furniture
manufacturer in a developing economy choos ing to use plantation t imber rather than
timber from old -growth forests. Of course, this decision may simply reflect normal business
cons iderations , if native forest timber is more expensive than plantation timber. However,
to the extent that the business is taking account of the environmental impact of its timber
sourcing strategy, ethics are playing a role in decision making.

Prices
On e of the mosc sig nificant changes that inform atio n and commun icati ons technologies
have brought ab out is a more well-informed marketp lace. Search engines g ive consumers
imm ediate onlin e access co any number of businesses locally or overseas, so chat th ey can
qu ickly compare pr ices between compe t ing firms. Thi s has squeezed p rofit marg ins and
forced firms to reduce th eir costs to comp ete with overseas competit ors.

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 Chapter 5: Business in the Market Economy I
Employment
N ew technologies have had a mixed impact on the dema nd s of firms for emp loyees. On e
obvious effect is chat techno logical change has made many p revious jobs redun dant.
Many businesses have been ab le co reduce th eir staffing levels substantia lly, as faster
production and data- processing techno logies have reduced their requi rem ent for labou r.
T he increased competitive ness of overseas firms has also caused some firm s co cue back local
man ufactu ri ng operations or move chem offshore, resultin g in job losses w ithin Austra lia.
O n th e ot her hand , the growt h of n ew techn ologies p rovides new job opportuni ti es,
wi th str ong de mand for emp loyees w ith specific inform ation techno logy ski lls, such as
computer programmi ng.
Ethica l decision making is also having an impact on firm s' employ men t stra teg ies. For
example, in hiring new employees, som e busi nesses have affirmative act ion strategies chat
act ively seek ro recruit women, reflecting the historical und er-represencation of women
in. senior leadership roles and certain pro fessions. Under law, all businesses must meet
eq ual employ ment opportun ity obliga tion s in hiri ng new emp loyees, but ethical factors
mi ght encourage busi nesses to go further than their legal obligations by act ively hirin g
emp loyees from groups chat have tradi tionall y suffered disadvantage or d iscriminat ion .

Output and profits

Businesses chat invest in techno logy are likely co be able to offer bette r-qual ity p roduc t s
at a lower price. In additi on, by uti lising the latest techn ology, they are bette r ab le to
respond to changes in mar ket demand and co custo mise the ir output to the specific needs
of the marketp lace. Thi s, in turn, is like ly to further increase demand for their p roducts,
result ing in a highe r level of outp ut and increased profita bility. Wh ile t h is can lead co a
vi rtuous cycle of investm ent , output grow th , and expandi ng profits in che longer term,
in. the shorter term, businesses muse be p repared co make a substa ntia l investment in
cochnology.
Ho wever, th ere is of course no gua rant ee chat a business chat invest s in new technologies
wi ll necessarily be successful. Some techn ologies may fail to perform co expectatio ns
and may requ ire su bstant ial expendi cure to repair prob lems. In the long term, not all
in.vestment s in technology will recoup their costs. A business may invest substa ntially
in. a new techno logy, only to find thac it is sup erseded by an even better techno logy chat
competitors invest in at a much lower p rice.

AUSTRALIAN TRADE COMMISSION -

INTERNATIONAL INVESTMENT IN AUSTRALIA

In 2019, Aust ralia's new foreign d irect investment (FDI} was over $75 billion - bringing
the tota l to almost $1 tr illion.
The two largest foreign investors in Austra lia are the United States (with $940 billion
or 27 per cent of total foreign investment in 2018) and the United Kingdom (with $575
billion or 16 per cent). The next largest equity investors in Austral ia are Belgium , Japan
and Hong Kong.
The mining and quar rying indust ry had significant growth in net FDI flows, despite the
slowdown in commod ities activity in the last few years. The tota l stock of FDI in the
mining and quar rying industry accou nts for more than $366 billion, equiva lent to 38 per
cent of the tota l FDI stock by industry . Investment in mining and quarrying was three
times the contr ibut ion of manufactu ring, the industry that has the second -largest share
of FDI. The sectors exper ienc ing the most growth in FDI stock in 2018 were finance
(up 46 per cent}, accommodation and food service (up 29 per cent) and rea l estate (up
13 per cent).

Source: ABS cat. no. 5352.0 International Investment Position, Australia: Supp lementary Statist ics, 2018, Australian
Trade Commission 2019

II
I
The Market Economy 2020

Examples of new business investment in Australia

Saputo Canada 1.3 billion Dairy company

Power China China 330 million Renewable energy - wind

farms

Bosch Group Germany 2.5 million Agricultural techno logy

Sou rce : Australian Trad e C ommission 2019

Types of products
New technologies expand th e range of p roduces chat may be p roduced co sati sfy
market demand. Techn ological change creates compl ete ly new produces and indust ries.
Improvement s in techn ology are a major reason why .somepeopl e regularly update produces
such as cars, cameras, computers and sound systems. If a new pro duction technology is
more flexib le, it may make it possible co custom ise outp ut co the specific wanes of
individuals. Small er prod uction runs may become more affordable, thus broadening t he
range of pro du ces and maki ng it easier co satisfy consumer deman d .
Eth ical decision maki ng in business has also played a role in th e producti on of new types
of produces and services, such as organ ic food, renewable energy and recycled paper . T he
growth of such markets is p rimarily dri ven by ethi cal consumerism , and businesses are
simply making profits by selling goods and services chat consumers wane co buy, such as
organ ic food, because of its health or caste benefits.. Equally, business et h ics p lays a ro le
in drawing peop le co ru n businesses in such markers.

Cloud services
Company intranets and cloud -based services are impo rtant business innovat ions
enabled by the internet. Cloud services allow emp loyees to access data on any
device, whether they' re at home, at work or travelling. Cloud services include:

• work management services such as work -from -home

software , time management systems and career
planning advice
• software-as-a-service, with access to account ing,
human resources and custome r relationship
management too ls
• shared development of work documents that can be
simultaneously edited by several people.

Globalisation
Techn ology is o ne of the major dr iving forces behfod the g lobalisation of markets . Th e
development of g lobal money and scock market s, med iated by g lobal compute r networks ,
has made it possib le for businesses co attrac t investm ent funds from across the worl d,
and for individ uals co diversify their investment s. Th e low cost of communication allows
informati on co flow more freely from overseas co consu mers and business, allowing chem
co make beccer-i nform ed decisions about p roduceion and consump tio n . Businesses are also

II
 Chapter 5: Business in the Market Econo my I
better able ro access overseas markets for their goods. The overall effecr is rhat technology
is facilitating rh e emergence of a global marker economy - a topic rhat is taken up in
deta il in rh e HSC Economics course.
G lobalisation has significa nt implicatio ns for et hical decision mak ing in business . Through
greate r access ro foreig n mark ets, bus inesspeople are able to source products that may be
cheaper because they have been prod uced in an economy with fewer regulations. Whil e
ir is legal ro buy th ese goods, some of th eir production processes involve forced labour
overseas, very low wages , dangerous work enviro nments and the denial of the rig ht to join
a ttrade union and seek bette r pay. In a global economy, consume rs and non-governm ent
organisa ti ons are payi ng greater atte nt ion ro rh e pract ices of trans natio nal corporations
in. poore r nati ons , and this is placi ng greate r pressure on them to improve the pract ices
of their su bsidiaries and thei r suppli ers. For example, confectio nary business Cadbury has
committ ed to using on ly fair-trade chocolate in its Australian manufacm ring operations.
Likewise, after rh e "Trear Your Workers " campaig n on college campus es in the United
Srntes, Coca-Cola agreed ro extend health care coverage for irs worke rs in irs bottlin g
and production supp ly chain in Africa , where many workers are HIV positive and need
m edical care.

Environmental sustainability
An impo rtant part of mod ern business is environm ent al susta inability - a concept that
in volves minimisin g pollut ion and waste, p reserving the natura l enviro nm ent , and
in.creasing the use of renewable energy. Businesses may change th eir activ iti es to make
t hem more environm entall y sustainabl e in response to demand s by consu mers, new
regu lat ions or financial incentives fro m governm ents, or because of bus iness ethics that
value the natural enviro nm ent. Efforts ro make busin ess more enviro nm entall y sustainable
are a significant drive r of investment in new technolog ies.
Environ menta l sustai nabilit y is affeccing what goods and services are produced and how
t hey are produced, with most major Australian corporations now having environ mental
policies that outline their stra tegy to be more environm entall y sustain able. Qant as, for
example, has an environ menta l sustain abi lity strat egy rhat p rovides p assengers wit h
t he option of flying "carbon neutra l" - rhat is, allowing them ro pay extra to offset rh e
em issions from th eir flig ht. Furth ermore, the compan y aims to cut net emissions by
50 per cent by 2050. N ew techno logy and investm ent is cent ral to its environ mental
sustainabi lity srraregy - for exampl e, its target ro improv e fuel efficiency by 1.5 per cent
a year requires investment in new, mor e efficient aircraft and more advanced navigat ional
aircraft technology.

1 Outline TH REE benefits of tech nologica l change for a business.

2 Explain how ethical decision making might affect a firm's environmental
practices .
3 Choose an industry that has undergone major changes in the past: decade ,
such as the telecommunications industry, food industry or energy i ndustry,
and consider the fo llowing questions :
a) How has the industry changed? For example , number of business firms ,
profit levels, number of customers, etc.
b) What impact has tech nologica l change had on businesses in the industry?
c) How has ethical decision mak ing affected what prod ucts or services are
produced or how they are produced?

II
The Market Economy 2020

1 A business firm is an organisation that uses entrepreneurial skills to comb ine

the factors of product ion to produce goods and services. An industry consists of
those firms invo lved in making a similar range of items that usually compete w ith
each other.

2 The firm , like an economy, has to answer the following questions:

• What to produce?
• How much to produce?
• How to produce?

3 In a market economy, the questions of what to produce and how much to

produce are determined by the level of consumer demand in the economy for
each individual product. The problem of how to produce is typically determined
by a comparison between the cost and efficiency of the factors of production in
producing that good or service.

4 Although maximising profits is a firm's major objective, the firm also has other
objectives, including meeting shareholder expectations, increasing market share
and maximis ing growth. In some cases, a firm may not seek to maximise any
particular object ive, but simply engage in satisficing behaviour.

5 To achieve max imum profit, the firm must comb ine resources at the lowest cost.
Increasing productivity and efficiency w ill further reduce costs.

6 Increased profits can be achieved through specialisation , where the factors of

product ion are used more intensively to complete a narrow range of tasks in the
product ion process.

7 A firm may reduce costs by increasing its level of output and achieving
economies of scale . On the other hand, diseconomies of scale may result if
increasing output levels begin to raise average p roduction costs .

8 Internal econom ies and diseconom ies of scale result from changes in production
levels for the individual firm, whereas external economies and diseconom ies of
scale result f rom changes in production levels or size of an entire industry.

9 Investment and technological change can affect the costs and

competit iveness of firms by improving production methods , lowering prices,
reducing staffing requirements, increasing outp ut , raising profits , expanding
product variety and fostering globalisation .

10 Ethical decision making influences businesses when questions such as what

to produce and how to produce are cons idered against social and environmental
outcomes beyond the objectives of the individual firm.

II
 Chapter 5: Business in the Market Econo my

1 Distinguish between the terms business firm and industry.

2 Exp lain how, in a market economy, firms select the resources that w ill be used
in production.

3 Discuss what business firms co ntribute to an entire economy.

4 Outline the different potential goals of a firm. Ident ify w hich goal is usually
considered to be the most importa nt.

5 Exp lain why a firm might use a higher proport ion of labour than cap ital in its
prod uct ion process and how th is is influenced by prod uct ivity.

6 Discuss how a business can use specialisation to increase the prod uctivity of th e
factors of product ion.

7 Exp lain how a long-run average cost curve can be used to explain the co ncepts
of internal economies and disecono mies of scale.

8 Hypot hesise TWO facto rs t hait could cause a firm to experience:

a) internal diseconomies of scale

b) external diseconom ies of sca le.

9 Analyse possible ways a firm can keep up with tech nological change and the
possible benefits that can result from innovation.

10 Discuss how ethical decision making may influence the product ion methods of a
firm and improve environmenta l sustainability. Provide examples of govern ment
initiatives and incent ives to firm s to help assist environmental sustainability.

Extended response
Outline the various possible goals of a business firm. Explain w hy maximising profits is
considered to be the most important goal of most firms. Examine the methods by w hich
a firm may maximise its profits .

II
TOPIC
MARKETS
Issues
By the end of Topic 3, you will
be able to examine the following
economic issues:
■ Identify how business and governments can
use information from the market
■ Examine t he forces in an econo my that t end
t o cause prices to rise
■ Identify reasons why government may
intervene in certain markets
■ Explain how market solutions can lead to
imp roved efficiency
■ Examine t he nature of competi tion in markets
characterised by oligopo ly and monopo ly
■ Identify some of t he prob lems that can ensue
with a heavy reliance on market solutions in
an economy
■ Discuss how market forces can lead to
environmenta l prob lems such as pollution
■ Propose alternatives to market so lut ions.
.---- - Focus
The focus of this topic is the operation
of markets. The way in which market
prices are determined and the need
and means available for governments to
intervene in markets is highlighted.
i---- - Skills
Topic 3 skills questions can ask
you to:
■ graph demand and supp ly curves and
interp ret the impact on t he equilibrium of
changes in market forces
■ analyse non-equilibrium market situations and
propose solutions to them
■ calculate the price elasticity of demand using
the total outlay method
■ work in groups t o investigate and report on
the nature of competi tion within a specific
industry.
Economics Stage 6 Syllabus 2009 ext racts e NSW Educatio n
St andards Aut hority for and on behalf of the Crow n in right of the
St ate of New South Wales, 2009; reprodu ced by permission .
Topic 3

Introduction
We saw in Topic 2 that both consumers and businesses are largely motivated by self-interest .
In Topic 3, we will look at how markets achieve a compromise between what consumers
and businesses want. Compromise occurs whenever firms and individuals come together in
a market for a certain good or service. Topic 3 examines how this comp romise rakes place
and how the different priorities. of firms and individua ls create different market outcomes.

Chapter 6 focuses on the consumer's point of view: the study of consumer demand . Nor
all consumers are as willi ng (or as able) to purchase a good or service at a particular p rice.
As a result, levels of demand will vary based on price . Yer we n eed ro unde rstand the
reasons why consumers are more or less willing to pay a certai n price. Why, for exampl e,
are prescript ion pharmaceuticals more expensive tha n washing detergents) Is it simp ly
because they cost more to pr od uce, or is it because they are more .important to us?

Chapter 7 focuses on the firm's point of view through the study of supply . Businesses
mak e decisions about how much to produce and at what price, dependi ng on mark et
factors. Again, not all firms w ill p roduce an equa l quantity at an equal price . Th erefore,
we have ro look at what considerat ions the firms will take into account in deciding pricing
and output issues. Th e type of industry the firm is in will affect these decisions. Consider,
for examp le, th e price-cutt ing effect of Amazon's entry into Austra lian retai l markers for
books and electron ics, in contras t to the add ition of anothe r petro l station in a subu rb,
which may have no effect on the price you pay for pet rol.

Chapter 8 examines the process of how consume rs and firms int eract in the marketp lace
to determine a final price and quantity of production. Th e marke c balances the interests
of both consumers and firms in such a way as ro allow exchange to take place. However,
it does not always bri ng about th e best outcome. T he mark et is very good at tak ing both
consume r inte rests and thos e of th e firm into account, but it does not consider othe r
concerns that we might have as ind ividuals or as a society, such as the p reservation of th e
natural enviro nment. Because of this, an examination of the market must include a study
of the solut ions ro th e prob lems of markers as well.

Th e individual market is in m any ways simply a smaller representation of th e mark er

economy as a whole. As you read the next chapter, consider how the characteristics you
learn here are applicab le to the economy as a whole. Are th ere p roblems with relying on
the marker ro determine economic outcomes, and if so, can those prob lems be resolved)

m
Demand

6.1 Factors affecting market demand

6.2 Movements along the demand curve
6.3 Shifts of the demand curve
6.4 Price elasticity of demand
6.5 Factors affecting elasticity of demand

Demand can be defined as the quant ity of a particu lar good or service chat consumers are
will ing and able co purchase at various price levels at a g iven point in time.

As we saw in Chapte r 4, the demand of each indiv idual consumer for a particular good
or service is referred co as indivi du al demand. In the d iscussion that follows we are
going co be concerned with market demand , which is the deman d by all consumers for
a particu lar good or service. Th e market demand is. obtai ned by summi ng the quantities
deman ded by all individua l consumers at rh e various price levels.

6.1 Factors affecting market demand

T he main facroirs affecting market demand for a part icular produce are similar in many
respects co the factors char influence a consumer's in dividual deman d, wh ich we discussed
in Chapter 4. Th ere are six main factors:

1. The price of the good or service itself

In considering whethe r or not ro pu rchase a good, consume rs must decide wheth er or not
they are willing co pay rh e nominated price for the item.

Some goods are considered nec essi ties for dai ly life, and people will need co buy chem
regard less of price changes . For examp le, if rhe price of basic food items increases, peop le
will not significan rly reduce the ir demand for food because th ey need it for survival.
However, they are likely co reduce their demand for orher goods, particularly luxury
items, if the ir p rices increase.

2. The price of other goods and services

T he quantity of a good demanded is also affected by the prices of orh er goods. Consume rs
consider some goods co be close substitutes, such as butter and margari ne or a Nerfl ix or
Foxcel Now subscription (consumers are able co subsrirur e one for rhe other). If the price of
margarine rises, one would expect the demand for butter, which is a substitute, to increase.
On rhe orh er han d, some goods are considered co be com p leme nt s and consumers tend co
purchase chem cogecher - such as a Blu-ray player and Blu-ray d iscs, or a car and pet ro l.
 Chapter 6: Dema nd I
If the price of cars increases, one wou ld expect a decline in rh e guanti cy of cars
Well, technically speaking, Ralph , you don 't.
de manded, as well as a decrease in de mand for irs comp lement good - pe tr ol. Economists only recognise consumers'
demand for goods and services when
they are both able and wi Hil'l!Qto pay for
3. Expected future prices them. You' re only six, Ralph, and you
don't even have an income!
T h e current consu mp tio n of a particular good or service will be affected nor Now, let's go to the books tore and I'll buy
you a copy of The Marl<et E conomy .
only by current prices, but also by expected future prices. If consum ers That' ll help explain things .
expect char rhe price of a certai n good will increase in the near future (for
in stance, due co the introduction of a new tax), they will bring forward
t heir consumptio n and increase the current demand for char produce. An
example of this was rhe large increase in expenditure on home building
in rhe months preceding rhe introduction of the Goods and Services Tax
in 2000.

4. Changesin consumertastes and preferences

As consumer castes change over time , so coo will the demand for part icular
goods. For example, clothing char com es into fashion would face an increase in
demand, while demand for clothi ng char is going our of fashion will decrease.

Innovation and techno logical p rogress lead ro consumers demandin g new and
better produces ar the expense of supersede d ones. For example , while m ost music sales
once came from CDs, people now mo stly buy mu sic online and downl oad ir ro their
smarrphones or compu ters.

5. The level of income

As income leve ls in rhe economy chan ge, so roo will consume r demand. As people earn
high er incomes, they become more willing and able to purchase more goods and services Income distribution
refers to the way in
char they could not previously afford. Rising incomes would tend co increase the deman d
which a economy's
for luxury goods more rhan rhe demand for necessities, which are nor very sensitive co income is spread among
changes in income levels. the members of different
social and socio-
A change in income d ist ribut ion could also change the level of demand for particular economic groups.
goods. For example , a redistribution of income cowards higher-income earn ers would lead
co a greate r demand for luxury goods .

Consumer expecta t ions about futu re income levels and prospects will influence their
decisions ro buy certain types of goods. For examp le, consumers would be less likely co
buy expensive luxury goods if rhe economic outlook was uncertain and they feared chat
t hey might lose their jobs in the near future .

6. The size of the population and its age distribution

Populatio n size will affect the coca) qua ntit y of goods de manded, whil e age dist ributi on
wi ll affect the type of goods demand ed. For instance, with Austra lia's ageing popu lation,
one would expect higher deman d for ret irement villages, aged care sel!"Vicesand orher
goods and services reguire d by older p eople.

Somet imes the behaviour of other consumers can influence an individua l's decision to
demand a good or service or not. If one person's demand is affected by the number of
other people who have purchased the good, there is a network externality.
A posit ive network externality - known as the bandwag on effe ct - occurs when people
demand a good because almost everyone else has one, such as children 's toys and
fashionable clothing.
A negative network externality - known as the snob effect - occu rs where demand fo r
a good is higher the fewer the people who own it, such as rare works of art and limited -
edition sports cars.

m
I
The Market Economy 2020
Ceteris paribus is an
assumption used in
economics to isolate the
relationship between two
economic variables. It is a
Latin phrase that means
"other things being equal",
or assuming that nothing
else changes.
m
The ceteris paribus assumption
In the analysis chat follows, we are going co adopt a num ber of simpli fying assumptions
co help us understa nd the nature of market dem and . In the real world, several of t he
above factors ofte n influence demand simultaneously, but it wou ld be a d ifficult cask if
we had co analyse all of them at once. To avoid t his, we focus on one factor at a tim e (for
examp le, the price of the good) and analyse th e response of de mand co a change in price,
wh ile we assume t hat all the ot her fact or s chat co u ld affect d emand remain co n stan t .
Obviously, we cou ld adopt t he same approach in exami ni ng each of th e othe r factors
that influence d emand . We call th is simpl ifying procedure the cete,·isparibm assumption
(ceterisparibtl.Sis a Latin phrase th at means "othe r t h ings being equa l", or assum ing chat
not hing else changes) . Th e ceterisparib11sassump ti on is often used in economic analysis
in order co isolate relationsh ips between par ticu lar variab les. For examp le, we might say
that if the p rice of a good falls, then ceterisparibm sales will increase.
1 Identify the impact of a rise in the price of staplers on the demand for:
• staplers
• staples
• paper clips .
2 State THREE examples of goods for w hich cons umer demand has decreased
because of changes in consumer tastes and preferences.
3 Explain the likely effect on demand for cars if the price of cars was expected
to rise in tthree months' time.
6.2 Movements along the demand curve
The most obvious factor chat influences the demand for a good is its price. We will therefore
begin our analysis by looking at how the de mand for a good responds co p rice changes.
The demand schedule
Making the assu mp ti on t hat all oth er factors (apart from price) t hat could infl uence
deman d remain constant , we can construct a demand schedul e. T his is a cable showing
the qua ntit y of a good chat will be dema nd ed over a range of prices, at a given point in
ti me. Figure 6.1 shows the weekly market demand for shoes over a given price range. T he
market demand schedu le wou ld be derived from th e summat ion of all indi vidua l consum er
deman d schedu les.
The dema nd schedu le in figure 6.1 demonstrates the Price Quantity demanded
($) (pair of shoes)
typical relationship between price and quantit y demanded,
sometimes referred to as t he law of demand . Th e law of 20 200
demand states chat th e quantity demanded by consum ers 40 160
falls as price rises. W hen t he price of a produce is reduced, 60 120
consum ers will b uy more of chat produce - first , because
80 80
they can afford co buy more of the produce, and second,
100 40
because the produce is cheaper compared with all ot her .
goods and services. Th erefore, more people are willing and Figure 6.1 - Market demand
able co buy the good at a lower pr ice. schedule for shoes
There are occasional exceptions co thi s rule. For example, some high-pr iced luxury items, such
as eating out at a fashionable restaurant, may experience a rise in t he quantity demanded as
their prices rise - because they become a more sought-after scams symbol.
 Chapter 6: Demand I
Price$
The demand curve
0 We can g raph rhe data presented in
100 ......
rhe demand schedule in order co ge e a
80 grap hical presentat ion , known as rh e
demand curve. This is shown in figure 6.2,
60
where price has been p lotted on the
40 vertical axis and quant ity dema nded on the
horizontal axis.
20
A typical demand curve slopes downwards
0

0 40 80 120 160 200 Quantity from left to r ight , ill uscraring the same
demanded relationship between price and demand
as seated in rh e law of demand - as
Fig ure 6 .2 - The demand curve for shoes rhe price of a product increases, ceteris
paribm, consumers will demand less. of that product . For examp le, ar a price of $20,
200 pa irs of shoes are demanded, whereas at a price of $100, rhe marker dema nd is only
40 pa irs of shoes.

Movements along the demand curve

In fact, we can say that, assuming all orher factors remain constant, any change in rhe pr ice
of a good will lead co a change in the quantit y demanded in the opposite direction co the
pr ice change. What we ger as a result of price changes is movement along the demand curve,
which we refer co as expans ions and contracti on s in demand (shown in figure 6.3). Contraction of demand
is when an increase in
From rhe d iagram: the price of a good or
Price$
servicecausesa decrease
D • A contraction in demand occurs in quantity demanded . It
P2 · .. . · : ~o ntraction when an increase in price from OP1 ro is shown by an upward
OP2 causes the quant ity demanded ro movement along the
demand curve .
fall from OQI co OQ2 •
• An expans ion in ,dema nd occurs
~ans ion Expansion of demand
when a decrease in p ri ce from OP1 ro
is when a dec rease in
P3 ...... .,....... ........ , ....
OP3 causes the quant ity demanded ro
the price of a good or
D
rise from OQI co OQ3 . service causes an increase
in quantity demanded. It
0
~ a, ~ Quantity Only price changes for the good itself
is shown by a downward
demanded will lead co movements a[ong rhe existi ng movement along the
demand curve by way of expansions and demand curve.
Figure 6.3 - Expansions and contractions
in demand contractions in demand.

1 Explain why the demand curve s lopes downward from left to right.
2 Describe the movements along the demand curve that result from an increase
or decrease in price .

m
I
The Market Economy 2020

6.3 Shifts of the demand curve

This price fall Ha ving looked at the effect of mo vements in price, we can now ru.rn
Funny, Bill, but
could lead to an incorrec t. Price our attention co rh e other factors chat can influence demand. Aga i n,
expansion of changes can only
demand ... for expand or contract t11;e when we consider rhe effects of a change in one of these factors we are
bigger T-shirts! demand for the good
~self. Since big T-shirts
cond ucti ng a ceteris pa,·ibttsanalysis; chat is, we are assum ing chat all
are a comp lement off factors, othe r rhan the one being considered, remai n constant.
ice cream, you're
actually referring to an
increase in demand. A change in any one of the orh er factors char can influence demand
wi ll lead ro a shift of the demand curve. Th ese shifts are referred co as
in creases and dec r eases in demand, and are brought about by changes
in the other factors affecting consume r demand, and not pr ice changes .

Increasesin demand
A movement in th e demand curve ro the right is called an increase in
demand . This is shown in figure 6.4. Because the change in demand is nor due to a pr ice
change we can make the following observations:

First , an increase in demand means chat

Price$
consumers are will ing and able co buy
more of rh e product ar each possib le
price rhan before . At price OPP consumers
D,
origi nally dema nded OQ I goods. Howe ver,
following an increase in demand (shift ing
the demand curve ro the right from D 1D 1
co D 2 D 2) consume rs now dema nd more of
the product (OQ 2) at th e same price.

Second, an increase in demand also means

D,
that consumers are will ing ro buy a give n
quant it y ar a h igher price tha n before. 0 a, Quantity
demanded
Consume rs were orig inally willing co pay
OP 1 ro obtain a quant ity of OQ1 of the Figure 6.4- lncrease in demand
product . How ever, following rh e increase
in dema nd (shifting the dema nd curve co the right from D 1D 1 co D 2 D 2) consum ers are
now prepared co purchase rh e same quantity (OQ 1) of the p roduce at a hig her pr ice (OP2 ) .

Decreases in demand
A decrease in demand (figu re 6.5) means
Sharevalues
chat consumers are willi ng and able ro D,
buy less of the product at each possible
price rhan before. At pr ice OP 1 consumers
orig inally de m anded OQ 1• How ever,
following a decrease in demand (which
shifts the dema .nd curve co the left, from
D 1D 1 co D 2 D 2) consumers now demand
less of the p rod uct (OQ2) ar the same p rice.

A decrease in demand also means that D,

~
consum ers are wi lling and able co buy a '------'----'---- Quantity
given quant ity at a lower price than before.
O Oi 0, demanded

Ori gina lly, consumers were prepared co pay

OP2 co obtain quant ity OQ2 of the product. Figure 6.5 - Decrease in demand

II
 Chapter 6: Dema nd I
H owever, following the decrease in dem and (th e shift of the demand curve to th e left from
D 1D 1 to D 2D 2) , consum ers are only p repared to pay a lower p rice (OP1) in order to pu rchase
th e sam e quant ity (OQ 2) of the product.

The main factors that cause shifts in the demand curve

Any factor, ot her th an a p rice change , that causes the demand for a g ood ro be str ong er
or weaker th an it was previously will cause a shift in the demand curve.

We have already considered th e facto rs tha t affect market demand. Changes in any of
t hese facrors, apar t from changes in che p rice of th e good itself, can cause sh ifts in th e
de mand curve.

FACTORS THAT MAY CAUSE AN INCREASE IN DEMAND

Taking the example of the market for shoes, an increase in demand might be caused
by the following factors :

Prices of other goods and services

• A rise in the price of subst itute goods will cause consumers to demand more shoes.
If the price of thongs and sandals increased , more peop le would be willing to buy shoes
(assuming the price of shoes remained the same).
• A fall in the price of a comp lementary good may also increase demand (although in the
case of shoes, it is likely that shoe prices would influence demand for co m plements such
as shoelaces and shoe polish, but not vice versa).

Expected future prices

• Consumer spend ing is inf luenced by expectat ions about future price trends .
If consumers expect that the price of new shoes will increase because of the impos ition
of a new governmen t tax , they will bring forward their purchases and increase the cur rent
demand for new shoes.

Consumer ta stes and preference s

• If a particular type of shoe becomes more fashionab le, more consumers would want to
buy more of those shoes at every p rice level. For examp le, as consumer tastes have
changed in favour of higher-quality impo rted items , the market for expens ive European
shoes has increased.
• New technology that makes running shoes lighte r and more shock -absorb ing may
increase the demand for such shoes .

Consumer incomes
• A rise in the level of income would mean that consumers can afford to buy more shoes
at the same price than they could befo re. As a result, the demand for all shoes, apart
from perhaps very low-quality ones , would tend to increase. People might simp ly build
up the ir shoe collec tion.
• A change in income distribut ion that is favourable to higher-income earners might increase
the demand fo r high-fashion Italian shoes .
• Improved consume r expectat ions about future income and employment prospec ts would
increase demand for shoes.

The size and age distribution of the population

• An increase in the size of the population will increase the demand fo r all shoes, while a
change in its age distribution will lead to an increase in demand fo r certain types of shoes.
For example, an ageing population wou ld increase the demand for Homyped shoes.

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I
The Mark et Econo my 2020

FACTORSTHAT MAY CAUSE A DECREASEIN DEMAND

The factors causing a decrease in demand are basically the opposite to those causing
an increase .
Price s of other goods and services
• A fall in the price of substitute goods (In our examp le of shoes, items such as sandals
or thongs)
• A rise in the price of comp lementary goods.
Expected futur e prices
• An expected dec line in the price of the product in the future (perhaps due to lower tax
on shoes)
Consumer tastes and preferences
• A product such as white tennis shoes becoming less fashionable
• Technological progress that causes a good to be superseded (such as the move away
from simple rubber thongs).
Consumer incomes
• A fall in the general level of income
• A change in income distribution less favourab le to demand (such as a crash in financia l
markets affecting wealthier people and reducing d emand for shoes made by expensive
luxury brands such as Prada)
• Deteriorating consumer expectations about future econom ic prospects (perhaps due to
a recession be ing experienced by our major trading partners).
The size and age distribution of the population
• A decrease in the overall size of the popu lation and a change in its age distribution (such
as a decrease in the birth rate bringing about a dec line in demand for baby shoes)

1 Distinguish betwee n an expans ion of demand and an increase in dema nd .

2 Identify the cha nge in demand fo r HD TVs caused by eac h of the fol lowing :
• a fall in t he price of HD TVs
• the introd uct ion of 4K Ultra HD TVs, with bette r screen resolution
• an expectat ion that TV prices will fall
• a rise in the price of Foxtel and other subsc ription television services .
3 Outl ine poss ible causes of a dec rease in dema nd fo r each of the following
goods and services :
• fixed -line telep hone services
• The Aus tralian daily newspape r
• inner-c ity rental apa rtments .

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 Chapter 6: Dema nd I
6.4 Price elasticity of demand
We have already discussed how changes in the pr ice of a good can bring about changes
in rhe quantity dema nded. We will n ow take this one seep further and look at the extent Price elasticity of
demand measures the
of these changes in demand char resu[r from price changes .
responsiveness of quantity
demanded to a change in
The meaning of price elasticity of demand price. It is calculated as
the percentage change
T h e p r ice elast icity of d ema nd measures the responsiveness or sensitivity of the quant ity in quantity demanded
demanded of a particular product ro cha nges in its p rice. As a figure, rh e price elasticity divided by the percentage
of demand shows the percentage cha nge in rhe quantity of a good demand ed resulting change in price.

from a one per cent increase in its p ri ce. For examp le, we know chat for most goods, a
fa[! in price will cause an increase in quant ity demanded, but if that increase in quantity
demanded is p roportionately greater than the fall in p rice, then we wou ld say that dema nd
is very responsive ro a pr ice change , and thus demand is said ro be relat ive ly e las tic.
T h e oppos ite situat ion - a less than p roportionate change in quantity dema nded wou ld
indicat e re lat ive ly in elas t ic demand . If rh e proportionate change in quant ity demand ed
is rhe same as the proport ionate change in p rice, demand is said ro be u n it e lasti c .

Elastic demand A strong response to a change in pr ice

Unit elastic demand A prop ortion al respo nse to a price change (tota l amo unt
spent by consu mers remains uncha nged)

Inelastic demand A wea k respons e to a price change

The importance of price elasticity of demand

A know ledge of price elasticity of d emand is important co busi ness firms and co rh e
government . Bus iness firms need ro understand price elasticity of dema n d for rh e goods
t hey sell in order ro decid e on the ir optima l pric ing strategy. If demand was relarively
elast ic, the firm wou ld know char loweri ng the price would g reatl y expan d the volume of
sa les, thus increasing coral revenue . On the orher hand, if demand was relarive ly inelastic,
t he firm could increase the price, which would also lead to an increase i.n coral revenue,
since the reduct ion in sales would be less rhan the price increase. Awareness of rhe elast icity
of demand in different p rice ranges is important for determ ining rh e best p ricing strategy
for a firm and in deciding whether or not to change prices. To char extent, bus inesses often
engage in scacisrical marker research .in order ro dete rmin e consume r prefere nces, and in
pa rticu lar rh e price elasticity of the dema nd for their product .

T h e gove rn me nt needs ro unde rstand p rice elast icity of demand when p ri cing rh e goods
and services char it provides for the commu n ity (such as public transpo rt fares). Further,
ir also needs to be able to p redict the effects of changes in the level of any indirect taxes,
such as sales taxes, excise duties and spec ial levies that ir imposes on goods such as alcohol,
tobacco products and petro l. These raxes and charges raise the price of rhe goods affected,
and rhe government needs ro be able to gauge the responsiveness of demand in order co
accurately estimate the amount of revenue rh ey will raise.

T h is relationship explains why govern ments tend ro charge indirect taxes, such as excise
duties, on chose goods that have a relatively inelastic demand, includ ing alcohol, petro l
and tobacco products. On rhe orher hand, if the government were co impose an excise duty
on a good for which dema nd is relarively p rice elastic, rh e increase in price caused by rhe
tax would lead to a more than p roportionate drop in sales. Because the introduct ion of rh e
excise rax results in reduced sales, governments may raise a lower-than-exp ected amount
of revenue when they impose an excise tax on a good chat has a higher price elasticity.

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I
The Market Economy 2020

Measuring price elasticity of demand

Ther e are a numbe r of ways of determ in ing the p rice elasticity of demand. A simp le way
The total outlay method of measuring t he price elasticity is ro look ar the effect of changes in price on the rota l
is a way to calculate
revenue earned by the produce r, known as rh e cor al outlay method. The coral outlay
the price elasticity of
demand by lookingat metho d is the si mpl est way of celli ng whethe r demand is relatively elast ic, relat ively
the effect of changes inelastic or un it ary elastic co p rice changes.
in price on the revenue
earned by the producer. If Th e information contain ed in figure 6.6 can be used co help demonstrate how price elascici.cy
price and revenue move of demand can be determ ined using th is method. Total outlay is found by multip lying the
in the same direction, price by rhe quantity chat would
demand is inelastic; if
be demanded a.c rhac price. In Price$ Quantity Totaloutlay Elasticity
price and revenue move
effect, the coral outlay (or coral demanded (price x
in the opposite direction,
expenditure ) by consume rs on a (units) quantity)
demand is elastic; and
if revenue remains certa in produce is equivalent ro 5 50 · I t1c
250 ) •········••ineas
unchanged in response to che rocal revenue sellers of the 6 45 270 } ........... ·1neIast,c
a price change, demand produce would receive ar char 7 40 280 } •·········•Unit eas,c
I f
is unit elast ic. 8 35 280
price . J ···········elastic
9 30
:;~} ········••elastic
If coral outlay moves in the same 10 25
di rect ion as rh e price change,
Figure 6.6 - Measuring the elasticity of demand: total
dema nd in rhac p r ice range outlay method
would be relat ively inelastic:

• At a price of $5, consumers dema nd 50 unit s, th erefore rocal outlay is $250 .

• When th e p rice rises co $6, demand falls co 45 units, and rocal outlay increases co
$270.
• Total outl ay has moved in the same dir ection as the price change - the price increase
wou ld lead co an increase in coral revenue for firms. Th erefore, dema nd is said co
be relatively inelastic over this price range.
If rocal outlay moves in the opposite di rection co the p rice change, dema nd in chat price
range wou ld be relatively elastic:

• At a p rice of $8, consumers dema nd 35 un it s and the refore coral outlay is $280 .
• When the price rises co $9, dema nd falls ro 30 units, and rocal outlay decreases
co $270 .
• Total outlay has moved in the opposite di rect ion co rh e price change - che quantity
demanded is hig hly responsive ro price changes . Ther efore, demand is said co be
relativ ely elastic over th is p rice range .
If rocal outlay re mains rh e same following a price change, rh en demand would be un it
elast ic:

• At a price of $7, consumers demand

40 units , and therefore coral outlay is Elasticity and total outlays
$280.
• Whe n th e p rice rises co $8, demand
Price t Revenue t = Inelastic

falls co 3 5 un i cs, but coral outlay

remains the same ar $280 .
Price t Revenue + Elastic

• Total outl ay has remained the same and

Price t Revenue
- Unit elastic

the refore demand has unit elastic it y

over rhis p rice range .

II
 Chapter 6: Demand I
Price elasticity and the slope of a demand curve
T h e slope of the dema nd curve should not be used as a measure of the price elasticity of
demand. In face, as the p revious example demonstrates, even with a linear (or stra ight)
demand curve, which has a constant slope, the price elasticity of demand will vary as one
moves down th e curve. In the upper part of th e curve (where prices are high) dema nd will
be relat ively elastic (quant ity demanded is highly responsive to price changes), whereas
at low price levels, demand will be relat ively inelastic.
We can illustrate this po int in figur e 6.7 by showing three dema nd curves with the same
slope, but with different positions from the origin.

Price$

:ffi~~
2

II I I
'-- --~-
o, o,
.:..-- '-- ----~-~---
I I
0
'
Quantit y
0 1O 20 30 40 50 60 70 80 demanded

Figure 6. 7 - The slope of the demand curve and elasticity

Us ing the total outlay method for det ermin ing elast icity of dema nd, figure 6 .7 reveals:
• Consider demand curve D 1D 1• When th e price falls from $4 to $3, the quantity
demanded rises from 10 to 20, causing total outlay co increase from $40 co $60.
As tota l outlay moves in the opposite direction to the pr ice cha nge, dema nd is
relatively elastic.
• Consider demand curve D2D2 . Wh en the price falls from $4 to ~3, the quantity
demanded rises from 30 to 40, but rota! outlay remains the same at $120. Because
total outlay remains the same following the price change, demand has unit elasticity.
• Consider demand curve D 3D 3 . When the pr ice falls from $4 to $3, the quantity
demanded rises from 70 to 80, causing rota! outlay to fall from $280 co $240. As total
outlay moves in the same direction as the pr ice change, demand is relatively inelastic.
We can also recognise two ext rem es of elasticity of demand - perfectly e last ic demand
and per fectly in elastic dema n d . These two ext reme circumstances are the only ones
wh ere looking at the slope of the demand curve is sufficient co dete rm ine th e price
elast icity of dema nd through the entnre curve .

Perfectly elastic demand

Whe n demand is perfectly elastic, the demand curve is a horizonta l straight line as shown
in figure 6 .8 on page 90.

Whe n demand is perfectly elastic, consumers will dema nd an infinite (un limited) quantity
at a certa in pr ice, bur nothing at all at a price above th is. As no such situation exists in
reality, this situation can be regarded as mere ly theoretical.

Howev er, when we consider the situat ion of an ind ividua l se ller , the demand curve that
he or she is facing may be consid ered almost perfectl y elastic under certain circumstances.
If the indiv idua l seller were in a perfectly competit ive market - a market situation with
many buyers and sellers, all selling a produce that was basically the same - ,rhen the demand

m
I
The Market Economy 2020

curve faced by th e individual seller would be

almost _perfectlyelastic. No individual seller Price $
would be able co charge a higher price, since
he or she would lose all cuscomers co the
others selling identical produces.

Consider the fol.lowing example. An app le P, 1------------ D

grower sells apples, along with many other
apple growers, at a fruit and vegetab le
marker. The grower can sell th e ent ire load
at th e going marker price. If th e grower
~---~----- Quantity
cries co sell at a p rice above chat of th e other O Q1 9i Qi demanded
growers, no one will buy the apples. No
grower will sell apples at a pr ice below the Figure 6.8 - Perfectlyelastic demand
other growers, because they can sell chem all
at the higher market price and make more
money. Therefore, from the point of view of th e individual seller, the demand curve for the
produce is perfectly elastic at the going market pr ice.

Perfectly inelastic demand

Price$
Perfec tly ine lastic
Wh en demand is perfectly inelastic, the
demand is where demand curve is a vertical stra ight line.
.. ...... ...... ........... D
consumers are willing This is shown in figure 6.9, which shows
to pay any price in order char consume rs are willing co pay any price
to obtain a given quantity in order co obta in a given quantity of a
of a good or service.
good . Again, it wou ld be very difficult co
This situation can be
represented by a vertical satisfy these conditions for any market as
demand curve. a whole. It could, however, apply co some P, ........ ...... ...........
produces over a given range of prices. For
examp le, persons with a life-threate n ing ~----~---- Quantity
O O demanded
disease chat can only be created with a
particu lar drug would be willing co pay Figure 6.9 - Perfectly inelastic demand
almost any price co obta in it. l e is often
argued chat governments should regulate
such markers, in order co prevent the exploitat ion of vulnerable consumers.

1 Describe what is meant by relatively elastic demand and relatively inelastic demand .
2 Identify ONE good or service that might be close to perfectly elastic demand and
ONE good or service that might be close to perf ectly inelastic demand .

6.5 Factors affecting elasticity of demand

The pr ice e lasc.icicy of dema nd for any good can be affected by one or more of five
mai n facto rs:
Whether the good is a luxury or a necessity
Goods and services regarded as necessities for dai ly life, such as bread or mi lk, have a
relat ively inelascic dema nd - even if ther e is an increase in price, th e quant it y demanded
will nor fall co a great extent. On the othe r hand , p rice elastic ity of dema nd would be
expected co be higher for produces char may be rega rded as luxuries, such as din ing our
in expensive restaurants.

II
 Chapter 6: Demand I
Whether the good has any close substitutes
Goods and services wit h close subsrirures , such as different brands ofbreakfasr cereal, rend
co have h ighly elastic demand. If the price of one brand of cereal increases, rh en demand
is likely ro contract more rhan proporrionarely, since people would sim p ly switch ro
another brand char they perceive co be equally good. Goods and services with few or no
close substitutes, such as the local wate r supp ly, wou ld have an inelast ic d emand - even if
price increases, people cann ot switch co anothe r produce, so demand will nor fall greatly.

The expenditure on the product as a proportion of income

Goods and services chat cake up a very small proportion of a person's i ncome, such as
d isposable lighters , cheap pens or chewin g gu m, would have a lower p r ice elasticity of
demand, whereas rhe demand for more expensive items would rend co be m ore elastic. For
example, most people would not refuse ro buy chewing gum because irs price increased
by 10 per cent, but rhey may well decide nor co buy a new car char has had a 10 per cent
price rise.

The length of time subsequent to a price change

Whe n rhe p rice of a certa in produce increases, rhe quantity dema nd ed m ay nor in itially
respond grea tly, as consumers cake time ro become aware and adjust co rh e price change.
If the price has increased, consumers will cake some time co seek out alternati ves, and
in. part icular, ident ify substitute p roduces, wh ich will make demand mor e responsive.
Simila rly, if rh e price of rhe p roduct has fallen, ir will rake rim e for consumers ro become
aware chat it is now relatively cheaper compared co its substitutes. They switch cowards
t he cheaper p roduce and dema nd becom es more responsive.

T h e ways char consumers respond co a price change may also depe nd on whether rhe good
in. question is durable or not. After a n initia l price change, durab le goo ds tend ro have
a more elastic demand than non-durabl e goods. For examp le, a rise in price of new cars
wou ld ini tially tend ro encourage peop le co repair rathe r rhan rep lace th eir existi ng cars,
so demand wou ld be hig hly elastic. With rim e, however, rh e elasticity wou ld decli ne, as
old cars have rob e replaced ar some point.

Whether a good is habit-forming (addictive} or not

Goods chat rend co be habit-formin g, like cigarettes and alcohol ic beverages, tend ro have
a relatively inelast ic demand. People who regularly drink alcoho l and s.moke cigarettes
te nd co continue with the same habirs , even following p rice increases.

1 Explain how the elasticity of demand changes over time.

2 Outline THREE characteristics o f a product w ith relatively inelastic de mand.
3 Considering the factors influencing the price elasticity of demand, analyse the
elastic ity for the following goods and services:
• laptop comput ers
• drinking water
• petro l
• hotel accom modation.

II
The Market Economy 2020

1 Demand is the quantity of a particular good or service that consumers are w illing
and able to purchase at various price levels, at a given point in time.

2 The law of demand states that as the price of a good increases, the quantity
demanded w ill decrease.

3 The demand for a good depends on a number of factors : the price of the good
itself , the price of other goods and services, expected future prices, consumer
preferences, level of income, size of the population and age distribution.

4 In economic analysis, the ceteris paribus assumption states that all factors
(apart from the one under analysis) remain constant.

5 Movements along the demand curve are caused by changes in price and are
called expansions or contractions in demand. All other factors cause shifts of
the demand curve. These are called an increase or decrease in demand .

6 The price elasticity of demand measures the responsiveness or sensitivity of

quantity demanded due to changes in price. The more elastic the demand , the
greater its response to a change in price.

7 Demand elasticity varies from perfectly elastic (a change in price will totally
eliminate demand for the good), to perfectly inelastic (a change in price has
no effect on quantity demanded) .

8 Business firms and governments need to understand price elasticity of demand

so they can .set prices and taxes that maximise their respective revenues.

9 The total outlay method measures price elast icity of demand by examining
changes in the tota l revenue earned by the producer . If price increases and
total outlay also increases, this is called inelastic demand. If price increases and
total outlay decreases, this is called elastic demand. If price changes have no
impact on tota l outlay, this is called unit elastic demand .

10 Factors that affect the elasticity of demand include the type of good, the existence
of substitutes , the proport ion of income spent on the good , the length of time
since a price change and whether the product is habit forming or addictive.

II
 Chapter 6: Demand

•
_ _ ___ __ __.::...::::..:~
~::..:=-..a
rev1ew
1 Define what is meant by market demand.

2 Explain the meaning and cause of:

a) a co ntraction in demand
b) an expansion in demand.

3 From the following demand sc hedule, plot the market demand curve for apples,
and explain the relationship that exists between price and the quantity demanded.

Quantity demanded
Price
(hundreds of kg)
1 175
2 140
3 105
4 70
5 35

4 Explain (using diagrams) what is meant by:

a) an increase in demand
b) a decrease in demand .

5 Draw a tw o-co lumn table. On one side, show the factors th at ca111 cause an
increase in demand, and on th e ot her, the facto rs that can cause a decrease.

6 Explain what is meant by price elasticity of demand.

7 When using the total outlay meth od for measuring elasticity of demand , state th e
relationship that must exist betw een a price change and total outtlay w hen:
a) demand is elastic
b) demand is inelastic
c) demand is unit elastic.

8 Use a diagram to demonstrate:

a) perfectly elastic demand
b) perfectly inelastic demand.

Give examples of market situ ations that might satisfy each co ndition.

9 Consider the follow ing demand curve:

II
The Market Economy 2020

Price$
D

D
Quantity
0 25 30 de manded

Using the toital out lay method , determine the elasticity of demand over the price
range $6 to $7 . Explain your answer.

10 Draw a table w ith two co lumns as follows , and summarise the facto rs affecting
price elasticity of demand.

Characteristics of goods Characteristics of goods

with ela stic demand with inelastic demand

Extended response

Explain w hat is meant by price elasticity of demand . Describe how we can measure
the price elasticity of demand. Explain w hy an understanding of elasticity of demand is
impo rtant to both business firms and the government.

II
 Supply

7 .1 Factors affecting market supply

7 .2 Movements along the supp ly curve

7 .3 Shifts of t he supp ly curve
7 .4 Price elasticity of supply
7 .5 Factors affecting elasticity of supply

In Chapter 6, we studied the factors influen cing consumer preferences and the determ ination
of market demand. In th is chapter, our focus shifts co the ot her side of the mark et exchange
re.lacing co productio n - rhe supply of goods and services by business firms . In rhe modern
mark er economy, firms are rhe core un it of product ion chat determ ine how rhe demands
of the household sector are met. Jusr as the examination of demand focused on consum er
behaviour, our exam inat ion of supply w ill focus on the behaviour of firms .

Supp ly is the quantit y of a good or service that all firms in a part icular industry are willing
and able co offer for sale ar different price levels, ar a give n po int in rime . This essentiall y
represents rh e ma r ket sup pl y of a particular product, wh ich is the sum of the ind iv idu al
fir m supplies of ind ivid ual producers ar the various price levels.

7 .1 Factors affecting market supply

T h e main factors affecting marker sup p ly includ e:

The price of the good or service itself

T he market pr ice of rhe good or service will influence the producer's ability and willing ness
co supp ly ir. For example, if the pr ice were roo low, some producers wou ld not be able ro
cover their coses of production and wou ld not supp ly the irem.

T h e expecta t ions of suppliers about t he fu ture pr ice of a goo d or serv ice also influences
t he level of supp ly. If the supp lier believes the price will rise in rhe future, perhaps due
co an increase in demand resulting from changing consum er castes, supp ly of rh e good or
service will increase. Th is is due co the possibility of increased profits aris ing from supply
of rhe good. Th e reverse is rrue if future pric es are expected co fall.
IThe Market Economy 2020
It t ook Manue l FOUR
HOURS to change the prices
on the menu s. With t hese
rising labo ur costs , we have
no altern ativ e - we'll have to
raise prices AGAIN!
II
The price of other goods or services
The quanti t y of a good or service supp lied at any ,cime will be affected by the p rices of
other goods and services. For example, if rh e price of good X remained the same, wh ile t he
price of good Y .increased, ir would become more profitable ro p roduce good Y. The refore,
firms may be less willing ro supply good X and more willing co start produc ing an d
supp lying good Y.
The state of technology
Improvements in technology lower p roductio n coses and allow more firms to supply
more goods at a given price. They also allow firms co adjust production runs to
quickly accomm odate chang ing demand patterns. For example, the use of automated
production-li ne techn iques in rhe motor vehicle industry has greatly reduced p roduction
costs and enab led produce rs to increase supp ly.
Changes in the cost of factors of production
Th e costs of factors of production are among the mosr important influences on th e
abi lity of firms to supply products in the marketplace. Any fall in the cost of facto rs
of produccion would allow firms to supply more of a particular good, whereas any rise
in factor costs would make it more difficult for firms co maintai n present supply. A
rise in rhe p rice of a factor of production would often lead co a decrease in supply of
those goods and services whose production was heavily reliant on char factor input.
For examp.le, if rhe major Hollywood production srudios that supply cinemas with
movies decided to increase their prices sharply, chey might force smaller, less profitable
cinemas out of business. This would lower marker supp ly of movies ro consumers,
since rhere would be fewer p laces ro go to see movies.
The quantity of the good available
The actual quantity of the good availab le is an overall limiting factor that affects supp ly.
For example, the supp ly of original paintings by the late Australian artist Arthur Boyd is
limited. Similarly, th e quantity of the rare metal irid ium that can be suppl ied is u ltimate ly
determi ned by the known reserves of iridium.
In many industr ies, the nu mbe r of su ppli er s also affects rhe quant ity of the good or
service available. As more suppliers enter an industry, supp ly increases, and vice versa. For
example, the supply of electric vehicles available on the market has gradually increased as
more suppliers have entered this market .
Climatic and seasonal influence
Changes in clim at ic condit ions and seasons will obvious ly affect agr icultural p roduct ion .
For example, an extended period of drought would cause the supply of most agricultural
products co decl ine.
1 Outline how an increase in the level of wages in the economy might affect
market supp ly.
2 Desc ribe TW O factors that might cause an incr ease in market supply.
 Chapter 7: Supply I
7 .2 Movements along the supply curve
In the analysis chat follows, we will examine the response of supply ro pric e changes, whi le
as.suming char all rhe orher possib le infl uences remain constant.

Changes in price: movements along the supply curve

Assuming that all oth er factors char could infl uence supp ly, apart from price , remain
constant , we can construct a suppl y schedule . It shows the quantity of a good rhar will be
supp lied over a range of prices , ar a give n point in rim e.
Quantity supplied Figure 7 .1 shows the weekly market supply of shoes over
Price($) (pair of shoes)
a g iven pr ice range. The marker supply schedule would be
100 200 derived from rhe summat ion of all th e supp ly schedu les
80 160 of rhe indiv idual firms that operate in rhe industry. Th e
60 120 supp ly schedu le demonstrates the relat ionship between
40 80 pr ice and quantity supp lied as stated by the law of suppl y.
20 40 According ro the law of supp ly, as rhe p rice of a certain
product rises, the quant ity supp lied by produc ers will
Ffgure 7. 1 - Market supply
schedu le: shoes rise. This occurs for two reasons:

• For firms already in rhe industry, produci ng rh e good becom es more p rofitab le, so
they increase the ir product ion of that good.
• Th e higher pric e also makes produci ng th is good more p rofitab le for other
busin esses, whi ch will attract new firm s to the industry . This wi ll also cause an
increase in the quant ity supplied .

The supply curve

Th e suppl y curve is th e graphica l
Price$ representation of rhe supply schedul e,
100 ......................................
·:s depicted in figure 7 .2, where we p lot price
on the vert ical axis and quantity supp lied
80 on rhe horizonta l axis.

60 The typica l supp ly curve slopes upwards

from left co ri g ht , portraying the same
40
relationship between pr ice and quantity
20 supplied as the law of supp ly (more is
:S
supplied ar a high er price and less at a
0 40 80 120 160 200 lower price). For examp le, ar pr ice $20
Quantity supplied only 40 pairs of shoes are supp lied, but at
p rice $100, supp liers are willi ng and ab le
Fi gure 7 .2 - The supply curve : shoes
ro put 200 pa irs of shoes on th e market .

Assuming all orher factors remain constant , any change in the price of a good will lead ro
a cha nge in rh e quantity supplied in rhe same d irect ion as the p rice change .

As a result of a p rice change, ther e is movement along rh e supp ly curve, which we refer
to as expansions and contractions of supp ly. Th ese are shown in figure 7 .3 overleaf.

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I
The Market Economy 2020

From the d iag ram:

Contraction of supply Price$
is when a decrease • A cont racti o n in supply occurs
s
in the price of a good when a d ecrease in pr ice from OP1
or service causes a to OP2 causes the quantity supp lied
decrease in quantity to fall from OQ I to OQ2 .
supplied. It is shown by
a downward movement • An expa nsio n in supply occurs
along the su pply curve. when an increase in price from OP1
to OP3 causes the quantity supp lied
to rise fro m OQ I to 0Q 3 .
Expansion of supply
is when an increase On ly a change in the price of the good 0 o, 03
in the price of a good itself wi ll lead to movements along the Quantity supplied
or service causes an exist ing supp ly curve (t hat is, expansions
Figure 7,3 - Expans
ions and contractions in supply
increase in quantity and contraction s in supply).
supplied. It is shown by
an upward movement
along the su pply curve.

1 Explain why the supply curve slopes upwards from left to right.
2 Using a diagram , identify the movement along the supply curve caused by:
a) a decrease in price
b) an increase in q uantity supplied
c) an increase in price.

7.3 Shifts of the supply curve

Having looked at price, we can now rurn our attention to the othe r factors that can influence
supp ly. Again, when we consider the effect of a c hange in one of these factors, we use
the ceterisparibus assumption. In other words, we assume that all other factors that co uld
influence supp ly, apart from the one unde r conside .ration , remain constant.

A change in any one of the factors, other

Price$
than the p rice of th e good itself, will lead
to a shift of t he entire supply curve for
th e product . Th ese shifts are referred to as
p .... ... ... .
in creases and decreases in supply and are 1

brought about by changes in condit ions for

th e bus iness firm, and not p rice changes.

s,
Increases in supply
A movement in th e supply curve to th e
r igh t is called an inc rease in supp ly. This 0 o, 0 2 Quantity supplied
is shown in figure 7 .4.
Figure 7.4 - Increase in supply
Because th e change in supply is not due to
a price change, we can make th e following
observations:

• First, an increase in supply means that firms are will ing and ab le to supp ly more
of a product at each p rice level tha n before. At price OPP firms orig inally supp lied
OQ1 good s. However, following an increase in supply (shift in th e supp ly curve from
S 1S 1 to S2 S2) firms can now supply more of th e good (OQ 2) at the same price .

II
 Chapter 7: Supp ly I
• Second , an increase in supp ly also means rhar firms are will ing co supply a given
quantity at a lower price than before. Orig inally, firms were only w illing co supply
quantity OQ , ar rhe price OP,. H owever, following the increase in supp ly, firms are
now prepared ro supply rhe same quantity OQ , ar the lower price OP,.

Decreases in supply
Price$
Movement in rhe supp ly curve co rhe left ~ s,
is called a decrea se in supp ly. T hi s is
shown in figure 7.5.

Aga in, because rhe cha nge in supp ly is

not due ro a price change, we can make
t he following observat ions:
Sz
• First, a decrease in supply m eans
chat firms are willing and able ro
supply less of a good ar each pr ice 0 Q Q ua ntity supplied
1
level rhan before. At price OP,. firms
origi nally supplied rhe quant ity OQ I Figure 7 .5 - Decrease in su pply
of rhe produce. H owever, following the decrease in supply (shift in t he supply curve
from S,S, ro S,S,), firms now sup ply less of the product (OQ ,) at the sam e pr ice.
• Second, a decrease in supp ly also means rhac firms are only wi llin g and able ro
supp ly a given q uantity at a hig her p rice than before. Or igi nally, firms were
supp lying a quanti ty OQ, ar rh e lower p rice OP,. However, followi ng the decrease
in supp ly, firms are now only prepare d co supp ly OQ, at rhe hig her price of OP,.

Factors that cause shifts in the supply curve

Any facror other rhan a change in the price of the product itself char will cause the supp ly
of a good ro be greater or less than it was p reviously will cause a sh ift in the supp ly curve.
T h ese can be briefly sum marised as follows:

FACTORS CAUSING AN INCREASE OR DECREASE IN SUPPLY

Increase
• A fall in the price of other goods ,
which makes production of othe r
goods less profitab le
• An improvement in the techno logy
used in the product ion process
• A fall in the cost of factors of
product ion, such as labour or cap ita l
• An increase in the quant ity of resources
available to be used in product ion
• Climatic condit ions or seasonal
changes that are more favourab le to
the product ion process .
Decrease
• A rise in the price of other goods
• A certain techno logy no longer being
available {which is highly unlikely)
• A rise in the cost of facto rs
of product ion
• A decrease in the quant ity of
resources available
• Regulations restricting the sale of a
good because of its risks to health and
safety (for example, fireworks)
• Climatic cond itions or seasonal
changes that are less favou rable to
the production of a particular good.

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I
The Market Economy 2020
Price elasticity of
supply measures the
responsiveness of quantity
supplied to a change in
price. It is calculated as
the percentage change in
quantity supplied divided
by the percentage change
in price.
Perfectly elastic supply
is where producers are
willi ng to supply an
infinite quantity of a good
or service at a particul ar
price but nothin g at all
at a price b elow t his.
This sit uat ion c an
be represented by a
horizontal supply curve.
Perfectly inelastic supply
is where producers are
willing to supply a given
quantity of a good or
service regardless of
price. This situation can
be represented by a
vertical supply curve.
II
1 Distinguish between an increase in supply and an expansion in supp ly.
2 Outline THIREE factors that cou ld cause a dec rease in supp ly.
3 Outline the likely effect of the following on market supply :
a) an increase in the price of substitute goods
b) a rise in the prod uctivity of labou r
c) an improvement in product ion tec hnology
d) tougher govern ment regu lation of the sale of a good or service.
7 .4 Price elasticity of supply
The idea of price elasticity appl ies ro supply in a si milar way rhan it does ro demand.
The p rice e lasc:ici ty of supp ly measures the responsive ness of the quantity suppli ed of
a produc t ro changes in price. Specifically, the price elast icity of supp ly is rh e percentag e
change in the quantity supp lied caused by a one per cent change in price . For examp le,
we know rhat for most goods , a rise in price will cause an expansion in supp ly, which
means rhat for most goods the p rice elasticity of supply is posit ive. However, if t he
rise in quantity supplied is p roportionate ly g reater tha n the increase in price, rh en we
cou ld say rhat supp ly is vecy responsive to a price change, and thus relat ive ly elas ti c .
The opposite sicuarion - a less-than-propo rtionate change in quantity supp lied - would
indicate relat ive ly in elas t ic supply. If quant ity supplied rises by rh e same propo rtion as
the p rice increase, supp ly is u n it e lasti c .
Price elasticity and the Price$
slope of the supply curve
We can recognise two extremes of elasticit y
of supp ly - pe rfec tly elast ic supp ly and
pe rfec tly inelastic supply. Each will be P i-----------s
examin ed in turn:
Perfectly elastic supply
Whe n supp ly is pe rfectly elastic, the supp ly
0 Quantity supplied
curve is a horizont al straight line, as shown
in figure 7 .6.
Figure 7 .6 reveals that at price OP,supp liers Figure 7 .6 - !=>erfect
ly elastic supply
would suppl y an infin ite quant ity of the
Price$
good, whereas be low that price they would
s
nor be will ing ro supply any. In reality,
this is a high ly unl ikely situation .
Perfectly inelastic supply
Whe n supp ly ns perfectly inelast ic, the
supp ly curve is a vertical strai ght line, as
shown in figure 7 .7 .
Fig ure 7.7 reveals that the quant ity
supp lied is fixed ar OQ regard less of the 0 0 Quantity supplied
price . Th e supply of a unique p iece of art
may be perfectl y inelastic - if on ly one Fig ure 7 .7 - Perfectly inelastic supply
exist s, then the supp ly is fixed at one
regard less of the price .
 Chapter 7: Supp ly I
Becween chese cwo cheorecic;al excrem es of perfectly elastic and inelastic; supp ly, there are
many possible variations in che shape of the supp ly curve. As is the case with dema nd,
t he slope of che curve wi ll noc necessari ly give a true indicatio n of elascicicy of supply.

1 Distinguish between relatively elastic supply and relatively inelastic s upp ly.
2 Identify TWO examp les of goods w ith relatively inelastic supp ly, and TWO
examples of goods that might have perfect ly inelastic supp ly.

7 .5 Factors affecting elasticity of supply

T h ere are a number of factors chat can affect the responsive ness of supply co price changes.
T h ey can be summarised as follows:

Time lags after a price change

Ge nerally speaki ng, the greate r the amount of time chat produce rs have co respond co a
price change, the more elast ic the sup ply for che produce in question. Following a price
in crease, produce rs are restricted in t heir attempts co increase product ion in che shore
ru n . In the t ime imm ediate ly after clheprice change, the supply of mosc pro duces wou ld
be virtua lly per fectl y inelastic, because producers cannot increase any of t heir inputs . All
t he p roducer can do is cry co increase production with existi ng workers and equipment
by work ing chem harder . In che shore run, p roducers can vary some of the inputs co che
pro duction process (such as the num b er of workers they employ, or the quantity of raw
mate rials) so they can respond co price changes more readi ly. T herefore, in the sh or e
ru n , che price elasticity of supply increases, altho ug h ic is still likely co be relat ively
in elastic. In che long run , however, pr oducers can increase any of the inputs, includi ng
t he size of the factory and che amou nt of machi nery, and thus facilitate a greate r increase
in pro duction in response co a pr ice change, mak ing supply relatively p r ice elastic.

The ability to hold and store stock

l e is possible co score some goods and noc offer chem for sale when there is a dow nturn in
market conditions and che price falls . This scock of goods , kn own as in v ent o ry, can be
offered for sale when prices rise agai n . O bviously, the ability co hold stock will affect che Inventory is the total
ease with wh ich p roducers can respond ro pr ice changes. As a ge neral ru le, the easier it is stock of goods and
co hold scock , che more elastic the supply. To a large degree, this will depe nd on the natu re services held by a firm at
of che good itself. For examp le, high ly perishable items such as fresh fruit and vegeta bles a particular point in time,
wh ich is intended for sale
are more d ifficult co hold in stock (and therefore their supp ly may be relat ively inelastic),
to consumers.
wh ereas durab le goods such as furni ture are easier co score, maki ng supply more elast ic.

Excess capacity
Excess capacity exists when a firm is n ot using its existi ng resources co their full capacity.
Supply will be elast ic when firm s have excess capacity because they can respond quick ly co
any price increase by simply using their existi ng resources more inte nsive ly. For examp le,
a firm operati ng ics p lane and machnnery at only half capacity could doub le its outp ut
very quic kly in response co a p rice in crease. On the ot her hand, supp ly wi ll tend co be
in elastic when resources are already being used at full capacity .

II
I
The Market Economy 2020

1 Explain how the elasticity of supply changes over time after a change in price.
2 Outline how an increase in the ability to store stoc k would affect the elasticity
of supply.

1 Supply is the quant ity of a part icular good or service that producers are willing
and able to supply at various price levels, at a given point in time.

2 Individual supply refers to the supp lies of individual producers at various price
levels. Market supp ly is the supply of the entire industry at various price levels.

3 The law of supply states that as the price of a good increases, the quantity
supplied w ill increase.

4 The supp ly of a good depends on a number of facto rs: the price of the good
itself, the pr ice of ot her goods and services, t he state of tec hnology, changes in
the cost of factors of prod uct ion, the quantity of the good available and climatic
and seasonal influences.

5 The higher the price of a good , the greater the w illingness of producers to supp ly
that good , which w ill lead to an expansion in supp ly.

6 Movements along the supply curve are caused by changes in price and are called
expansions or contractions in supply. All ot her factors cause shifts in the
supply curve . These are called an increase or decrease in supp ly.

7 The price elasticity of supp ly measures the respo nsiveness or sensitivity of

quant ity supp lied due to changes in price. The more elast ic the supp ly, the greater
its response to a change in price.

8 Supp ly elast icity varies from perfectly elastic (a change in price will totally
remove supply for the good) to perfectly inelastic (a change in price has no
effect on q uantity supp lied).

9 Factors that affect the elasticity of supp ly include the time lags after a price
change, the ability to hold and store stoc k, and excess capac ity.

10 Supp ly will be more elastic if a firm has more time to respond to a price change,
the ability t o store stock , or the ability to increase product ion w ith exist ing
facilities (excess capacity).

II
 Chapter 7: Supp ly

•
- - --- -- ~~ ~::..:-...a
rev1ew
1 Define what is meant by market supply.

2 Explain, using diagrams, the mean ing and cause of :

a) a co ntraction in supp ly
b) an expansion in supply.

3 Using a diagram, demo nstrate an expansion and a co ntraction in supp ly.

4 From the fo llowing supp ly schedu le, plot the market supp ly curve fo r sunglasses, and
expla in t he relationship that exists between price and the quantity supp lied.

Price($) 2 4 6 8 10 12
Quantity ('000) 0 20 40 60 80 100

5 Explain (using diagrams) what is meant by:

a) an increase in supp ly
b) a decrease in supp ly.

6 Draw up a tab le w ith two co lum ns, and summar ise the factors that can cause an
increase and decrease in supply:

Factors that can cause an Factors that can cause a

increase in supply dec rease in supply

7 Explain the term price elasticity of supply .

8 Explain what is meant by the te rms pet1ectly elastic supply and pet1ect/y inelastic supply .
Use diagrams to illustrate your answer.

II
The Market Economy 2020

9 Draw a tab le w ith two co lumns, and summarise the factors affect ing price
elasticity of supply .

Factors causing supply Factors causing supply

to be e lastic to be inelastic

10 Classify the fo llowing products according to the ir supp ly elasticity :

a) fresh flowers
b) furn iture f rom a firm with excess capacity
c) bottles of 25-year-old whiskey.

Extended response
a) Exp lain the term market supply . Compare a movement along a supply curve to a
shift of the supply curve. Dist inguish between the factors that may cause expansions
and contract ions , as well as increases and decreases in supply . Use diagrams to
illustrate your answer.
b) Outline what is meant by price elasticity of supply . Discuss the factors affecting price
elasticity of supp ly for a business firm. Explain why an understanding of elasticity of
supp ly is important to both business firms and the government.

II
Market Equilibrium -•
8.1 The concept of market equ ilibrium
8.2 Establishing market equilibrium
8.3 Changes in equilibrium
8.4 The role of the market
8.5 Government intervention in the marketplace
8.6 Competit ion and market power

8.1 The concept of market equilibrium

T he previous two chapters examined in derai l how demand and supply operate in a marker.
T h is chapt er brings those two sides togethe r, explain ing how a market economy determines
how much of a good or service is produced and ar what p rice it is sold.

T h e following analysis makes rwo impo rtant assumptions: char we have pure competition
in. rh e mark etplace; and char the re is no govern ment intervent ion . This concept of pu re
comp etition simp ly means char no pa rticipant in rh e marker has rh e powe r ro influ ence
marker outcomes directly, such as by sett ing prices. Th e concepts of compet ition and
marker powe r will be examined in more deta il in section 8.6.

Our focus is now on how rhe price mec h an ism dete rmi nes rhe equilibrium in the marker, Price mechanism is
as shown in figure 8.1. Th e price mechanism is rhe interplay of the forces of supp ly and the process by wh ich
demand, wh ich determi ne rhe prices at which commod iti es will be boug ht and sold in the forces of supp ly
and demand interact
t he mark er. to determine the
market price at wh ich
Mar ket equilib r ium is the situation whe re, ar a certa in price level, rh e quantity supp lied
goods and services
and the quantity demand ed of a part icular commodity are equal. This means char rh e are sold and the
marker clears (th ere is no excess supply or demand ), and ther e is no tend ency for change quantity produced.
in. eithe r p rice or quantity.

-- •
•
........
.....

······
······•
Price
mechanism
•W.
··········· .

····· · · · • ■Mi
Figure 8 .1 - The functioning of the market
I
The Market Economy 2020
Equilibrium is achieved
in an individual market
when any consumer
who is willing to pay the
market price for a good
or service is satisfied, and
any producer who offers
their goods or services
at the market price is
able to se lI their product.
It occurs when quantity
demanded is equal to
quantity su pplied, that is,
when the market clears.
II
8.2 Establishing market equilibrium
Mark et equi librium occu rs whe re t he
dema nd and supp ly curves inte rsect - th e Price$
po int whe re t he quant ity deman ded is
exactly equa l co th e quantity supp lied. D s
Equilib rium
Figu res 8.2 and 8.3 are used co
demonstrate ho w a market reaches the
equi li brium positio n .
!
Figure 8.2 reveals that at price OP,, the
quant it y deman ded (OQ 2) exceeds the
quant ity supp lied (OQ 1). Competitio n s D
among buyers for the limited quantity of
0 a, Quantity
goods available m eans chat consumers will
scare bidding up the price. Th e rise in the
Figure 8 .2 - Excess demand
price results in an expansion in supply and
a contraction in demand (movement along
the curves cowards th e equi librium point ). Price$
Thi s will cont inue co occur as long as there
is excess demand , unti l we eventuall y
reach the intersect ion of the supply and
demand curves, where the price is OPEand
the quant ity suppl ied (OQE) exactly equals
the quantity d emanded by consumers.
We say chat the market clears (no excess
supply or demand) at the p rice OPE- the D
equi librium or mark er-clearing price.
0 Quantity
In figure 8.3, a t price OP2, rh e quantity
supp lied (OQ 2) exceeds rh e quantity Figure 8.3 - Excess supply
dema nd ed (OQ 1). Thu s we have a situatio n
of excess su pp ly, or a g lue in rhe mark er. In order ro remove the excess supp ly, sellers
will offer co sell ar a lower price. Th e fall in the pr ice results in an expansion in deman d
and a contra ction in supply (movement along rh e cu rves cowards the equ ilib rium po im:).
This will continue co occur as long as the re is excess supply, until we eventuall y reach rhe
intersection of supply and demand where , at p rice OPE,rh e market clears - the quantities
supp lied and demand ed are equa l (at OQE).
Thi s is rhe price mechan ism in action - the market forces of supply and dema nd int eracti ng
co bring about the equ ilibrium price chat clears rhe mark et and eliminates any excess supply
or demand. At rh e equi librium po int , th ere
is no tende ncy co change. In thi s way, ir is Market equilibrium occurs when:
said chat the mark et mechan ism achieves 1 quantity demanded = quantity supp lied
consistency between the plans and outcomes 2 the market clears
for consu mers and p roducers without any 3 the re is no tendency to change .
exp licit coordi nation.
1 Explain how prices are determ ined in a market with pure compet ition.
2 If price is set below equilibrium, explain how the market will reach equilibrium.
 Chapter 8: Market Equilibrium I
8.3 Changes in equilibrium
T h e equ ilibrium price and qua nti ty can be changed by any circumsta nces that lead to a
sh ift in eith er or both the supply and demand curves . Shifts in the supply and demand
cu rves are caused by changes in che co nditions beh ind supply and demand - not a change
in the price of che good itself.

We now focus on exactly what happens to equilibrium when we have an increase in demand
(a shift in the demand curve co che rig he), as well as othe r possible changes to equil ibrium.

How an increase in demand can change equilibrium

An increase in demand means chat more of
Price$ a good will be demanded at any given price.
s,
For example, on a rainy day, the demand for
umb rellas increases so that more consumers
An increase in are willing co buy umb rellas ac any given
demand raises pr ice. Th is causes a shift in che demand
both equilibrium
price and quanti ty curve to the right, as shown in figure 8.4.

In figure 8.4, because che demand curve

shifts co the right (from D,D, to D 2D 2),
s, consumers demand more um brellas ac the
old equ ilibrium price (OPu,)· Ac th is price,
0 Qx Quantity
the quant ity demand ed (0Qx) exceeds the
quant ity supp lied (OQ ., ). Competition
Figure 8.4 - An increase in demand
among buyers for the limited quantity of
umbre llas will force che price up, causing an expansion in supp ly (moveme nt along the
supp ly curve co the rig ht ). Thi s will continue co occur unt il the market clears again ac a
new equil ibrium pr ice (OP, 2) and quantity (OQ .,) .

T herefore, an increase in demand raises both equi librium price and equil ibrium quant it y.

A summary of other conditions that can change equilibrium

T h e following symbo ls apply to figures
8.5, 8.6 and 8 .7 : Price$
D, s,
• S,S, and D,D, = the origi nal
supply and demand curves
+-- A decrease in
• S2S, and D2 D2 = che new supply demand lowers
and demand curves PE, ·l ········
·· both equilibrium
price and quantity
PE2.••.••.••.••.•..••.
• P., and Q., = the origi nal
equi librium price and quantity o,
• P., and Q ., = the new
equi librium price and quantity
0 Quant ity

Figure 8.5 - A dec rease in deman d

II
I
The Market Economy 2020

Price$ o, Price$ 0 ,

crease
pply lowers
librium price
raises
librium
lily
s,
D, D,

0 Quantity 0 Quantity

Figure 8,6 - An increasein supply Figure 8, 7 - A decreasein supply

1 Using diagrams , illustrat e the change in equilibrium price and quantity caused
by a decrease in demand and an increase in supp ly.
2 Outline the effect on market equilibrium caused by:
a) a reduct ion in the cost of prod uction
b) an increase in the price of complemen tary goo ds.

8.4 The role of the market

In a market economy, the pr ice mechan ism plays rhe mosr impo rtant role in determ ining
rhe solut ions ro the e co nomic pr o b lem. The p rice determi ned in the mark er conveys
impo rtant information that helps provide answers to questions about rh e p roduct ion ,
dist ribut ion and exchange of goods and services in the economy.

Product market is the The price mechan ism attempts to solve the econo mic prob lem in pr oduct mark ets
interaction of demand for for goods and services. Th e demand curve represents the wants of indiv idua ls in the
and supp ly of the outputs
economy, and rh e supp ly curve represents the production of firms wit h limited resources.
of production , that is,
goods and services. The inte ract ion of demand and supp ly determi nes a price and quantity that best satisfies
ind ividua l wanes with rhe limit ed resources availab le ro firm s, giv ing a soluti on to the
economic prob lem facing all economies.

Producers will only produce th ose goods and serv ices for wh ich the re is consum er
dema nd - in orher words , where consu mers are w illing and ab le ro buy rh e prod uct
at a certa in pr ice. Producers allocate resources in this way because there is a higher
opportunity cosc in produc ing orher goods when the price of p roduct X rises. Th e quest ion
of the quantity of goods and services p roduced and sold is also determ ined through the
interact ion of supp ly and demand. Increasing demand for pro duct X will be tran slate d
into a higher mark er price, wh ich will be a signa[ for pro ducers ro reallocate resources
away from orh er areas of p roduc tion, in order to produce more of product X. In th is way,
inform ation about tastes and preferences is conveyed betwee n consu mers and p roducers
in rh e economy· thr oug h relative price changes and with out any central coordi nati on or
need ro obtain such informat ion di rectl y from consumers.

II
 Chapter 8: Mark et Equ ilibr i um I
T h e p rice mechanism also p lays a centra l role in rh e markers for the factors of production,
Factor marke t is a
or fact o r m ark e ts. Demand and supply forces in factor markets dece.rm ine the price
market for any input into
pa id for the factors of production and thus the share of coral outp ut char is received by the produc tion process,
indi viduals. T hose ind ividua ls who possess resources (includi ng ski lls) or produce goods including land , labour,
and services chat are scarce and in h igh demand will command higher incomes and a capita l and enterpr ise.
greate r p roportion of rota l outp ut.

It is said char the mark et mechan ism also ensures alloca t iv e effi c ienc y in rhe economy. Allocative efficiency
In the examp les we considered earlier, the dema nd curve gave us an indicat ion of rhe refers to t he economy's
value char consumers p lace on a certa in product, wh ile rhe supp ly curve gave us an ability to alloc ate
resources to satisfy
in dicat ion of producers ' coses in supp lying char prod uct. Th e mark er mechanis m ensures
con sumer wants.
char equi librium is reached at the i.nte rsection of chose cwo curves. Thi s means that
production cont inues co increase until the po int where the value co consu mers of the last
good produced is equa l co the cost co produce rs.

The price mechanism is efficient because:

Any consume r willing Any p roducer offe ring

to pay the market price goods or services at the
for a good o r service ma rket price will be able
will be sat isfied . to sell all they produce.

Competition among producers also en sures char they are responsive co consume r demand
and char they attempt co min imise thei r coses of productio n in order ro remai n compet it ive
in rh e mark er and maint ain th eir profitabi lity. T his ensures chat rh e most cost-efficient
m ethods of p roduct ion are used .

1 Exp lain how t he mar ket ensur es a lloca t ive eff ici enc y in p rod uct and factor mar kets .
2 Ou tli ne th e b enefits of com pet it ion betw een firms in a ma rket economy .

8.5 Government intervention in the

marketplace
A[chough mark ers can be effect ive at resolving the basic issues of what and how mu ch ro
produce, th is is nor th e end of the story. Left co operate by itself, the market can still create Market failure occu rs
unsatisfacto ry outcomes. Th e mark et p rice for goods and services in p roduc t markets (or when the price
mechanism takes into
for the factors of prod uction in factor markets) may be considered ro be roo high or roo
accou nt private benefits
low. Th e equi librium quant ity chat resu lts from the free int erplay of demand and suppl y
and costs of prod uction
may also be considered coo high or coo low - and some goods and services may not be to consumers and
produced at all. Whe n mark ers do nor produce the desired outco mes it is called m ark e t producers, but it fails to
fai lu r e. Th is occurs because the price mechan ism rakes account of the private coses and take into account indirect
benefits of product ion (that is, co producers and consumers) bur does not take int o account costs such as damage to
the environment.
social coses and benefits (that are born e and en joyed by the who le of society). When this
occurs , govern ments may int ervene in the mark et.
I
The Market Economy 2020

Figure 8.8 represents market failure using

a typ ical dema nd and supply diagram. Price($)

It shows that the price mechanism, S (social cost)

through the int eraction of demand and the
produce r's supp ly curve, will result in the
Ps1------- ..,x
market p rice and quantity levels. Society's
supp ly curve , however, wh ich takes into PMl-- ----:; ,/4---!---:; ,K'
account all costs of product ion (includi ng
environmental and social coses), lies above
the produce r's supp ly curve. The socially Quantity
opt im um price level is above the market Where:
pr ice (indicating that the price mechanism PM = market price
undervalues the natu ral environment) , and Ps = socially opt imal price
the socially optimum quantity is below Q,M" market quantity
the market leve l (ind icating that market Os = socially opt imal quantity
forces result in the overuse of natural
Figure 8 .8 - Market failure
resources).

Price intervention
Price$
The government may feel that the market- D s
determin ed price for some commod ities (for
instance the cost of train or bus travel) is too
high , or that the market-determ ined pr ice
of some items (such as unski lled labour)
is too low. Therefore, the government
may intervene in the marketplace in order
to impose p rice ceilings (the maximum
price that can be charged for a part icular s D
commod ity) or price floor s (the minimum 0 Quantity
price that can be charged for a part icular
commodity). The ma in reason for
Figure 8 .9 - Price mechanism w ith a price ceiling
influencing pr ices in this way is to affect the
di st r ibution of income . Price ceilings will
redistribute money from sellers to buyers, Price
D
whereas price floors will redistribute money s
from buyers to sellers.

Conside r the market for a basic necessity,

such as bread, in figure 8.9. The free-market
ourcome would be to produc e up to the
point where the supp ly and dema nd curves
intersect and cha rge the equ ilibrium price
s D
PE. If the government conside rs PE to be
excessively high, it may impose a price 0 Quantity
ceiling at P max - the maximum price
that can be cha rged for bread • At P max, Figure 8 .1 o - Price mechanism w ith a price floor
produce rs would be will ing to produce
OQPwhile consum ers demand OQc- Therefore, there is disequi librium, with excess dema nd
for bread of QpQc-

In figure 8 .10, on the othe r hand , the government may consider that the market-
determi ned price for wheat (a commod it y that is an impo rtant source of income for ma ny
farmers) is too low and may therefore impose a price floor ar P min above the market clearing
price of PE· Aga.in, whi le this would lead to an increase in the p rice of wheat, the market
will be in d isequilib rium, with an excess supp ly of wheat of Q cQP.

am
 Chapter 8: Market Eq uilibri um I
T h e prob lem in both of rhe above cases is chat interve nt ion by the govern ment led ro
mark e t di sequilibrium . In rhe first case, there was an und er-product ion of bread, whi le
in. the second case there was over-prod uctio n of wheat . Because of these prob lems, in
re-cent decades governments have turned ro more soph ist icated means of int ervention
in. the market.

Quantity intervention
T h e quantity of some goods and services p rovided by the market may be roo hig h or roo
low because ind ividual busi ness firm s and ind ividua l consu mers often do not consider rhe
social coses and benefits of the prod uctio n and consump ti on of certain goods and services.
T herefore, such social coses and benefics, also referred co as externaliti es, are not raken int o
account in rhe operat ion of rhe price m echanism . For instance, in rhe p rocess of product ion,
ind ividual produce rs consider the obv ious coses they incur in order co supp ly rhe prod uct,
in.eludi ng the cost of labour, raw macerials and elecrriciry, but they do not consider rh e
social coses (or n egativ e ex ternalitie s) of rh e prod uctio n p rocess, inclu d ing pollution
and environ menta l da mage. In th ese situatio ns, rh e gove rnm ent can art ificially rest rict
product ion levels through laws (such as issui ng po llution emission permi ts) . Alterna t ively,
th e governm ent may impose taxe s on ibusinesses, which increase th eir p rod uct ion coses and
red uce pr odu ctio n levels. Making the individual business pay for rh e social coses created Merit goods ar,e goods
by prod uctio n is known as interna lising the externality . that are not produced in
sufficient quantity by the
Simi larly, it can be argue d char indi vidual consumers do nor consider rh e social benefit s private sector because
(or po s iti ve externaliti es) that come wirh their indivi dual consumptio n of some goods private individuals do
not place sufficient value
and services, such as museu ms, pub lic parks, ar r ga lleries and pu blic tra nsport . Th e
on those goods, that is,
gove rnm ent may intervene in order ro encourage t he p rovision of these merit g oo d s and they involve pos it ive
services rhat have posi ti ve exte rnalit ies, throug h subsid ies ro consumers (or produce rs) ro externalit ies that are
lower p rices and increase consu mpt ion . not fully enj oyed by the
individual consu mer. Merit
Some goods and services wi ll nor be provided by ind ividua l firms ar a ll, because once goods include educat ion
prov ided , p roducers woul d nor be ab le ro exclude those who are unwilli ng co pay from and health care.
usi ng and obta ining rhe benefits of chose pub lic good s . Examp les include nati onal
de fence, rh e police service, pu blic roads and cleani ng up wate rways. Everyone may benefit
Public goods are goods
fro m the securit y p rovided by defence forces, bur they wou ld be unlikely ro cont ribut e
that private finms are
volu nt arily (since they get the benefit of the defence forces' prorecrio n of th eir country unwilling to supp ly, as
wh ether or nor they pay). For this reason, the governm ent int ervenes ro supp ly th ese items they are not able to restrict
and finances them with its tax revenue . Th ese p roblems are su mm arised in figure 8.11. usage and benefits to
those willing to pay for
the good. Because of
PROBLEM GOVERNMENT OUTCOME this, governments should
ACTION provide these goods.

Market price too high Price ce iling Reduces price , quant it y shortage
[disequ ilibrium]

Market price too low Price floor Increases price , quant ity excess
[disequilibrium]

Market quantity too high Taxes Increases equilibrium price,

[negative externalit ies] reduces equ ilibrium quant ity

Market quant ity too low Subs idies Reduces equ ilibrium pr ice ,
[pos it ive externa lities] increases equ ilibrium quant ity

Ma rket does not prov ide Government prov ides Government must co llect taxat ion
good or serv ice good or serv ice revenue to finance its supp ly
[pub lic goods ] of pub lic goods

Figure 8 .11 - Summary of government intervention in the marketplace

I
The Market Economy 2020

1 Identify TWO examples each of goods and services that you think should have
a price ceiling and TWO examples of goods and services that you think should
have a price floor. Justify your choices .
2 Outline TWO examples of products with negative externalities and prop ose a
possible fo rm of government intervention to reduce the quantity suppl ied and
cons umed in the market.
3 Discuss the potential reasons for government intervention in the follow ing sectors :
a) higher ed ucatio n b) postal services c) waste removal.

8.6 Competition and market power

In our analysis so far, we have assumed chat there is a large number of firms in each
industry - so large, in fact, chat no individua l fir m has the ability ro raise irs prices
without losing all of its custome rs ro its comper irors. In this situat ion - known as pure
compet ition (som et imes also descri bed as perfect compet it ion) - no firm has the m ar k et
powe r co be able ro raise pr ices above rhe competitive equi librium. In reality, no such
situation exists (although some indust ries, such as fresh food, might come close). 1n
most indust ries, firms enjoy some deg ree of marker powe r, which results in a h ig h e r
equ ilib r ium pr ice (and lowe r equil ib r iu m qu anti ty) than the equi librium price and
quant ity levels char wou ld result under pure comp e tition. The degree of competit ion in
an industry is primari ly determined by the ma r ket st ructu r e, wh ich refers co rhe number
and relat ive size of the firms with in an industry, the nature of the produce being sold, and
the ease with which new firms can enter into char industry. These structures and their
characrer isrics a.re summarised in figure 8 .12 and figure 8 .13 (on page 114).

Pure compet ition A theoret ical model of perfec t compe tition

Monopolistic competition Many small firms in the industry

Oligopoly A small number of large firms domina te the industry

Monopoly Only one prod ucer in the industry

Figure 8 .12 - Four main market structures

Pure competition
Firms operating under p u r e compet ition are faced w ith the following market conditions:

• There are many small buyers and none of chem are sufficiently large enough co be
able co affect the market price (for example , by arrangi ng bu lk buying discounts) .

• The p roduces sold by all firms are homoge neous (all firms sell rhe same p roduc e).
Buyers and sellers all know char the produc e is che same, and they also know t he
prices ar which the produces are being offered for sale throughout the market.

• Buyers do not incur any cost for moving from one supplier co another .

• There are no barr iers co new firms enter ing or existing firms leaving the marke t .
• Sellers can sell as much of the ir product as rh ey like, at the market price.
Under these marker conditions, firms are pri ce tak ers - rhey muse simply accept t he
market price dete rmined by the forces of supp ly and demand. They can sell as much as
they want at char price . If rhey ccy co sell above it, n o one will buy thei r produce, because
buyers can gee exactly the same p roduct at the lower market price elsewhere (since rh ey
 Chapter 8: Mark et Equ ilibr i um I
know the market price and there is no cost of moving from one producer tQ anorher). Th ey
wi ll nor sell at a price below rhe market p rice since this would nor be profit-maximising,
as rh ey can sell the same amount ar a hig her price . Advertisi ng by firms in th is situation
wou ld be a waste of mon ey, as it wou ld nor help them sell any more of their product.
Pure competit ion is, however, really on ly a theoretical mode l, and ir is hard ro identify a
real-life exampl e of pure compet ition .

Monopoly
A mo n op oly can be regarded as rh e opposite of pure competition. It is cha racterised by
t he following conditions:

• There is only one firm selling rh e product, and th ere is no market compet ition at all.

• Th e p roduce sold has no close subsritures .

• Th ere are sign ificant barriers co entry, and th is effectively prevents any pote nti al
competito rs from enteri ng rh e market.
U nder th ese conditions, rhe monopo list has great cont rol over the market price. Un like
t he pure competito r, the monopo list is a p r ice sette r and can set rh e price of the product
in order to maxim ise profit. Advertising by monopo lists may be used simply to mainta in
product image, since rhey do not have to worry about winn ing customers away from
compet itors . There are few remaining monopo lies in Australia, although the marker for
wate r supply is one such examp le.

If a product were to be produced by a monopo list rathe r rhan unde r p1.11

re competition,
t he monopolist would restrict the output and raise the p rice. In gene ral , as the level of
compet ition within a market increases, prices are like ly ro fall and output increase.

T h e remaining two market structures - monopolistic compet ition and oligopoly - are
in stances of imp er fect compet it ion , since borh have more rhan one firm compet ing in
t he market, but they do not face the cond itions of pure competition.

Monopolistic competition
Mon op olist ic compet it ion is a form of impe rfect competition and is characterised by
t he following conditions:

• Th ere are a large number of re[arively small firms.

• Th e products sold in the market are similar, bur nor identica l. The firms engage Product differentiation
in p rodu ct d iffe r enti at ion (they package and present their products so rhat they is when firms try to
appear different from those of ,rheir competitors) . make their good or
service look different
• The fact rhar rhe p roducts are diffe rentiat ed g ives firms some deg ree of p rice- from compe t itors' (such
sett ing power. as t hrough pac kaging
or product imag e) to
• Th ere are some small barr iers ro entry for new firms enteri ng the market, increase brand loyalty and
includi ng the fact that existi ng firms have loyal customers who, through product give the firm some deg ree
d ifferentia t ion , consider that t heir firm supp lies rhe best p roduces (th is is referred of price-setting power.
to as b rand loyal ty).
T h rough product different iation, rh e firm operat ing under conditions of monopo listic
competitio n has some cont rol over the price of its product. However, rhe firm does nor have
t he marker power of the monopolist, as it is aware that there are many close substitutes
for its product and rhat competition is fierce. Advertis ing wou ld p lay an important role
in arrracr ing new custome rs and maintaini ng existing ones. Examp les of rh e types of firms
ope rating under monopol istic comperir ion are resta urants and hairdressers.
I
The Market Economy 2020

Oligopoly
The most common market srrucrure in most of Australia's large industr ies is oligopo ly.
O ligopoly is als,o a form of imperfect competition and is characterised by the following
marker conditions:

• There are only a few relative ly large firms, each of which has a sig n ificant share of
the market.

• They sell snmilar bur different iated products.

• There are significant barriers ro ent ry, and th is ge nerally accounts for the fact that
there are on ly a few firms in the ind ust ry.
The oligopo lisr firm constantly monitors the behaviour of the orher rival firms in rhe
indust ry. It muse consider very carefully the reactions of its competirors whenever it decides
ro change irs prici ng or output po licies. For example, if an oligopolisr firm lowered irs
price in an attempt to undercut irs rivals, th is could start a price-cutti ng war that would
cause profits to drop dramat ically for all firms in the industry. For this reason, oligopolisrs
tend ro compete throu g h advertis ing campaigns promoti ng th eir produces, rather rhan lby
price cutting. Exampl es of oligopo lies in Australia are:

• supermarkets, dominated by Woolworths and Coles

• airl ines, dominated by Qantas and Virg in Australia
• bankin g, do minat ed by rhe Commonwea lth Bank, NAB, Westpac and ANZ .

Market structure Number and Product Barriers Examp les

size of firms characterist ics to entry

Pure competition many firms , homogeneous no barriers fruit & vegetab les,
•••••• very sma ll product to entry fish markets

Monopoly one firm only, no close extreme ly high water supply

•Mo nopolistic
generally large

many firms,
subst itutes

d ifferentiated
barriers to entry

relatively easy mote ls,

competition relatively sma ll products entry restaurants
•• d>
• •~
Oligopoly a few, relatively usually high barriers supermarkets , banks ,
■ eA large firms d ifferentiated to entry oil compan ies,
products airlines

Figure 8. 13 - Summary of characte ristics of the four main market structures

1 Distinguish between pure competition and monopolistic competition .

2 Outline the degree of price-setting power in each of the four main market
structures.
3 Choose an industry in Australia and examine the nature of compet ition
thro ugh an analysis of :
a) the number and size of firms in the indust1ry
b) the degree of product differentiation between firms in the industry
c) the barr iers to entry for potent ial firms to the industry .

1111
 Chapter 8: Market Equilibrium

1 Market equilibrium is the situation where , at a certain price, the quantity

supplied and the quantity demanded are equal. Markets always t end towards
equilibrium , and if excess demand or excess supply exists, the market w ill bid
the price up or down until the equilibrium price is reached.

2 After a change in demand or supply, the market will move to a new equilibrium
through the same process.

3 The price mechanism is said t o be efficient because any consumer who is

willing to pay the market price fo r a good or service w ill be satisfied, and any
producer offering their goods and services at the market price will be able to sell
all they produce .

4 The government can intervene in the market by setting a maximum price (price
ceiling ) or a minimum price (price floor ).

5 Market failure occurs w hen there are costs and benefits of prod uction not
reflected in the demand and supply curves of individuals. The government may tax
firms or industries whose produ ction processes result in negative externalities, such
as pollution. The government may subsidise the production of merit goods (which
have positive externalities), such as museums, art galleries or public transport.

6 Public goods will not be prov ided by individual firms because they are unable to
exclude those who are unwilling to pay for them. The government provides public
goods , such as natio nal defence, and raises taxatio n revenue to finance them.

7 Pure competition is a market structu re where there are many buyers and sellers
produci ng homogeneous goods or services.

8 Monopolistic competition is a market structure where there are many small

firms, w ith differentiated products and each w ith some degree of market power.

9 Oligopoly is a market structu re where a few large firms dom inate the industry,
with differentiated products and high barriers to entry into the indust ry.

10 Monopoly is a market structure where th ere is one large firm prod ucing a
unique prod uct , with very high barriers to entry into the indust ry.
The Market Economy 2020

1 Define what is meant by the price mechanism.

2 Describe what is meant by market equilibrium .

3 With the aid of a diagram , explain how market forces of supply and demand will
establish an equilibrium price and quantity.

4 Exp lain why markets are said to achieve a/locative efficiency.

5 Define what is meant by a price ceiling, and ident ify the circumstances in which a
government would use a price ceiling.

6 Define what is meant by a price floor, and ident ify the circumstances in which a
government would use a price floor.

7 Exp lain what is meant by the term market failure , and distinguish between positive
and negative externalities.

8 Briefly outline the main character istics of each of the four market structures.

9 Exp lain what is meant by the term product differentiation and why it is important
to a firm operating under conditions of monopo listic competition .

10 Classify each of the follow ing industr ies as either pure compet ition, monopolist ic
competit ion , oligopo ly or monopo ly:
a) manufactu rers of electric vehicles
b) the fish market in Sydney, where many producers sell seafood and consumers
perceive tthat all the seafood is of the same quality
c) the market for developing websites, where many compan ies compete to sell
their services
d) Australia's domest ic airline industry
e) the local 1restaurant industry, where there are many firms
f) the market for personal delivery of ordinary letters.

Extended response
Define what is meant by market equilibrium . With the aid of diagrams, explain how
market forces determine equilibrium price and quantity. Discuss the reasons for and
methods of government intervention in markets.
 TOPIC

LABOUR MARKETS

Focus
The focus of this topic is an examination
of a factor market - the market for labour
resources, The contemporary institutions
Issues and outcomes of the labour market are
By the end of Topic 4, you will key elements.
be able to examine the following
economic issues:
■ Analyse the factors that create d ifferences in
Skills
incomes from work Topic 4 skills questions can ask
you to:
■ Compare and contrast wage and non-wage
outcomes for individuals in diffe rent ■ compare and contrast the labour market with
occupat ional groups product markets
■ Examine the relationship between work and ■ research an outcome of the contemporary
the quality of life Australian labour market
■ Analyse the arguments for and against a more ■ work in groups to investigate the efficiency
equitable distr ibution of income from work and equity of labour market outcomes .
■ Assess the impact of labour market tre nds
on individua ls
■ Investigate the reasons for gender differences
in labour market outcomes
■ Investigate recent trends in unemp loyment
in Australia
■ Compare and contrast unemployment levels
in different parts of Australia
■ Predict impacts on society and the
economy of changesto the nature of work
and the workforce . Econo mics Stage 6 Syllabus 2009 extracts © NSW Educ ation
Standards Authority for and on behaH of the Crown in right of the
State of New South Wales, 2009; reprodu oed by permission .
Topic 4

Introduction
In the first th ree top ics of th is book we have examined how the market economy operates ,
looking at the role of consumers and busi ness and how demand and supply int eract co
produce market equi lib rium. In the next two sections we examine two markets that are
particularly important co our economy - the labour and financial markers.

T he labour marker is one of th e most complex sectors of th e marker economy. It has a

very di rect impact on our lives because each of us part icipate in it , and so much of our
life is spent "selling" our "labour resources" at work. Th e operation of the labou r market
determines how easy ir is co find educatio n, trai n ing and work; how much we gee pa id;
the cond it ions unde r which we work; and, for businesses, how th ey can use labour most
efficiently in their operat ions. Understa nding how labour markets function is cruc ial co
understanding th e operation of a market economy.

Chapter 9 exami nes how the labour market, in its simplest form, can be viewed as
the interactio n of supp ly and dema nd for labour, wh ich is a factor of p roduction. In one
sense, the labour market is just like any othe r pa rt of the marker economy. Emp loyees
"sell" their labour and emplo yers "buy" hou rs of labour from emplo yees. Th e price of
labour (wage levels) an d th e quantity of labour (emp loym ent levels) are determ ined by
the interact ion of the forces of dema nd and supp ly, combi ned with any other factors
chat influence this process, such as government regulations and the skills and tra ining
requ ired for specific jobs.

Chapter 10 analyses the two main outcomes of the labour market: wage levels and
employment patterns. It also highlights the differences betw een the labour marker and
othe r markers for goods and services. We look at the factors chat can influence wage levels,
such as occupat ion, age, gender and cu ltu ral background, and consider the impacts of
income inequa lity on society. Chapte r 10 concludes with a review of employment patterns ,
such as unemp loyment and th e movement away from full -time work.

Chapter 11 examines rhe infl uence of insrirur ions in Ausrralia 's labour marker,
including trade un ions, emplo yer associations, industri a l tribuna ls and governments .
Wh ile inst itutio ns have historically played a major role in influenc ing wage levels and
work patterns, this has declined over time ro allow the market forces of employers and
emp loyees co work our thei r own work and pay arrangements with much less interventio n
from government .
Labour Demand
and Supply

9. 1 The demand for labour

9.2 The supp ly of labour
9.3 The Australian workforce
9.4 Ext ension : labou r market equ ilibrium

T h e lab our market is a crucial pare of a market economy. It involves the interact ion A labour market is
between individuals seeking emp loyment ro earn income and employers who want ro find where individu als seeking
worke rs with rhe most appropriate sk ills for rhe production process. If a labour marker employment interact
does nor function well, it will sign ificantl y constrain the economy's abi lity ro grow. Labour wit h employers who
is critical for businesses ro operate, and for individuals ro find work and a stable income. want to obtain the most
appropria te labou r skills
In th is chapter, we will build our understa nding of the labour marker from rhe groun d for the ir produc tion
up by looking ar the facrors that determ ine an ind ividual firm's demand for labour - in process.
effect, a microeconom ic approach.

In reality, an economy does nor just h ave a single labour marker. Instead , there are many
d istinct labour markers - a labour mar ker for each ind ividual firm and industry, as well
as a labour marker for local areas and occupations . Similarly, the re is no single price for
labour . Instead, each individual labou.r marker will have irs own labour marker outcomes,
both in terms of wage levels and em ployment opportun ities. Conditions in one labour
marker may vary significantly from con d itions in another. This explains why there may
be a shortage of workers with specific skills that are in high demand, such as software
engineers, while the economy overall still has many unemployed people . In the labour
marker for software engineers, rhe dem and for labour may exceed supply, wh ile ar the
same rime the overall supp ly of labo1.11racross the economy may exceed d emand . Despite
am this , for simplicity economists often still refer to "th e labour market" as if it is a sing le
marker (and this chapter follows char convention).

9.1 The demand for labour

Firms demand labour by offering wages, just as consumers demand
goods and services in product markers by offering ro pay a
price . However, rh e demand for labour d iffers from consumer
demand for goods and services because the demand for labour
is a deri ved demand . T he demand for labour is derived from
t he demand for goods and services withi n rhe economy. Wh en
consumers dema nd higher levels of goods and services, firms are
forced to increase their level of output ro meet the higher demand .
I
The Market Econ omy 2020

This means that the firms muse hire more labour to help p roduce more, increasing labo\lr
demand . In other words , labour is demanded only because it is needed for the firm to
produce goods and services and make a profit.

Like the demand curves we have previously seen, th e demand for labour is a downward-
sloping curve. In orher words, as the price of labour (wages) falls, an individual firm will
emp loy more labou r. Th e factors that determine how much labour a firm will demand ar any
specific price, and how it will respond to changing economic conditions , are examined below.

The output of the firm

Because the demand for labour is a derived demand, the sing le most sign ificant influence
on a firm 's demand for labour is its level of ourpur. If a firm is experiencing highe r sales,
ir will increase p roduction and the refore increase demand for labour.

Many factors will, in rurn, influence the level of a firm 's output, rhe mosr important of
wh ich are genera l economic conditions, the pattern of consumer demand and the demand
for the goods an d services chat the indiv idual firm produces.

General economic conditions (aggregate demand)

Wh en economic conditions for rhe whole economy are buoyant, a firm is more likely ro
Aggregate demand
enjoy higher sales and will therefore need more emp loyees. In general terms , higher rates of
refers to the total demand
fo r goods and serv ices
economic growt h are associated with falling unemployment levels and vice versa. The refore,
with in the ,economy. changes in the dema nd for labour will occur as a result of fluctuatio ns in the business cycle, as
Components of agg regate shown in figure 9 .1. Only a few firms would benefit from an economic downturn and actually
demand are: consumption emp loy more peop le in bad economic condit ions (such as a discount retailer or an accountancy
(C); investment (I); pract ice that specialised in company liquidations or personal bankruptcies).
government spending (G);
and net exports (X-M).
%
12
• - - - - • Unemp loy ment
10 , ,- ' ' --- Econo mic growt h
I '

8
\
'- - -,
I
' ' ',
,, .,,,,......
I

6 ...........
...._... I
'....__,
,..........._- _,,
------
,,,....

-2 « «
o~N~~~w~oomo~N~~~©~oo m o~N~~~~~oo m o~
~ ~ ~~~~ ~ ~ ~ ~88888888880000000000~~
~~~~~~~~~~NNNNNNNNNNNNNNNNNNNNNN
Year
Source: ABS cat . nos. 5206.0, 6202, *2019-20 Budget forecast. Note: Year average economic growth

Figure 9 .1 - Unemp loyment and economic growth since 1990

However, changes in economic act ivity do not always lead to immediate changes in rhe
level of emp loyment - th ere is always a time lag betw een firms observing a p ick-up in
rhe level of demand and raising their demand for labou r. On e of rh e reasons for this is t he
fact that firms te nd to operate with excess capacity. Firms do nor always fully uti lise their
resources and tend ro hoard labour to avoid having to train new sraff when product ion
picks up. Wh en agg regate demand increases, firms can satisfy the highe r dema nd, at least
in rhe short run, by using rh eir exist ing labour and capital resources more efficiently an d
intens ively. For example, rhe firm may ask its workers to work overt ime, in return for a
hig her hourl y wage.

II
 Chapter 9: Labour Demand and Supply I
Du ring a fall in the level of agg regate- dema nd, ir cakes rime for firms co n otice rhac rheir
sa les are falli ng, cur back production and retrench some of their worke rs. For examp le, rh e
slowdown in the Austra lian economy rhac began in early 2008 only began co affect rh e
level of unemployment cowards rh e end of 2008. Firms genera lly do nor ret rench worke rs
immediately after a fall in business accivicy. Since it rakes a Lor of rime and expense ro tra in
a worker, firms will want co avoid retrenchi ng worke rs if they expect busi ness conditions
co imp rove in rh e near future . In orher words, firms will often on ly retre nch worke rs when
t hey face a s11.Jtained deteriorat ion in economic conditions .

In add ition, employees and emp loyers sometimes sign contracts rhac restri ct the abi lity
of firms co retrench worke rs. Th e emp loyer may have p rom ised ro keep a person in
emp loyment for a specified period, or rh e contract may requ ire rhe emp loyer co pay a
pe nalty (for example, thr ee months' pay) if the contract is terminated early. T hese provisions
may stop the employer from retrenchin g workers unti l rhe term of the contract expires.

Conditions in the firm's industry

Labour is a derived demand; any changes in the pattern of consumer demand will obviously
affect rhe pattern of dema nd for labou r. Th erefore, a change in consumer castes and
prefe rences for different goods and services will see a change in the allocat ion of labour
between different indust ries. Furthe r, a part icular industry's barriers co entry, the level
of regulatio n or pr ice competition can also affect rhe demand for labour. T he demand for
labour will increase in industries chat see an increase in the dema nd for the ir produces,
and decrease in chose experiencing lower consume r demand. One recent example of this
is the increase in emplo yment in rh e m in ing industry resulting from the mining boom.
At rh e outset of the min ing boom in 2003, the mining industry emplo yed 87,500 people
around Austral ia. As a result of the enormous increase in dema nd for mi nerals, by 2012
emp loyment in the mini ng industry lhad risen by more tha n thre efold co278,000 peop le
(before declining ro 245,500 in 20 19).

The demand for an individual firm's products

A firm's output is ultimately determin ed by irs effectiveness in selling its goods and
services in the mark etplace . T his is determ ined by factors such as th e qua lity of irs
produces, the reputatio n and size of rh e firm, irs custome r service and its market ing
efforts . Even in a situatio n where ther e is an overall decline in the demand in an industry
in which a firm operates, it is srill possib le for rhar firm ro achieve growth in output if
ir can increase its market share.

The productivity of labour

Ap art from determ in ing irs overall level of output, a firm must also determine how
ir will organ ise its production. Th is will often involve choices between using labour
mo re inte nsively in production, or relyi ng more heavily on technology and automated
processes . Th e product ivity of labour and overall labour coses, in compa ri son co the cost
of other inputs such as capita l, will d eter mine the extent ro which a firm uses labour in
irs production.

T h e p rodu ct iv iry o f labou r can be defined as the output per unit of labour per un it
of rime:
Total output
Labour productivity = -----
Labour input

In a general sense, labour productiv ity depends upon rh e qual ity of the workforce,
in cludin g irs overall level of education, skill, health and mor ivacion. Ir also depe nds on
how efficiently labour can be com bined with orher factors of production in the production
process. It is possible for the workforce co become more productive .simp ly th rough
I
The Market Econ omy 2020

invesrmenr in techno logy (cap ital) and wirhour any actua l improvement in the ski lls or
work patterns of employe es. This could occur because the investment in technology has
allowed more co be produced for each hour of labou r input .

An increase in labour p roductivity wi ll have eithe r a positive or negative impact on t he

dema nd for labour . In the short run, higher labou r p roduct ivity means that a fixed numbe r
of workers will be producing more goods and services - therefore rh e output of a firm w.ill
be rising wirhom rh e firm having co increase the n umbe r of workers. Th e overall effect
of an increase in p roduct ivity on the dema nd for labou r in the short term will depend on
the current !eve.I of agg regate demand.
• If agg rega te dema nd is rising, there is hig her demand for goods and services. If
agg regate dema nd is rising at a faster rare than rh e increase in product ivity, rhe
higher demand will be greater rhan rhe highe r product ion generated by the existing
workers. Businesses will increase demand for Jabour t0 meet the higher level of
agg regate demand in a firm or economy.
• If agg rega te demand is unchanged , but labour productiv it y is rising, the exist ing
worke rs will be produci ng more goods and services, but the re won 't be any higher
demand fo the economy. T his means char bus inesses wi ll have excess capacity and
will not need any more labou r. Demand for laibour would decline because the highe r
productivity means chat busi nesses can cut back on workers and still produce t he
same out p ut as they did before.
• If aggregate demand is fall ing, but labou r productiv it y is rising, dema nd for labour
will fall even more. Although exist ing wor!kers wi ll be producing more output,
there will be less demand for that output i.n the economy. If businesses wish co
mainta in the ir profits , they will have ro lower thei r dema nd for labour .
In the long run, however, high er labour productivity will make labour a more attractive
input co production than the other factors of p roduct ion . For examp le, a firm may decide
chat ir will shift cowards labour-inte nsive production methods because labou r is more
productive than capita l (or capita l is roo expe nsive) . H igher labour productivity should
increase labour demand in the long rerm as firms substitute labour for orher factors of
production (such as capital). If , on rhe other hand , rh e productiv it y of labour is lower th an
imp rovements in technology and capital, labour dema nd might decline. New cechnolognes
improve the efficiency of capita l investment and create cheaper alternative product ion
methods, whic h might allow some firms co reduce the ir dema nd for labour wh ile their
output levels rem ain the same or even increase.

The cost of other inputs

Whe n a firm considers how ro comb ine rh e different inputs in the production process, it
Capital is the
often has a range of options for how it combines la.bour and capi ta.I. If int roducing new
manufactured products
used to produce goods technologies can p roduce overall cosr reductio ns, then firms will use more capital
and services, commonly (tech nology) inputs in the production p rocess, and! less labou r. Likewise, if labour coses
desc ribed as "the fall, firms may shift back cowards a greater use of labou r relat ive co capita l in product ion .
produced means of In determ in ing rhe rat io of labour co capita l, firms attempt co measure the full cost of
product ion".
labour against rh e full cost of capita l investment over time. In effect, capital is a substi tu te
for labou r; changes in the price of capita l have a sim ilar effect on the demand for labour
as a change in th e p rice of any subst itute good has on a dema nd curve. A firm's demand
for labou r will be more elast ic - chat is, it will respo nd more sharply co price changes -
when:
• le is easy co subst itute between labou r and cap ital.
• Labour costs are a relat ively high proport ion of its total costs.
• It is mor e difficu lt for the firm ro pass on .increased labou r coses in the form of
higher prices co consumers.
 Chapter 9: Labo ur Demand and Supply I
Give n chat firms can subscicure berween labou r and capita l in production, they will want
co compare the cosr of labour against rhe cost of capital. In compa ring labour coses co rhe
coses of other inputs, it is important co reme mber chat the cost of labour for employers does
not jusr reflect wage races; ir also includes orher labour on-coses. Th ese are rhe add iti onal
coses of employi ng labour and include long service leave entitle ments, sick leave, holiday
pay, workers' compensat ion , payroll tax, fringe benefits tax and superannuat ion . All
orher thin gs being equa l, the demand curve for labour reflect s rh e fact chat bus inesses
wi ll employ more labour when the cost of labour decli nes and less labo ur when rhe cost
of labour increases.

T he cosr of capita l is represented by a number of factors. Th e most important is the int erest
rare, as it represents the cost of borrow ing funds co pu rchase new capita l equip ment (if
t hese fund s were borrowed from overseas, changes in exchange races would also impact
upon the cost of these funds). Th e int erest race also represents an opportun ity cost if rh e
firm is using irs own funds co finance capital expend itu res - it could be earnin g retu rns
on its funds rather tha n investin g chem back into irs own business operations. Further
considerat ions in determ ining the cost of capital include rhe structure of the tax system,
incl uding any special tax allowances char might encourage greater business investm ent.
Whe never it becomes cheaper co use capital rathe r rhan emp loy labour, emplo yers may
dec ide co subst itute capital for labour and the demand for labour would fall , and vice versa.

Choosing berween labour and capital is not the only consideration for a firm in determinin g
irs demand for labour with in Austra lia. Equally, a firm might consider the option of
sh ifting some of its operations overseas, especially if labour coses are lower elsewhere. It
is now increasingly easy for firm s ro sec up operations in foreign countries, or ro engage
overseas cont ractors co manu facture goods or provide services from offshore. Th erefore,
t he dema nd for labour in certa in ind ust ries in Australia will be influe nced by rhe cost and
productivity of foreign labour as well. If a firm is facing cost pressu res at home, ir might
close down its local operations and shi ft its p roductio n overseas if labour the re is cheaper.
For instance, during recent decades, m osr Austra lian cloches manufactu rers have moved
t heir manufactu ri ng operations from Australia co lower-cost economies su ch as China and
Indon esia, where labour is much cheaper. More recently, some firms in services industries
such as bank ing, insurance and relecom municarions have shifted customer services such
as call centres and back -office informat ion p rocessing ro othe r countri es , such as Ind ia
and the Philippines.

FACTORS INFLUENCING LABOUR DEMAND

Outp ut fa ctors
• General economic cond itions
• Conditions in the firm's industry
• Demand for an individual firm's product
Input factors
• Productivity of labour versUJ
s other inputs
• Cost of labour versus other inputs
• Cost of labour versus cost of foreign labour

1 Explain w hat is meant by derived demand in relation to demand fo r labour.

2 Outline how econom ic co nd itions affec t th e dema nd for labour.
3 Discuss the impact of the fo llowing changes on th e demand for labou r in
Aust ralia:
a) the introduction of driverless cars
b) rising labour prod uctivity comb ined w ith fall ing eco nom ic activity
c) an increase in overseas wage levels.
I
The Market Economy 2020
Human capital is the total
sum of the know ledge,
skills, t raining and
experience of workers that
contributes to the process
of product ion. It reflects
the "quality " of a labour
force and it is the main
influence on productivity
growth.
II
9.2 The supply of labour
In studying rh e labour marker , we tend co focus mo re on the demand for labour tha n on
the supply. T his reflects a genera l assumption char th ere is an adequate supply of labour bur
nor enough dem and. However, this assumption may nor always be valid . Th e populations
of industrialise d nations are growi ng older, and w ith lower birth races rhan in previous
generat ions, there may be a shortage of skilled labour over the next two or thr ee decades .
For char reason, governments have begun ro pay g reater attent ion ro measures that may
increase the supp ly of labou r over time .
Individuals supp ly labou r when they are ready and wi lling ro work in the labour market .
Like an ordinary supply curve, rh e labour supp ly curve is upward slopi ng, since t he
hig her the wage, the more indiv idua ls will be ready and will ing co work . In most produce
mark ers it is rh e firms that supply the p roduce, and the ind ividuals who demand it for
consumptio n . Th e labour mark et is the reverse of th is, and individuals make up rhe supply
of labou r, whi le firms mak e up the demand for labour .
Pay levels
Th e wage or salary pa id ro emp loyees (the price pa id for labou r) is an important
determi nant of rh e supply of labou r for any individua l firm or indust ry. In general, rhe
high er rhe wage or salary offered, rh e more people will be prepared co sacrifice the ir leisu re
time and supply their labour. Other non-wa ge an d salary incent ives may be included
in an employee's remu nerat ion package, such as rh e use of a compa ny car and excra
supera nn uation benefits, wh ich would also influence one's willingness co supp ly labour
co a particu lar firm or indust ry.
Working conditions
Attra ctive work ing cond itions encourage a highe r supply of labou r co a workp lace, whereas
unattractive working conditio ns wou ld discourage workers from join ing char workplace.
Firms and industries char offer emplo yees more flexib le work ing hours, rh e opportun it y co
work from hom e, generous holiday leave entitleme nts and a p leasant working environment
will tend co attract more labour than chose who do not.
Some jobs offer the opportun ity co trave l and experience d ifferent cultures, which
may be more attractive for some people tha n a we ll-paid job. Other jobs may provide
excellent traini ng opportun ities and experience, which may be a hig h prior ity for younger
employees. Some jobs may offer more mean ingfu l work or a higher level of job satisfaction,
wh ich may attract workers even if rh ey do not pay hig h salaries.
Education, skills and experience requirements
Th e education, ski ll and experie nce requi rements for some types of jobs can lim it rhe
supp ly of labour. Th ese are all elements of hum an c api tal , and a country with relat ively
hig h levels of human capita l is more likely ro achieve low unemp loyment. Because t he
acqu isition of education, skills and experience requ ires considerab le time, sacrifice and
effort, the re may be a lower supp ly of labou r co chose firms and industries chat require a
hig her level of ed ucation , skills or expe rience. In add ition, changes in the availabi lity of
education and t raini ng (such as th rough gove rnme nt scholarsh ips or subsid ies for course
fees) will also in flu ence the skill levels in the workforce.
 Chapter 9: Labour Demand and Supply I
The mobility of labour
T h e supply of labour will be affected by its responsiveness co changes in the demand
for labour in d ifferent areas and industries . Th ere are two types of labou r mob ility -
occupationa l mobi lity and geographical mob ility.

Oc cu pa t ional mo b ility refers co the abi lity of labour co move betwe en different
occupations in response co wage different ials and emp loyment opportu n ities. T he degree of
occupat ional mobility main ly depends on the educat ion and ski lls requi red for a particula r
occupation, as well as the time taken co gai n chose credent ials. As the ski lls required for
a particu lar occupation increase, it generally becomes more d ifficult for labour co move
into that occupation in response co imp roved wage or job opportun it ies. T his is because
of the time and effort needed co acqu ire the new skills. For examp le, it wou ld be difficult
for a motor mechan ic co become a veterinary surgeon, but it wou ld be relat ively easy co
become a bar atte ndant.

Geog raphical mo bili ty refers co the abi lity of labour co move betw een d ifferent locations
in. response co improved wage differentia ls and employment opportu ni ties. Factors chat
limit geog raphical mobil it y of labour include:

• the coses of relocating, includi ng trav el, transpo rtation and real estate coses
• the personal upheaval associated with moving, such as breaki ng tties with family
and friends and childre n chang ing schools.

T h erefore, chose jobs and occupations that requi re workers co relocate co more distant
locations, with fewer ed ucational and entertai nment opportu ni ties, will receive a lower
suppl y of labour. As a result , emp loyers in remot e locations (such as solar power p lanes in
western New South Wales) may need ro offer higher wages co attract worke rs.

The labour force (or workforce) participation rate

T h e above-ment ioned factors will all have an impact on the proport ion of the population Working-age population
chat decides co supp ly its labour - known as the labour force partic ipation rate . In is the number of people
in an eco nomy who are at
Aust ralia, anyone age 15 or over is a p otentia l participant in the workforce (even though
least age 15 (the wo rking
techn ically th e wo rki ng- age popu la t ion is defined as peopl e between t he ages of 15 and age).
64) . Peop le may decide not co partic ipate in the lab our fo rc e (or workforce) because they
want co undertak e further study, rake care of family, or concentrate on leisure activit ies,
or because the y thi nk the y are unlike ly co find a job or wou ld rather rely on other forms Labour force cons ists
of income. Th e labour force participation rate can be defined as the pe rcentage of the of all the employe d and
civi lian populatio n aged 15 years and over who are in th e workforce (that is, either working unemployed perso ns in
the country at any given
or act ively seeking work).
time. Also known as the
workforce.
Labour force 100
labour force participation rate (%) = ---------- X --
Population aged 15 or over 1

Figu re 9 .2 reveals the following tren d s in the labour force partic ipation rat e in Australia:

• T he overall partic ipatio n rate has risen slowly over the past th ree decades, from 61 per
cent co 66 per cent (a record high that was achieved in 2019).
• T here have been significant changes co the male and female part icipation races. Th e
male part icipation rate dropped considerably from over 80 per cent in the early
1970s co 7 1 per cent by 2018-19 . The labour force partic ipatio n race for females has
shown a stro ng upward trend , d r iven particularly by the increasing participat ion of
married women in the workforce. Participatio n races of both men and women changed
dramatically in the 1970s and 1980s but have plateaued in th e past ,decade.
IThe Market Economy 2020

There are a numbe r of boch long- and shorr-cerm factors chat influence the part icipat ion
rate, incl uding:
• In the shore term, th e scare of t h e economy will rend co be t he
M ales Fema les All persons
Year most impo rtant influence. The participation race is said co be
(%) (%) (%)
1969-7 0 83.2 39.1 pro-cyclical. In other words, in rim es of prospe ri ty and econom ic
61.0
1974-75 81.4 43.1 62 .0
growth, people will be more inclined co actively seek work, since
1979-8 0 78.3 44. 1 61.0 there are better p rospects of find ing a job. In rim es of recession, on
1984-85 75.8 45.6 60 .5 the other hand, peop le are le.ss optimistic about job p rospects and
1989-9 0 75.5 51.8 63 .5 therefore les.s inclined co actively seek work.
1994-95 73.7 53.1 63 .2 • Trends in the ageing of the p opulation and the age of reti rement
1999-0 0 72.1 54.1 62 .9 are long-term influences on participation races. The Government's
2004-05 71.7 56.4 63 .9 2015 IntergenerationalReportprojected a decl ine in th e part icipat ion
2009- 10 72.2 58.5 65 .3 rate from around 65 co 62 pe r cent by 2054-55, reflecting t he
2014- 15 71.0 58.7 64 .7 impact of th e ageing of the population. Even though part icipat ion
2018- 19 71.0 60.6 65 .7 races among the popu lat ion aged 15- 64 are expected co rise from
Source : ABS cat. no. 6202.0 76.2 per cent in 2015 co 79.3 per cent in 2055, and more peop le
Figure 9 .2 - Labour force part icipation rate begin co delay retirement and exte nd th eir working lives, overall
participation among the pop u lation aged 15 or over will decrease,
because of the sig n ificant growth in the propo rtion of th e population aged 65 or
older. However, th e shift cowards a less labour-intensive services-based economy
could mea n chat older Australians participate for longer in the workforce.
• Changing soci al attitu de s co th e role of wome n in work, coup led with imp roved
prov ision of child care and declining birch races, have seen an increasing tend ency
for marri ed women co participate in the work force for longer periods. This large ly
explains the increased workforce part icipation race for females. An increase in female
partic ipation in the workforce was the p rimary cause of a rise in the part icipation
race in 2019.
• Increased sch oo l r etenti on ra ces due co th e growing tende ncy for young people co
remain at school longer, as well as seek further full-r ime tertiar y educatio n, mean
chat peop le rend co join th e workforce lacer in life. The proportion of Austra lians
with a un iversity degree has risen from 23 per cent in th e generation chat is now
aged 55-64 co 39 per cent for people now aged 25- 34. A comparat ive scudy
unde rtaken by the OECD in 2018 reported char overall, 46 per cent of Auscralia.ns
aged betwee n 25 and 64 have obta ined some level of pose-secondary schoo l
qua li fication, sig n ificantl y above the OECD average of 3 7 per cent.

Other factors
Th e supp ly of labour may also be affected by government policy decisions or the collective
action of chose p rovid ing labour within an industry.
• Throughout its histo ry, Austra lia has filled gaps in its labour market th rough
immigration. Australia 's immigration pol icies are heavily weighted cowards
ski lled migrants. In 2016-17, more than cwo our of every three newcomers under
Australia's migration program were give n ent ry on the basis of the ir skills (123,567
our of 183,608). Skilled migrants enter because they have skills chat are in shore
supply in Australia, and most of chem are professionals (64 per cent of th e intake).
Around 39 per cent of skilled migrants are individually sponsored by employ ers
(48,250 i.n 2016- 17).
• Professional associations such as the Law Society, the Australian Medical Association
and the Engi neers Australia impose sranda rds of education, cont inu ing train ing
and profess ional conduce on their members, and this rend s co restrict the supp ly of
labour to these occupations. In the past, some un ions p ressured emp loyers to hire
only union members (although this has been prohib ited for many years).
• Th e government can also lim it the supply of labour co particu lar occupations lby
imposing certai n qua lification and licence restri ctions . For example, builders muse
II sat isfy certain competency standards in order co obtain a builder's licence.
 Chapter 9: Labo ur Demand an d Supp ly I
A more detailed discussion of how labour demand and supply int eract to achieve
eq uilibrium in the labour market is includ ed as an extension in section 9.4.

1 Outline the impact of the following changes on the supp ly of labour:

a) an increase in wages in an ind ustry
b) a large reduction in Australia's migration intake.
2 Outline the impac t of the following c hanges on the labour force participa tion rate:
a) an increase in economic growth and the availability of jobs
b) a fall in superannuation returns that causes many older workers to d elay their
reti rement.
3 Distinguish between occ upatio nal and geog raphic mob ility.

9.3 The Australian workforce

T h e workforce can be defined as that section of the popu lat ion 15 years of age and above
wh o are eithe r worki ng or act ively seeking work . Figure 9.3 on page 128 shows the Unemployment refers
re lat ionship between the populatio n in work, the workforce, the civilian popu lat ion aged to a situation where
individuals wan t to work
15 and over and the overall popu lation .
but are unable t o find a
job, and as a resul t labour
T h e workforce can be d ivided into two categories, the employed and the unemployed.
resources in an econo my
A person is defined as being emp loyed if they have one or more hours of work per week. are not ut ilised.
A person is defined as un employed if they are cur ren tly available for work , are actively
seeking work , and are unable to find it.

~ Not included

1·
/ Includ ed

Aged I 5 and over Retired from workforc'

Employed at least
one hour per week Aged under 15
Performing full-time . . ~
OR domestic duties ·

i
On paid leave, strike,
Full-time.
or workers' compensation
non-working students
OR
Without a job but not
Unemp loyed - actively
seeking and available available for or not
actively seeking wo ·
for work
(for example.
because
<>
of illness) ,.

From an econom ic po int of view, tw o aspects of the workforce are impo rtant - its size
and overall qua lity. T he bigger the workforce, the greater the contribut ion it can make to
the p roduct ion of goods and services. However, of equal importa nce is th e quality of th is
labour . A well-educated, hig hly skilled, healthy workforce is much more productive than
one that lacks these characterist ics. T he size and qual ity of the workforce are affected by
th ree main factors - the size of the popu latio n, the age distributio n withi n that popu latio n
and educatio nal patte rns.

Population size
I
The Market Economy 2020

Unemployed

Figure 9.3 - Australia's workfo rce

T he size of our popu lat ion gives us a scarring po int for dete rmin ing the size of rhe
workforce, because it sets the limit to wh ich the workforce can grow . Th e larger the
total population, the greater the potential workforce. Over rim e, a nation's population
tends ro increase. Population g rowth is influe nced by two factors - natural incr ease and
ne t migra t ion .
Natural increase refers to the excess of births over deaths in rh e population, taken over
a period of one year. N et migratio n refers to the excess of perm anent new arrivals to our
country over pe rmanent departures, over a period of one year.
T he demograph ic stat istics presented in figure 9.4 show char over the past few decad!es
Australia 's natura l increase has decli ned. Th e rare o f natura l increase declined to a level
of just above 0.6 per cent of the population per year ar the srart of this decade. This has
been a result of families having fewer chi ldren, influ enced by coup les marrying at a lacer
age than in previous generations, and both spouses remaini ng in full- time work.

Peo ple

350,000 350 ,000

--- Nat ural increase
300,000 300 ,000
--- Net migration
250,000 250 ,000

200,000 200 ,000

150,000 150,000

100,000 100,000

50,000 50 ,000

0 0

- 50,000 -50 ,000

- 100,000 - 100 ,000

- 150,000 - 150 ,000

0 0 0 0 0 0 0 0 0 0 0 <X>
0
;;; <.O ..... <X> 0
0)
('J
a> "
0) "'
0) a> a> a>
0)
0) 0
('J
0
('J
0
('J

Source : ABS cat . no. 3101.0

Figure 9.4 - Populat ion growth in Australia since 1903

Net migration has made an impo rtant contribution to the increase in Australia 's
population, accounting for approximately 40 per cent of our total population growt h
since World Wa r 11. Th e rate of net m ig ration fluctuates considerably, and it is stro ng ly
infl uenced by the level of economi c activ it y. In r im es of dep ressed econom ic activity
and high un emplo yment levels, the government usually reduces our migration intake to
reduce pressures on the labour marker. In times of srrong economic g rowth, when there
are shortages in the labour mark et and very good job prospects , governm ents have tended

II
 Chapter 9: Labour Demand and Supply I
co raise Austra lia's migration quotas. A recent example of this is the use of Ent erp rise
Migra t ion Agreements, where rh e government has permitted compa n ies ro bri ng in
tempo rary m ig rants co fill ski lls shor tages in some of Austra lia's largest m ining projects.

Age distribution
Aust ralia's workforce mostly comprises peop le in rh e 15 co 65 age g roup. Chi ldren under
15 are at school, wh ile most people tend ro retire by the age of 65, even though th ere is
no compu lsory retireme nt age. Obviously , rhe greater rh e p roportion of clhepopu lation in
t he 15 co 65 age gro up, the g reater th e potentia l for a larger workforce.
Figu re 9 .5 hig h lights age disrrib ucion trends for Austra lia in recenc decades, with
project ions up co 2055 .
• Th e propo rtion of the popu lat ion in rh e 15 co 65 age group (the age group chat
provides mosr of our workforce), is begi nn ing co decl ine after increasing for several
decades. An impo rtant factor d riving this has been the movement of chose born in
the pose-war "baby boom" into the working-age group . Th is group is now moving
into retireme nt.
• In rhe past three decades, th ere has been an overall ageing of rhe popu lation, with a
decrease in the proport ion of people under 15 and an increase in rhe propo rtion over
65 years of age. In the quarrer-cencury between 1991 and 2016, the median age rose
from 32 co 38 years. T he ageing of the popu lation is a phenomenon char has been
observed in many indust rialised economies as a result of declin ing birch races and
an increasing life expecta ncy (due ro higher living and health standa rds). T his is a
prob lem because, in the medium co long term, the potent ial size of the workforce is
lower, whi le it needs co suppor t a growing population of aged peop le. For examp le,
wh ile the size of the Australian workforce grew by 2,266,000 du ring the 2000s
decade, rhe workforce is expected ro grow by just 190,000 dur ing the 2020s decade
- in other words, ar current races of imm igrat ion and births , Auscralia's workforce
will be growi ng ar less tha n one-tench of irs growth rate dur ing recent years. T his
could put a significa nt constraint on futur e economic growth .

Percentag e of population ■ 0-14 years D 65+ years

80 ■ 15-64 years 80

70 70

60 60

50 50

40 40

Source: ABS cat. no. 3222.0, Austra lian Governme nt's 2015 Intergenerationa l Report ,
Commonwealth of Austra lia• Proj ectio ns

Figure 9 .5 - The age distribution of A ustra lia's population

II
I
The Market Economy 2020

Ageing population?
Send them back to work!
A grow ing number of voices are calling on govem ments and emp loyers to encourage
older Austra lians to stay in the workforce , in response to the ageing of the Aust ralian
popu lation. The National Seniors Productive Ageing Centre, the National Seniors
Assoc iation , the National Advisory Comm ittee on Ageing, and the Commonwealth
Governmen t have all raised similar concerns as fears grow that Aust ralia's ageing
popu lation cou ld result in a labour crisis with in a decade . Accord ing to research,
Australia's popu lation will grow by 15.8 million over the fou r decades follow ing 2015,
reaching 39 .7 million in 2055, yet only 10.4 million of the increase will be aged under
65, a trend that will exacerbate the imbalance between work ing and retired Aust ralians
and cou ld lead to skill shortages in c ertain indust ries.

A greater proportion of the population will be aged 65 and over. The number
of Australians in this age group is projected to more than double by 2054- 55
compared with today . . . There will be fewer peop le of traditional working age
compared with the very young and the elderly. This trend is already visible, with
the number of peop le aged between 15 and 64 for every person aged 65 and over
having fallen from 7.3 peop le in 1974- 75 to an estimated 4.5 people today. By
2054- 55, this is projected to nearly halve again to 2. 7 people . . . With an ageing
population , economic growth is projected to be slightly slower over the next 40
years than over the past 40 years. Slower growth is due to slightly lower projected
population growth and declining partic ipation rates.
- Australian Government's 2015 Intergenerational Report,
Commonwealth of Australia.

A higher part ic ipat ion rate will be the key to avoiding futu re labour market problems.
The Federal!Government is addressing the challenge of demograph ic changes through
several success ive measures. In 2014, the government announced a long-term plan
to lift the qua lifying age for the pension (often called the retirement age) to 70 by
2035, building on the increase from 65 to 67 announced in 2009. This was intended
to encourage older workers to remain in the workforce for longer. However, this was
unpopu lar, and in 2018, on becom ing Prime Minister, Scott Morrison abandoned the
plan to raise the retirement age to 70.

Education patterns
Education outco mes are rh e sing le most impo rta nt factor influencing rh e q uality of a
nation 's workforce. Whi le educati on can be expen sive, it is critical for an economy ro
have a hig hly ski lled and p rod ucti ve workforce. Ind ividuals who endure years of tra ining
and stu dying bene fit throug h higher earnings. Fig ure 9 .6 shows results from the 20 16
census concern ing rh e link between edu cation and average weekly earni ngs. Th e fig ure
shows that, com pared co a person who d id nor co mp lete high school, someone with a
bachelor's deg ree will on average earn around 2 .4 rim es as mu ch. Across OECD count ries,
un employment races among people who d id not comp lete high school were five pe rcentage
po int s h igher on average than peop le who comp leted h igh school bu t had gained n o
further q ualifica tions .

Today's Aust ralfans spend more years in educati on rhan previous generati ons. In the 10
years ro 2018 , th ere was a 6 percent age p oint increase in t he p roportion of young workers
aged 2 5 ro 34 wit h a pose-school qua lification, rising from 69 co 75 per cent. Neverth eless,
only 67 per cent of Australians aged 25 ro 64 have co mp leted secondary school ed ucatio n .

II
 Chapter 9: Labo ur Demand and Supply I
Average weekly earnings ($)
1600 ~

1400 -
1200 ,-

1000 ,-

800 -
600 ,-

400 ,-

200 ,-

I I I I I I I
0
Post- Bachelor's Di plom a Cert ificate Average Year 12 Year 11
gradua te degree or below
educatio n level
Source: 20 16 Censusof Population and Housing Education level

Figu re 9 .6: Impact of educat ional atta inment on income

Aust ralia's pub lic spendi ng on education is slightly above average by internat ional
sta ndards. In 20 15, p ublic spending on educationa l inst itutions in Australia was 13.5 per
cent of gove rn ment spend ing. Th is i.s h ighe r than rhe OECD average of 11.1 per cent.
H owever Austra lia differs from orher count ries in irs reliance on private fund ing ro cover
t he coses of education. Some 34 per cent of coral education spendi ng is privately funded
in Austral ia, a larger share rhan any OECD count ry othe r rhan Chile.

1 Identify the impact of the follow ing on population size:

a) a decrease in deaths and increase in births
b) a reducti on in net migration.
2 Examine the impact of an ageing population on Australia's future labo ur force .
3 Compare the funding for education in Australia wit h ot her advanced econom ies.

9.4 Extension: labour market equilibrium

W e have noted chat labour markets are more comp lex than most orher markets . T he
labour mar ket does nor functio n a.s a perfectly compe ti tive market , where rhe free
int erplay of supply and demand dete rm ines the price and qua ntity outcome for labour .
T his is large ly because of the role char various institutions p lay in the labour marker.
H owever, before we exami ne rhe inscitutio nal features of rhe Austra lian labour marker,
t his secti on outl ines a theore ti cal view of how equi libri um in the labour marke r woul d
be achieved under conditions of perfect competition. (ThiJ material goeJbeyondwhat
is requiredin the syllabusbut helpJto explain exactly how the labo11rmarket fitJ in with our
analysis of othermarkets.)
I
The Market Econ omy 2020

Determining equilibrium
Generally speaki ng, the usual supp ly and de mand principles apply co labour (figure 9.7) .

• Th e sup p ly cu rve slopes upwar ds

from left co right - as the wage Wage rate$
race increases, people will be more D s
willing co supp ly their labour . It
is assumed in trad it ional econom ic
analysis char in decidin g wheth er
and how much co work, indiv idua ls
weigh che u tility or sa tisfact ion they
der ive fro m leisu r e (which includes
all non-workin g act ivities such as D
rest, recreation and educatio n) and
Oe Quantity
the satisfaction chey derive from of labour
the real income chey wou ld earn
to spend on consumpt ion if they goc Figure 9.7 - Eq uilibrium in the labour market
a job (or worked longer hours) . As
the wage rate increases, che opportun ity cost of leisure rises and working is mor e
attractive - people wi ll subst itute leisure for work and work more. How ever, as
the wage race becomes higher, workers can also achieve che same level of incom e
by workin g less. So at high wage races, labour supp ly declin es as the wage rate
increases, wh ich means that the labour supply curve is backwa r d be nd ing .
N evertheless, most economises wou ld agree that che supp ly of labour does nor
change sig n ificancly when th ere are changes in che wage rate . In ot her words, labour
supp ly is regarded as relative ly wage-inelastic (however, th is is not represent ed in
the simp l ified fig ure provided).
• Th e d ema nd cu rve slopes downwar ds from left co right. With orh er factors of
production constant, according co the law o f di m in is hin g ma rg in al retur n s,
each extra worke r will cont ri but e less co coral production chan the p revious worker .
A profit-maximising firm will only emp loy· the extra worke r if chey pay him or
her a wage race char is lower than margina l revenue earned from their production .
Th erefore, as che wage rate declines, che dem and for workers by firms will increase -
for chis reason, che labour demand curve is d ownward slop ing .
• Eq uili b ri u m is achieved at the intersect ion of che supply and dema nd curves - t he
equi librium wage race occurs where the quantity of labour supp lied is exaccly equa l
to che quantity of labour demanded by firms.
Ac any wage race above We (for exampl e, W ,) the quantity of labour supp lied exceeds che
quant ity demand ed and unemployment exists. In such a situati on, che unemp loyed wou ld
presumably offe.r co work at a lower wage, thus bidd ing down the wage race, forcing it
down co its equ ilibrium level. Ac any wage rate below We (for examp le, W2) che quant ity
demanded for labour exceeds che quantity supp lied, and firms compet ing for labour wi ll
force che wage race up co We.
 Chapter 9: Labo ur Demand and Supply I
Changes in equilibrium
Any changes in the conditions that determ ine the supply and demand for labour will
bring about changes in the wage rate and th e quantity of labou r emp loyed . These changes
can be shown in a d iagram as shifts in the supply and demand curves.

Figure 9.8 demonstrates the effect of an

W age rate$
increase in demand (that is, a shift in the
D demand curve co the right).

A likely scenario to explain figure 9.8

mig ht be that the ageing of the popu latio n
We wou ld see an increase in demand for aged
D, care nursing, increasing the deman d for
health worke rs. Th is wou ld shift the
dema nd curve for labom to the rig ht
s D (from DD to D,D,), caus ing an increase
~ Quantity in the wage rate (from W e to W e,) and an
of labo ur
increase in the level of em ployme nt (from
Figure 9.8 - An inc rease in the demand fo r labour Q e to Q e,).

It is clear that it can be very difficult to isolate the relative importa nce of the factors that
can infl uence the demand for labou r and thus the level of employment. What we can say
wi th some deg ree of certa inty is:

• Th e overall demand for labour is most heavily influenced by the leve l of agg regate
dema nd in the economy (the level of econom ic activ ity).
• An increase in che producriv ilty of labou r will have a posit ive in fluence on che
dema nd for labour, provided ic is accompanied by rising aggregate demand.
• A change in the relative coses of capita l and labour will influence the demand for
labour, bur that infl uence can be overshadowed by changes in the level of econom ic
act ivity. It is usually the case that persistent declines in labour product ivity and rises
in the relative cost of labour wi II create long-ter m incentives for firms to substitute
labour for capital.
• In reality, the re are many int erre lated labour markets in an economy, and the degree
to which people can move becween labour markets (for example , the market for
airl ine pilots and the mar ket for bus dri vers) depen ds on their ski ll levels and the
requirements for each occupac ion . Th ose labour markers that require h igh- level
ski lls, such as medica l specia lists and scientific research, are more closed (and have
more inelasti c supp ly curves) tha n those requiring lower-level sk ills.

1 Outl ine how wages are determ ined in the labour market.
2 Using diagrams, outline the likely change in wage levels from the follow ing
changes:
a) the reduct ion in de mand for jou rnalists , due to the decline of newspaper
pub lishing
b) peop le choos ing to subst itute more leisure time for work.

II
The Market Economy 2020

1 The demand for labour is a derived demand because the number of employees
required by a business firm is determined by the level of output of the business.

2 The main factors affecting labour demand include the output of the individual firm,
general economic conditions , the productiv ity of labour and costs of other inputs.

3 The supp ly of labour depends on pay levels, working cond itions, skill and
educat ion requirements, the partic ipation rate and the mobility of labour.

4 The mobility of labour can be divided into two categor ies: occupational
mobility , which refers to the ability of labour to move between different
occupations ., and geographical mobility , the ability of labour to move between
different locations .

5 The productivity of labour can be defined as the output per unit of labour per
unit of time .

6 Unemployment consists of all persons aged 15 and above who are currently
available for work and are actively seeking work , but have not yet found work .

7 The size of the workforce depends on the overall size of the popu lation, the age
distr ibution and the labour force participation rate.

8 The participation rate is the percentage of the work ing age populat ion who are
work ing or act ively seeking work . The participa tion rate has reached record levels
recently, due in particular to rising female participation rates, but with an ageing
popu lation it: is expected to decline in com ing years.

9 In the long nun, a nation's economic growth and living standards are substant ially
determined by population growth , product ivity growth and the part icipation rate.

10 The main factors influencing the quality of the workforce are levels of training and
educat ion, lit eracy levels and work experience.

II
 Chapter 9: Labour Demand and Supply

•
- - --- -- ~~ ~::..:=-..a
rev1ew
1 Explain why it might be said that there is more than one labour market.

2 Explain what is meant by the statement that labour is a derived demand.

3 Discuss how an increase in the level of economic activity would lead to an

increase in the demand for labour.

4 Explain what is meant by the productiv ity of labour.

5 State the circumstances under which an increase in the productiv ity of labour
wou ld lead to:
a) an increase in the demand for labour
b) a decrease in the demand for labour.

6 Examine how a firm's demand for labour would respond to the following events:
a) a reduction in the cost of new technolog ies
b) a boost to sales after a successfu l marketing campa ign
c) a new national online database that makes it easier to find skilled workers
d) an increase in the cost of labour in neighbouring countr ies.

7 Explain what is meant by the subst itut ion of capital for labour. Identify the
circumstances under which th is wou ld occur.

8 Account for why the labour force participation rate is important to the economy.

9 Ident ify who of the follow ing wou ld be included in the measurement of the
Australian workforce:
a) an 18-year-old TAFE st udent
b) a 53-year-o ld bus driver who left her job to look after her mother who has a
serious illness
c) a 35-year-o ld unemployed person who is available for work and actively
seeking work
d) a 16-year-old school student who works on weekends at a cafe.

10 Explain how the labour market is similar to and different from markets for
consumer goods and services .

Extended response
Outline the main factors that influence the demand and supply of labour for a firm.
Explain how the interact ion of the demand and supp ly of labour determines labour
market outcomes. Analyse how changes in consumer tastes, productiv ity levels,
workforce participation rates and the ageing of the population might affect the
labour market.

II
 Labour Market
I Outcomes

10.1 Wage outcomes

10.2 Trends in the d istribut ion of income from work
10.3 Non-wage outcomes
10.4 The costs and benefits of inequality
10.5 Unemp loyment
10.6 The movement away from full-time work

10.1 Wage outcomes

Havi ng looked ar rh e basic demand and supply forces chat operate in the labour market,
we can now examine what outcomes the labour market produces. In the product markets
for goods and services chat we srudied earlier, rhe ma rker outcomes were an equi librium
of p rice and qu antit y. Likewise, our analysis of labour market outcomes will focus on rhe
pr ice oflabour (such as wage levels and non-wage benefits of employment) and rhe quantity
of labour (such as job grow th, unemployment leve ls and hours worked by employees) .
In examin ing t hese outcomes we confront difficu lt choices about how we balance t he
compet ing goals of fairn ess and efficiency in the labour mar ket .

Wages and salar ies are the major source of income for thre e our of every five Austra lian
househo lds. Wages and salaries prov ide app roximately 56 per cent of househo ld incomes
in Australia, followed by 18 per cent from business p rofits and capita l investment, 1 1
per cent from p roperty income and 8 per cent from gove rnment benefits such as rhe age
pension . Th erefore, wage outcomes produced by th e labour marker have more infl uence
on how income is distributed throughout the Australian community than any other facror.
T here are severa.l ways of measuring wage outcomes and compar ing chem across d ifferent
catego ries. In rhe following section we look at broad measures of wage outcomes and rhen
examine how wages d iffer amongst working peop le in Austra lia.

Average weekly earnings

A good scarring point for our analysis of wage outcomes is co look ar changes in ave ra ge
tot al e arning s for al l employees, which measures the average weekly gross rate of pay
(char is, pay before rax) ro all employees, both in full-rime and part-time employment,
includ ing any payment for overtime. In 2019, the average coral earnings of all employ ees
was $1238 per week. Figure 10.1 shows char average rocal earnin gs have grown at a n
average ann ual rare of 2.6 per cent during rh e past two decades. During the five years
co 2019 ann ual wages g rowth slowed co an average of 1.6 per cent , which is very low by
compa rison ro recent decades.
 Chapter 1 O: Labour Market Outcomes I
How ever, looking ar changes in n ominal (or money) wages does nor rell us wherher
Nominal wag e is
peop le are bette r off because they do not take into account changes in p rice levels chat
t he pay received
might be occurring at the same time. by employees in
dollar tenms fo r t heir
% contr ibu tion to the
---- Productiv ity product ion process, not
8
-------· Rateofinflation adjusted for infl ation .
7 --- - Nominal wage growth

-1

Source: ABS cat nos. 5204.0. 640 1.0, 6302.0 Ye ar

Figu re 10. 1 - Changes in nominal wages, iinflation and productivity

To see whether people are bette r off over time, we must look ar changes in real w ages,
Real wage is a measure
wh ich are a measure of the actua l pu rchasing power of nom inal wages (that is, money wages
of the actual pu rchasing
ad justed for any increase in the level of inflation). Figu re 10.1 reveals that in mosr years, power of mo ney wages
th e percentage increase in nom inal wages is g reater rhan the percentage increase in the (that is, nom inal wages
ge neral price level. In orher words , real wages have generally been rising . However, there adjusted for the effects
are some years when rhe growth of money wages is outstripped by rhe rare of growth of of inflat ion).
pr ices. This has occurred three times in the past decade, and reflects the fact that Austra lia
has been in an extended per iod of low wage growth.

Emp loyers can afford higher real wages if there are also strong increases in productivity. If
the growth in real wages is higher than productiv ity growth, real lab ou r cos ts will rise and
th is will eat into the employer's profits. Equa lly, when wages growth is be low the sum of
inflation and productiv ity growth, rea[ labour coses will fall and profits wi[l expand. If real
labour coses are rising, in order to protect profit levels employers may choose ro employ less
labour and use more technology in product ion, leading ro a high er rare of u nemployment (as
labour wou ld be pricing irself our of a job). In mosr years, the percentage
ch ange in nomina l wages has been less than the combined percentage
Ms Yi, the workers )
ch ange in prices and labour productivity (this means that real labour are demand ing a
coses have been falling). However in occasional years, such as 2018-19 5 per cent wage Raise wages 5 pe r cent,
when producr iviry growth was negative, wages growth can be above rise. What do then raise prices 5 per
you want to do? cent - I'm protect i ng my
the sum of inflatio n and productiv ity growth. -.._ ~ profit margin !

Differences in wage outcomes

So far we have on ly examined wage outcomes ar rhe level of the whole
economy. We have looked at the overall movement in wage races as reflecced
by the changes in average weekly earn ings without taking into accou nt
wage rate differences between various occupat ions, and with in rh e same
occupations . In this section , we are remi nded that rhe labour market is mad e

II
IThe Market Econ omy 2020

up of a number of many different m icro-ma rkets - a mark et for each type of occupat ion
and even for each indiv idua l ente rprise - and that wage rare differentials occur betwe en
these markers .

Wage differentials between different occupations

Different occupations require different levels of ed ucation and ski lls. Worke rs fall into
occupationa l g roups rhat do nor compete with each orher (such as arch irecrs, carpente rs,
clerical assistan t s and engi neers), and rhe wage differentia ls betw een rh em reflect t he
different levels of educatio n and skills required to pe rform the jobs. In rh e labour market,
peop le ge nerally receive greate r rewards for working in occupations rhat requ ire a higher
level of skill and a longer period of tra in ing. People will generally nor spend time and
mon ey acquiri ng educatio n and skills unless they are confident that the ir occupation wj ll
eithe r resu lt in higher wages, or provide some orher benefit, such as a more sat isfying job .

Some occupations, by th eir natu re, involve working cond itions rhat are less appeal ing
rhan others (for example , rhey are dangerous, d irty or involve irregu lar hours). People who
work in these occupat ions quite often get paid a h ighe r wage rate as compensatio n for
those poore r worki ng conditions . A handfu l of roles - such as being the CEO of a large
compa ny - receive dramat ically highe r pay. A survey published in 20 18 by rh e Aust ralia n
Council of Superannuation Investors found that rhe median pay for CEOs of Australi a 's
top 100 publicly listed compani es was $4.4 million per year, which was 66 rimes medi an
wages for Aust ral ian workers.

Occ upa t iona l mo b ility (the ease with which labour can move from one occupat ion to
anothe r) will also influe nce occupationa l wage races. Where occupat ional mob ility is
high , the supply of labour to that occupat ion is always likely to be high, and the re is less
need for emp loy-ersto raise wages to attract labour . On rh e othe r hand, when occupat ion al
mob ilit y is rest r icted, labour supply is less abundant, and wage rates tend to be higher .
For example, highly specialised occupat ions such as veterin ary surgeons , accounranrs and
lawyers experience limited occupational mob ility because it rakes a long rime ro learn t he
skills to be able ro move into these occupations .
Figure 10.2 indicates that:
Managers $ 1630
Professio nals $ 1450 • Income dist ribut ion is markedl y unequal across the eight
Technicia ns and trades workers $ 1157 major occupation g roups.
Machinery operators and drivers $ 1100 • The highest-paid g roup were managers, with a medi an
All employees $1066 weekly income of$1630 per week. This reflects rhe higher
Clerical and administrative workers $ 1019 level experience require d in these occupat ions.
Commurnity and personal service workers $750 • The lowest-paid group were sales worke rs, with a medi an
Labourers $750 wage of arou nd $600 per week. T his is due to rh e lower
Sales workers $600 level of skills and tra ining required for th ese occupations
Source: ABS cat. no . 6333 .0, Table 4 and the hig her level of occupatio nal mobil ity for these jobs .
Figure 10.2 - Median weekly income by occupation fo r 2018

Wage differentials in the same occupation

Wages also d iffer markedly for workers in the same occupation, reflecting the various
deg rees of exper ience. More experienced worke rs are generally conside red to be more
valuable and are qu ite often paid more. Likewise, workers with higher qualificat ions are
generally paid mor e.

Geog raph ic m ob ility (t he ease with which labou r can move from one area to anothe r)
will influ ence wage rates withi n th e same occupation . For examp le, employers find it
difficult to attract labour to isolated locations and genera lly have to pay higher wages
to do so. T herefore, a similarly qual ified worker may be paid a highe r wage rate in order to

II
 Chapter 1 O: Labour Market Outcomes I
be attracted co work in a more dista nt location , such as Broken H ill, tha n if they were
co work in an area like Sydney, where rhe supply of all types of labour is p lent iful. This
has been experienced in the past decade in remote min ing regions in Queensland and
Western Aust ralia . For examp le, in the Western Quee nsland town of Roma during rhe
peak of the mi ni ng boom in 2011 , mi ning compan ies were offering year 10 school leavers
up ro $100,000 as an apprentice scarring wage. With such high pay on offer from mi n ing
companies, small businesses strugg led ro hold on ro their sraff, with the rown's pizza shop
experiencing a turnover of almost 100 staff in just 18 months.

T h e p roduct iv ity of labou r will influe nce wage races pa id . Under enterp rise bargai n ing, Labour prod uctivity refers
employees often gain higher wages at t he individua l ente rpr ise level in exchange for raking to the quant ity of output
seeps co increase the ir productivity. produced in a production
process per unit of labo ur
T he capa city of t he fir m to pay also influences wage ourcomes. Some firms are more per unit of t ime.
profitable and have a greater capacity copay higher wages. For instance, firms chat have market
power and, therefore, rhe ability ro sec pr ices and earn higher profits would be able co pay
highe r wages compared with firms rha.c face greater competit ion in their produce markets.

Age
Income varies over the course of life, although ir tends co remain highest betwee n rhe ages
of 25 and 64 - the main years of a person 's working life. Figu re 10.3 in dicates chat rhe
35-44 age bracket earns the highest media n income per week ($1268) whi le the 15-19
age bracket earns the lowest ($255), followed by chose aged between 20 and 24 ($7 50).
T h ere is less variat ion in income leve ls if we on ly look at full-time workers, and in face
t he highest earn ing full-r ime workers. are chose in the over-65 bracket (reflecti ng the face
char among chose work ing full-r ime over the age of 65 , there are more highly-sk illed and
fewer low-skilled workers). Overall, :figure 10.3 shows char income levels are generally
lower in rhe earlier years of work ing life (since peop le have less educat ion and experience
an d hold lower paying jobs). Similarly, income levels decline as peop le get older and need
co rely on age pensions or oth er forms of retirement income.

Age groups 15-19 20- 24 25-3 4 35-44 45-54 55- 59 6()-64 65 and over
Weekly inco me ($) 225 750 1140 1268 1250 1200 1050 850
Source : ABS ca t. no. 6333 .0. Tab le 2

Figure 10.3 - Median weekly income by age, 2018

Gender
Discrimi nation by emp loyers against certain groups in our society means chat peop le in
some groups have fewer job opporcunir ies and less access co high er paid jobs, leading
co lower earn ings. Groups char have t radit ionally suffered discrimi natio n in this respect
include women , some mig rant group s and Aborig inal and Torres Strait Islanders.

Cons ider the difference between ma le and fema le earn ings in more der:ail. Since 1969,
Au stra lia's emp loyment laws have recognised the pr incip le of equ al p ay fo r equ al
wo r k. H owever, th is princ ip le alone fails co correct the imbalance between men 's and
women 's wages as many women are forced co reduce thei r paid work hours because
they ful fil orher roles , such as ch ild-rear ing, for which they are not pa id . As a resu lt,
a second p ri ncip le of equ al pay for wo r k o f equ al valu e emerged , requi ri ng chat
remuneration should rake account of both rhe qua lity and the quant it y of work. T he
ev idence nevertheless suggests chat d iscr imination still exists with respect co job
oppo rtunit ies, part icu larly in terms of the h ighest paid jobs or posit ions . In th is sense
women are said ro face a "g lass cei.ling" in employment - an invisib le, rathe r than
a forma l, barrie r chat makes ir harder for women co ga in access co rhe rop pay ing
posit ions . T he presence of such a ba rr ier is reflected by the substant ial difference in
average weekly earn ings between m:ales and fema les shown in figure 10.4 .

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IThe Mark et Econo my 2020

Figure 10.4 shows char in 20 19, che average week ly earnings of women were only
Year Males Females
cwo-chirds of chose of men. Furth er, wage relativities have bare ly changed in t h e
1990 520 345 past cwo d ecades. Pare of chis difference in the earnings of males and females can
1995 623 420 be exp lained by h uma n cap ital factors - du e co past attitudes about che role of
2000 784 516
women in society, females had fewer opportunities co acquire educatio n , sk ills
2005 955 640
and qualifications. Ho wever, even caking into account chose differences in sk ill s
2010 1227 819
and qualificacions, fema les earn less than males in many simi lar jobs . Anoth er
2011 1267 849
2012 1285
ana lysis from che Austra lian Nationa l Univ e rsity in 2016 suggested chat men
822
2013 1357 850
earn on average 19 per cent more than women working full-time in the same
2014 1365 881 occupations . Thi s suggests chat there is discrimination in the labour market
2015 1370 908 because females wit h sim ilar ski lls and expe rience nevertheless receive lower
2016 1395 925 incomes chan th eir male counterparts . Th e 2016 report She's Priceless:The Economics
2017 1428 961 of the Gender Pay Gap by che D iversity Counc i l of Australia quantified the variou s
2018 1445 975 factors chat contribute co why women are p a id less than men. Th e repo rt found
2019 1476 1010 chat wome n are on average paid $2.32 less per hour than men. As figure 10 .5
Source: ABS ca t. no. 6302.0 shows, the th ree factors contributing most to cine gen der pay gap are di scrim ina t ion ,
Figure 10.4 - Average weekly to tal
interruptions in working life (usua lly because of caring for chi ldr en) and working
earn ings ($) in lower paid "segrega ted" indu st ries with hi g h races of female emp loyment.

Fact or Per centage Absolute per

of effect hour equivalent
Sex d isc rimination 38 $0.88
Years not working (interruptions) 21 $0.48
Industry segregation index 19 $0.45
Occ upational segregation 11 $0.24
.Age (experience , prox ied by age, years) 6 $0.14

I Share in par1-time emp loyment 4 $0.08

Tenure with current employment (years) $0.03

I Share work ing in government or NGOs 0.4 $0.01

Source : Diversit y Counci l of Austra lia (2016)

Figure 10.5 Causes of the gender pay gap , 20 14

Migrant status and cultural background

Anoth er influ ence on labour market outcom es is che migration and cultura l
background of individuals. Almo st 3 in every 10 Australian workers were born
overseas (3.4 million out of a coca! working population of 11.6 million in 2015, of
whom 1.2 million migrated co Au stra lia within che prev ious d ecade) .

Annual income ($) All Migrant Skilled

Australians Australians migrants
Average income 49,075 48,398 55,443
Managers 69,100 61,775 67,607
Pro fessionals 7 1,353 74,865 79,051
Technicians and trades workers 53,629 51,5 14 54,679
Sal es workers 27,3 19 25,204 26,133
Lab ourers 33,076 29,933 32,287
Source : ABS cat. no. 3418.0

Figure 10.6 Ave rage income levels for migrants and non-m igrants in Austra lia

Figu re 10. 6 shows data on che incomes of migrant and non-migrant taxpayers in
Aust ralia , which forms pare of a repo rt released by the Australian Bureau ofStaciscics
in 2015 . Not e in part icu lar:
• Overall, Austra lian workers with a migrant background earn an average of $48,398,
wh ich is slig htl y less than che average taxpayer ($49,075) .

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 Chapter 1 O: Labour Market Outcomes I
• However, rhose who came ro Austra lia as skilled migrants earn an average of
$55,443, wh ich is well above the national average . This reflects rhe fact rhat ski lled
migrants have higher levels of sk ills rhan the average of the Australian workforce
(unsurpris ingly, since rhey are being recruited ro Australia for exaccly that reason).
Skilled migration now comprises most immigrat ion to Australia, having grown from
20 per cent to 65 per cent of rora l immigrat ion between the early 1990s and 2010 .
• A compa rison of incomes by occupat ion shows that in rhe highest-pay ing occupat ional
categories, such as managers and professionals, workers with a migrant backg round
earn more than average taxpayers . This again is a reflection of rhe fact that Australia
recruits many highly qualified workers from overseas. However in t he lowest-paying
occupat ional categories , such as la bourers and sales workers, Australian-born worke rs
are more high ly pa id than workers from a migrant background. Because these are
occupat ions wirh lower skill levels and therefore less rewards for those skills , even
workers in rh is group who have come to Australia through the skilled migrant
program earn less than Austra lian-born worke rs.
• Othe r data suggests that workers who have most recently migrated ro Australia rend
to have lower income levels rhan rhose who have been in Australia longe r, but incomes
tend ro rise relative ly qu ickly towa rds average levels.
Simila r concl usions have been reached in orher stud ies of the impact of migration and
cu ltural background on labour market incomes. A 2014 Monash Univers icy study, Native-
immigrant W'ageGap ac,-ossOcc11pations: Evidencefrom A11st1·a/ia
, found that al though workers
wh o have migrated to Australia earn highe r incomes, they actually receive lower rewards
for the ir education rhan Australian-born workers . This appears to be explained by having
weake r English languag e profic iency, rathe r tha n discrimination. Previous research has
also found that a migrant who has an English-speaking backgrou nd i.s likely ro earn
an above-average income (while a migrant from a non- Engl ish speaking background is
likely to earn a below-average income). Worke rs whose background invo lved speaking
English earn an extra 10 per cent, accord ing to rhe study . Even if non-Eng lish-speak ing
background m igrants have the equ ivalent skills and experience of the ir Austra lian-born
counterparts, they may not be able to obtain better paid jobs if they do nor have a strong
command of rhe Eng lish language .
Overall, Austra lian research suggests char wage outcomes for migrants to Austra lia slowly
conform ro rhe average for all Austra lians. Whe re there are worse ourcomes for some
migrants, they are more likely to be ,rhe result of a lack of Eng lish language profic iency
or skills rhan discrimination. In this respect, Australia is different from orher Western
countries , such as the United Stares and several European econom ies, where there are
srronger links between m igrant and ethnic background and a sustained experience of
lower wages and higher unemp loyment.
I ndigenous Au st ral ian s (Aborigin es and Torres Strait Islanders) , however, do not
follow these trends and experience h igh levels of disadvantage. Indi gen ous Australians
rep resent around three per cent of Austra lia's popu lat ion . Mean weekly persona l income
for ind igenous Australians was only 71 per cent of income for rhe overall population
according to 2016 census data ($622 pe r week compa red wirh $876 per week). Similarly,
mean weekly househo ld income for ind ige nous Australians was $1505, or 80 per cent of
t he mean income for Australian househo lds generally . Indigenous Australians were also
less like ly ro earn a high income, wi,rh just 20 per cent earning a household income in
excess of$1000 per week, in compa rison to 34 per cent of the ge neral population. Furthe r,
app roxima tely 43 per cent of indige nous people were in rhe lowest income quinti le in
2012 - 13. Conversely, jusr 6 per cent of ind igenous Australians were in rhe highest income
quintile (rhe 20 per cent of Ausrralian s with the highesr incomes).

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I
The Market Econo my 2020

1 Outline the impact of the following changes on real wages :

a) nominal wages rise faster than inflation
b) nominal wages rise more slow ly than inflation
c) nominal wages and inflation rise at the same rate.
2 Account for the differences in wages outcomes between occ upations.
3 Choose ONE group in Austra lian soc iety tha t tends to be adverse ly affected by
income inequality :
a) Compare their wage outcomes w ith the average for other groups and w ith
the rest of Australia .
b) Discuss poss ible reasons for their disadvan tage.
c) Suggest ways in which the government could intervene to reduce such inequality.

10.2 Trends in the distribution of

Enterpris e barg aining
refers to negotia tions
between e mployers
and employees (or their
representa tives) abo ut pay
and work condi tions at the
level of the indiv idual firm.
income from work
During the past three decades , rhe Australian labour market has undergone dramatic
changes chat have altered rhe way in wh ich people receive thei r wage increases. In t he
1980s, rhe centra l role of rh e award wages system (in which mosr wage levels were ser
by rh e Aust ralian Ind ust rial Relations Commission, which is now known as rh e Fair
Work Commission ) ensured that d ifferences in wage outcomes borh betwee n and with in
occupat ions were smaller. However, the shift towards enterprise bargaining since t he
early 1990s - where employers and employees negotiate wage increases at the workplace
level - has created much greate r d ifferences in wage ourcomes for both different indusrri .es
and ind ividua ls.

Income distribution
refers to th e way in
which an economy's
income is sp read among
the members of d iffere nt
socia l and socio -
eco nomic gro ups.
At an economy-wide level, this has resulted in the creation of considerable d ifferences in
income distribution betwee n sections of rhe community. However, as highlighted lby
figure 10.7, relative househo ld incom es have only changed slightly since rhe mid-1990s.
This reflects rhe fact that increased family benefits for lower-in come earners have offset
increased wage different ials.
Quinti le Share of income (%)

1994-95 1999-2000 2005-06 2009-10 201 1-12 2013- 14 20 15-16 2017-18

Lowest qu intile 7.9 7.7 7.8 7.4 7.5 7.5 7.7 7.5
Second qu intile 12.8 12.6 12.7 12.4 12.6 12.3 12.5 12.5
Third qu intile 17.7 17.7 17.4 17.0 17.3 16.9 17.0 17.0
Fourth qu intile 23.7 23 .7 23.0 23.0 23.0 22.4 23.0 22 .7
Highest qu intile 37.8 38 .7 39.2 40.2 39.5 40.8 39.8 40.4

Source: ABS cat. no. 6523.0 Note that statistics are not released for every financial year and
statistical changes mean that statistics since 2007--08are not directly comparable to previous statistics.

Figure 1O.7 - Gross week ly individual income quintiles

Figure 10.7 shows the proportion of coral income that is received by each income quinti le over
tim e (that is, five equal-sized income groups ranked from lowest to highest). It reveals rhac:
• Th ere is considerable inequa lity in the disrrnbur ion of incom e in Austra lia, which
has grown slightly over the past decade.

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 Chapter 1 O: Labou r Market Out comes I
• Th e top 20 per cent of income recipients accounted for 40.4 per cent of total income.
Furth er, they had average weekly incomes over five t imes hig her than the average
of the bottom quintile.
• Th e share of coral income accruing to th e bottom 40 per cent of income recipients
has remained relat ively consta nt in recent years.
• Over rh e past rwo decades , the hig hest- income earners have gai ned a larger share
of income while the share of every other g roup has shru nk . Th e hig hest income
earners have ga ined income sha re at the expense of rh e midd le quinti les.
Different wage outcomes across different indust ries are also the resu lt of changes in rhe
st ru ctu re of rhe economy. Emerging industries that require ski lled labour (which may be in
sh ore supply) are likely to pay hig her wages than declin ing indust ries char are experiencing
fa[ling demand for the ir goods and serv ices.

Income distribution within occupations

In addition to rh e increasing gaps in earnings betwee n occupat ions and social groups,
re-cent years have seen an increase in the dispersion of earnin gs with in occupations and
am ong emp loyees with the same ski ll levels or educationa l qual ifications. Th e shift away
from centrali sed wage dererminarion si nce the early 1990s has contr ibuted to thi s outcom e,
alt houg h rh e trend was already evidem duri ng rhe 1980s. Anothe r cont ri but ing factor is
t he decl in ing level of union members h ip in Austra lia. Hi g her rates of un ion memb ership
te.nd to create more simila r wage out comes for workers doing simila r jobs in d ifferent firms
and industr ies, bur as the role of unions has decli ned, ther e has been great er variation in
wage levels withi n indust ries.

1 Describe the recent trends in the d istribut ion of incom e in Australia.

2 Assess the impact of enterprise bargaining on the distribut ion of income .

10.3 Non-wage outcomes

In add ition ro th eir ordinary and overtime payments, man y emp loyees receive addit ional
Superannuation 1sa form
be nefits such as sick leave, ho liday leave , sup eran n u at io n and other fringe benefits.
of saving that individuals
T h ese are known as n on -wage outcomes . Wh ile these are of sign ificant value to the
can not access unti l they
employ ee and repres ent a sig n ificanil:cosr ro the emplo yer, they do nor appear in the reach retirement age.
average weekly earn ings sratisr ics.

T h ere is no sing le measur e of non-wage out comes for employees , because many cannot be
Non-wage outcomes
quant ified in dolla r terms. No n-wage outcomes can vary substantia lly from one workplace
are the benefits that
to another . In some industries , workers often earn far more tha n th eir regu lar wage because many employees receive
of substantia l non-wage allowances. in addition to their
ord inary and overt ime
Several t ypes of non-wage outcomes exist. Salary packaging is a popula r means of payments, such as sick
supple mentin g wages, with emp loyees receiving a compan y car, a laptop comput er, leave, superannuation,
su bsidised child care, gy m membership and orher types of assistance from their emp loyer. a company car, study
leave or arrangemen ts fo r
An oth er form of non-wage outcome is bonus cash payments on rop of an emplo yee's normal employee s to work from
wage. Th ese payments are norma lly mad e as a p erforman ce bon us, eith er based on rhe home fo r part of the week.
compan y's profit pe rforman ce or rh e e mp loyee's indiv idua l work performance.

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The Market Economy 2020

A final form of non-wage outco me is to imp rove ,che flexibi lit y for emp loyees in their
work patte rns. Th is mig ht include allowing rim e for smd y leave, extra parent al leave,
leave ro look aft er a sick fami ly member, allowi ng extend ed leave without pay, maki ng
arrange ment s for employees ro work from home for pare of the week or allowing
emp loyees to sh are jobs.

1 Distinguish between wage and non-wage outcomes.

2 Identify TH REE occupat ions where bon us payments are common ly used .

WORK AND QUALITY OF LIFE

Work is not on ly a source of income for individua ls, it is also a major influence on an
individual's qua lity of life because it makes peop le fee l product ive and needed by society.
Working provides people with social interaction; fellow workers are not just co lleagues, they
can also be friends , sport ing team members, husbands and wives. Social stud ies of work in
Australia and overseas have consistently found a strong link between secure employment
and individual happ iness or wellbeing.
One source of ongo ing informat ion about work and personal satisfaction is the Australian
Unity Wellbeing Index, which has been pub lished regu larly since 2002. It has found that on
average, that peop le who are in full-ti me work have a significant ly greater "wellbeing index"
than those who are unemp loyed (76 compared to 68) . However, when people's work hours
become too long , their wellbeing dec lines. It has also found that wellbeing is the same for
those in full-time study and full-time work , but peop le who are retired generally report an
even greater sense of wellbeing than those who are in work (78 compared to 74). The highest
level of work -related satisfact ion was recorded by peop le who work as unpaid volunteers
(for examp le, for a charity) on a part-ti me basis, although full-time volunteers also have
greater wellbe ing than full-time workers.
Further insights into how work affects Australians' quality of life is given by the 20 14
Australian Workplace Relations Study. When asked about their job satisfaction on a
spectrum from 1 (low) to 7 {high), Australians rated 5.42 on average. In other words , most
Australians are relatively happy with the ir job . In overa ll terms, women are happier with
the ir jobs than men, part-time workers are happier t han full-time workers , and emp loyees
in small organisations are happier than those in large organisations. While the work itsel~
contributes to job satisfaction , both men and women say that the most important contributor
to job satisfact ion is the flexibility to balance the ir work and non-work comm itments (see
figure 10.8).

Most important factor in determining job satisfaction (%) Ma les Females

Flex ibility to balance work and non- work co m mitments 26 37

The wo rk itself 19 20
Job sec urity 17 15
The tota l level of pay 18 12
Othe r 20 16

Source : Australian Workplace Relations Survey 2014. Survey respondents were asked to ident ify
what was the most important aspect of employment that co ntributes to their job satisfaction.

Figure 10.8 - W hat m akes Aus tralia ns most sat isfied with their job

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 Chapter 1 O: Labour Market Outcomes I
10.4 The costs and benefits of inequality
T h ere are advantages and disadvant ages associated with an inequitable distribution of
income. Howeve r, in genera l, inequal ity has economic benefits bur socia.l costs .

At one end of rhe spectrum, some economists argue that inequality is a natural consequence
of the free market funct ion ing effective ly, since each individual receives a share of income
according ro th eir margi nal productiv it y. In addition, rhey contend that inequality has
t he advantage of creating and srrengchening individuals' incentives and increasing their
share of output . In orher words, inequality encourages peop le to work harder to improve
t heir position in the dist ribut ion of in come.

At rh e othe r end of rhe spectrum, some economists emphasise rh e social costs associated
wi th inequality . The y argue that the system of free-marker capitalism div ides society
in.co an upper class, a midd le class, a worki ng class and an "u nderclass ", and rhar chose in
t he unde rclass have limited oppo rtunities to fulfil their potential because of barriers ro
pa rricipar ing in education, work and social life.

Economic benefits of inequality

Income inequal ity can lead ro an increase in rhe productive capacity of resources and
t hus an increase in real GD P per capita . Econom ic benefits are main ly d erived from rh e
in ce nti ve effects of inequa lity.

Inequality encourages the labour force to increase education and skill levels
If chose with higher qualificatio ns and skills reap highe r income rewards , new ent rants
and existing participants in rhe labour force will be encouraged ro improve th eir educat ion
and skill levels. T herefore, so long as low- income recipie nts can afford to pay for educat ion
and train ing, income inequal ity encou rages an increase in the qua lity of the labour force.

Inequality encourages the labour force to work longer and harder

T h e potential to earn higher incomes p roduces an incentive for worke rs. to work longer
hours or to work overtime, which may enhance economic growth. Howev er, workers will
only be will ing to give up leisure in order to work longer hours when they feel rh e ext ra
income is more valuab le than their leisu re rime.

In addition, if increased output is rewa rded through highe r pay, this encourages improved
labour productiv it y.

Inequality makes the labour force more mobile

T h e use of highe r incomes can act as an incentive to encourage labour to move ro where
ir is most needed . A more mobi le labou r force wi ll lead ro a more efficient allocat ion of
resources and a higher rare of econom ic g rowth .

Inequality encourages entrepreneurs to accept risks more readily

T he prospect of considerable income rewards accruing to entrepreneurs is necessary ro
en courage rhem to undertake investment . Unless ent repreneurs received an exrra reward
fo.r risk raking, there would be fewer ent repreneurs and businesses, a lower rare of economic
growth, fewer jobs and a reduced prod uct ive capacity in the economy.

Inequality creates the potential for higher savings and capital formation
T h ere is a srrong relat ionship between income and saving levels. Th e highe r the income
an indiv idual earns, the g reater the propo rtion of income that will be saved; likewise, rhe
lower rhe income, rhe lower the propo .rrion of savings . In theory, g reater income inequal ity

II
I
The Market Econ omy 2020

shou ld encourage increased savings in the economy because of the greater number of
higher-income earners. Increased savings should reduce Aust ralia's reliance upon foreign
capital by providi ng domestic funds for investmen t .

Economic costs of inequality

Inequality reduces overall utility
Inequality in the d istribution of income reduces the rocal ut ility, or sat isfaction, in societ y.
T his is because peop le on highe r incomes gai n less uti lity from an increase in income
rhan people on lower incomes. This is explained by the pri nciple of diminishing margi n al
utility: as more of a good is consumed ir wi ll provide progressively less uti lity co rhe
consumer . This means char an extra $1 of income is worth more co a lower-income earn er
rhan co a higher-income earner. A more equ itable d istribution of income would the refore
increase cocal ut ility (in orher words, create a greater overall level of sacisfacrion in society) .
However, it is n ecessary ro bear in mi nd rhar ir is extreme ly d ifficult ro measure relative
utilities accurately.

Inequality can reduce economic growth

High levels of inequality will rend ro slow down the rare of economic g rowth in an
economy. O ne reason is because low-income earners spend a highe r proport ion of their
income and therefore contribute co growth. Anoth er reason is chat more unequal societies
underm ine educationa l opportun it ies for childre n from the poorest backgrounds, resulting
in a less productive and less skilled workforce. Conversely, by reduci ng inequal ity and
dist ri but ing the benefits of economic growth, economies shou ld be able ro srrengrhen
the ir growth race.

Inequality reduces consumption and investment

Low-income earners spend a higher proportion of thei r income than richer peop le, since
the cosr of basic essentials such as housing and food cake a higher proport ion of their
income. A hig h er level of income inequa lity will the refore mean char less income will
go cowards consumpt ion . T his in turn leads co lower economic activity, employment,
investment and living standa rds.

Inequality creates conspicuous consumption

Some economises argue char inequality in rhe distributio n of income creates a "leisure class"
consisting of rh e higher-income earners in society. The leisure class puts a large p roportion
of their money cowards "conspicuous consumpt ion", which is the consumpt ion of expensive
goods and services, such as design er-label cloches, pure ly for rh e pu rpose of d isplaying
wealth . Th is can contribute cowards a cultu re where individua ls' sense of the ir own worth
depends on their relative position in the wealth and income hierarchy.

Inequality creates poverty and social problems

Inequal ity in income d istribution causes relat ive poverty. Poverty cont ributes co
the development of an underclass of low-income earners, who have limited access co
educationa l opportun it ies and can suffer health and orher d isadvantages rhar may reduce
labour force participation and create a self-perpetuat i ng cycle of disadvantage. T his reduces
educational opportunities and lowers self-esteem, wh ich over rime may result in peop le
nor work ing co their full capacity or not working at al l.

Inequality increases the cost of welfare support

Governments provide safety net income suppo rt for people out of work, the aged and
peop le with disab ilities. This places dema nds on government revenue, as a large number
of peop le on low incomes may requ ire government assistance.

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 Chapter 1 O: Labour Market Outcomes I
Social benefits of inequality
In theory, inequality should have a social benefit if individuals' incomes genuinely reflected
their relative productivity . In those circumstances, people would be rewarded for their
enterp rise and effort, and this would provide an incentive for individua ls to work harder
an d more productively, and acquire new skills and knowledge, knowing that their effort
would be rewarded.

However, since th e economic system chat determines the dist ributio n of income and wealth
does nor give everyone the same level of opportunity to acquire knowledge and skills, the
dist ributio n of income does not accurate ly reflect the product ivity levels or work effort of
indiv iduals.

I ne q uali ty of op portun ity exists in Australia due to several factors:

• Existing inequality in the distributio n of income and wealth rends to perpetuate
inequality of opportunity. For instance, higher-income earners genera.Uy have access co
better educational opportu nit ies, making it more likely that they wi ll gain adm ission
to un iversity courses, allowing chem to take up higher-paid occupar ions.
• Nor everyone has the same mental and physical att ri but es and the same potentia l
with regard co th e acquisit ion of income and wealth. For examp le, some people are
more talented at manual work, which rends co lead to lower paying jobs than jobs
that require analytica l ski lls.
• People who acqu ire wealth through inher itance have a much greater opportunity
to bu ild up the ir wealth th rough investments, as opposed co those chat start with
no wealth.
• People may nor have access to the same networks of peop le chat may lead co new
opportunities. For examp le, new migrants are likely to find it d ifficult co access
social and business networks. T his inequal ity can be especially difficult to overcome
because many of th e barrie rs co opportun it ies are informal barriers (for example,
businesspeop le may p refer to d o business with peop le who went co the ir school or
have a simi lar social backgro und, because they feel more comfortab le with such
people - th is will informally exclude other people).
Give n the problem of inequal ity of opportu n ity, it is generally agreed chat the social
benefits associated with inequa lity are very limited .

Social costs of inequality

T h e three main social costs of inequa lity are social class div isions, poverty and lower levels
of wellbeing. This was highlighted by a global survey of more than 48,00 0 people across
44 countries in 20 14, which found t hat inequa lity is one of the greatest concerns around
t he world today. T he Pew Global Att itudes Survey 20 14 reported chat in the United
Srates, most European countries and other nations such as Argent ina an d South Korea,
t he growi ng gap between rich and poo r raced as the "greatest danger to the world" ahead
of religion and ethn ic hatred , nuclear weapons , pollut ion and d iseases.

Wellbeing
Research undertaken by The Equality Trust in the UK suggests that in advanced economies,
social p roblems such as menta l illness, crime, lower levels of life expecta ncy and lower
levels of social mob ility are all more relate d to a country's level of inequa lity than changes
in the level of nat ional income. The Spirit Level, a book published in 20 09 by R ichard
Wi lkinson and Kate Pickett, analysed data from economies with different dist ri but ions of
income across the industr ialised world. They concluded that th e best long-te rm strategy

II
I
The Market Economy 2020
Unemploym ent refers
to a situation where
individuals wan t to work
but are unable to fi nd a
job, and as a result labour
resources in an econo my
are not ut ilised.
II
co reduce social p roblems, such as high cares of crim e and imp risonm ent, chronic healiC
h
prob lems and low levels of rrusr wit hin societ y, is not ro focus on increasing econom ic
grow t h, bur ro focus on reduci ng inequa lity.
Social class divisions
T he distributio n of income and wealt h creates class d ist inctions in modern economies, such
as between groups broad ly descri bed as upper class, m iddle class and worki ng class. Large
differences in incomes can resul t in tensions betwee n people and between d ifferent regions.
Disagreement s betwee n workers and employers about wage levels, in which worke rs r ry
ro improve their income level, are a common cause o f indu stri al disp utes. Th ese divisions
can somet imes lead co social and economic inscabil.iry.
Poverty
Ineq uality resul ts in h igher levels of poverty. Many Australians live in relative povert y.
Poverty tend s co trap fam ilies into a vicious cycle of low incomes and limi ted econom ic
opportunities. H igh poverty levels also tend co be associated with increased levels of crim e,
su icide, d isease and reduced life expectancy.
1 Explain how reducing inequality might increase econom ic growth .
2 Outline the major social and economic costs and benefits of inequality.
In his famous 1971 book A Theory of Justice , philosopher John Rawls argues
a perspect iv,e on income distribution that became w idely accepted during the
late twent ieth cent ury. Rawls argued that the fa irest way to identify w hat level of
inequality should be permissible in a society is to put individuals under a "veil of
ignorance"- that is, by asking them how they wo uld like society to be structured
if they did not know w here they would sit on the social and economic hierarchy.
In other wo rds, he wo uld ask that if you were about to be born into a random
family, w hat kind of income distribution wou ld you want in Austra lia? Would
you want a substantial gap between rich and poor and risk being born into a
low- income fam ily, or would you prefer to have a smaller gap and be born into a
high-income family that was n't much better off than a low-income family?
Considering this perspect ive. identify the groups in society that tend to argue
that inequality is a "necessary part of any society ". Which groups advocate a
lowe r level of income inequality?
10.5 Unemployment
On e of the hig hest p rioriti es of all polic ies affecting the labour marker is co reduce
un e mp loym en t . To be classified as unemp loyed, a perso n must be over the age of 15, be
with out a job, or have been let go from a job wirhour pay, but be acti vely seeki ng full-rim e
or part-ti me work. "Actively seek ing work" means more tha n just looki ng through t he
"positions vacan t" secti on of rhe classified advertisem ents in newspapers - the person mu st
be wi lling ro app ly for jobs, atte nd job int erviews and be ab le ro srarr work if asked ro do
so. To be classed as act ively seeking work, a person witho ut a job shou ld satisfy any one
of a nu mber of crit eria, such as:
 Chapter 1 O: Labour Market Outcomes I
• regu larly check ing advertisements from different sources for availab le jobs
• being willin g co respond co job advertisements, apply for jobs with employers and
attend interviews
• be registere d with any emp loym ent p lacement provide r chat is a member of J ob
Services Australia.

T h e Australian Bureau of Statist ics (ABS) defines the unemp loyment race (also known
as the leve l of unemp loyment) as t he numbe r of unemployed persons expressed as a
percentage of the coca) labour force.

Number of persons unemployed 100

Unemployment rate ( % ) = ------------- x- -
Total labour force 1

For example, if the size of the labour force was 10 million, and the numbe r of persons
classified as u n emp loyed was l mill ion, then the unemployment race would be 10 per cent.

Types of unemployment
A[chough it is comm on co speak of a level of unemployment in the econ omy, in reality
t here are many different types of un employment, each reflecting a differe nt cause. Some
types of unemployment have a cyclical cause, and they increase or decrease accord ing co
fluctuations in the business cycle - these include cyclical unemployment and hidden
unemp loyment. Unemp loyment can also arise as a result of changes in the structure of the
economy - structura l unemp loyment and long-ter m unempl oyment are exam ples . Finally
th ere are some types of unemploymen t that have causes separate from the economy - these
in clude seasonal, frictio nal and hard-co re unemp loyment.

Cyclical unemployment
Cycl ical unemployment is caused by a dow n turn in the business cycle. lit occurs because
t he dema nd for labour is a derived de mand. Whe n there is a dow nturn in the business
cycle, de mand for goods and services. falls. Firm s are forced co cue back productio n and
wi ll lay off some workers in order co maintain their profit levels.

Cyclical unemployment will be reduced when there is an upturn in the business cycle.
Agg regate demand rises, increasing demand for a firm's goods and services, and so firms will
increase their demand for labour in orde r co increase their product ion levels . As demand for
labour increases, more jobs become available and the level of unemployment falls.

Structural unemployment
Structural un empl oyment occurs because of a mismatch between the ski lls demand ed by
TONY'S
emp loyers and chose possessed by une mp loyed people . Restructu ring of t he economy from

-
ABACUS
old industries co emerging indust ries and the introduction of new tech nology will usually REPAIRS

in crease the level of structu ral unemployment. Thos e workers who were laid off in the
decli n ing old industries may find tha c their particular skills are not app ropriate in newer
indu stries where the type of skills requi red may be different . So even if t he unemployed
person wanes co work, and th e firms in the new industry require more labou r, the mismat ch
of skill s means that the structurally u nemployed cann ot find work.

Long-term unemployment
To be das .sified as long-cer m unemp loyed, an indiv idua l muse have been unemployed
for a period of 12 month s or more. Generally, the longer a person is out of work, the
ha rder it becomes for them co get a job . Th e long-term unempl oyed ma y have scarred

II
I
The Market Economy 2020

our origi nally as cyclically unemp loyed persons. An economic downturn may have caused
a person co lose their job. However, during an economi c recovery the economy may nor
grow quickly enough ro eli minate all cyclical unemp loyment, and some people may find
themselves unemplo yed for more tha n 12 months. Aft er a long period of unemployment,
a person may lose th eir job-related skills, while emp loyers will also be more reluctant co
hire someone who has been our of work for a long cime.

Seasonal unemployment
Seasonal unemp loyment occurs because of the seasonal natur e of some jobs (chat is, changes
in rh e labour mark et char occur regularly each year, independent of rhe business cycle).
Examples include rourisr-r elared jobs and jobs associated with holiday seasons, such
as plump older men working as shoppi ng centre Santa Clauses ar Christmas . Seasonal
unemployment also rises duri ng the Decemb er- March period of each year when new
school leavers are seeking jobs and enter the labour force.

Frictional unemployment
Frictional unemp loyment occurs as people change jobs, moving from one job co another. It
usually cakes some rime ro move between jobs as individua ls muse search for employment
opportunities, acrend job interviews and complete any administrative derails. There will
always be a small level of frictional unemployment in che labour market, although improving
the efficiency of job placement services can reduce the level of frictional unemp loyment.

Hard-core unemployment
Hard-core unemplo yment refers co chose individua l.s who might be considered unsuitab le
for work because of personal reasons such as ment al illn ess, physical d isabilit ies or drug
addiction .

Hidden unemployment
Hidde n unemp loyment refers co chose individua ls who are not count ed in the official
unemp loyment figures because they have g iven up actively seeking work or have gone back
ro school. Hidd en unemployment usually rises during a prolonged economic downturn .
Slower growt h in aggregate demand means char the prospects of finding a job are very low,
and some individua ls become discouraged from continu ing ro seek work. Since the hidden
unemployed are no longer actively seeking work, they are not officially unemp loyed, but
rhey are still considered ro be a part of rhe unemp loyment problem since rhey would
work if labour ma rket conditio ns were becrer. A r ise in hidden unemployment will be
reflected in a fa.II in the labour force parr icipar ion race rather than as an increase in t he
official unemp loyment race.

Underemployment
Individuals who have pare-rime or casual jobs but would like co work more hours per
week are said co be underemp loyed. T echnically, these workers are nor unemployed .
However rh ey are a significant problem in rh e labour market since they represent under-
utilised labour resources - rh e workers are ready and willi ng co work more hours , but
the conditions in the labour marker mean char they cannot. Estimates of the level of
underemp loyment in Australia have risen sign ificantl y in recent decades, as an increasing
share of jobs have been created on a pare-rime or casual basis. (T his is discussed in more
derail in section 10.6).

II
 Chapter 1 O: Lab ou r Market Out co m es I
Recent unemployment trends
Unem ployment
rate( %)
12
11
10
9
8
7
6
5
4
3
2

"<t <D
..
co o ~
~ J, ...
'M ~ N
00 0
N N N
00
NN

Source: ABS ca t. no. 6202.0 '20 19-20 Budget forecast Year

Figure 10.9 - Unemploymentin Australia

For rhe past four decades, unemp loyment has been a sign ificant economic po licy
A recession is the stage
challenge in Austral ia. As shown in figure 10.9 , Austra lia experienced a n upwa rd trend of the business cycle
in the average level of unemplo yment between rh e 1970s and 1990s . After recording where there is d ecreasing
very low unemplo yment rares in the 1960s and early 1970s, Ausrra lia's average rare of economic activity, defined
unemp loyment rose co an average of 8 .6 per cent in the 1990s, peaki ng at 10.7 per cent as two consecutive
unemp loyment in 1992-93, irs hig hest level since the Grear Depression of rh e 1930s. quarters (six months) of
negative economic growth,
T h e main reason for this increase was a severe recess ion in Austra lia and in the g lobal
that is, a fall in GDP.
economy. Falling agg regate demand saw cutba cks in production and the closure of many
firms, which led co rh e shedding of labour and an increase in unemp loyment.

Add ing co the unemp loyment prob lem duri ng the early 1990s was stru ctu r al ch ange Structural change refers
and microe conomic refo rm. Many peop le who had lose th eir jobs in decl ining industries to the process by which
during rh e recession were unable co obtai n new jobs created in emergi ng indust ries the pattern of p roduc tion
because the job vacancies often requi.red hig her or different skills. As new technologies in an eco nomy i s altered
over t ime, and certa in
and product ion techn iques changed rh e structure of businesses, Austra lia's unemp loyment
products, processes of
problem became one of the major structural issues facing the Austral ian economy. production, and even
indust ries d isappea r,
T h ere was a g radual downward tre nd in unemp loyment for rhe 15 years from 1993 ro
while others eme rge.
2008, when it fell co 4 per cent, its lowest level since 1974. Conditions changed sudde n ly
in 2008 as the glo bal financial crisis tri ggered a worldwid e recession, lbur in Austra lia
t he increase in unemp loyment was mu ch mild er than in mosr advanced econom ies.
U nemp loyment rose by almost 2 per ce nt during 2008-09, bur a quick recovery in growth
t he following year meant rhar unemplo yment was again down co 5 per cent by 2010.

Since 2010, Austra lia's unemplo yment rate has stayed mostly in rhe ran ge of 5 ro 6 p er
cent. Australia's unemplo yment has been around the OECD average (5.3 per cent in
2019) but above the United States (3 .6 per cent), United Kingdom (3 .8 per cent ) and
N ew Zealand (3.9 p er cent). During 2018 and 2019 , economists were surp rised ro see
Australia's labour market continu ing ro gene rate jobs g rowth , rising partic ipation races
and low un emplo yment desp ite a slowi ng economy. Othe r econom ies h ave experienced
simi lar outcomes , suggesting that a w ider set of factors might be at pla y. Unemployment
is nor expected co change sign ificantly over the next rwo years. According co 20 19-20
Budg et forecasts, unemp loyment is expected rob e 5 p er cent in 2019 - 20 and 2020 - 21.

II
I
The Market Economy 2020

Unemployment and geography

5.1%

6.4 %
WA
5.8 %
SA
7.3%
NSW
4.3 %

ACT
3.5 %
Australia 5.3 %
9 'l.

Sour'C&: ABS calno. 6202.0

6.4
.,,.v
TASH

Figure 10.10 - Unemp loyment in Australia, August 2019

We gai n a better insight into the unemp loyme nt prob lem by contrasti ng rh e
unemployment rates in d ifferent pa rts of Austra lia . Figure 10.10 shows rh e differen ces
betwee n rhe unemplo yment experiences of individual scares and rerriror ies. Australia's
economy has sngnificant regional d iversity, and [abou r mark er conditions can differ
significantly, borh within scares and between the m . Unemployment levels are closely
related ro econom ic grow th. Scares where g rowth is high (such as NSW, wh ich has
unde rtaken a large amount of public infrastructure investment in recent years) record
lower rates of unemployment than the nationa l average . Thos e scares that are experie ncing
slower g rowth (such as South Ausrra lia, which has been adversely affected by job losses
in rhe manufacturin g sector) record hig her un employme nt races rhan the nationa l average.
By exam in ing scare and regional trends in unemp loyment, po licymake rs can bet te r
unde rstand the w ider structural adjusrments raking p lace in the economy .

Unemployment(%}
10

--- Sydney
--- Regiooal NSW

0
0
"' "' ... "' <D ,-.. <O

~ ~ ~ ~ ~ ~ ~ ~ ~ ~
"'
~
§
-, I
-,
§
-, -,~ -,~
§
-,
§
-,
§
-, -,~ I
-,
§
-,
Source: ABS eat. no. 1338 .1. 629 1.0.55.00 1 Yea,

Figure 10 .11 - Sydney and regional NSW unemp loyment

 Chapter 1 O: Labou r Market Out comes I
T here are large differences in unemp loyment races within stares - within cicies, and berween
c itties, regio n s and remote areas . Regional areas of Australia often tend to have a higher
level of unemp loyment than metropo litan areas. For example, the unemp loyment rate in
Sydney was 4.2 per cent in 2018-19, whi le ir averaged 4.9 per cent in the rest of rh e
srate . Unemplo yment was around 2 per cent in Sydney's Sutherla nd region. In contrast,
ir was above 6 per cent in many pares of NSW, includi ng arou nd Parramatta in Sydney
and the Coffs Harbou r regio n.

1 Outline the majo r types of unemployment.

2 Account for recent trends in Austra lia's unemployment rate.
3 Propose TWO reasons for d ifferences in unemployment between states .

10.6 The movement away from

full-time work
T h e labour market has been undergo ing substantial change over recent years as a resu lt
of changes in business practices , economic cond itions and governm ent po licies. Th e most
clearly defined change in work practices is the shift away from full-tim e work towards work
ar rangements char g ive businesses mo re flexib ility. Th is includes pare-r ime employment,
casual jobs, outsourc ing, individual contracts and sub-contracting.

Part-time employment
Parr-t ime emplo yed is defined by the ABS as those emp loyees regularly working less rhan
35 hours per week. Casual emplo yment occurs when emp loyees have occasional working
hours bur do nor follow any ser pattern . Casual emp loyees tend ro be rhe mosr insecure
because they do nor have any certainty about whethe r rh ey will have work in the futu re.
Casualisation of work
T h e proport ion of emplo yees working part-time has g rown dramatically over recent refers to th e grow th of
decades . A comparison ofOECD count ries has shown that Australia has rh e third-highest casua l employm ent (and
rare of part-r ime emp loyment in rh e industrial ised world (seen in figure 10.12) at the relative decl ine of
25.7 per cent, compared to an average of 16.5 per cent across the OECD . In recent fu ll-time permanen t jobs)
as a proport ion of th e
decades , Australia has also experienced a large increase in casual employ m ent (known as
total wo rkforce.
t he "casu alisati on " o f wo rk ).

Several factors help to explain rh is shift. Some emp loyees pre fer part-rime work, allowing
t hem ro balance orher responsibi lities such as family comm itments. A mu ch hig her
proportion of women than men are in part-time work (46 per cent of emplo yed women
compar ed ro on ly 19 per cent of emp loyed men), reflecting several facto.rs includin g rh e
fact chat more women carry a greater share rhan men of child-ra ising respo nsibi lities . This
option of part-time work has been made easier by some indust ries, such as information
and commun ications technology, which mak es it possible for some emplo yees to work in
mo re flexib le arrangements such as wor kin g pare-t ime from hom e.

How ever, for others, part-tim e or casua l work is the choice of their emplo yer and nor their
own. Employers have greater flexibi.lity in the ir staffing arrangements if a substantia l
proportion of their emp loyees are less than full-r ime workers. Durin g busier times, they
can increase hours for their staff and rh ey do not face extra overtime costs or rhe coses
of hiring additional staff. In addition, employing workers on a casual or part-time basis

II
I
The Market Economy 2020

may help them ro avoid some of the responsibilities th ey have co full-time workers, su<;h
as granti ng holiday leave, long service leave, sick pay enti deme nt s and redundancy pay if
they no longe r have work for the employee.

%
40

35

30

25

20

15

10

0 <O
·~
O> ig
Q)
C1> 0
C:
~
!!! ·c: ·c:
!!! Q) :, E
.. .... -g.. ~
.2:,

"" ~
~ :,
:,,:
.. .. -g -8
C: .!!1
a. I!! j
..,
<O
<O C
<O
:5 (!) > C: :,0
u. <O ~ Qi
tn
-8 ~ ~
~ !:
ID (.) N !:l
(!) ,:;
0 ill 0
.... 3: j
(.)
w
a. (!)
0
Q)
z
en J
0 ~
w
S0U(C8:OECO statistics
. September'2019

Figure 10 .12 - Part-time employment as a proport ion of tota l employment

Changing employment structures

Another trend seen in recent years is the shift away from direct emp loyment arrangements
rowards th e use of cont ractors , oursourc ing and su b- cont ract ing arrang ements. Th e ma.in
purpose of these more flexible and less secure work arrangem ent is co allow busin esses
co change th eir s raffing levels more easily and more often , as busin ess conditions change .

Firms engaging cont ra cto rs pay chem co p rovide a specific service for the busi ness, such
as specialised consu lting advice or work that is generally not inte nded co be full-time over
an extended per iod of tim e. Arrangements with contracto rs are different from emp loyment
arrangements in that th ey are governed by commercial law rather than employment law.
In theory, contractors are inte nded co have greater cont rol over how they prov ide their
services. An exampl e of where contracto r arrangements are commo n is the truck ing
industry , where many truck drive rs own their truck and rake responsibi lity for its runni ng
expenses wh ile being paid by firms for carrying freight, usually on a per ki lomet re or per
assignment basis.

Anothe r development related co the growth of emp loyment contracts is the practice of
outsourc ing. Outsou r cing (also known as sub -con t ract ing, or contracting out) occurs
when an organ isation pays anoth er business co perform a function that it does not rega.rd
as a core part of its business focus. For example, governments now outsou rce most of
their information technology operations , leaving most compute r operat ions performed
by government .in th e hands of privat e compa nies. Th is includes data processing of social
security claims, medica l claims and taxation returns . Outsourcing aims to improve efficiency
becauseir allows a business or government agency to focus on irs areas of specialisation
whi le leaving ot her compan ies who specialise in other functions to do those tasks . However,
it also tends co create shorter-te rm emp loyment arrangements , because workers usually
work on short-term contracts, and th ey are actually employed by a different organisatio n .

II
 Chapter 1 O: Labou r Market Outcomes I
T h ese chang ing employ ment srruccures allow firms co have che benefit of scaff without the
ob ligati ons chat go with normal employ ment arrange ment s, such as paying award wages,
worke rs' compensation, superann uati on , long-service leave and redunda ncy entitl ement s.
T h e flexibili ty of th ese work arrange ments may be beneficial for some emp loyees, but
for ot hers who are "permanent casuals" it can simply resu lt in less job securit y and lower
in comes. For emp loyers, th ere are also some downsides wit h having fewe.r employees and
m ore cont ractors in a workp lace. Th ose downsides include a loss of staff loya lty (since staff
have no security of emp loyment , they are un likely co feel a loyalty co th e busi ness), a higher
race of sta ff turnover, and a less experienced and possib ly less hig hly sk illed workforce.
Fur th er, it is not always t he case char cont ractors will cost less th an employees, as firms
usually have co pay a higher hourl y race for cont ractors and outsourced em p loyees in order
co reflect t he coses that t he firm is no longer paying d irectly.

CASUALISATION OF WORK

Advantages Disadvantag es
• Flexibility for employers to increase • Less job security
or reduce staff as business demands • More d ifficult for employees to plan
change for the future, obtain home loans, etc.,
• Employers may avoid paying some without secure income
non-wage costs such as penalty rates • Less staff loyalty and less development
or redundancy entitlements of workforce skills.
• Flexibility for employees with family or
other commitments.

1 Distinguish between part -time and casual employment.

2 Account for recent trends in the shift away from full-time work in Australia.

Research ONE of the fo llow ing labo ur market outcomes:

• wage outc omes for all persons
• the distribution of income from wo rk
• non-wage outcomes
• unemp loyme nt levels
• casua lisation of work
• c hanges in employme nt struct ures.
Write a two-page report on you r fi nd ings, exam ining recent tre nds in the labour
market outc ome, reasons for these trends and what , if any, role the government
has played in influencing the labour market outcome .

II
The Market Economy 2020

1 At the economy-w ide level, the growth in average tota l earnings for all emp loyees
gives the best indication of wage trends .

2 From the firm 's perspect ive, labour costs increase if the growth of nominal
wages is faster than increases in inflation and p roduct ivity combined .

3 Wage outcomes differ accord ing to occupationa l groups , age, gender and
cultura l background.

4 In recent years , the wage gap between those workers who rely on award wage
increases and those who are able to negot iate agreements through enterpr ise
bargaining has increased .

5 Non-wage outcomes refer to financial benefits other than wages (such as

performance bonuses , comm issions, company share issues) and features of
work ing condi tions such as flexible work ing arrangements .

6 Enterprise bargaining has produced stab le and moderate increases in wages

since its introduct ion in the early 1990s, but it has also contr ibuted to greater
inequality in the distribution of income from work.

7 Unemployment is defined as all those over 15 years of age, without a job , or

let go from a job witho ut pay, but actively seeking work . There are many types of
unemployment, including cyclical, structura l, long -term , seasonal, frict ional, hard
core, hidden and underemployment.

8 The long-term unemployed are those who have been unemployed for a year
or longer. Around one-sixth of unemployed peop le are long-term unemployed .

9 Recent years have witnessed a shift away from full-time to part-time, casual and
contract-based employment. These forms of emp loyment give greater flexibility to
employers in how they manage their workforce.

10 Another significant trend is the growth of outsourcing and sub-contracting ,

where organisations pay a private sector company or an individual to do non-core
functions. These jobs are normally contract based (that is, they only last for a
limited time p eriod) because the jobs only exist while the firm or individual still has
a contract to work for the other organisation.

II
 Chapter 10: Labour Market Outcomes

•
- - --- -- ~~ ~::..:=-..a
rev1ew
1 Define real wages and explain how they are determ ined.

2 Define wage inequality . Explain why we experience wage inequality :

a) between different occupations
b) with in the same occupation
c) between different groups in our society (give examp les).

3 Outline TWO factors that help explain why, on average, women r,eceive lower pay
than men.

4 Outline how age can influence income levels. Examine w hether or not you th ink
this is an indication of discrim ination.

5 Exp lain why some industries pay workers less than other industries. Provide an
example of a lower-paying industry.

6 Exp lain what is meant by non-wage outcomes in the economy. Identify the
occupations in which these 01Utcomesmight be most significant.

7 Exp lain how the Austra lian Bureau of Statistics defines unemployment. Identify
TWO dimensions to the unem ployment prob lem that are not reflected in the
official measure.

8 Briefly describe the fo llowing terms :

a) cycl ical unemployment
b) structura l unemployment
c) hidden unemployment
d) long-term unemployment.

9 Exp lain how unemployment levels may be influenced by local or regional facto rs
in different parts of Australia .

10 Analyse why there has been a shift away from full-time towa rds part-time
employment over the past decade .

Extended response
Outline the difference between wage and non-wage outcomes . Examine the factors
that influence wage outcomes for employees . Analyse the arguments for and against a
more equitab le distr ibution of income from work.

II

Th e industrial relations
system involves the
laws, institutions and
processes established
to manage the
relationship between
employers and
employees. The structure
of the ind ustrial relations
system d etermines
the process of wage
determina tion and
conflict resolution
in the Australian
labou r ma rket.
The Changing
Australian
Labour Market
11.1 The role of t rade unions
11.2 The role of employer associations
11.3 Australia's current industrial relat ions fram ework
T he relationshi p between emp loyers and emp loyees - the forces chat demand labour,
and chose char supp ly it - is a cruc ial part of how an economy functions. To emp loyees
who supply labour , the p rice of labour is thei r source of income and rhey natura lly wa.nt
the highest wage possib le. To emp loyers who dem and labour, wage rates are a cosr of
production and rhey want wages kept low. Th e relatio nship betwee n emp loyees an d
employers is known as indu str ial r elati on s (or workp lace relat ions), and econom ises
frequently talk of th e ind ustr ial relat ions system , or th e workplace relations system . T he
ind us tr ial r elat ion s system involves the laws, institutions and processes esta blish ed to
resolve rh e conflict between emp loyers and emplo yees. In effect, rh e industria l relatio ns
system sets rhe rules for how the labou r market operates. Th is chapter examines rhe
srructure of rh e industrial relations system and rh e roles p layed by rhe representa t ives of
employers and employees in rhe labour marker.
Over the past century, Australia has deve loped a un ique industria l relatio ns system . For
many years rh e majorit y of workers belonged to a un ion , and the Australian trad ition
of egalitarianis m - that is, trying ro ensure fair ou tcomes for everyone - led Aust ral ia
ro create safegua rds chat guaranteed relatively hig h wages for all workers and aimed to
prevent employ e rs from misusing their power over workers. T hroughout the tw entiet h
century, Austra .lia maint ained a system of specia.l tribunals to make decisions about
wage movement s and ro help resolve industrial disp utes. More recently, rhe role of these
institut ions has been reduced and greater emphasis has been placed on employe rs and
employees negotiating pay and work condit ions.
Because of the operat ion of special laws and institutions , rh e labour mark et is not a
perfectly compet itive marker. Institutiona l forces affect the operation of the free marker
in order to improve labour mark et outcomes, such as guara nte eing minimum wage leve[s.
Four importa nt institut ional forces affecting labour markets will be exami ned in this
chapte r - trade unions, emp loyer associations , indu strial tribunals and rhe govern ment .
11.1 The role of trade unions
A trad e un io n is an association of workers chat aims to advance rh e int erests of irs
members by imp roving their wages and working cond it ions. Th e main role for un ions is
ro represent their members' inte rests by negotiating wage increases, but unions also p lay
a role in present i ng employees' interests in such issues as tra in ing, safety in the workplace ,
 Chapter 11: The Cha nging A ustra lian Labo ur Market I
and orga nisational changes such as compan y restru ct ures. Un ions have been an important
pa rt of labour markets since the ni neteenth centu ry. Un ions are usually based on particu lar
occupati ons , indust ries, firm s or a m ixture of th ese.
• Occupationa l unions (also known as craft uni ons): T hese un ions draw th eir
members from persons who possess a particular occupatio nal ski ll, or range of skills,
regardless of the indu stry or firm in wh ich they work (for example, the Electri cal
Trades Union or the Australian Medical Association) .
• I ndu stry-ba sed unions: T hese unions cover workers in a particu lar industry,
regardless of the type of work tha t th ey do (for example, the Austra lian Meat
Industry Employees Union and the Finance Sector Union) .
• Enter p ri se-based unions: Thes e unions represent only the workers of one specific
ente rprise. T his kind of union is very rare, although past governm ent po licies have
tried to encourage th e creation of ent erprise-based unions.
• General unions : General unio ns cover a whole range of workers wit h many
d ifferent ski lls across various industries (for examp le, the Austra lian Workers'
Un ion and the Construct ion, Forestr y, Mining and Energy Un ion).

Most unions are affiliated with the Au stralian Coun c il of Trade Unions (ACT U) . The
ACTU was fo rmed in 1927, and it is the national voice of the trade union movement.
The ACTU has several roles today: coo rd inatin g union act iv ities ac ross Australia ,
incl ud ing wage claims and industr i al act ion ; conduct ing campaigns and research ;
and prov iding input to go vernmen t policies .

Union membership (% total employees)

50

Visit the website of the

10 Australian Council of
Trade Unions at
www.actu .org.au.
It contains useful
information about the
latest developments
So urce : ABS cat . no. 6333 .0
in industrial relations
in Australia from the
Figure 11 .1 - Trade union membership since 1991
perspective of unions.
Like most ot her advanced economies, Australia has experienced a large fa[! in trade un ion Choose a recent campaign
m embership in recent decades. Duri ng the postwar era when there were large workforces of the ACTU. Identify
in. factories and manua l work, most be.longed to a union. At the peak of un ion membership the key demands being
made by the A CTU, what
in. the mid-1970s, 55 per cent of workers were union memb ers, but b y 2018, uni on
action it took, and the
m embership had declined to just 15 per cent of the workforce (see figure 11.1). Un ion likely economic impact if
m embership is sign ificantly hig her in ,che pub lic sector (39 per cent) th an th e private sector employers implemented
(9 per cent ). Union membersh ip among older workers is also much higher than among the ACTU claim fully.
younger workers (for example, it is 25 per cent among 55- 59-year-old workers bur only
8 per cent among 20- 24-year-olds).
I
The Market Econ omy 2020

There are a number of factors chat have contributed co rh is decline in union membersh ip,
including:
• Ch anges co wage d ete rm in at ion : The movement away from centralised wage
decermi n.acion ro ente rprise barga ining has te nded co reduce the overall influence
of un ions in wage outcomes .
• Ch anges w it hin in dustr ies: The indust ries chat have exper ienced the greatest
growth in recent years do nor have a history of high levels of un ion membersh ip -
this is rrue of busi ness services, domestic services and retai l trade sectors. Equal[y,
sectors with high levels of union membe rship, such as manufactu ri ng and
government-owned busi nesses, have shrunk as a share of coral employment.
• Ch anges in t he n ature of em p loyme nt : Un ion membership has always been
highest among permanent full-time workers, but the proport ion of full-time
worke rs i n rhe workplace has fallen in recent decades . The fastest employment
growth has occurred in casual, pare-rime and temporary emp loyment, and among
contract ors, all of which have lower levels of trade union membe rship th an
perma nent full -time emp loyees.

The role of unions in the labour market

Un ions can influence the labour market in a variety of ways. The mosr important role
of unions is in bargaini ng for increased wage outcomes . By coord inati ng the bargain ing
power of indivi d ual emp loyees, unions are ab le ro stre ngthen emp loyees' bargai ni ng power
and achieve hig her wages.

Representing employee interests

Un ions also play a broader role in influenc ing labour market outcomes by representi ng
the inte rests of ind ividual emp loyees (for example, th rough lega l assistance and advice)
and prov id ing a collect ive voice for workers when management is imp lementi n g
orga n isatio nal changes, as well as in issues chat affect workers, such as p roviding better
access ro tra inin g and education, improv ing safety sranda rds in rhe workp lace, maki n g
ir easier co comb ine work and fami ly responsibi lities, and changes in work srruccures.

Exercising their bargaining power in negotiations with employers

Whe n emp loyees acr alone against an employe r (for example, by threaten ing co
go on stri ke), chey are un likely co have any substantial influence on the emp loyer
because rhey have lim ited bargai n ing
powe r, and ind ividua l employees are Wage rate $

generally easy co replace. However, if s

employees join together (for example,
by all rhreareni ng ro go on str ike), they
have significant · power because ir is very
We
difficu lt ro rep[ace an entire workforce.
Thi s is why unions can p lay an impo rtant
role in industrial relat ions. Through
their collect ive bargai n ing stre ngth, D
s
un ions can negot iate a highe r wage
rate rhan marker forces might normally ~ o, Quantity
of labour
determine (as shown in figu re 11.2).
Dara on the income levels of different Figure 11.2 - Effect of bargaining power
indust ries prov ides evidence chat union
members are better paid than non-union members. In 17 out of 19 industr ies, un ion
members are bette r pa id rhan non-u n ion members, by marg ins of up co 38 per cent.
Overa ll, union m embers in Austra lia receive wages t hat are 12 per cent highe r on average.

II
 Chapter 11: The Changing Austra lian Labo ur Market I

Do higher minimum wages always

mean higher unemployment?
Economists, employers, governments and unions often argue about
the impact of minimum wage rises on the level of unemployment.
Unions argue that wage rises for low -income earners boost consumer
spending and therefore boost econom ic growth . Employers argue
that wage rises will make employees too expensive and will therefore
lead to higher unemployment. Econom ists generally argue that wages
growth should not exceed the sum of inflation plus productivity growth .
In reality, the major cause of changes in the level of unemployment has
been the ups and downs of the business cyc le, not the general level
of wages or the pay rates of specifiic industries and occupat ions. One
explanation fo r this phenomenon relates to our discussion of the price
elasticity of demand in chapter 5 - that is, the responsiveness of demand to changes
in price, or in the case of the labour market, the responsiveness of labour demand to
changes in wages.
Australia's experience in the past two decades has shown that it is poss ible to reduce
unemployment at the same time as awarding moderate increases to the m inimum wage .
However, whenever unemployment rises, there is always some debate about the level
of minimum wages . For examp le, Australia's minimum wage levels were frozen in 2009
during the height of the global financial cr isis. The effect of this decision was that , given
the impact of inflation, workers expe rienced a reduct ion in their real wages . After the
economy returned to stronger growth , the new Fair Work Comm ission m inimum wages
panel awarded modest real wage increases each year between 2010 and 2019, arguing
that th is was affordab le and was not in conflict with the goa ls of lower unemp loyment
and sustaining low inflation.
Economists have different views on the relationship between minimum wages and
unemployment , but in recent years the re has been a shift among cent ral banks and
institut ions such as the International Monetary Fund towards believing that in cu rrent
cond itions , many econom ies would benefit from higher wage growth . They argue that
higher minimum wages will result in increased household spending and increased
econom ic activity, and therefore mo re jobs. This is because the dema rnd for labour is
a derived demand - that is, it is based on consumer demand for goods and services.
Therefore, while higher wages will increase product ion costs for an individual firm,
possibly reduc ing that firm's demand fo r labour, those higher wages will also increase
the purchasing power of consume rs, and by increasing demand for the output of
businesses, higher wages may act ually increase labour demand .

If srr ong unions convi nce empl oyers co pay a h igher -t han- equi l ibri um wage rare (th at is, a
wage rare of W , rath er t han W J, rh ey actu all y change rh e shape of rh e supp ly cu rve (fr om
SS ro W,S). H owever, at rh e hig her w age rare, rh e quanti ty of labour supp li ed (Q ,) w ill
exceed t he qu ant ity of labour dem anded (Q 2) , and emp loym ent wi ll also be less t han rh e
ori gina l equilibri um qu antity (QJ. I n o rh er words, excessive wage deman ds in one industr y
m ay cont ri bute ro a h igher level of unemplo yment by p rici ng labour our of a job . Th erefore,
w hen uni ons bargain w ith emp loyers for wage adju stment s, they may face a trad e-off
between achi eving a hig her wage rare and ma inta ini ng current levels of em ploym ent.

Restricting the supply of labour

U n ions can also restr ict t he sup p ly of labou r ro a fir m or industry on a.n ongo ing basis,
th us brin g ing about an increase in t h e w age rar e (show n i n fi g u re 1 1.3 on page 162) .
M easures th at mi g ht reduce th e supp l y of labour in clude resrricri ons on hirin g emp loyees
(fo r examp le, doctors' pro fessional associati ons often oppose admi ssion of overseas tra in ed
docto rs ro work in A ustra l ia, w hich resul ts i n reduced supp ly of labour and hig her pay for
docto rs in Au stralia ). U ni ons may also restri ct t he supp ly of labour by dem andi ng t hat

II
I
The Market Economy 2020
For more information on
employer associations,
visit the follow ing webs ites:
Australian Ind ustry Group:
www .aigroup .com.au
Australian Chamber of
Comme rce and Industry:
www .acci .asn.au
Business Counci l
of Australia:
www .bca.com.au .
II
employers only hire members of thei r
Wage rate$
union or association, or only provide a
licence ro work for their membe rs. This s
approach has been used by professional
groups such as the NSW Law Society. We, .....
However, these types of restrictions are
We
less common nowadays, as mosr forms
of compulsory union or associat ion
membership are now proh ibited.
Restricting labour supp ly shifts the s D
supp ly curve ro the left (from SS ro S,S,) Quantity
and increases th e wage rate (from W e ro of labou r
We,), bur it also reduces the quant ity of
Figure 11.3 - The effect of restricting the supply
labour employed (falling from Qe ro Q e,). of labour
1 Describe the role of a trade union .
2 Explain why union membership has declined d uring recent decades.
3 Briefly out line how unions can influence labour market outcomes by :
a) restricting the supply of labour
b) exercising their bargaining powe r.
11.2 The role of employer associations
In response to labou r organisi ng itself through un ions on the supply side, emp loyers
combine to form their own organ isations. However, although larger employers have greacer
financial resources than unions, employe rs are generally nor as well coordi nated as
employees because employers already have greate r b argaining powe r wirhour needing to
coordinate the ir efforts, and also, in many instances , they are in d irect compet ition with
each other. Larger emp loyers mostly deal with un ions directly rather rhan going th rough
an emp loyer association.
Emp loyer associations typica lly operate as indusr .ry-based lobby groups or as genera l
lobby g roups to represent business interests on issues of economic policy such as taxation,
regulations and industrial relations. In relation co the labour market, they play two ma.in
roles:
• They represent and promote the interests of the ir members by lobbying rhe
government on industr ial relations policies.
• They assist emp loyers in managing industria l relat ions issues, such as lby
representing their members in the various indust rial tribuna ls set up to settle
indust rial disputes .
At a federal level, rhe th ree mosr important em ployer associanons are rhe Business
Council of Austral ia (BCA), the Australian Industry Group and the Australian Chambe r of
Commerce and In dust ry (ACCI). These associations provide a nat ional voice for emp loyers
and have p layed an important role in the debate over industr ial relations po licy changes
du ring recent years.
 Chapter 11: The Changing Austr alian Labo ur Ma rket I
A range of employer organ isations a[so exist in major indus rries, such as the N ati onal
Fa rmers Federation (N FF), rhe Housing Industry Association and the Mine rals Council of
Aust ralia . These organ isations represent rhe specific ind ust ry concerns of members. T hey
are involved in wage negotia ti ons and represent emp loyers in specific indus t rial disputes
wi th in their industries.

The role of employer associations in the labour market

Ind ividual compan ies are genera lly more Wage rate $
impor tant than emp loyer associatio ns D s
in. influencing wage ourcomes . Larger
busi nesses generally have rhe expertise
and resources ro negoti ate wages wi t h
unio ns directly (if rheir workers a.re
rep resented by unions), and emp loyers o,
mos tl y do not coordi nat e those
negoriarions with each orher.
D
On some occasions, however, rh e
Quantity
act ions of emp loyer associatio ns have of labour
been of benefit to both emp loyers
and emp loyees. Through lobbyi ng the Figure 11.4 - Effect of industry protection on the
govern ment for pro recrion from foreig n labour market
competition, for tax exemp t ions, or for
in dust ry assisrance, employer associati ons have, in the past, been able ro secure a larger
sh are of the domestic marker for Austra lian producers. As shown in figure 11.4, this would
increase the demand for labour (shift rhe demand curve to the right , from DD to D ,D ,),
causi ng an increase in rhe wage rate (from W ero We,), and an increase in t he emp loyment
of labour (from Q e to Q e,). However, such dema nds by indust ry associati ons have been less
su ccessful in recent years, as governm ents have cut back sharp ly on protectio n levels and
in dust ry assistance. Economists ge nera lly believe that even if industry assi.srance helps one
sec tor, ir will hur t orhers and have a negat ive effect on employ ment levels in the long run.

THE MAIN ROLES THAT EMPLOYER ORGANISATIONS

NOW PLAY IN THE LABOUR MARKET

• assisting members in negotiating wage agreements with emp loyees

• in some instances , negot iating wage agreements that might cove r a large number of
their members (although the govern ment argues that this undermines the idea that wage
agreements should focus on the needs of individual enterprises)
• providing advice , training and d irect assistance to employers
• lob bying the government for changes to government policies, espec ially relating to
industrial relations and skills training
• represent ing emp loyers' interests in any hearings in industrial tribunals.

1 Descr ibe the role of an emp loyer associati on .

2 Explain how employer assoc iations may influence labo ur market ouitcomes.

II
I
The Market Economy 2020
Fair Work Co mmission
is the govern ment agency
that regulates industrial
relations in. Australia. It
com bines th e functions of
an indus trial tribuna l (such
as the Indus trial Relations
Co mm ission) with a role of
educa tion and promotion
of enterprise bargaining.
II
11.3 Australia's current industrial
relations framework
Australia's ind ustr ial relatio ns framework has gradually evolved during th e past three
decades from a h igh ly centra lised system of wage determinat ion towards one that allows
more room for wage levels and work arrangeme nts to be negotiated at the level of t he
indi vidual firm . This has allowed wages and working cond itions to rake into account t he
specific characteris tics of th e workplace. Austral ia's industrial relations system is governed
by the Fair W'o,·kAct 2009.
T he Fair Work system estab lishes three main streams in the labour market that determ ine
the pay and conditio ns of emp loyees - industri a l awards, collecti ve agreements and
individua l emp loyment contracts. Th e system is overseen by th e Fair Work Commission
(previous ly known as th e Aumalian Indumial Relat ions Commiss ion), which sets
minimum stand ards, includ ing the minimum wage, and helps resolve d isputes.
Minimum employment standards
Australian employees have 10 guaranteed emp loyment condit ions, which are set out in law
through a docum ent called the National Emp loyment Standard s. These provisions include:
• Maximu m weekly h ou r s of wo rk: A full-time emplo yee's hours of work must
not exceed 38 hours per week, plus reasonab le additional hours of work.
• Right to reque st flexib le working arrangements : Parents or carers may request
a change in work ing arrangements to assist chem in caring for a chi ld . Emplo yers
can only refuse on "reasonab le business groun ds" and must justify the ir actions
in writing .
• Leave: Emplo yees have th e right to paid annua l leave, publ ic holidays, and
carers and compassionate leave. Th ey further have the rig ht to unpa id parenta l,
com mun ity service and long service leave.
• N ot ice o f te rm inat ion and redundanc y pay: Employers are require d to give
between one and four weeks' noti ce of a job t ermi nation, determ ined by how long
a person has been emplo yed . Further, in most circumsta nces worke rs are ent itl ed
to redundancy pay, determi ned by th e duration of the ir employ ment.
Formal system Informal system
Awards Collec tive Common law contracts Working owner
only agreeme nts 37.3% of incorporated
21.0% 37.9% business 3.8%
t
( Trade-offs of award conditions, ·;
l subject to "better off overall" test J
• •••••••••••••.. . .... ••••••••••••••• .... •••••••• : •••••m •••••••••••••m••
Modern awards (10 matters)
National Emp loyment Standards (10 guaranteed employment conditions)
Source: ABS ca t. no. 6306 .0. Note: percentages indicate the proportion of the workforce covered by each type of agreemen t.
Note that as of 20 10 , individual contracts canno t be made with in the forma l system. Note also that high-income earners
(more than $148,700 ) on common law co ntracts are not covere d by awa rd provisions .
Figure 11 .5 - The industrial relations framework
 Chapter 11: The Changing Aust ralian Labour Market I
In addition , a n atio nal m in imum wage prov ides a safety net for any emp loyee not covered
by an award. A specialise Minimum Wage Pane l with in the Fair Work Commission is
respons ible for setting rhe nationa l m inimum wage annually .

Industrial awards (the safety net)

Aw ard s are a set of pay and cond itio ns that are specific roan employee's work or indust ry
soctor (such as a shop assistant or a con struction indust ry worker). Awards prov ide a safety Awards est ablish the
net of min imum wages and cond ition s. Many employers pay above award wage races, but minimu m wage and
awards ser rhe absolute minimum rates of pay and ent irlements. T his means char instead of worki ng co nd1t1o ns for
having a sing le m in imum wage rate, Austra lia has d ifferent mi n imum pay rates in around em ployees.
122 d ifferent awards . The Fair Work Commission sets these m in imum award wage rates
and casual loadings . Around 2 1 per cent of workers have the ir pay ser d irectly th rough
award rates, and a further 38 per cent of emp loyees have "award-based" pay arrangeme nt s
(char is, rheir pay is set direcdy or indirecdy through awards).
Awards extend rhe p rorecrions of the Nationa l Employment Standa rds, with p rovisions
tailored to rhe needs of rhe specific i.ndusrry or occupation. These may .include types of
emp loyment ; arrangements for when work is performed; overtime and penalty rates;
annualised wage or salary arrangemencs; allowances; leave-related matte rs; superannuat ion;
and procedures for consultat ion , representation and dispute settlement.

Enterprise agreements
T h e mosr common method of wage determ ination in Ausrra lia is a work p lace agreement
t hat is negotiated collect ively th rough ente rp rise bargain ing betwee n an emp loyer
(or emp loyers) and emp loyees, usua lly represented by un ions. These agreements are
known as enterprise agreements (previously called collective agreements or certi fied
agreeme nts), and they cover around 38 per cen t of emp loyees.
As a minimum, all agreements must comp ly with the Natio nal Emp loyme nt Standards
and cannot offer pay races below char mandated by rhe equiva lent award. Workplace
agreeme nt s must also pass rhe "Bette r O ff Ove rall T es t " (BO OT ), requiri ng that the
employees be made better off overall by an agreeme nt compa red to an app licab le award.
T h is test is admi n istered by the Fair Work Commiss ion.
Collect ive enterprise agreements usu a lly cover all of the workers up to management level
in a compa ny or workplace. Un ions usua lly negoriare these agreements on beha lf of all rhe
emp loyees in a workplace, even thoug h in most workplaces less than half of the emp loyees
belong ro the un ion. Collective agreements norma lly cover issues such as wage increases,
load ings for addit ional work hours, changes to workplace practices and ot her changes that
are inte nded ro increase producriviry ·. Since the early 1990s, collective agreements have
ge nerally produced an nua l wage increases averaging around 4 per cent, although more
rocenrly an nua l increases have fallen to around 2.5 per cent . Figu re 11.5 shows how rhe
Natio nal Emp loyment Standards and modern awards togethe r p rovide the basis for rhe
t h ree mai n ways of determ ining pay and conditions for emp loyees.

Common law contracts

Individua l emp loyment contracts have always been an importa nt part of wage
determ ination in Australia. Under rhe Fair Work Act, there is only one type of indiv idua l
cont ract in rhe industrial relations system, and this is known as a co mm on law co ntra ct.
Common law cont racts (also known as unreg istered indiv idua l agreement.s) are not part of
th e formal industr ial relations system, bur they comply with all of the min imum standa rds
in the system and apply ro around 37 per cent of the workforce.

II
I
The Ma rket Eco nomy 2020

H istorically, mo.st individua l cont racts have been commo n law contracrs, and rhey remai n
overwhelming ly the most common form of individua.lemployment arrangements , especially
in small businesses. Comm on law contra cts are simp le agreements that are often just a few
pages long. Essemially, they involve add-ons to relevant awards. Th ey cannot offer pay races
and condit ions chat are below rhe rate that would be paid by the equivalent award. T he
exception to this rule is when they offer high rates of pay above $ 148,700, in wh ich case the
award require ments do nor app ly, and the common law contract effect ively can replace rhe
award . Comm on law cont racts are generally enforced throug h ordi nary law cour ts, rat her
rhan th roug h ind ustr ial t ribunals, which usually involves greater expense for emp loyees and
emp loyers. O ne form of commo n law contract that has become more comm on in recent years
is the shorr-rerm work contract - in particu lar, contr acts under which workers are emp loyed
by a labour hire company rhar sells their labour hire services ro another company.

Breaking the rules:

MasterChef judge in wage scandal
Economists generally assume that the rules in Australia's industrial relations
framewo rk are followed - but a series of scanda ls in Australia's restaurant and fast
food industry suggest that many employers are underpaying staff by millions of
dollars. The wage scanda l reached headline news in the winter of 20 19, when it
was revealed that MasterChef judge George Calombaris's restaurant business, the
Made Group , had underpaid 515 workers by $7 .8 million. The TEN Network then
announced that Calombaris would not return as a judge on MasterChef .
"Wage theft" appears to be widespread in the restaurant and fast food industry,
which emp'.loys around 750,000 Australians. During recent years the Sydney Morning
Herald has alleged underpayments by numerous emp loyers, includ ing many of
Sydney's nnost prominent restaurant owners. Tlhe Fair Work Ombudsman , Sandra
Parker, not ed in June 2019 that it has found mo re infringements of the law in the
fast food , restaurant and cafe industry than any othe r secto r. In fact , the FWO has
issued more than six times as many infringement not ices to this sector than the
next-worst industry.
The fast food and restaurant industry is not the only secto r with a record of
underpaying workers. The conven ience store cha in 7- Eleven has had a string of fines
and court p rosecut ions for underpaying wages , in some instances also involving
the creation of false employment records and pay ing employees less than half the
minimum rate of pay.
Common to both industry secto rs is a higher number of casual wo rkers who are
more easily exploited because they are younger , do not belong to a union, and are
often in Aust ralia on work visas.

1 Outl ine the main ways in w hich emp loyees ' wages and cond itions are
determ ined in Australia .
2 Explain the difference between a co llective agreeme nt and an individua l
contract.
3 Discuss how different met hods of sett ing pay within Austra lia's industrial
framework affect wage outcomes in Australia.

II
 Chapter 11: The Changing Austra lian Labour Market

1 The industrial relations sy·stem consists of the laws, institutions and

processes established to resolve confl icts between employers and emp loyees.

2 The th ree types of institut ions that play a role in the industria l relations system
are trade unions, employer assoc iations and governments (includ ing through
industrial tribunals such as the Fair Work Commission) .

3 A trade union is an associat ion of employees that represents the interests of its
members , part icularly relating to pay and working cond itions.

4 Trade unions attempt to strengthen the bargaining power of employees by

negotiating on behalf of all workers in a workp lace and, in some circumstances,
using the threat of going on st rike in order to w in their demands for improved pay
and cond itions.

5 An employer association is an organisation of employers that represents their

interests, in particular by helping employers to manage their relationsh ips with
employees and unions.

6 The minimum standards for pay and cond itions in Austra lia are estab lished by a
comb ination of 10 National Employment Standards and a system of awards
specific to individual industries or occupations .

7 Minimum wages in Australia are adjusted each year by a specialist minimum

wage panel w ithin the Fair Work Commission , which takes int o account a
range of economic and social factors in making a decision on inc reasing
minimum wage levels.

8 The most common agreement for setting wage outcomes is an enterprise

agreement . Under enterprise agreements, wage increases are normally
negotiated between employers and groups of employees, usually represented by
unions.

9 Another common method for setting wages is through a common law

agreement , an individual contract that adds to an award . Common law contracts
are often informal arrangements , and they are widespread in small businesses.
They cannot reduce the award entitlements of workers (unless they pay a very
high salary, exceeding $148,700).

10 The industrial relations system has changed from a highly centra lised system
to a decentra lised system , wit h most wage outcomes now determ ined through
bargaining - either co llective bargaining agreements or individual co ntracts .

II
The Market Economy 2020

1 Describe the three main inst itut ional forces affect ing Austra lian labour markets .

2 Explain what is meant by a trade union. Outline the three types of trade unions in
Austra lia, and give an examp le of each.

3 Explain how membersh ip of a trade union may influence an employee's wage

outcomes .

4 Outline the ro le of employer assoc iations in Australia 's labour market.

5 Explain how minimum pay rates and condit ions are set in Australia .

6 Define what is meant by an award , and exp lain how awards are determined
in Australia .

7 Explain what is meant by enterprise bargaining. Explain the role of enterpr ise
bargaining under our present wage determination system .

8 Describe how workers who have not negot iated an enterprise bargaining
agreement can still secure a wage increase.

9 Explain what is meant by a common law employment contract .

10 Discuss the ,extent to which our present wage determ ination system encourages
direct bargain ing between employers and employees .

Extended response
Explain how wages are currently determ ined in Australia. Describe how the current
industrial framework combines the goals of equity and efficiency in labour market
outcomes .

II
 TOPIC

FINANCIAL
MARKETS

~- - Focus
The focus of this topic is the operation
of financial markets in Australia , the
contemporary institutions and the controls
existing in the market which influence
market outcomes. The different types of
markets and the influence of the Reserve
Bank of Australia on interest rate s are of
Issues centr al concern.
By the end of Topic 5, you will
be able to examine the following --- -- Skills
economic issues:
Topic 5 skills questions can ask
■ Examine the contr ibution of financia l you to:
markets to the econom ic welfare of individuals
■ compare and contrast financial markets with
and firms
product markets
■ Investigate the extent of compet iti on in
financial markets ■ explain the role of institut ions in the operation
of financial markets
■ Discuss the need for regulation in
financial markets . ■ analyse the impac t of financial innovations on
individuals and the economy
■ work in groups to investigate the econom ic
role of the superann uation industry
■ analyse the factors that influence the level of
interest rates
■ predict trends in interest rates in
hypothetical sit uations.

Economics Stage 6 Syllabus 2009 extracts e NSW Educat ion

Sta ndards Autho rity for and on behalf of the Crown in right of the
State of New Sout h Wales, 2009; reproduc ed by penniss ion.
 Topic 5

Introduction
Th e financial market, like the labour market, is an int egra l pare of any economy. Banks,
money, interest races and the share market are all part of our daily lives, yet few people
understand che complex inner workings of the financial system.
Financial markets have many similarit ies with ot her mark ets . Financial produces and
services are created and then offered for sale, with prices based on the interact ion of
de mand and supply. Yet, as with the labour market, the financial market differs from other
markets in sign ificant ways, and it also has large impacts on our economy and society. It
is therefore subject co greate r degrees of govern ment contro l than many other markets .
Financial markets p lay a key role in the economy, pr imar ily by facilitat ing savings and
investment, with th e latte r being a key driver of economic growt h. Without the institutio ns
chat make up financial markets, we would have no safe way of deferring consumptio n and
no way of gaining extra funds for investment . For thi s reason, one of the most important
foundations for developing an economy are well-developed financial markets.
Th e othe r impor tant reason for studying financial markets is that chey have a sig n ificant
effect on the lives of m osc Austra lians. Every day, we deal with banks and other financial
inscirucions, and chese have a profound influence over how we ace and interact in che
economy. Just chink of che way home loan races, interest payments and bank fees affect
most Australian s.
Underscandin g how financial markets work also prepares u s for Topic 6, the final section
of the Year 11 Course, wh ich looks at the role of govern m ent s in the economy. Financial
markets g ive governm ents one of the ir cools for influ en cing the economy, known as
monetary pol icy. Monetary policy gives the government considerable infl uence over rh e
economy's growth, inflat ion and unemployment races, and .it is th erefore hig hly sig nificant
for our sru dy of economics. As you cover the next rwo chapt ers, also chink about how
governm ent s may use the financial system co achieve d ifferent economic outco mes.
Chapter 12 reviews rh e rypes of financial markets and financial market produces and
the role they play in modern market economies. We exami ne the role of rhe share market;
how it aces as a bridge between compan ies and investors an d gives individua ls a chance co
share in rhe success of Austra lian businesses. Chapter 12 also discusses rh e role of financial
marker regulation co ensure rhe stab ilit y of rhe financial system .
Chapter 13 provides a derai led explanation of the role of the money marker and the
influences on its key part icipant s: borrowers and lenders. W e look ac the role of money in
the economy, rhe infl uence of int erest races on rhe economy, and how rh e Reserve Bank
of Austral ia influ ences. interest races.

II
Types of
Financial Markets

12.1 The role of financ ial markets in the economy

12.2 Primary and secondary financ ial markets

12.3 Financial market products
12.4 The share market
12.5 Domest ic and global markets
12.6 Regulation of financ ial markets

12.1 The role of financial markets in

the economy
Financial market s play a cruc ial ro le in rh e operation of modern marke r economies.
Fin ancial markets create p roduc es cha t prov ide returns for those who have excess funds ,
mak ing these funds available co chose who need add itional money for consumption or
in vestment . Not only is the financial services industry one of the largest industries in
Australia , bur irs actio ns also influence all orher indus t ries because many businesses rely
on financi ng in some capacity .

Trad iti onally, economists have viewed individuals as rh e net savers and busi nesses as the
net borrowers in rh e economy. Ge nera lly, th is is t rue . H owever, rhe reali ty is much more
comp licated. Savings come from all pares of the economy, as well as overseas, jusr as all
socrors of the economy, includi ng ind!ividuals, borrow fund s.

Financial int e rm ediarie s are firms chat receive the accumu lated funds of ind ividua ls
or firm s, and the n make loans to othe r firms or indiv idua ls who can ma!ke use of them.
In essence, financial intermediaries create a bridge betwee n the savers an d borrowers in
our economy.

SOURCES OF SAVINGS:
• The proport ion of household income that is not spent on consumer goods is saved.
• Businesses can save by not distribut ing all of the ir profits to the ir owners. The funds that
are not distributed can be supp lied to financial markets unt il needed.
• When the government budgets for a surp lus (that is, current revenue is greater than its
expenditure), th is means that it is accumu lating savings.
• There are also foreign pools of savings supp lied by individuals, firms and governments
from other count ries that Australians can borrow from.
I
The Market Economy 2020

REASONS FOR BORROWING:

• Consumers borrow when the ir demand for goods and services exceeds the ir c urrent
capac ity to pay for them. For example, many consumers borrow to purchase houses and
expens ive co nsumer durab les , such as ca rs .
• Entrepreneurs and bus iness managers borrow to fund the operation or expansion of their
businesses.
• The government becomes a borrower of funds when it budgets for a de ficit (when its
current expend iture is greater than its current revenue).
• Australian financ ial institutions can lend money overseas to borrowers. (While this does
occur, in overall terms Australia borrows far more i rom overseas countries than it lends ,
that is, Australia is a net borrower in the global financial system.)

Financial markers are also rhe facr or markers for capi t al in the economy. Cap ita l is
req uired by busi nesses as an inpu r into rhe pro duction process, so that t he goods and
services required to sarisfy rhe economy's wanes can be prod uced. Financial markers
provide an efficient p rocess by which income chat is nor expended im mediarely can still
cont ribute ro th e present level of aggregate de mand by allowing ot hers ro borrow t he
surpl us for im med iate consumptio n and invesrm ent . Savings from consumers, businesses
and governm encs can not only be used for future consumprion, but also to invest in capiral,
wh ich increases rhe pro du ctive capaciry of t he economy.
Financial marke rs have become more impo rtant for t he economy since t he sector was
dereg ulated in t he early 1980s. Wh en a "cred it supp ly shock" occurs, where businesses
report d ifficulry obrain ing finance, G DP is typ ically reduced by 0.33 per cenc, or aroun d
$5 .5 bill ion, accord ing co research conducted by th e Reserve Bank of Aust ralia in 2012.
Th e g lobal finan cial crisis in 2009 was so severe that t he redu ctio n in G DP caused by t he
credi r cru nch was esrimared by the RBA as one per cent of G DP, or around $ 17 billion
based on currem numbers. Th e increased sig ni fica.nce of financial markers, par ricu larl y
following t he global financial crisis, is also eviden t in t he narure of the RBA's research
more generally; since 20 11, around 30 per cent of t he RBA's pub lic research papers have
focused on finan cial markets, money or t he pay menrs sysrem , comp ared ro around 10 per
cent in the years lead ing up ro 200 7. As we look at financial markers in t his chaprer, we
will consider rh e links between financial markets a.nd rhe broader economy.

1 Outline the advantages of having financial intermed iaries in an eco nomy.

2 Ide ntify THREE major expe nses you are likely to incu r over the next 20 years of
your life that may req uire you to borrow money.

12.2 Primary and secondary financial

markets
Tradi rionally, most consumers have saved money rh rough financial instiru tions (such
as bank s) and on ly a small propor rion have invested in more sop histicated financial
insrrument s (such as shares, investmenc funds and supera nn uarion). Since t he early 1990s,
however, t his has changed dra marically. Ausrralia now has one of rhe h ighest levels of share
ownership in th e induscrialised world , w it h around 37 per cenr of th e ad ult popul at ion
owning shares (or ot her financial p rod uces boug ht rhroug h a financial exchange) in 2017 .
At t he same ti m e, the growrh of world financial markets has increased the variety of
 Chapter 12: Types of Fina nc ial Mar kets I
financial instru ment s availab le co rh e average ind ividua l. Th e era when .most consume rs
went to the ir local bank branch for all th eir financial decisions is long gone.

Australia' s financial sec tor consists of a wide range of finan cial institutions . It emp loys
around 450,000 peop le d irectly and provides many d ifferent finan cial services, includ ing
ho me mort gages , credit cards, persona l loans, supera nn uation manage ment, insurance and
in.vestment products. Th e financial secto r has been one of the fastest growi ng areas of th e
economy in recent years, with the finance and insurance industry cont r ibuting around
$170 billion to Austra lia's Gross Domestic Product in 20 18-1 9.
Finan cial markets are commonl y div id ed int o two mai n types, shown in figure 12.1.
• P r imary financial markets facilitate th e creatio n of financial asset s, known as
securi tie s , that can be sold into the economy. If a business wants co raise funds , it
can eith er borrow mon ey by issuing debt securiti es or expand the ow nership of th e
Securitiesare any form
compan y by selli ng new shares. In a primary mark et , th e mon ey received from
of financial instrument,
investors goes dir ectly to th e company. Th e sale of a new issue of Westpa c shares including shares and
to the pub lic is an examp le of a pri mary mark et transaction . bonds, that provides
the holder of that
• Secondary financial markets involve transactions with financial assets that have instrument with a claim
already been issued on a pr imary market some time in the past. Most financial market over real assets or a future
transactions are cond ucted on secondary markets. Companies whose securities are income stream.
traded on th e secondary markets do not receive any money from these transactio ns.
.-----------------------------------.
' '
$
Company Investor Investor
A B
Shares ► Shares►
'
' -- ----------------------------____..
~ '
Primary market Secondary market
transaction transaction

Figure 12. 1 - Primary and secondary markets

It is important to remember that a market does not always need a physical location . Th e
Australian Securities
maj ority of trade that occurs on the Aus tralian Secur ities Exchange (ASX)- th e largest
Exchange (ASX) is the
pr imary and secondary financial mark.et in Australia - occurs over a set of interconnected major share market in
comput er systems. Th e amount of activity that occurs in financial markets will depend Australia, where the
largely on th e general state of the economy and the strengt h of different industries and firms. purchase and sale of
most shares in public
T h e main finan cial markets that exisr in economi es across the world are: compan ies occurs.
The share market
The share or equity market where ownership shares in companies are
brings together people
issued or exchanged
wishing to buy and
The debt market whe re debt secur ities (such as bonds) are sell shares to al low
exchanged , or cash is lent and borrowed transactions to occu r.

The derivatives market
The foreign exchange market
where peop le buy and sell financ ial assets that
are based on the value of other financial assets
whe re financial assets defined in one country 's
currency are exchanged for assets defined in
another country 's currency .

In various ways, all financial intermed iaries perform the same basic function - th ey channel
t he excess savings (from the ne t saver s) in the economy to those who wish to borrow
fund s (the net borrowers ).
Traditionall y, the finan cial system has been d ivided into banks (which ca.n accept savings
as deposits) and non-bank financial intermediaries (NB Fls). Because of th e blurrin g
I
The Ma rket Eco nomy 2020

of disti nctions between different rypes of financial service provide rs, t his div ision has
become less relevant . Many services offered by banks are now being offered by ot h er
financial insti tu tions , and banks are also now offering a range of pro ducts (such as
insurance, superann uati on funds and investment options) that were previously out side a
bank 's domain. A s a result , t he traditio nal approac h of different regu lati ons for each pa rt
of the financial sector has been rep laced by a single system of regu lati on for th e ent ire
financial sector.
Banks remain th e largest and most impo rtant par t of the financial sector. Th ey gene rall y
offer a compr ehen sive range of financial services, in clud ing accepti ng deposi t s (savings),
making advances (loans), issu ing credi t cards and cravellers' cheques, arrangi ng overseas
payment s and collection off und s, providi ng safe-deposit facilities, offering financial advice
and arrangi ng for external fund managers co invest an indiv idua l 's savings . However,
lendi ng activi t y from non-t radi ti onal lenders, includ ing fint ech companies, cont inu e to
grow in pro m inence in Aust ralia.

OTHER FINANCIAL INSTITUTIONS

Fintech is a type
of financial services
businessthat uses digital
technologies such as
artificial intelligence or
blockchain to increase
efficiency or deliver new
services.
• Finance companies obta in most of the ir funds by borrowing from the general pub lic ,
through the issue of debt securities , or from banks like non-financ ial businesses. The
funds are re- loaned to households or businesses at higher rates of interest so that they
can make a p rofit. Fintechs are a relatively new and grow ing type of finance company
that use techno logy to make more efficient lend ing dec isions. For example, some
have developed automated loan assessment processes that do not rely on humans
making dec isions.
• Investment banks generally borrow on a short -te rm basis from compan ies with
surplus funds , and lend these funds to other larg:e compan ies (fo r business expansion
purposes) and government agencies. They also prov ide financial advisory services to large
compan ies on issues such as takeove rs or issuing securities , and also trade securities
and other assets on their own accounts fo r profit.
• Credit unions are non-profit, cooperat ive organ isations whose members belong to a
particular trade , industry, profession, or live in a part icular area. People can depos it or
borrow money , with any profits returned to members .
• Permanent building societies accept depos its from the public and provide funds
mainly for home loans. They can also offer other personal and business loans, although
their interest rate structu re is cont rolled to some deg ree by state governments .
• Mortgage originators (also referred to as mortgage funds), such as Aussie
Home Loans and RAMS , offer home loans t o consumers. Non- bank mortgage
funds grew rapidly after the mid-1990s by offer ing low interest rates and more
flexible repayment opt ions than banks. Howeve r, after the global financial c risis in
the late 2000s , it became very difficult for mortgage originators to borrow funds
in financial markets , and as a result most mo rtgage originators were bought by
traditional banks.
• Superannuation funds receive the cont ribUJ tions of emp loyees and emp loyers
and invest them in financial assets in order to provide retirement income for the
contributors. Since the introduc tion of compu lsory superannuation in the early 1990s ,
the superannuation sector has grown to become a major part of the financial sector.

1 Outline the d ifference betwee n pr imary and secondary markets for shares .
2 Identify FOUR exam ples of financ ial intermed iaries in the Australian financial market.
3 Explain the role of the four main financ ial markets in an economy .

II
 Chapter 12: Types of Financ ial Markets I
12.3 Financial market products
T h ere are a variety of finan cial market produces in the economy co meet cihevarious needs
of lenders and borrowers . T hey vary in risk , ret urn and liquidit y.
Consumer credit allows consumers co purchase consum er goods and services in advance Cred it is the loans
of actua l payment. In orher words, consu mer credi t enabl es individuals ro rap into future extended to individuals,
st reams of income rhac rh ey are likely co receive in order co fund cons umption in rh e businessesand
present. T he most common type of consum er credit are cred it cards. Credit cards allow governmentsfor spending
cons um ers co purchase goods and rep ay their borrowings with interest at a later dare. on consumption and
investment.Credit
Credi t cards are offered by banks, cred it uni ons, and, more recently, by other businesses
constitutes assets for
such as Woolworths, J ecsrar and Virgi n, in conjun ctio n wirh credit card compani es such financial intermediaries
as Masrercard and Visa. Orher credit card compa nies such as American Exp ress and Din ers that they derive income
Cl ub offer credit cards indepe nd ently of other financia l institutions . The other major from and liabilities for the
form of consu mer cred it are personal loans offered by banks and credit un ions. T hese are individuals and businesses
that borrow the funds.
charged ar a hig her rate of interest cihan housing loans. Personal loans genera lly have a
high interest rate of around 10-15 pe r cent , and credit card cares gene rally range between
10 and 20 per cent. Differences in imeresc races charged on different financial pro duct s
largely reflect differences in the risk ro rh e ultimate lender char rh e borrower will not
be able ro pay rhem back.

HOW COMPETITIVE ARE AUSTRALIA'S FINANCIAL MARKETS?

Successful economies depend on a compet itive financial
system to transfo rm savings into product ive investment.
In general, increased competit ion in financia l markets
w ill improve the allocation of resources in the economy
and make it easier for firms to raise funds . This, in turn,
w ill contribute to higher levels of investment , econom ic
g rowth and improved standards of living.
Aust ralia has large and sophisticated financial markets. In
2019, Aust ralia's stock market had a total value (market
c apitalisation) of around $2 trillion and an annual turnover
of around $1.7 trillion. The value of dai ly transactions of
Aust ralian foreign exchange markets averaged US$134.8
billion in April 2016, and the Australian dolla r is the fifth
most traded cur rency in the world. In addition , Australia
has one of the largest funds manag:ement industry in
the wor ld, with just under $3.6 trillion in assets as of
March 2019.
Australia 's banking sector is highly concentrated, with
the largest banks (ANZ,Commonwea lth Bank, National
Australia Bank and Westpac) dominat ing the markets
fo r depos its, home loans, and other lending . The major
banks accounted fo r 77 per cent of all housing loans
and 83 per cent of all loans to small businesses in
2017 - these are some of the highest market shares
in the developed world . While foreign banks and othe r
f inance companies have increased their shares of
lending in some market segments more recently, they
remain small players in the Aust ralian market in relative
terms. With large market shares, the major banks wield
significant market and pricing power. As a result , they
are some of the most profitab le banks in the world and
have typically been able to charge higher interest rates
c ompa red to banks in other developed countries .
Market concent ration increased in the years following
the global financ ial crisis because it has been more
difficult for finance companies to access c redit to lend
to customers. Most affected have been mortgage
originators, wh ich before 2008 were a strong competit ive
force in the home loan secto r. There was also furthe r
conso lidation among banks, with the Commonwealth
Bank buying BankWest and St George merging with
Westpac. Since 1999 the number of authorised deposit -
taking institut ions (that is, banks, cred it unions and
building societies) in Australia has halved.
Governments often face pressure to increase compe tition
in the banking sector because of perceptions that banks
are making excessive profits and are "ripping off"
households and small businesses with interest rate
margins and othe r fees and charges. The increased
conso lidation of banking in Aust ralia in recent times has
certain ly increased this pressure. The government has
tried to introduce compet itive pressures by implementing
policies to make it easier to switch between banks ,
introduc ing a ban on mortgage exit fees and imposing
a duty on financial advisers to put the interests of their
clients first in order to encourage greater competition
in the banking sector. More recently, the Productivity
Commission in a 2018 report called fo r policies that
lower barriers to entry for new participants seeking
to enter markets and regulatory reforms . In particula r,
they highlight ed the need for ASIC to be given an
explicit mand ate to cons ider competition in financial
services - thi s was a flagship recommendation of the
Murray Financ ial System Inquiry in 2014 that has yet to
be imp lemented .
I
The Market Economy 2020

Housing loans. are offered by bank s, as well as .mortgage orig inators such as Aussie
and RAMS. Th ese are long-rerm loans used ro purchase property, requi ring periodi c
repayment s with int erest. Competition in rhe home loan market has fallen since the g lobal
financial crisis in 2008, which resu lted in tradi tiona l banks taking over many non-ba nk
lenders. Housing loan rates are typ ically one to rwo per cent higher rhan the Reserve Bank
cash rare. In mid-2019, Austral ian households had outsta ndin g borrowings of just over
$ 1.1 trillion for the purpose of owner-occupied hous.ing (char is, mortgages for indivi dual s
buying houses and apartments to live in).
Business loans are a form of debt chat allows businesses ro invest in their business
operati ons, such as with new techno logy or expanded office space. Th ese rates are typicall y
higher than household lend ing rates because mort gages are t ypically "secured" by t he
proper ty they are used ro purchase. T his means t hat lenders can sell rh e proper ty in
situatio ns when the borrowers default on th eir debt to offset losses on the loan, so these
loans are not as risky ro suppl y. Large corpora tion s typically pay similar races to housing
loans, wh ile small businesses may pay as much as five per cent more. Pardy this reflects
the greater risks associated with lending to sma ll business (they are more likely ro defaUL lt
on th eir loan obligations). Small businesses typically borrow funds from finance compa nnes
and banks . Larger compa nies borrow from investme nt banks as well. Australia n businesses
had arou nd $95 0 billion in deb t outstanding in mid-20 19.
Th e sh ort-t erm money market brings together people and businesses with tempora .ry
Bonds are a written
shorta ges or surp luses of funds. Tho se with surpl us funds, such as banks , issue various
record of a debt. The
borrower sells a bond forms of deb t securities (such as bank bills or prom issory notes) ro chose in need of funds.
in return for a loan. The Th ese debt securities all have a maturity dare of less tha n one year.
holder of a bond receives
interest payments and the Bonds (sometimes referred to as fixed-income securities) are longe r-ter m securities for
final repayment. Bonds wh ich lenders receive regu lar fixed payments (kn own as coupon payments ) from t he
can be sold in secondary issuing institution , and receive the principal value of the debt (known as the face value
financial markets. of the bond) at the end of the bond period (know n as the date of maturity ). Bonds are
issued by rh e government and a small number of la rge companies and banks . Th e value

What is a bond?
A bond is a specia l type of loan taken out by governments and large compan ies. Also
known as a debt security, a bond is a written financ ial document "issued" by the borrower
to the lende r, an individual or company , who is known as the "bondho lder". The initial
price of the bond, written on the document , is the size of the loan, known as the face
value of the bond. The bondho lder is entit led to a fixed stream of income payments
(known as coupon payments), which are like interest repayments , and to the repayment
of the initial loan amount when the bond "matures" . Bonds can be bought and sold in
a secondary market known as the bond market. The rate of financial return on a bond ,
known as its "yield", is calculated by d ividing the coupon payment by the bond price.
For example , a large company might issue a 10-y,ear corporate bond of $1,000,000 with
annual coupons of $50,000 which is sold for $ 1,000,000.
This means that every year the bondho lder receives a payment (coupon) of $50,000 ,
or five per cent. At the end of 10 years (the maturity period), the bondho lder gets back
$1,000 ,000 (the face value).
The yield on this loan is five per cent ($50,000/$1 ,000,000). However, the yield on this
bond may change if the general level of interest rates in the economy also changes .
Generally, if interest rates across the economy increase, then the yield on a bond will also
increase (because any buyers of bonds will now demand more compensat ion fo r the ir
loans). Since the amount of coupon payment is fixed , this higher yield will be reflected
in a lower p rice for the bond . A fall in interest rates across the economy will result in a
fall in the yield of a bond and hence a higher price . After it has been issued, therefore ,
the price of a bond will fluctuate acco rding to c hanges in the level of interest rates.

II
 Chapter 12: Types of Financ ial Markets I
of Comm onwealth bonds on issue fell duri ng t he 1990s and 2000s v nti l th e g lobal
re-cession pro mpted a large increase in gove rnm ent borrowi ngs in 2008. In 20 19, rh e
value of long-ter m gove rnm ent debt secur ities issued in Aust ralia was $797 billion , whilst
corpora te bonds out stand ing amo unted ro $605 bi llion .
Fiinancial future s and opt ion s are contracts to t rade in financial instru ment s (such as
shares or bonds) ar a lacer date for a certa in price. Futures marke rs allow investors ro protect
themselves against adverse moveme nt s in int erest rates, currency fluctua t ions or share prices
by agreeing on a pr ice and curre ncy ar which ro buy or sell t he financial product now, even
thoug h they do not have to make the rransacrion unt il a lacer date. Opt ions g ive th eir holder
the right to make such a transaction, but nor the obligat ion, that is, rhey can choose ro
comp lete t he transaction or rhey can choose not to and let the optio n expi re.
The foreign excha nge or forex market is rhe market for buyi ng and se lling of foreign
currencies. J ust as indi vidua ls regui re foreig n currencies when they go on h oliday, investo rs
and businesses require foreig n cur rencies when they do busi ness with peop le overseas.
T h e forex market prov ides a market for peop le ro buy and sell curre ncies, and it operates
24 hours a day.

SU PERANNUATION
Since the early 1990s , Austra lian emp loyers have the economy . Superannuat ion funds can be loaned
been ob liged to pay superannuat ion contr ibut ions to financial institut ions and may be loaned to
into ind ividua l emp loyees ' superannuat ion househo lds that borrow money to purchase a
accounts. Superannuat ion funds invest these house. Superannuat ion funds may be d irect ly
contr ibut ions into a range of financia l products , invested in new share issuances by businesses that
inc luding shares and bonds in Austra lia and are used by bus inesses to purchase more cap ital.
overseas. When emp loyees ret ire, these funds are Changes in supera nnuat ion can have significant
used as retirement income - either throug h regu lar impacts on the rest of the economy. Because
payments , or through a single lump sum. of the amount of superannuat ion invested in
Superannuat ion is part icu lar ly i mportant to shares , changes to the share market are the main
Austra lia's financ ial markets. W ith around dr iver of superannuat ion balances. Because of
$3.5 tr illion under management , Austra lia has the its importance to emp loyees and bus inesses ,
fourth largest funds management industry in the the superannuat ion industry is regu lated by the
wor ld - a remarkab le feature of a re latively sma ll government through the Austra lian Prudent ial
economy with j ust over 25 million peop le. Regu lation Author ity .

Superannuat ion plays several important

ro les in the Austra lian economy . It Other assets
Assets overseas
is an important source of retirement 15%
16%
income when peop le finish the ir work ing
lives. The superannuat ion system allows Cash and
\
deposits Land and
more peop le to ind irect ly own shares 8%
and part ic ipate in more soph isticated '---..
parts of the finance sector (w ith Short-term
securit ies
higher returns) than simp ly depos iti ng
2%
money in a savings bank. The growth
of superannuat ion therefore reduces
Long-term
pressure on the government to provide· the securities
age pension to people over the retirement 2%
age of 65. For this reason, the Government
increased the superannuation guarantee
from 9 to 9.5 per cent in 2014 and plans to
gradually increase this rate until it reaches
Equiti'es and
12 per cent in 2025. units in trusts
The large poo l of finance made availab le Sou rce: ABS cat . no . 5655 .0 51%

through superannuat ion also plays an

important ro le in promot ing growth in Figure 12.2 - Asset allocat ion of domest ic managed fund institutions
I
The Market Economy 2020

1 Outline the basic features of loans and bonds .

2 Investigate th e level of comp etitio n in Australia's financial markets .
3 Discuss wh ich financial products might be req uired in the fo llowing
circumstances and what financial institutions might be involved:
a) A parent is slightly low on cash at Christmas but still wants to buy a range
of presents for th e family.
b) Telstra needs to borrow $10 million for 72 lhours.
c) A small business wants to finance the purc hase of a new comp any car.

12.4 The share market

A share 1s a type of Th e share market is rhe financial market where investors buy and sell shar es, which are
f1nanc1al asset that financial assets that g ive their owner part-ownersh ip of a company. The share market p la.ys
provides an 1ndMdual with an important ro le in rhe Austra lian economy because businesses can sell shares in their
ownersh ip over part of a companies ro raise funds needed for growth , and individuals or orher businesses can ga.in
business or company.
returns on the ir surplus funds. In 2017 it was estimated that 37 per cent of Austral ians
own shares (or ocher financial produces purchased th rough an exchange). Many people rake
an interest in the stockmarker and trade in shares online, with the hope of making profirs .
The share market is the
deman d an d supp ly of o w nersh ip For a firm to issue shares, it must be a compa ny - (t hat is, it must be incorporated)
.
of public companies . An incorporat ed business is one that is recog n ised as a separate legal entity from
Madam! lt"s your those individuals who own or manage the bus iness. Th is means that it has limited
lucky day! I can sell Print media is old
you 1OO0shares in news ... I'd rather liability,so if the businessfails the individuals who operate the businessare protected
Newspapers Ltd own lnstagram! from the risk of bankruptcy. The peop le who own shares in a compa ny are known
for just $4!
as shareho lde rs.

{M<o In corporated companies can be either pub lic or p rivate . A pub lic co m pa n y is on e
whose shares a.re nor subject ro any tra nsfer restr ict ions (beyond chose estab lished by
government regulation), and therefore rhe company's shares can be traded freely on th e
share market. By contrast, a pr ivate com p an y is on e that restricts ownership of shares to

~ J!
A public company is
an ent ity whose shares
are traded freely on the
share market and are not
subject to any restrictions
on being transferred to
other parties.
on ly a few individuals and p laces restri ctio ns on share transfers so chat ownership cannot
be freely bought or sold betw een indiv iduals (we somet imes refer ro these compan ies as
being Propri etary Limited, wh ich is abb reviated to Pty Ltd) . Th e share marker dea ls only
with rh e trad e in shares of publ ic compa n ies.
Th e share market brings togethe r buyers and sellers in a med ium of exchange. Mose share
transactions take p lace through a market facilitator known as a stock exchange. In many
ways, the stock exchange is simp ly the man ifestation of the market, with buyers and sellers
comi ng togethe r in one place at one time for trad e in a range of securit ies, such as shares .
It is important t o note chat rhe share marker is not a phys ical location . Shares are moscly
traded through computer networks and over rh e In ternet, increasing the speed, efficiency
and accessibi lity of the mark er.
Seller ) -. Stockbroker _. .. +-- Stockbroker +-- Buyer )

i contacts registers :! registers contacts "'::

• stockbro ker sale price : : bid price stockbroker A
! on ASX using !! on ASX
$ comput er system : : Shares
'----- - - - - - ----- - - - - - - - - - - - - - - - -; !............................................................
J
Figure 12 .3 - Share market transactions

II
 Chapter 12: Types of Financ ial Markets I
T h e largest share market in Austra lia is the Ausrralian Securi ties Exchange (ASX). Th e
ASX prov ides a regulated environment for investors co buy and sell shar es, by match ing
sellers who have a desired selling price with buyers who are willing co pay char price. An
in vestor wi lling co buy (or sell) shares must do so th rough a broker who is registered with Visit the "About ASX"
t he ASX. T his broke r can be a specialis t on line trading agency, such as Errade; a finance sect ion of the webs ite
company, such as Macquarie Bank; or a person , known as a stock broker. of the Australian
Securit ies Exc hange
In 20 10, Singapore Exchange Ltd made an $8 bill ion takeover bid for the ASX . Th e (www .asx.com.au) and
m erged share market wou ld have been world's fifth largest at the time . Th e Singapo re ident ify the follow ing:
takeove r bid prompted a major public debate about foreig n ownership of Aust ralia's srock • the number o f
exchange and was rejected by rhe Treasurer in 2011 on rhe grou nds rhat ir was contrar y co companies listed
th e nat ional int erest . In recent years, rh e ASX has faced increasing competit ion from Chi-X on the ASX
Australia , an alternative securities tradi ng platform char also operates fra nchises in ot her • the average dai ly
cou ntri es as competitio n co the main domest ic exchange. As of 2019, Ch i-X accounted turnover of shares
for over 20 per cent of the coral tradi ng volume of ASX-listed financial securities. on the ASX
• the market
cap italisation (the
Role and function total value of shares)
of the ASX.
T h e role and function of rhe share marker can be seen from borh the pe rspective of rh e
in vestors or shareholders, who buy and sell shares, and the companies , whose ownership
is bought and sold in rh e share market .
T h e main reasons for in vesto r s co purchase shares are ro gain a stake in any compan y
profits and ro make capital ga ins from increases in share prices. Owning sha res also g ives
in vestors the right co vote for a company's board of directors, who appo int the compan y's
sen ior managers and ultimat ely decide how the compa ny wi ll acr co maxi mise the wealth
of shareholders. Th is is a un ique relacionship, as shareholders norma lly only meet once a
year co vote on key compan y matt ers and ro voice their opi nion . As such, managers have
an eth ical duty - known as a fiduciary dury - ro manage the compan y in a way rhat best
serves rh e interests of shareho lders.
As owners of rhe compan y, shareho lders are enti tl ed co share in rhe successes of rh e
Dividends are t he profit
company . If rh e compa ny returns a profit, a propo rtion of these p rofits ma y be returned
returns received by the
co shareho lders. T hese payments are known as di vi d en ds , and are awarded on a per-share shareholders (ow ners) of
basis. Mosr compa n ies have auto nomy ro decide what fraction of th eir profits should be a business.
returned ro shareholders. In addit ion , as rhe compa ny grows, the value of the compan y
in creases and its share price wi ll also i ncrease. Wh en th is occurs , sharehold ers may decide
co sell the ir shares, as they will make a profit because rh ey will sell their shares for more
t han rhey paid for them. Such profits are called capi tal gains. Capital gains are t he
profits made by investors
For shareholders, rhe possib le ga ins from hold ing shares are almost limitless. If rh e valu e
who sell their shares
of th eir shares contin ues co increase, the shareho lder may sell at any rim e co make a ga in. or assets at a price
Ar the same rime, the risks of being a shareho lder are limited. If a compa ny loses mon ey above the level t hat they
or closes du e co busi ness failure, shareholders only stand ro lose rhe amo unt they initia lly originally paid for them.
in vested in the shares. Th ey are not responsible for any further debts th e compan y may
have incur red.
Many peop le rely on the savings char are invested in shares for income, espec ially in th eir
ret irement years. Th e share mark er b oom of rh e mid-2000 s increased hous ehold wealth
and encouraged workers ro leave the wor kforce before th e legal ret irement age. By contra st ,
t he sharp downturn in the share marker in 2008 resulted in some workers having ro sray
in rh e workforce longer ro save for the ir retire ment . Over rh e long run though, many
shareholders have benefited noticeab ly from th eir shareholdings. Accordi ng ro RBA
research, coca! yearly returns on shares (capital gai ns plus div idend paym ent s) has been A float occu rs w hen a
around 10 per cent on average over rh e past 100 years. compa ny lists its elf on the
stock exchange and offers
For a compa ny, the share market p rovides an opportunity ro raise new fund s for investment
its shares to the general
and business growt h . Wh en a compa ny decides co list itself on rh e stock exchange and public fo r the first ti me.
offer its shares co rh e public for the first time it is called a fl oat , or an init ial pub lic

II
I
The Market Econ omy 2020
The All Ordinaries Index
is a stock ma rket index
measuring ch anges in the
overall value of companie s
listed on the Austral ian
Securities Exchange.
II
offering (IPO). O nce a company has listed , it can access further equ ity funds ar any time
by issuing an ap proved prospectus for the release of new shares. However, issuing new
shares reduces t he contro l existi ng shareholders have over rh e compan y, as they will own
a smalle r propo rt ion of rh e company.
The sale of new shares is a p ri mary financial mark er transact ion . Wh en an exist ing
shareho lder sells the ir shares ro another investor, this is a secondary financial market
transaction. By facilitating both types of share trad es, the ASX is both a prima ry and
secondary financial marker. Over three-qua rters of crades on the Austral ian share market
are secondary mark et transactions.
Changes in the sha re market can play an important role in determi n ing rh e structure an d
operat ion of a company. A compan y's share price is set by the market forces of supp ly
and demand, and ir reflects factors such as confidence in manageme nt , previous earnin gs ,
expected earnings and ge neral economic cond it ions. A fall in a compa ny's share price
results in a loss of value for shareholders, who will pm pressure on management co improve
the ir performanc e and may even vote in new management . Addit ionally, a low share price
can expose the compa ny ro the possibility of a takeove r. Th e relat ionship between sha re
price and the inte rests of shareho lders and managers is illustrated in figure 12.4.
Happy, as the value of their Possible bonuses and
price rises investme nt increases increased job secu rity
Share Unhappy , as the value of Increased pressure from
price falls their investme nt decreases. shareholders and the th reat
Mayreplace managers. of a poss ible takeover may
lead to job insecurity
Figure 12.4 - The effect of share price mo vements on a company
Effect on the economy
Share market values are often an indicator of a countr y's economic conditions. Because
mark er p rices rise in accordance with new and betcer economic p rospects for compani es,
rising share prices will generally suggest char the economy is enjoying good conditions .
By contrast, an economy chat is moving cowards. recession will have fewer econom ic
oppo rtu n ities for companies, leading co lower share prices .
The relationship between general economic condi cions and share valu es can be seen in
figure 12.5, wh ich shows char fluctuat ions in rhe share market mi rror changes in econom ic
growt h . A dowmurn or upturn in rhe share market can be measured by the All Or d in ari es
In d ex, wh ich measu res changes in the overall value of compan ies listed on the Australi a n
Securities Exchange. By comparing the changes in che All Ordi naries Index with changes
in a count ry's economic grow th rate, we can see char the mark et ge nerally rises and fa[ls
in line with a country's economic p rospects. How ever, we can also nore chat the share
mark er is mu ch less stab le rhan rh e real economy, an d small changes in econom ic g rowth
can contribute co enormous changes in share values.
 Chapter 12: Types of Financial Markets I
%
50 -- Percentage change in
all ordinaries index
40
-- Percentage change in GDP
30

20

10

-10

-20

-30 ,.._ ,.._

r-. a, r-. a, a,
"i' "i' er
(')

9'
l()

9' a,
I
a,
! 9
(')

9
l()

9 9<O "'
'T' 'T co
9co 'T
'T
(')

'T
(J)

<O co 0 <O co 0 0 <O

co
a,
co
a,
a,
a, "'(J)
(J)
"'
(J)
(J)
a,
a,
a,
a,
0
0
0
0
"' 0
0
"'
0
0
"' 0 0
0
5,
0 5 "'
5
"' "' "' "' "' "' "' "' "' Year
Sources: ABS ca t. no. 1350.0 , 5206 , ASX Grou,P Monthly Act ivity Report
"'
"GOP growt h based on March 2019 da ta

Figure 12.5 - Stoc k market perfonnan ce and ec onomic g rowth rates

T h e share mark er also aces as a method of allocating resources co different types of

production. Tho se compa n ies and secto rs with the best grow th p rospects will be ab le
co use addit ional investment funds m osr effectively, and th erefore wi ll raise the most
funds when float ed. In this way, an efficient share mark et will raise che medium-te rm
growth prospects of an economy. Share prices will be highe r for firms in industr ies chat
shareho lders expect will experience high grow th , Assumin g perfect market conditions,
we can expect chat che areas in which the share prices are highe r wi ll reflect che g rowth
areas of che economy. Thi s can then b e a very useful gui de co investm ent more gene rally.

T h ere is, however, a major p roble m in using the share market as a guide co the health of
t he economy or as an indicator of g rowth industries . When we argue chat che market is
t he barometer of the economy and a gui de co allocating resources, we are assuming chat
al[ share purchases are based on a rationa l and ge nui ne belief by the shareholder char che
indust ry's or economy's future prospoccs are solid.

Many share purchases, however, are spe cu lat ive - mean ing shares are bought with che
Speculation occu rs when
intention of being resold within a shore period. Th ese investors are not buyi ng co gain investo rs buy assets w ith
a long-ter m income scream from the shares, but are hop ing co make sho rt-te rm capita l the 1ntent1on of reselling
ga ins. Th e prob lem with chis type of invest ment is chat speculators base the ir investm ent them for a highe r pnce
decisions on ''hype " in che market, and not on the real proficabi licy of firms. 1'hi s can lead w ith in a short perio d .
co certain shares or industries having g reatly overvalued prices, drawing further investment
and leading co a misallocarion of resources.

As figure 12.5 shows, share p rices can rise and fall sharply. In 2007, the Austra lian share
mark er had recorded several consecutive years of st rong grow th in share prices, led by
mini ng, energy and finance compan ies. Whil st this grow th was nor sim p ly speculative,
t he growt h in share p rices outstripped che g rowt h in earnings in these lucrat ive sectors.
In 2008 - 09, against che backdrop of the mosr severe financial crisis since che Great
D epression of the 1930s, Austra lia's share market plummeted by almost 30 per cent , a
d isproportionate fall in light of cont in uin g profits being earned by Austra lian compani es.
Since the n , che share market has seen further cyclical upturn s and downturns, mostly
reflecti ng the impact of external facrors such as com mod ity price movem ent s and, more
rocently, g lobal po litical tensions .

II
I
The Market Economy 2020

1 Define the following terms:

• share
• publi c com pany
• dividend
• float.
2 Exp lain the role of the share market for individ uals and businesses.
3 Discuss the effects of changes in the share rmarket on th e economy.

12.5 Domestic and global markets

Austra lian financ ial mark ets are integ rated with g loba l financia l markets. Recent decades
have seen a dramatic increase in rhe participation of foreign investors in Aust ralian
mark ers - borh rhrou g h increased lendin g to Aust ra lia and increased foreig n owne rship of
Austral ian compan ies. Likewise, there are more opporru n iries for Austral ians to lend their
surplus funds overseas or to invest in compani es overseas. Th e greater g lobal int egration of
the Australian financia l secto r means chat Austra lia is more influenced by deve lopme nt s
in mark ets arou .nd rhe world.

Despite rhe increased sign ificance of g lobal financ ial mark ers ro Aust ralia in recent
decades, the vulnerability of the domestic economy ro events overseas is nothing new. As
a resource-ric h economy, Austra lia has always been dependent on foreign sources of capiral
ro finance its d evelop ment, necessitati ng foreign participation in Austral ia's financial
mark ers. J ust as Australian financia l markers were impacted by the g lobal financial crisis
in rhe late 2000s, domest ic markets were also impacted by the g lobal share market crashes
of 1929 and 1987, rh e increases in internat ional irnrerest rates arou nd the world th rough
rhe 1970s, and che financial crisis in East Asia in the late 1990s.

Austra lian finan cial markets have neverthe less become much more closely integrated
with global ma rkets over rh e past th ree decades . In part, th is reflects deve lopme nt s
in information and commu n ications technology, wh ich have lowered commun ications
costs and increased the reliability and speed of the electro nic transfer of funds. T he
deregulation of Australia's financia l markets since the early 1980s has also encouraged
foreign part icipation in domest ic markers .

Fo reign exc han ge mar k ets enab le the movemem of funds around rhe world - if a
Japanese investor could not exchange the ir yen for Aust ralian dollars, they could not invest
in Austra lian compa n ies or loan mon ey to Aust ralian borrowers. Austra lia has been more
open to foreign exchange markets since 1983, when the exchange rate was floated and
most exchange controls were abolished . By April 2016, the value of dai ly rransacrions on
Austral ian foreign exchange markets averaged US$ 135 billion, around 2 .6 per cent of t he
global total. The Austra lian do llar was the world's fifrh-mosr traded cur rency worldwi d e.

G lobal d ebt m ark ets are important for Austra lia's economic development because of its
reliance on foreign borrowing. In 20 19, wh ile Austra lians had arou nd $1.2 tr illion in loa.ns
to foreig n ent icnes, Austra lia had outstanding foreign loans worth nearly twice as much,
around $2.3 trillion (see figure 12.6). Mose of these movements of funds are facilitated
by Austral ia's four majo r banks, which source finance for domestic loans from overseas.
Even so, foreig n banks have esta blished a stro nger di rect presence in Australia since rh ey
first esta blished Austra lian operations in 1985.

II
 Chapter 12: Types of Financial Markets I
$bill ion
$2414 bn
2500 Net foreign debt ■

2000

1500 Gross for eign debt

1000
""'
500 Overseas · debt
owed to Australians

0 a,
cp "'
... a, ... a, ... a,
"' cp cp 9 "'9 9"' "'
"i" "'
~

'? cp cp 9 9 "i" "i" "i" "i"

~
~ ~
(X) 0 <O (X)

~
N N
a, ~ ~ §
N
8 8 8 8
N N N N
5
N
5
N
"
5
N
5 5
N N

Source: ABS cat. no. 5302.0 Year

Figu re 12.6 - Austra lia's inte rnationa l investment pos ition : debt

Eq ui ty market s are regulated by nartional governm ent s, so they exist primari ly within
ind ividual count ries, such as rh e New York Srock Exchange in rh e Unit ed Stares or rh e
Tokyo Srock Exchange in J apan , bu c the re are some regiona l stock exchanges such as
Euron ext. International movements of fund s between equi ty markers are dom inated
by financial insrirurions such as banks and superannuat ion funds. In 20 19, Austra lian
ownership of foreign compan ies and foreig n ownersh ip of Austra lian compa n ies had
both reached over $1.3 tri llion each (see fig ure 12.7). Th e Austra lian share marker
is still p rim ari ly a domestic marker, with foreig n participation, rath er rhan a g lobal
marker - it is regu lated by rh e Austra lian Securities and Investme nt Commission, and
significant pu rchases of Australian sha.res by foreig ners are subject ro review by the Foreig n
Investme nt Review Board. Howe ver, the Singapore stock exchange's attempted takeover
bid for rh e ASX in 2010 high lighted the trend toward increased regional and g lobal
in.regrarion of financial mark ers.

$ billion
1500 ,
Net foreign equity ■
I
/
I
Net Aust ralian equity• I

1200 , I.
I
,- ..'
I '
900

600
"' Overseasequity
owned by Australians
$148.2bn
300

0
..... 8l ..... ..... a>
~ 1n ~ "'
a> a>
9 9 "'
9 9 9 "' "i"
"i" "'
(IC)
(IC)
a,
0
I
a>
a>
I
"' a>
a>
a> "
a>
I I
<O
a>
a>
I
(IC)
a,
a,
0
0
0
0"'
0 " 00 00
0
0
<O

"' "' "' "' "' "' "'

(IC)
"i"
0
0 "'0 "5N
<O
0 '"' '"' (IC)

0
·Net Australian equitydescribes Australia•s international equity posit;on where Yea r
Australian ownership of foreign equity outstrips the foreignownership of Australian equity.
Source: ABS cat. no. 5302 .0 ··oata as of M arch 20 19

Figure 12. 7 - Austra lia's internationa l investment pos ition : eq uity

II
I
The Market Economy 2020

As we shall see in the next secrion, regulat ion by governments is important for rhe scabiliry
and efficiency of financial markets . Globa l financial markets are not subject co the same
level of regu lat ion as domestic markets, but some limited functions are performed lby
internationa l organ isations.
• Th e Ban .k for Int ernat io nal Set tl eme nt s is an internationa l organ isation rhat
helps centra l banks (such as rhe Reserve Bank of Austral ia) promote financial
stabi lity through appropriate market regulatio ns. A related organisat ion, the Base l
Com mitt ee, sers standa rds for banki ng regu lat ions with the broad objective of
promot ing effective and un iform financial reg ulatory systems around rh e world.
• Th e Int er na cio nal Mo netary Fu nd oversees rh e general stab ility of rh e interna-
tional financial system, th rough monitoring econom ies and markets and assisting
countries having difficulty meeti ng the ir international financial obl igat ions.
Othe r organisations char coordinate approaches co financial market reg ulation include
the I nte rn at ion al O rga n isat ion of Sec ur it ies Comm issio n (for share markers) and t he
Int er natio nal A ssociat ion of I nsu r an ce Superv iso rs (for insurance markers).
The benefits of g lobal financial markers are that they allow Australians access ro foreig n
capital co invest in houses and businesses. Without access ro international finance,
For more informat ion Austral ians would face highe r borrowing coses or might not be able co access finance
about globa l financ ial as easily. Internac ional financial markets also offer Australians the opportun ity co invest
markets and their impact
and earn returns from bus inesses overseas. Th e main disadvantage of integration with
on economies , visit the
following we bsites: global financial markers is chat the regular d isturbances in markets overseas are more
quickly transm itted ro Austral ia, especially th rough financial market speculation. From
International Monetary
time co time, concerns are raised about whether the high level of foreign ownership of
Fund: www.imf. org
Austra lian businesses might affect the Australia n economy in the long term and whether
Bank for Inte rnational
Austra lia should impose greate r cont rols to prevent overseas inte rests owni ng large pares
Settlements:
www .bis.org
of Australian industries.

1 Discuss rece nt trends in the participation of fo reigners in Australian

financial rmarkets .
2 Accou nt for the increased integration of domesti c and global
financial rmarkets .
3 State three organisations that are involved in the regulatio n of global
financial rmarkets .

12.6 Regulation of financial markets

Stable financial markers are critica l for the functioning of the economy. If the steady flow of
funds from savers ro investors th rough financial interm ediaries is affected by disturbances, it
can have severe consequences for the households and bus inesses involved, with savings being
losr and compan ies going bankrupt. Instabil ity in financial markets can also underm ine
confidence more broadly across the economy and reduce economic growth.
Maintaining financial market stab ility through regulation is a key objective of government
economic po licy. In Austra lia, four government bodies have responsibility for t he
regu lation and supervision of the financial system.

II
 Chapter 12: Types of Financ ial Mar kets I
Financialmarket regulators
Reserve Bank of Australia (RBA) respon sible fo r monet ary policy, paym ents system
regulat ion and the stab ility of the financial system

Aust ralian Prude ntial Regulation responsib le fo r prudential supe rvision and regulation
Aut hority (APRA) of all depos it -taking institut ions , life and general
insurance , and superannuat ion funds

Aust ralian Securities and respon sible fo r corporate regulation, con sumer
Investments Co mmissio n (ASIC) p rotect ion and oversight of f inancial service produc ts

Aust ralian Treasury advises the governme nt on financial st ability issues

and the legislative and regulatory fram ework fo r the
financ ial system.

T h e Council o f Financial Reg ulat o rs is a coordi nating body for financial mar ket
regu lati on chat p rovides for cooperation and collaboratio n among irs four members - rhe
R13A, APRA , ASIC and Treasury. It is an informal body that allows informa ti on sharing
and coord inati on of advice but does not have any functio n separate from irs indiv idua l
m em bers. W hen the global financial crisis srruck in 2008, the Coun cil of Financial
Regulato rs pro du ced a joint Memorand um of Understa nd ing dealing spec ifically with
how rh e orga nisations would respond .
T h e structu re of responsib ilities for fin ancial marker regulatio n betwee n t he four agencies
has been in place since rh e !are 1990s and was esta blished in response co an infl uent ial
in quiry kn own as the Walli s Co mmittee . Th e Wall is Com m ittee recommended
sig nificant changes co regu lati on co !keep pace with financial sector cha nges, includi ng
new tech nologies, increased comperi r.ion , and the breakd own of old d istin ctio ns between
differe nt types of institu ti ons. Th ese were rhe largest changes ro financial sector regu latio n
sin ce the d eregulati o n o f t h e financ ial sec to r in the early co mid- 1980s , which removed
many govern ment cont rols over the finance sector and exposed the indus t ry ro greater
infl uence from do mestic and g lobal marke r forces.
T h e g lobal financial crisis of rh e late 2000s put the adequacy of Aust ralia's financial sector
regulatio n un der greater scruti ny. W hile later regulatory changes were not as wide-ra ng ing
as chose imple mente d in orh er countries whose financial systems were mo re exposed co
t he impac ts of the g lobal financial cris is, some changes were made co st rengt hen financial
marke r regulatio n in response co the crisis:
• An int erim ban was imposed by ASIC on the practice of "shore selli ng", in wh ich
a person sells a share they do not own at rh e tim e of sale and plans co buy lacer at a
lower price (and pro fit from any decline in its value). T his was lifted in May 2009.
• A government guara nt ee was given for 15 million depos it accoum s (worth $800
bill ion) in Austra lian-owned banks, locally incorporated subsidiaries of foreign
banks , cred it unions and bu ild ing societies alongsi de a guara nt ee on wholesale
finance issued by th ese same institutions . Bank deposi ts up co a certa in value
(currently $250,000 per person in any given bank ) are srill gua ranteed by rh e
governm ent today.
• Austra lia's Fut ure of Financial Advice reform package, whic h cam e int o effect in
20 13, banned financial advisers from receiving comm issions and imposed a duty
on chem ro p ut rh e interests of th eir clients first .

II
I
The Market Econ omy 2020

The conduce of Austra lia's financial system has come under increased scrutiny du ring rhe
past decade. In 2014, rhe Financial System Inquiry, also known as the Murray Review,
was conducted co assess the state of Austra lia's fina.ncial system. Its overarchi ng aim was
co provide recom mendations on how ro make Austral ia's financial system more robust
co internat ional developments , technological change and broad demographic trends such
as population agi ng. Th e final report made wide-rangi ng recomme ndations , although
ir did not propose radical reforms ro rhe cur rent system . Some of the more notewort hy
recomme ndatio ns were:
• increasing the amount of capital that banks muse hold against their loan assets co
a level in line with the safest banks in rhe world;
• leveling che p laying field for smaller banks by mak ing regulato ry requireme nt s
more compecicive ly neut ral rathe r rhan advantaging rh e big banks; and
• stre ngthening consumer protection Jaws on financial products.
So far, little legi.slative p rogress has been achieved co turn the recommendat ions into law.
Consume rs have beneficed since 2016 from laws ban n ing excessive cred ic card surcharges ,
but little else has been imp lemented.
In 2018, the government esta blished a Royal Comm ission into Misconduct in t he
Banking, Superannuat ion and Financial Services Indust ry. The Royal Commission was
set up following several high profi le bank scandals , includ ing the alleged rigging of one
of Austral ia's key shorr-rerm interest rare benchmarks (called rhe bank bill swap rate),
breaches of anti-money-lau ndering laws, and the charging of custome rs for financial advice
that was never prov ided, all by rh e major banks. Th e Commiss ion uncovered a range of
dishonest practices, includ ing breaches of indust ry codes of pract ice, failings on contraccs ,
and widespread m istreatment of custome rs. Beyond individua l examples of problems, rhe
Royal Commiss .ion found widespread governa nce p roblems at senior levels in financial
institutions and revealed sign ificant p roblems in how rh e industry was regulat ed by ASIC.
The Royal Com mission concluded in irs final report in 20 19 char rh e cur rent laws and
regu lations are already fairly approp riate, although ir prov ided 54 recomme ndations for
the government ro ace on . In 2019, the gove rnment committed co implementing all bar
one of these recom mendations by rh e end of 2020, includ ing requiring mortgage brokers
(who help borrowers find the best loan from a financial inst itution) co act in the best
inte rests of borrowers (before rhey had no such lega l obligation co do so), and extend ing
the range of fina.ncial produces co which consumer p rotection laws apply. Th e Commissio n
recommended bann ing "trailing commiss ions" charged by mortgag e brokers, but this was
rejected by the government on the basis char it wou ld inh ibit brok ing and compet ition
between banks . The Commissio n also recomme nded that the financial industry regulato rs,
APRA and ASIC, should apply existi ng regulations and laws more strictly and impose
harsher pu nishments when rh ey are breached. The govern ment has labeled its response
co the Comm ission as the most significant reforms co the financial services industry since
the 1990s.
Despite th ese recent issues, ir is important co keep some perspective about Australia's
financial institut ions. Th e Australian financial system is globally regarded as stable and
well- regulated; in its 2017 -1 8 G lobal Competitiveness Report, the World Econom ic
Forum rated Austra lia's banki ng system sixth out of 137 banki ng systems around t he
world in terms o f its overall status and development.

The Reserve Bank The Reserve Bank of Australia (RBA)

of Australia (RBA) is
Australia's central bank. T he Reserve Bank o f Aust ral ia (RBA) is Australia's cent ral ban k. A central bank generall y
Its main ro les are to has rhe role of executing monetary pol icy on behalf of rhe government, print ing banknotes
cond uct m onetary policy
and regulating a country's banking system. As such, it is different from othe r banks - it is
and oversee the stability
of the financial system.
not set up as a financial business with the desire co make profit, and it does not deal with
ordinary customers. Rather, irs primary pu rpose is the overall management of the financial

II
 Chapter 12: Types of Financ ial Markets I
sysrem in accordance with the economic object ives of the Commonwea lth Gove rnm ent . Th e
Rl3A was created in 1959 under rhe ReserveBank Act 1959 . Prior to that, limited centra l
banking operat ions were conducted by the Commonwea lth Bank.
Accord ing ro the Reserve Bank 's charter, in irs condu ct as Austra lia's central bank,
t he Reserve Bank is ro be gui ded by th ree broad objectives : the sta bility of Austra lia's
cu rrency, the mainte nance of full employ ment and the economic prosperi t y and welfare of
t he peop le of Australia. In reality, its highest priority in recent years has been to sustain
low and stab le inflat ion (which is typically linked to irs original goal of maintaini ng rh e
stabi lit y of the currency).
T h e functions of the Reserve Bank of Austra lia can be summari sed as follows:

Conducting monetary policy on behalf of the government

T h e conduct of monetary po licy is the most impo rtant ongoing respo nsibi lity of
t he Reserve Bank. Mon etary po licy can be defined as Reserve Bank action designed
to influence rh e cost and availabi lity of money in rh e Aust ralian eco nomy th roug h
influ encing rhe ge neral level of interest races. It is important to note chat the Reserve
Bank conduc es monetary pol icy with the aim of achievi ng a sustai ned low inflat ion rare
wh ile encouragi ng econom ic grow th.

Systemic stability
T h e Reserve Bank 's traditi onal role of prude nti al supervisio n of bank s is now rh e
respons ibility of the Australian Prudential Regulat ion Autho ri ty (AP RA). Howeve r, rh e
Rl3A retains irs trad it ional respons ibility for rhe overall stabi lit y of the financia l system.
It mon itors risks and deve lopments in Austra lia's financial syste m, cond uces research and
prov ides gu idance to APRA that helps APRA implement and enforce regulatio ns. T he
RBA also seeks co mainta in the longer-term stab ilit y of the financial syst em by avoidin g
(or ar least reducing rhe risk of) financial crises. One examp le of th is was rh e RBA's creation
of an emerge ncy fund ing facility in 20 15 that banks can access in the event rhar rhey are
desperate for cash to fund their obliga tions (so far th is fund has never been used) . Policies
like this protect rh e deposits of memb ers of the public, with the aim of nor having to
rely on a formal govern ment gua rantee for depos itors' funds. Centra l banks around rh e
world have also forced banks to hold a min imum amount of the ir asset s in a very safe or
"liquid" form (although this policy was technically imp lemented by APRA in Austra lia).

Control of note issue

T h e Reserve Bank is the sole issuing authority for Aust ralian currency. All Austra lian
cu rrency is manufactured by Nor e Pr inting Austra lia, whic h is a compa n y wholly owned
by the Reserve Bank. Th e volume of notes and coins on issue ar any particular time will
vary accord ing to the communi ty 's demand for cash . At certain times of the year (for
example, Chinese N ew Year and Chr istmas) rh e demand for cash will be g reater rhan at
ot her times, and rh e RBA will seek to accommodate this demand for money.

Regulation of the payments system

T h e Reserve Bank is responsible for the payme nt s system. T his mea ns ensuring rh e
efficiency of payment meth ods - such as credit cards, electro nic cash, tra vellers' cheques
and store d-value cards - and promocing sta bility in the clearing and set tl ing of large
transact ions in financial mark ets. Th ese function s are carried our by the Payments Systems
Board with in the Reserve Bank .
Banker to the banks
Bank s hold exchange settl ement accounts wit h the Reserve Bank. Th ese accounts are used
to allow banks to settle debts betwee n themselves, as well as with the Reserve Bank, at
t he end of each day 's trad ing . Th ey ca.n also be used by banks to buy and sell gove rnm ent
securities from the RBA .

II
I
The Mark et Econo my 2020

Global financial crisis

The global economy expe rienced its most severe financial crisis in several generations in 2008,
with the overnight collapse of major financial institutions, share· markets crashing around the world,
econom ic activity collaps ing into recession and many governments taking unprecedented measures to
stabilise their financial systems and econom ies. The events of the crisis are a powerfu l demonstrat ion
of the impacts of financial markets on econom ic activity and econom ic policy.

The orig ins of the global financial cr isis can be traced back to the mid-2000s in the United States,
when low mortgage interest rates encouraged lending to househo lds with a higher risk of defaulting
on their mortgage. The risks of these "subprime " loans were spread th rough the system when
investment banks created comp licated financial instruments that packaged higher and lower risk
loans toge ther, and "secur itised" them so they cou ld be sold off to other investors . As interest
rates increased, mortgage default rates climbed on the 15 per cent of US mortgages c lassified as
"subprime" , Financial institutions stopped doing business with each other because they cou ld not
identify how exposed each institution was to subpr ime loans. Markets became volatile, and access
to new loans was restricted.

The crisis soon spread throughout the US financial system. The US Government was forced to take over
two financial organisations, Fannie Mae and Freddie Mac , which held over half of all US mortgage loans
at US$5 trillion. In 2007 and 2008, more than 25 financial institut ions either collapsed or were "bailed
out", including some of the biggest compan ies in the US, such as Bear Stearns, Lehman Brothers,
Merrill Lynch, HBOS, Wachovia, Goldman Sachs, Morgan Stanley, American International Group and
Washington Mutual. In February 2009, the United States enacted a massive $780 billion stimu lus
package to buy "troub led assets" and to restore stability to the financial system.

As the financial system fell into crisis, it had flow-on effects for the share market and broader economy.
During the crisis, the United States share market lost over a third of its value, and house prices
declined by almost 20 per cent. Share markets in the UK, Europe and Asia also fell sharp ly, with
trillions of dollars being wiped off the value of compan ies within a few months . Financial institutions
became reluctant to lend to compan ies or to households , underm ining confidence and causing a fall
in business investment and household consumpt ion.

By restricting access to cred it and influencing business and consumer confidence, developments in
financial markets have a strong impact on the level of economic activity. As a result of the global financial
crisis, many major count ries saw their econom ies contract in 2008 . In 2009, growth for advanced
economies was -3.7 per cent and 0.7 per cent for the global economy - the first annual contraction in
the global economy since the Second World War. From 20 12, the role of financial markets in the global
economy was again at the centre of developments, with concerns about government debt levels in
Greece, some other European count ries and in the United States. As they had done just four years earlier,
international organisations I ike the IMF and G20 stepped in to prevent a more widespread financial crisis.

The global financ ial crisis had impacts on the Aust ralian economy , but these were less severe
than in other developed econom ies (partly due to sound po licymak ing, but also due to good
fortune). While none of Australia's main financial institut ions co llapsed, the financial industry was
restructured , with mortgage originators like Aussie Home Loans , Wizard and RAMS being bought by
the traditional banks, and the merging of two of Aust ralia's largest banks, Westpac and St George.
As in other econom ies, Aust ralia's share market dec lined, los'ing over one-th ird of its peak value
in 2007. Other impacts on Australia included a slowing of house price growth , a collapse in the
exchange rate from over US95 cents to US60 cents in just three months , a sharp fall in commod ity
prices, and a slowdown in econom ic growth . While Australia was insulated from the global financial
crisis by better financial regu lation, the Aust ralian Government was nevertheless forced to respond
with a guarantee on all bank depos its and bank borrowing from overseas to imp rove financial
market stability, and almost $80 billion in stimulus measures to support econom ic activity dur ing
the downturn .

In the years before the globa l financial crisis, many economists had argued that financial markets
were better able to regulate themselves without any government intervention. However, in the
aftermath of the global recession, there was a widespread recognition that governments have a key
role to play in regulating markets to underpin conf idence and stability in the financial sector and the
broader economy.

II
 Chapter 12: Types of Financ ial Markets I
Responsibilityfor holdingAustralia's reservesof gold and foreign
currency dealings
T h e RBA's reserves provide the funds that can be used to make internariona l payments,
or for Reserve Bank operations in rhe foreig n exchange market . The RB A also oversees
dealers in the foreig n exchange market .

Banker and source of financial and economic advice to governments

T he Reserve Bank provides banking and financial agency services to rhe Commonwea lth
Government, as well as some stare governments. Th e governm ent can lodge excess funds wit h
the Reserve Bank and complete transact ions on behalf of rhe governm ent such as welfare and
pe nsion suppo rt payments to Austral ian cit izens. Finally, the Reserve Bank aces as a source
of financial and economic advice ro the governm ent. Th e Reserve Bank pub lishes regular
assessment s of the scare of rhe econom y and financial markets. Its pub lications are highly
respected and have a sig nificant influence on economic policymaking.

Australian Prudential Regulation Authority (APRA)

T h e Aus tral ian P rudent ial Regu la t ion Aut h ori ty (APRA ) provides prudentia l The Australian Prudential
regu lat ion for all authorised depos ic-raking institut ions (ADl s). ADl s includ e banks, Regulation Authority
supera nn uation funds and insurance compani es, cred it unions and buil d ing societi es. (APRA) is the government
AP RA has two main regulatory roles: body established to
regulate all depos it -
• APRA encourages behav iour by inst itutio ns that will ensure chey are able to taking institut ion s, life
meet th eir ob ligations to the peop le who p lace money wit h th e m . Essentiall y, and general insurance
organisations and
APRA regu lates inst ituti ons co ensure char deposi t-h olders can take back th eir
superannuation funds.
depos it money when rh ey wane it, that insurance companies can m eet thei r policy
ob ligatio ns, and that superan nuat ion funds p erform well and can pay peop le
who withdraw th eir savings. APRA requi res its deposit -tak ing institut ions to
mainta in certai n levels of funds on hand and ro manage risks according ro specific
financia l mod els.
• For any ADl s, insurance com panies or supe rannuation funds that experience
financial difficu lty, APRA has rhe role of sorti ng our the inst itu tion's financial
position and ensu ring that po lncy or depos it-holders receive as much of thei r funds
as possible. T his recovery role is supported by a range of invesrigarive powers,
g iving APRA the right ro interve ne in any of irs related inst itutio ns if ir feels they
have become financially unviab le.

Australian Securities and Investments Commission (ASIC)

T h e Au stra lian Securit ies and I nvestme nt s Commissio n (ASIC) regu lates Austra lian AustralianSecurities
and Investments
compani es and financial mark ets, with the aim of p rotecti ng investors and consum ers and
Commission (ASIC) is
imp roving rhe performance of rhe financial system. It has the power to monit or, investigate the government body
and act in situations where rhe int egrity of rhe financial system has been unde rmin ed with responsibility for
by rh e illegal acts of indiv idua ls or rh e creatio n of uneth ical investment products. ASIC corporate regulation,
also has powers to p rotect consu mers against misleadi ng or deceptive and unconscionab le consumer protect ion and
the oversight of financial
conduct affecting financial p roduc es a nd services.
service prod ucts .
ASIC's role is critica l ro lifting rh e sta ndards of corporate behaviour and mainta in ing
confidence in financial markers. Som e exampl es of specific offences regulated by ASIC
inclu de insider tradi ng, where company d irectors use non-pub lic informat ion about
t he company to buy and sell shares on the share market ro make a p rofit; and compan y
executives failing ro inform the mar ker of price-sens itive informat ion .
ASICt ypically has hu ndreds of investiga t ions underway at any point in rime. Each year
irs legal act ions can see individuals and compan ies payi ng fines, assets being frozen, or
even peop le being jailed for major offences.
I
The Market Economy 2020

In recent years, rhe scope of ASIC's role has been expanded ro cover a g rearer amount of
financial markec acriviry. In 2009, ASIC became the national regu lato r for consumer cred it
(such as home loans , personal loans and credit cards), raking over from the scares and
territo ries. Since 2010 , ASIC has increased responsib ility for supervis ing security markers
For more info rmation
abou t t he regulatory
such as rhe Auscralian Securities Exchange.
framework of Australia's
financ ial sys tem, visit the
ASIC's approach to financial regu lation came unde r scrut iny during rhe 20 18 Bank ing
follow ing websi tes: Royal Comm ission. Comm issioner H ayne chided the regulator for crying to resolve
instances of miscondu ct by financial institut ions "by agreement" rathe r than enforcing
Reserve Bank of Australia:
www.rba .gov.au
the law and impos ing penalt ies. Wh ile not comp lete ly agreeing with this critic ism ASIC
responded to rhe Royal Commission's report by strengthe n ing its app roach to enforcement .
Australian Prudential
In rhe year after the Royal Comm ission, it recorded a 20 per cent increase in investigations ,
Regulation Aut hority:
www.apra .gov.au establ ished an Office of Enforcement, stre ngt hened penalties for m isconduct and adopted
a new ph ilosophy of "Why Not Litigate?" This sig naled a more hard- line approach
Australian Securities and
co enforcement. As powerful as ASIC's role is in setting and enforcing regu lat ions, it
Investmen ts Commission:
www.asi c. gov.au
is important to recogn ise chat ir is not ASIC's role ro p revent investors from mak ing
losses. ASIC does nor try to stop people from investi ng in high- risk ventu res, which may
Australian Treasury:
end in corporate failure . ASIC also does not seep in to "bail our" or prevent companies
www.treasury .gov.au
experiencing financial difficu lties . Whi le facilitating the flow of information and hold ing
Governme nt 's fi nancial partic ipants to sranda rds, ASIC's role reflects a view that financial markers will be more
literacy prog ram: www.
efficient and better for investors in the long run if they operate with minimum government
moneysmart.gov.au
interfe rence.

Australian Treasury
T he Au str alian Tr easury also plays an important role in the funct ioni ng of Aust ralian
financial markers. As the main source of econom ic pol icy advice to rh e government,
the Treasury can infl uence how governments devise budgets , collect taxes, allocate
expenditure, and implement othe r polic ies such as mo netary po licy, labour market policy,
and marker reg ulations .

For financial market stab ility specifically, the Treasury provides advice to governme nt s
on regulatory setti ngs for financial markers, corporate pract ices and consumer protection.
During the globa l financial crisis in the late 2000s , the Treasury had an important role to
play in keeping the government up ro date on developments in Aust ralian and overseas
markers and advisi ng on the best approach to min im ising the impacts of financial market
distu rbances on the Austral ian economy. Recently , rh e Treasury has been responsi b le
for turn ing the recommendations made by the Royal Commission on misconduct in
the financial system into new laws. Imp lementing sound economic pol icy and prudent
financial market regu lat ions is critical for governments ro mainta in srab iliry in financial
markers in the long rerm.

1 Explain the Reserve Bank's role in the Aust ralian econo my.
2 Discuss the potential importanc e of the Council of Financial Regulators and
the Australian Treasury during a major financial crisis.
3 Using the website links in the margin, distinguish betwe en the roles of APRA
and ASIC in Australian financial markets.

II
 Chapter 12: Types of Financial Markets

1 Financial markets play an importan t role in allocating resources in the

economy . They provide a mar1<etthat bridges the gap between those with excess
funds and those requiring funds . The "prices" estab lished in financial markets
include interest rates, share and bond prices , and exchange rates.

2 In primary markets , the issu ing company directly sells new secur ities to
investors . In secondary markets , investors trade second-han d (previous ly
issued) secur ities w ith each ot her.

3 There are a variety of financial market products , each with its own purpose and
participants . These include consume r credit , housing loans, short-term debt
securities , shares, financial fut ures and foreign exchange .

4 There are a number of types of financial intermediaries . They can broad ly be

divided into banks and non-bank financial institutions , suc h as finance
compa nies, merchant banks, cred it unions, building soc ieties, mortgage
originators and superannuatio n funds .

5 The share market is the market for the trade in shares or equity ownership of
compa nies. The All Ordinaries Index is the share market index measuring
changes in the overall value of compan ies listed on the Australian Securities
Exchange (ASX) .

6 Once a company has floated on the share market , it pays regular dividends to
shareholders. Shareholders who sell their shares for more than their purchase
price make a profit know n as a capital gain .

7 The share market plays an important role in the econom y by providing an income
for investors and a source of finance for businesses to invest and grow. The share
market is also an indicator of economic conditions , demonstrat ing the level
of confidence of individuals a111
d businesses in the economy.

8 Australia's domestic financial markets are increasingly integrated w ith global

financ ial markets , with foreig n investors being a significant source of lending for
Australian individuals and bus inesses. The Austra lian do llar is now the world 's
fifth -most traded currency on foreign exchange markets .

9 The Reserve Bank of Australia is responsible for the overall stability of the
financia l system . The Australian Prudential Regulation Authority provides
prudential supervision and regulation of all depos it-t aking institut ions, life and
general insurance compan ies and superannuation funds . The Australian
Securities and Investments Commission has responsibility for corpora te
regulation, consumer protection and oversig ht of financial services .

10 The Australian Treasury also plays a role in financial markets because it is

responsible for advis ing the government on financial stability issues , and for the
legislative and regulatory fram ework for the financial system. The Council of
Financial Regulators is a coordi nating body for financial market regulation that
provides for cooperatio n and co llaboratio n among its four members - the RBA,
A PRA, ASIC and Treasury.

II
The Market Economy 2020

1 Explain what is meant by financial markets.

2 Distinguish between primary and secondary financ ial markets .

Give examples.

3 Discuss why there are so many different financial market products in the
economy, and descr ibe the purpose served by each product ident ified .

4 Ident ify the different types of financ ial institutions in the Austra lian economy ,
and briefly out line the roles played by each of these institut ions .

5 Describe the level of compet ition in Australian f inancial markets.

6 Describe the features of the Austra lian Securities Exchange and the
All Ordinaries Index .

7 Explain the role of the share market in relation t o:

a) shareholders
b) compan ies .

8 Discuss the relationship between econom ic cond itions and share prices in an
economy with reference to recent trends in Australia .

9 Examine the extent of integration between dom estic and globa l financ ial markets .

10 Outline the ro le and funct ion of each of these regulatory institut ions :
a) Reserve Bank of Australia
b) Australian Prudent ial Regulation Author ity
c) Australian Securities and Investments Comm ission
d) Australian Treasury
e) Council off Financial Regulators.

Extended response
Discuss the role of financial markets in a modern market economy. Explain the role and
function of the share market and its effect on the economy .

II
 The Money
Market

13.1 Borrowers: the demand for funds

13.2 Factors affecting t he demand fo r funds
13.3 Lenders: the supp ly of funds
13.4 Money and money supply
13.5 Interest rates
13.6 The Reserve Bank of Austra lia and t he cash rate

A key part of financial markets in Austra lia is the money market - the market for borrowing
funds. Just like other markets in the economy, there is demand, supp ly and a price. In
the money market, borrowers are the "consumers" demanding funds. Lenders are the
"producers" supp lying funds. T he pr ice of money in the money market is the rate of int erest
chat borrowers pay. How ever, unl ike norma l markets , the pr ice in the money market is not
achieved through the equi librium of market forces alone, with the Reserve Bank of Austra lia
play ing a key role in influenc ing vario us interest rates in the economy.
Money is cent ral to so many parts of the economy, such as buying goods and services,
saving for reti rement or investing in p roperty and bus inesses. Underst a nding how th e
mo ney market works is the refore cri tica l co understand ing the market economy.

13.1 Borrowers: the demand for funds

Ind ividuals, businesses and governments borrow money for different purposes. Ind ividu als
borrow mostly for personal reasons. The most common form of borrowing by individuals
or househo lds is a mort gage for the pu rchase of a family home. Und er a mort gage, a
bank is g iven the home as security on the loan . This means that if the borrower defaults
on making their repayments on the loan, th e bank effective ly gai ns th e r ight to sell th e
house to regain the debt, before givi ng any leftove r money to th e borrower .

Indiv idua ls also borrow for shorter-term purposes , such as purchasing a ca r, int ernatio nal
trave l, or payi ng for an educat ional course. Credit cards are in a simi lar catego ry but are
an even shorter-term form of borrowing . T hese loans are mostly unsecu red, which means
t here is no asset the financial insticurion can claim if the borrower defau lts on th e loan .
T h is exp lains why loans for th ese pu rposes, particu larly those attache d to cred it cards ,
have a higher inte rest rate relative to mortgage int erest races.
Overall, th e bu sin ess secto r does t h e most borrowing of any sector in th e economy.
Businesses need access to funds in order to expand production, invest in research and
development, or comp lete other special projects. Businesses can do this directly by issuing
shares co raise equ ity or debt by issuing bonds . Alte rnative ly, this can be done indirectly
I
The Market Economy 2020
Liq uidity is the ease w ith
which a financ ial asset
can be transformed into
cash so it can be used as
a medium of excha nge.
II
by borrowin g m oney from a financial insrirution such as a bank . Even if a busin ess relies
mainly on raising fund s by issuing equ it y or bonds , many often need to borrow mon ey
for brief period s th rough rh e course of the year in order to overcome downturns in irs
cash flow. For examp le, a business char relies on t he tou rist rrade experiences a frequent
change in irs level of activity, due to seasons, domestic and overseas holiday patterns, and
econom ic conditions. Since expenses are often relat ively constant, the business may require
access to an overd raft on its account in order to compensate for the cycles in its cash flow.
Governments can also part icipate in financial markers as borrowers. This is somet im es
done deliberate ly, in an effort to raise the level of economic activity. If the economy's
growth rare is slow, and funds are readi ly available from financial markers, a government
might borrow mon ey in order to increase its spend ing or give tax cuts, with the aim
of srimular ing t he economy. At othe r times, governments may borrow simply because
the ir spend ing unintent ionally grows faster tha n th eir revenue . Governments will also
sometimes borrow for rhe pu rpose of funding major i nfrasrructure p rojects. If a government
is bu ilding a road, bridge or rai lway line that is likely ro be in service for many decades ,
economises often argue chat it is approp riate that governments borrow and that the asset
is paid off over the lifetime of its use. In this way, rhe future returns from such assets can
be used to cover rhe coses of investment.
SUPPLY OF FUNDS/LOANS DEMAND FOR FUNDS/BORROWING
Businesses Individuals
Savings if profits are strong and • Home loans
there's no immed iate use for • Personal loans
funds • Credit cards
Individuals Governments
Saving up for Borrow ing occurs
future needs when expenditure
exceeds revenue
Governments Businesses
Savings occu r when surplus • Starting up a business
exists in budget (that is, • Expandi ng a business
revenue exceeds expend iture) • Managi ng cash flow
Figure 13.1 - The borrowing and lending of funds
1 Describe THREE examp les of loans that indiv iduals may use to borrow
money.
2 Ident ify the aspects of the circular flow of income that affect the demand for
money.
13.2 Factors affecting the demand
for funds
Ind ividuals with surp lus funds must decide what form ro keep chem in . The choice is to
eithe r hold chem as money (currency and bank deposits) or to purchase financial assets
(such as bonds or shares).
The benefit of ho lding money is liqu idiry. This allows for the easy use of fund s when
necessary. The benefit of purchasing financial assets is rh e retu rn you can earn by holdin g
them . For examp le, owners of shares in a company can receive a proport ion of the pro fits
made by that company in the form of d ividend payments. In contrast, no return is earned
by holding cash. In fact, the value of cash is eroded by inflat ion over time, although money
 Chapter 13: The Mo ney Ma rket I
ocherwise holds ics value over cime. O n the other hand, financial assecs carry r isks, as cheir
value can change dependi ng on market conditio ns.
T h ere are a nu mber of reasons why so.me people prefer co hold money (or high ly liqui d
as.sees)rat her than invesc surp lus fund s in financial assets chat offer a recurn :
• Tran sacti o ns m oti ve : People have day-co-day transaccions (purchases) for which
they need co use money. Thi s includes maki ng regular paymencs for goods and
services. Individuals have co hold a certain quancicy of currency for carrying out
day-co-day transactions, as most financial as.sees, such as shares, ca nnot be used co
pay for everyday p urchases.
• Precau t ionary m o tive: Quite apart from regular and predicab le cransaccions, chere
are nu merous unp redictab le circu mstances and emergencies (such as sickness) for
wh ich peop le need co have liqu id funds.
• Sp eculat ive m ot ive : Buying financial assecs carries the possibility of mak ing
capita l gains or losses. If che pr ice or value of shares or bonds goes up , the ind ividual
makes a capital gai n; if it goes down, they make a capita l loss. Ind ividuals will try
co avoid capital losses, so if t hey expect the value of financial assets co fall, chey
wi ll seek co sell their financial assets and convert chem inco money.
Th e level of de mand for liqui d funds (that is, mo ney) also depe nd s on che sophis cicacion
of the financia l syste m , and the ease wit h wh ich one can convert non -liqui d assecs
into money.
In a very simple financial system, where banks only operate branches and passbook savings
accouncs, individuals will wane co hold more cash for cransaccions and precaut ionary
purposes, because ocherwise they cannoc easily access cheir funds.
T h e enh anced operation of financial markets has meanc chat people find it easier co convert
financial assets, such as bonds or shares, inco liqui d funds. T his has led co a redu ction in
the demand for liquidity. Ind ividuals and businesses can confidently hold more of cheir
savings in less liqu id financial assecs when the markecs for these assecs are deep (that is,
have lots of buyers and sellers) and function more efficiently.

CASHED OUT
The use of cash and other payment methods in the eco nomy is affected by many factors,
including techno logy, an individua l's age , and personal preferences, acco rding to 2016 research by
the Reserve Bank of Austra lia. Some key po ints are that:
• Cash is no longer the most frequently used method of payment ; it is used in 37 per cent of all
transact ions , down from 47 per cent in 2013 and 69 per cent in 2007 .
• This trend has mostly been caused by the increased usage of new electronic payment
.----
techno logies (such as contactless card and mobile phone payments) that are more convenient
and time efficient than cash for some transactions, and a shift in transactions from face-to-face
interactions to online, where cash is not used.
• Cash remains the dom inant payment fo r small-value transact ions , although cards are being used more
frequently for them (due to the greater growth of contactless card funct ionality).
Further techno log ical developments in payment methods, such as w ith mobile payments comp leted via a smartphone,
are expected in future years. However, t he RBA still pred icts that cash w ill cont inue to play some role as a t ransact ion
med ium, particularly as some Austra lians (such as the elderly and lower-income households) still rely on cash for
mak ing payments.
In contrast , several Scandinavian count ries are pushing to go comp letely cash less in the next few years. Cash in
Sweden is already nearly obso lete, as around 87 per cent of all transact ions were made w ithout it in 2018.
Wh ile Austra lians have been shifting away from using cash for payments , the value of banknotes ci rculating in
the Aust ralian economy has cont inued to grow robustly. Th is may seem puzz ling. However, RBA research in 2018
estimated that 60 to 80 per cent of all b anknotes are not used for transact ions. This suggests that there is still a lot
o f demand for liquidity in Austra lia beyond the transact ion mot ive.
I
The Market Economy 2020

In summary, the ma in oppor tun ity cost of hold ing [iguid fund s is t he forgone retu rns (or
int erest) th at woul d have been earned by hold ing financial asset s. As long as the benefit
of hold ing liquid it y (includ ing lower cost s for transact ions and no risk of capital losses)
ourweig hs the costs (the retu rns forgone), ind ividua.ls will seek to hold money rath er t han
financial assets.
Businesses face a simil ar trad e-off when decid ing w heth er to invest any surp lus funds. 1n
general, de mand for funds by businesses wi ll be affected by several factors. Thi s includes
th e cash flow ge nerat ed by bu siness ope rat ions and whether th is cash flow is sufficient to
cover expenses. Ge neral econom ic cond itio ns will a lso p lay a large role - when econom ic
condit ions are go od , bu sinesses are more likely to be comfort able caking on debt to fund
major investments and expansion. Business lend ing is also sensiti ve to t he level of int erest
rates, as busin esses wi ll be more likely to borrow w hen int erest rates are low.

Household debt
The debt of the househo ld secto r in Aust ralia has increased much faste r tha n househo ld income , grow ing from
an average of 41 per cent in the 1980s to 65 per cent in the 1990s and 131 per cent in the 2000s . The growth in
household debt slowed after the globa l fi nancial crisis, due to a comb ination of increased caut ion about taking
on more debt and higher saving levels, but it began to increase substant ially again afte r 2014. By mid-2019,
the ratio of household debt to income reached around 190 per cent , a level greater than most other advanced
co untries. Aust ralian househo lds are the second most heavily indebted househo lds in the wor ld (slightly behind
Switzerland} when measured as a percentage of GDP. By far, the greatest component of this grow ing debt is
housing-related debt , or mo rtgages. Hous ing debt makes up over 70 per cent of tota l househo ld debt. This
growth in housing debt over a number of years is mainly due to:
• Low interest rates fo r almost two decades {but particularly in recent years). When dec iding to borrow, peop le's
main concern is how much they will have to pay back in monthly repayments. Interest rates charged by the
banks fo r people borrow ing money to purchase a home are around one-third of what they were at the end of
the 1980s, meaning that households can effect ively afford to borrow more.
• Rising house prices, with buyers keen to profit from buying and selling real estate.
• The strong growth in property investment. Borrow ing for an investment property (not the home that borrowers
live in) represents over 25 per cent of tota l household debt compared to 15 per cent a decade and a half ago.
However, growth in property investment has eased off since mid-2017.
• Financial deregulation has increased compet ition, which has lowered borrow ing costs and increased the debt
opt ions available to homebuye rs. For examp le, existing homeowners can now easily borrow against the value
of the ir home if they already own it, allow ing them to increase the ir consumpt ion or invest in othe r propert ies.
• Increasing superannuation means that the tota l value of household assets has increased, making households
mo re comfortab le with a great amount of debt.
The increased borrow ings of Austra lian househo lds have greatly increased the overall debt burden of the
co untry. However, for Austra lian househo lds , lower interest rates have partially offset the impact of higher debt
levels. In fact , the cost of servic ing househo ld debt in Aust ralia has been large ly flat in recent years , desp ite the
overall increase in indebtedness. Austra lians have also increased the ir use of other bor rowing facilities in recent
decades , such as personal loans for ca rs or othe r durables, and cred it ca rds , which are a very conven ient way
of buy ing goods and services .

FINANCIAL INNOVATION
Financial innovat ion can affect consumers ' demand for liquidity and also reshape financial
markets . One of the key forms of financia l innovation in recent decades in Australia has
been the increased use of techno logy to deliver financial services . Many new forms of
accessing funds and making payments have emerged , including automat ic teller mach ines
(ATMs), giving custome rs 24- hour access to funds from bank accounts; electronic funds
transfer at point of sale (EFTPOS); and online banking and online payment systems. Each

II
 Chapter 13: The Mo ney Ma rket I
of these changes has meant that peop le need not hold high volumes o f liquid funds to cove r
day-to -day transactions.
Other examples of financial innovatio n include:
• The growth of internet - based discount stockbrokers , such as E-Trade and CommSec . These
com panies have broug ht down the cost of trading shares and made it much easier for small
individual investors to participate in financial markets.
• The recent rise of "buy now pay later" products offered by compa nies such as Afte rpay. These
arrangements allow consumers to receive goods and services immediate ly but pay for them in
installments over time without need ing a credit card or other type of trad itional loan. Demand
for these products has increased rapidly in recent years.
• The increased use of mortgage brokers , such as Aussie Home Loans, which help individuals
find the most suitab le loan products . These brokers can play an importa nt role in the economy
by helping to link lenders and borrowers. However, these providers have a smaller market share
than before the global financial cr isis of 2008.
• The increased availability of contact less payment systems such as PayPass and card less
payment systems , where consumers can pay without having to sign or prov ide a personal
ident ificat ion number (PIN). People can pay by putting their card or smartphone near the signal
reader. These techno logies reduce transact ion time by 25 per cent compared with deb it and
cred it cards , improving convenience for consumers.
• The creation of digital currencies such as Bitcoin allows modern electron ic payment systems to
operate - like cash - without the need for intermediaries such as banks. As digita l currenc ies
can be directly exchanged for goods and services, the transact ion costs involved are much
lower relat ive to other forms of electron ic payment.

1 Disc uss w hich mot ive fo r holding money might app ly in the fo llowing
circ umstances :
a) A student wants to buy a lapt op to cond uct mo re eco nomics research .
b) A farmer expects the price of Qantas shares to fall sharp ly next week .
c) A ski instructo r is worr ied that he mig ht lose his job during the summer .
2 Describe the costs and benefits of holding funds in the form of cash rather than
as shares or property.

13.3 Lenders: the supply of funds

Individuals, businessesand governments participate in financial markets as lenders when
t hey are seeking a return on their weal t h.
I ndi v idual s who place depos its in financial insritur ions are, in effecc, lend ing their
m oney co chat inst itu tio n for rh e purpose of gett ing a retu rn on it , as shown in
figure 13.2. Individua ls who hold wea lth bu t do nor wish co spend it have a ran ge
of opt ions. Some may invest in assets , suc h as reside nt ial p roperty. O th ers may buy
shares , while chose who want co avo id r isk will ge nera lly p lace t heir money into an
inte rest -bearing deposit in a fin ancia l inst itut ion .

$100 0
savings
$90 e
loan

Individual
◄
► Bank
J ◄$901oan
► Borrower
J
$2 interest
+ $100 savings
when required
e + interest

Figu re 13 .2 - Deposits by individuals and bus inesses create a supp ly of funds that are used by
banks and other institu tions as a source of funds for lending.
II
I
The Market Economy 2020

Bu sin esses sometimes also participate in financial markers as lende rs. A successful
business may have a very stro ng cash flow and good p rofits, bur it may nor have imm ediate
pla ns for expansion or buyi ng our anot her bus iness. In such circum stances, it may deposit
irs funds in a financial insrirutio n. If interest rates are at a level where maint aining deposit
funds is likely co be more lucrative than investi ng i n expand ing the busi ness, rh e firm is
more like ly ro d eposit the funds.
Go ve rnment s can also become lenders, alt houg h histor ically governments have partic ipated
in financial markets mostl y as borrowers. Wh en the governm ent is runnin g a surp lus on
its budget, irs revenue exceeds irs spendi ng and th is allows ir ro eith er pay off ourstandi ng
debts from rhe past, or maint ain positive financial balances (char is, loan money th roug h
the financial sector).
T he international sector is also an important sour ce of fund s for domestic borrowers.
Ausrralia has histo rically had low savings races and has relied upon overseas savings co
finance domes t ic consump ti on and invest ment . Wh en Aust ralians borrow money from
overseas, t his is recorded as a foreign liability and mu st be repaid in t he future . Th e valu e
of Austra lia's net foreign deb t has grow n significa n tly over t he past decade, amo unti ng
co more rhan $ 1.1 trill ion in 2019 . T he importance of rh e inte rnatio nal sector co lende rs
in Austral ia was highlig ht ed duri ng the g lobal financial crisis in the late 2000s, when
there was a short age of cred it inte rnatio nally. Bank s and ot her lenders in Austral ia were
forced ro raise t heir int erest races in excess of official increases in t he cash rate by rhe
Reserve Bank co attract overseas funds co lend co borrowers in Aust ralia. In addi ti on , rhe
Austra lian Gove rnm ent pr ovided a g uarantee for a ll overseas borrowings by Australian
bank s, co reassu.re overseas lenders char th ere was no risk in lend ing co Aust ralian banks .

1 Outline TWO reasons that firms and individ uals may have for saving.
2 Describe the factors that have led to increased levels of household debt in
Australia ove r the past decade.
3 Give an example of a transact ion in the international sector that wo uld increase
the supply of funds in Australia.

13.4 Money and money supply

Mone y pl ays a crucia l role in rh e functi oni ng of any modern economy. Thi s is because rhe
value of all goods and services in pro duct markets and all resources in factor markers can
be expressed in ,cerms of money. A stab le monetary system is impo rtant for t he successful
perform ance of an economy because it will affecc rhe abilit y of markers ro function
prope rly and all ow the economy co g row over rime. Financial market volati lity, such as
was experienced in many count ries duri ng t he g loba l financial crisis in 2008 and 2009,
can have drama ti c consequences on t he level of out put, emp loyment and living standa rds
of an ind ivid ual countr y, a region , or even rhe g loba l economy.
Money is an important component of modern econom ies because of its four characteristics.
It is:

0 8 E) 0
A medi um of exchange A meas ure of value A sto re of value A method of
Money can be used to Money can be held over defe rred payment
Goods , services and
resources are exc hanged compare the relative time and used predictab ly Money allows the
for money value of good s, services for future exchanges of development of a system
and resources foods , services or resources of lending and borrowing

II
 Chapter 13: The Money Market I
Mose peop le ch ink of money as t he noces and coins (currency) in circu lat ion , bur in Money supplyis the
econom ics, our major focus is on t he broader concept of the m on ey supp ly - rhe coral total amount of funds
am ount of money in the economy chat has the four characterist ics above. Cur rency accounts in an economy that can
be used as a medium of
for less than five per cent of rhe Reserve Bank's main defini t ions of rhe money supp ly. exchange, a measure of
T h e money supp ly can be measured in three main ways, wh ich are each called fin ancial value, a store of value
(or m on eta ry) agg regate s: and a method of deferred
payment. The R-eserve
• Mo ney ba se - consists of all cu rrency in circulatio n and all bank depos its wit h rhe Bank's measure of the
Reserve Bank. T his is a measure of rhe mosr liquid financial assecs, which can be money supply is M3.
used almost instant aneously ro comp lete rransacrions.
• M3 - consists of the money base p lus all bank deposits.
M3 is a measure of
• Bro ad m on ey - consists ofM 3 p lus depos it s in non-bank financial inter mediaries the money supply that
(such as credit unions and buil di ng societ ies) m inus th eir holdi ngs of bank deposits. consists of all currency
in circulation, bank

■d• 1 • 1§+Hi I Currency I Bank deposits wit h RBA

depos its with the Reserve
Bank and private-sector

111 Money base I Ban k deposits

depos its in banks.

Broad money I M3 I N BFI deposits I NBFI depo sits in banks

An othe r importa nt financial agg rega te measured by the Reserve Bank is cred it , wh ich
is a system that allows payments for purc hases co be deferred. Cred it specifically refers ro
loans that are provided by banks and orh er lenders co household and bus iness borrowers.
T h e borrowers receive money up-fro nt , wh ile the lenders receive a cred it asset , which
m eans they have the right ro receive inte rest pay ments from the borrower and the amount
of money init ially borrowed at the end of the loan period . Th e credit itse lf is the loan
as.set that banks and othe r lende rs ho.Id . Cred it is therefore nor money, b ut clearly it is a
close ly related concept .
In our d iscussion of money supp ly, we will use rhe Reserve Bank 's measure of M 3. In
doi ng so, it is important ro remember char our major focus is deposits in banks, because
t hey make up about 95 per cent of t he money supp ly, whereas curre ncy in circulation
accounts for unde r 5 per cent.

1 With reference to the four characteristics of money, explain the impo rtance of
money to market economies.
2 Outline the different measures of the money supply measured by the Reserve
Bank of Australia.

13.5 Interest rates

T h e rate of interest is one of the mosr important prices in the economy. It is the price that
Interest rates are
bri ngs about eq uilibri um in a financial marker, where the qua nt it y of fun ds supp lied by
the cost of borrowing
lenders is equa l ro char demanded by borrowers. If we assume char lend ers will rend co money expressed as a
offer a higher quantity of funds as the inte rest rate increases, and that borrowers will rend percentage of the tota l
co borrow more at lower interest races, the role and determ inatio n of the rare of interest amount borrowed.
can be represented as in figure 13.3.
IThe Market Econ omy 2020

Th e interest rate is the rare of return (yield) on financial assets or financial instru menr s,
such as bonds . Th erefore, in figure 13.3, rhe demand-fo r-funds curve represent s rhe
demand for mo ney by borrowers, wh ile the supply-of-funds curve represent s rh e supp ly
of credit or mon ey by lende rs. An y factor that affects the supply or
Interest rate demand for funds in rhe economy will lead to a change in the rate of
D funds S funds interest .
In reali ty, financial markets do not funct ion like product mark ers for
goods and services, and interest rates are not determi ned by the norma l
r* interaction of supp ly and demand! forces. Th e supp ly of funds (savings)
rends ro be unrespo nsive to changes in rh e interest rare (char is, very
inelastic) and, as we shall see in sect ion 13.6, interest rates are ind irectl y
determ ined by the Reserve Bank of Austra lia.
D funds
Financial insrirutio ns act as borrowers of funds when rhey accept saving s
Quantity of depos it s, as the banks effectively use these funds to make money for
funds
themse lves by lend ing these fund s on ro orher borrowe rs. T herefore, a
Figure 13 .3 - Interest rate determi nation rate of inte rest , known as a bor row ing r ate, is offered on these funds.
In add ition, financial institutions charge a rate of interest , kn own as a
lend in g ra te, when they make loans to th eir cuscomers. Th ese inst itutions are able to
make a p rofit by chargi ng a lend ing rate that exceed s th eir borrowing rare. Th e difference
betw een th ese two races is known as rhe in te rest ra te differentia l, or the net interest
marg in.
We often disti nguish betwee n sh or t-t erm an d long- te rm inte r es t ra tes based on
rhe length to m aturity of the financial assets or securi t ies. For instance, when t he
Commonwealth Government needs ro borrow funds, ir can use eit her sh ort-te r m securit ies
(such as Treasury nores that are issued for terms of only 13 or 26 weeks) or long- term
securities (Treasury bonds that can be issued for 5 or 7 or 10 years). Inte rest rates on loa.ns
with a matur ity of less than a year are known as shore-t erm int erest rates. Some instruments
can have very long-rerm maturities - for exampl e, .mortgages for house purchases can be
for up to 25 years. Th e int erest rates on longe r-term securi ties are nor necessarily rh e sam e
as int erest races on short-te rm securit ies. Longer-ter m securities are mostly seen as riskier
(as much more can change over time) and are also less liquid (since it is more difficult to
convert them inr o cash). As a result, the return requi red for these assets will usually be
higher and lend ers will receive a highe r interest race.
Any factor that affects rh e supp ly or demand of funds in the financial markers will also
lead to a change in the equ ilibri um level of inte rest races in rh e economy. Some factors
that wi ll influence the ge neral level of inte rest rates include :
• Th e dema nd for capita l goods (inves tme nt ): Stronge r investment demand w.ill
usually lead to hig her dema nd for borrowing by firms seeking ro finance the ir capita l
expansion , putt ing upward pressure on interest rates. Either an increase in the real
wage rare, mak ing capital relat ively cheaper compar ed ro labour, or an increase in
the level of economic activity, where firms need ro expand capacity ro satisfy stronger
dema nd, could lead ro greater demand for capita l goods by businesses.
• Th e level of sav ings in the economy: A hig her level of savings means that there
is an increased supp ly of loanable funds, wh ich shou ld put downward p ressure on
int erest r-ates.
• Th e dema nd for liq uid funds: If ind ivid uals in the economy have a srronger
preference for highly liqu id funds, they may be willing ro forgo the yields (retu rns)
from buying securities, and instead choose to hold th eir funds in bank depos it s or
in the form of curre ncy. Th is would mean char rh e supp ly of loanable funds is lower
and would put upward pressure on the rare of interest .
 Chapter 13: The Mo ney Market I
• I nfl ati ona ry expecta tion s: Inflatio n reduces the value of money and financial assets.
T herefore, if inflati on is expect ed ro rise in rhe economy, lenders would requ ire a
hig her interest rate to be pai d as compensati on for the loss of value of their financial
asset s. The refore, eve n if the real rare of return on securiti es srays the same, higher
expected inflation will lead ro hig her nom inal int erest rates in the economy.
• Gov er nment b u dg et : If the govern ment has a greater level of spe nd ing than it
receives in revenue, it has a budget deficit , and is a borrower in financial markers.
Thi s can result in hig her interest rates. If the govern ment is a net lender in financial
markets, t his pu ts dow nward pressu re on interest races.
• Internati onal inter est rate s: In a world where capita l markers are reasonably open
and funds can move across natio nal borde rs quite easily, the leve l of worl d interest
races has a sign ificant impac t on domes ti c interest rates. If the d omestic rate of
interest is lower relative ro overseas rates, domestic lenders may seek to invest their
funds overseas, to take advant age of the hig her rates of ret urn . T h is wou ld reduce
the supp ly of loanab le funds do mesti cally and put upward pressure on do mestic
interest races.
• Th e RBA, in its condu ct of d o me st ic market opera tion s, affect s rhe supp ly of
fund s in the shore-ter m money marker in order ro ser the cash rare. T his has a d irect
influe nce on rh e retu rns for shor e-ter m loans, and an indi rect infl uence on interest
races on longer- term loans.

1 Distinguish between borrow ing rates and lending rates and accou nt for
the d ifference.
2 Describe the impact of each of t he following actio ns on interest rates in
an economy:
• The increasing use of contac tl ess card payments means that cons umers
prefer to leave their savings in bank accou nts rather than as cash .
• Interest rates in Japan increase by two percentage points .
• A slump in demand for Australian iron ore in China causes a cance llati on of
planned investments in the Australian mining industry.
• Individ uals expect the inflation rate to double this year.

13.6 The Reserve Bank of Australia

and the cash rate
T h e Reserve Bank of Aust ralia, as the country's central bank , has sig n i.ficant influ ence
ove r inte rest rates in the economy. T his infl uence comes from the RBA's responsi bility
for d irectly managing the cash rare. T he cash rate is rhe interest rare in a funda menta l
financial marker called the overn ight money market - the market for very short-te rm loans
betwee n banks, where loans are lirera.lly made for overnig ht use in many cases.
T h e cash rate infl uences many ot her interest races in the economy (such as races on
m ortgages) , and the general level of inte rest rates infl uences the overall level of econom ic
act ivity. The RBA t herefore uses the cash rate as a pol icy cool ro help m anage the level
of economic acriviry in Aust ralia - th is po licy is called monerary po licy, wh ich is covered
in. derai l in rhe H SC Econom ics Course. For now, ir is important to und ersrand what rhe
cash rate is and the mechanics of how it is determined. This will set the stage nicely for
next year. T he mechan ics of rhe cash rare and rhe overnight money market can be jointly
exp lained by three thi ngs: 1) exchange set tlement accounts , 2) t he p olic y int er est ra re
co rrid o r , and 3) open market operat ions.

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I
The Market Economy 2020

Exchangesettlement accounts
Banks need ro ho ld a certain proport ion of the ir funds with the Reserve Bank in exchange
settlement account s (ES accounts) in order co settl e payments with orher banks and t he
Reserve Bank . For example, when a custom er of ANZ uses a debit card ro buy a good or
service from a business char has a bank account at Westpac, funds need co flow from ANZ
co Westpac co complete the transaction. Many int erbank payments like thi s need co happen
every day. These payments are made by tra nsferring funds between banks' ES accounts . At
the end of every tradi ng day, some banks will not have enough funds in th eir ES accounts
co sat isfy all of t heir interbank payment obl igariom for rhac day, whi le other banks w.ill
have a surp lus of ES funds rhac rh ey do nor need ro hold. Some banks also choose co hold
ES balances in accounts at che RBA as a way of scoring value.
The overnight m oney marker (also known as the sho re-term money market) is rh e market
where banks that have a shortage of ES funds can borrow money from banks that have an
excess of ES funds beyond what they need in th eir accounts. Th e market th erefore enabl es
banks co always settle the ir interbank payment ob ligations with each orher. Like with
any orher financial market, demand by borrowers and supp ly from lenders interact co sec
che market price (interest race). For examp le, when rhe supp ly of funds from lenders rhac
have excess ES ba lances increases, the price of borrowing th is money, chat is, the cash race,
will fall. But un.like in orher financial markets , the RBA intervenes heavily ro ensure rhac
che actual cash race lines up with a target chat rh e RBA sers for it (the RBA publicly
ann ounces what che target is every month except for January ). Th e RBA does th is using
the policy race corrido r and open market operation s.

The policy rate corridor

The RBA does not have rhe power ro d irectly annou nce the actual cash race at the target
chat it sers. Bue rhe RBA is able ro ensure rhac the actual cash rare can never srray far
from the target because of how rh e RBA deals with ES funds outside of the overnight
money marker.
First, rhe RBA pays an int erest race ro banks on funds held in ES accounts char is always
0.25 percentage points below the cash rare target (for examp le, if the cash race target is
1 per cent, the RBA's deposit rare is sec co 0.75 pe r cent). This means chat banks with
excess ES balances are not incent ivised co lend fund.s co othe r banks if the actual cash race
is less rhan 0.25 percentage points below the target; these banks could earn g reater returns
by simp ly leaving the ir excra funds in th eir ES account . Th e RBA's deposit race the refore
creates a "floor" or m in imum value for the cash rare.
Second, the RBA is always willi ng ro lend ES balances d irectly co banks oucside of rhe
overnight market . Th e RBA always sees an interest rare on these loans equal co 0 .25
percenta ge po in.cs above the cash rare target (for examp le, if the cash race target is 1 per

Actua l Cash
rate (price)

RBA lend ing rate Supp ly

+0.25 ppt

Policy interest
Cash rate target -- -- - -- -- - -- -- - - -- - -- -- - -- - - • rate corr idor

RBA deposit rate

-0.25 ppt Demand

ES bala nces (qua ntity )

Figure 13 .4 The overnig ht mone y market

 Chapter 13: The Money Market I
cent , the int erest rate on rh ese loans is set ro 1.25 per cent). Banks char need ro borrow
ES balances are not incent ivised to pay a rare higher rhan rh e RBA's lending rare in rh e
overnight money market . If rh e cash rate were higher than the RBA's lendi ng rare, banks
wou ld simply borrow ES funds directl y from the RBA outside of rhe overnight market.
T h e RBA's lending rare the refore creates a "ceiling" or maximum value for the cash rare.
Toget her, the floor created by rhe RBA's deposit rate and the ceiling create d by the RBA's
lend ing rate form rhe policy rate corr.idor for rh e cash rare. No banks, whether they have
a surp lus or a shortage of ES funds, have an incentive to comp lete tra nsactions in rh e
overnight money market outside of th is corridor. It is called the policy rare corridor because
t he RBA's po licy target for the cash rate is always exactly in the m idd le. This ensures that
t he actual cash rate always closely foUows the RBA's target cash rate .
T h e po licy rate corridor is responsible for imp lementi ng changes to rh e RBA's cash rare
ta rget. T his is because the ceiling and floor of the corridor are automat ical ly ser so that rhe
cash rare target is in the m idd le of the corridor. If the RBA were ro decrease the target, rh e
floor and ceiling of rhe corridor would shift downwards immediately, and banks would be
immed iately incentiv ised to borrow and lend from each orher with in a new range char is
consistent with the new cash rate target (see fig ure 13.5 below). Because of this , changes
to the cash rare happen as soon as rhe RBA ann ounces a change to its target - the RBA
does nor have to do anyth ing extra .

Rate

I
RBA lending rate
+0.25 pp t

Cas h rate ta rget

----! Banks want to.
borrow at
_____ _ lowest rate _ Policy inte rest
RBA deposit rate
-0.25 pp t Banks want to rate co rrido r

i deposit at
highest rate
-------------·
Day 1 Day2 Time

Figu re 13.5 Decrease in the ca sh rate targe t

Open market operations

D emand for ES balances by banks fluctuates on a daily basis. This is esp ecially rhe case
on days where there are large transactions or payments in rhe economy, such as when rh e
government pays social security benefits . Th e actual cash rate is the p rice ar which this
demand int ersects with rhe supply of ES funds that are available . T he RBA manages rh e
level of supp ly of ES funds so chat ic meets demand at a p rice equal to the RBA's cash
rare target . Th is management of supply is what keeps rh e cash rate ar irs ttarget on a daily
basis. Without this intervention, rh e cash rate would bounce around insid e rhe po licy rare
corridor whenever demand flu ctuate d .
T h e RBA manages rh e supp ly of ES funds by conduct ing open market operat ions (OMO).
OMO refers to the purchase and sale of financial securities by the RBA in exchange for
ES balances. T hese purchases and sales affect rhe supply of ES funds becau se ES funds are
used to actually complete these transactions . If the demand for ES funds increases, rh e
RBA would need to increase the supp ly of ES funds to keep the cash rate ar target, all else
eq ual. To do th is, the RBA wou ld buy financial securi ties held by banks, and in exchange
depos it additional funds in the ir exchan ge settlement accounts . As with any marker , this
wou ld increase rh e supp ly of ES funds so that it could meet the additional demand. If rh e
IThe Market Economy 2020
Tightening of monetary policy
RBA raises the policy rate corridor
Banl!<spay more to borrow
ES funds
•
Cash rate ~
To maintain margins ,
banks ~ market interest rates
Consumers and businesses have to pay
more on ex isting debts; new borrowers
find it harder to borrow funds
Consumpt ion and investment spend ing ,J.
•
Economic act ivity ,J.
Loosening of monetary policy
RBA red uces the policy rate corr idor
Banks receive less interest
from loans of ES funds
•
Cash rate ,i.
To maintain margins,
banKs ,J. market interest rates
Consumers and businesses have to pay
less on ex isting debts ; new borrowers
find it easier to borrow funds
•
Consumpt ion and investment spending ~
T
Economic act ivity ~
Figure 13.6 - The impac t of monetary po licy
II
RBA needed ro decrease rh e supp ly oflES funds ro keep the cash rare ar target
(because of a decrease in demand ), the RBA would sell financial securities to
banks, and in exchange wit hdra w funds rhat were sitti ng in their exchange
sectlement accounts . This wou ld decrease rh e supply of ES funds down to
the lower level of demand.
OMO may involve eith er outrig ht purchases or sales of securiti es, such as
second- hand Commo nwealth gove rnm ent bonds , or repurc hase agreeme nt s
(also called repos), where rhe "seller" of a bond or security effectively agrees
to buy rhe bond or securi ty back from rhe "buyer" at a later date. In practice,
the RBA p refers using repos ro cond uct OMO because they are much more
flexible instruments and can be used to manage ES supply muc h more
prec isely than ourrighr transactions .
To su mmaris e rhe discussion so far, the RBA uses rh e cash rate po licy
corrid or ro imp lement changes to the cash rat e target, and uses open market
operations ro ensure rhat the cash rate stays at irs target every day when rhe
demand for ES funds changes. Borh features of rhe overnight mon ey mark et
allow rh e RBA ro cont rol the cash race.
Why is the cash rate important?
Th e cash rare p rovides the foundatio n of the int erest rare structu re in rhe
economy. An increase in the cash rare m eans that it becomes more expensive
for finan cial institut ions to obtai n funds in rhe shore-term money mark et .
Thi s increases rh e overall cost structu re of borrowin g, eventua lly flowing
th rough to longer-term and mort gage interest rates, as banks try to maintain
their profit marg ins. Simi larly, a reduction in rhe cash rate lowers rh e cost
of borrowing for banks in the shorc-rerm money mark et, and finan cial
institutions rhen pass this cosr saving on to their custome rs in the form of
lower lend ing inte rest races.
Changes in the ge neral level of inter est races (caused by changes in the cash
race) impact upon the level of economic activ it y. If interest races fall, this
enco urages consumption and investm ent spend ing, which increases rhe
level of econom ic activity. If int erest races rise, th is deters consumption and
investment spendi ng and reduces rh e overall level of economi c act ivity .
Th e Reserve Bank's influ ence on int erest rates to affect the level of economic
act ivity is known as monetar y policy. The Reserve Bank can either tig h ten
mon etary po licy, by raising interest .races, or loo se n monetary po licy, lby
loweri ng interest races. Th e impacts of mon etary policy changes are shown
in figure 13.6 .
1 Distingu ish open market operations from the cash rate policy corr idor .
2 Explain how changes in the cash rate affect financ ial markets and
econom ic activ ity .
Web exercise
Visit the webs ite of the Reserve Bank of Australia (www.rba.gov.au) and
prepare a brief report with the follow ing informat ion :
• State the c urrent level of the cash rate.
• Identify when the RBA last adj1Ustedthe cash rate, and whether this
move increased or decreased tthe cash rate.
• Outline TWO reasons for the RBNs most recent cash rate change .
Hint: Every time the RBA adjusts the cash rate, it issues a med ia release
(available on the RBA's webs ite) expla ining the reasons for the move .
 Chapter 13: The Money Market

1 Borrowers represent the demand for funds in financial markets and include
individuals borrow ing fo r housing or consumpt ion, businesses borrow ing
for investment and governments borrow ing to finance budget def icits or
infrastruct ure projects .

2 Lenders represent the supp ly of funds and consist of individuals that may have
unspent income , businesses th at may have unused profits, governments that may
run budget surpluses and international lenders w ith surplus funds .

3 Individuals demand money beca use it is an easy form of payment for day-to-day
transactions, that is, it is liquid , and does not carry the risk of capita l losses.
Individuals demand financial assets because they can earn a return (interest) and
may possibly make capital gains.

4 Innovations in technology, such as an increase in the number of ATMs and

increased use of credit cards, have changed the demand patterns for money.
This is known as financial innovation .

5 Broad money includes all currency and all deposits in banks and non-ba nk
financial intermediaries, minus all NBFI holdings of bank depos its .

6 Interest rates represent the cost of borrowing and the return from savings. These
are called borrowing rates and lending rates respectively. The financial
sector earns its income by charg ing a lending rate greater than the borrowing
rate. The diffe rence is often referred to as the interest rate differential.

7 The cash rate is the interest pa id on overnight loans in the short-t erm money
market.

8 The policy interest rate corrido r is established by the RBA's depos it and lending
rates for exchange settlement account balances . The corrido r gives banks an
incentive to borrow and lend in the overnight money market close to the cash rate
target , and is used to implement cash rate changes - in order to influence the
cash rate and the general level of interest rates .

9 Open market operat ions are act ions by the Reserve Bank to manage the supply
of funds in the overnight money market. These actions involve the purchase and
sale of financial securities - either outright or through repurchase agreements.

10 A change in the cash rate affects the cost of short-term borrowing fo r financial
institutions. This will flow through to market interest rates for co nsumers and
businesses, influencing their co nsumption and investment decisions and therefore
influencing the level of econom ic activity.
The Market Economy 2020

1 Outline the sources of savings in the economy.

2 Exp lain why an individual wou ld borrow funds .

3 Discuss how changes in econom ic cond itions m ight affect borrowers and lenders
across the househo ld, business and government sectors.

4 Ident ify the sign ificance of each of the following factors for a lender of funds:
a) returns
b) risk
c) liquidity.

5 Ident ify the economic meaning of the follow ing terms :

a) credit
b) currency.

6 Distingu ish between the following financia l aggregates measured by the

Reserve Ban k :
a) M3
b) broad mon ey
c) money base .

7 Outline the factors influencing the lending and borrowing rates in the economy,
and exp lain why these rates differ.

8 Expla in the effects of the fo llowing on the leve l of interest rates in the
Austra lian economy :
a) a rise in internat ional interest rates
b) a decrease in the level of investment
c) deter iorat ing consumer sentiment
d) increasing inflationary expectat ions
e) increasing domestic savings.

9 Explain what is meant by domesticmarketoperations.

10 Discuss what steps the RBA would take if it decided to use interest rates to
stimulate economic activ ity.

Extended response
Discuss the role of borrowers , lenders and the Reserve Bank of Austra lia in Australian
financia l markets .
 TOPIC

GOVERNMENT AND THE

MARKET ECONOMY

Focus
The focus of this study is the role of
government in a mixed economy. The main
concepts are management of the economy,
and problems and issues arising from the
free operation of markets.

Issues
By the end of Topic 6, you will
be able to examine the following Skills
economic issues:
Topic 6 skills questions can ask
■ Assess the need for governmen t intervention you to:
in a market economy
■ determ ine whether a spec ific tax is
■ Examine how t he operation of the free progress ive, proport ional or regressive
market without government intetvention
■ interpret Federal Budget data
might affect the distribution of income, quality
of life of individuals and the management of ■ predict the impact of a budget deficit or
the environment surplus on economic act ivity
■ Evaluate the impact of different taxes on ■ discuss how monetary and fiscal policies can
the distribut ion of income and wea lth , on be used to stabilise econom ic activity
business and on the allocation of resources
■ analyse the performance of government
in t he economy
business enterprises .
■ Evaluate t he role of soc ial welfare for an
ageing populat ion
■ Investigate alternat ive sources of revenue
for governments .

Econo mics Stag e 6 Syllabus 2009 extracts © NSW Educ ation

Standard s Aut hority for and on behalf of the Crown in rig ht of the
State of New South Wales, 2009; reproduced by permission.
Topic 6

Introduction
Econom ics is a scien ce that examines how societies attempt to solve a basic human
d ilemma: how we sat isfy our virtua lly unlimited wanes w ith the limited resources availab le
to us. As the study and pract ice of econom ic theory has deve loped , especially over the past
two centuries , the app roach adopted co deal with this dile m ma has often changed. Di fferent
ideas about how best co solve the economic prob lem have clashed, and these debates have
spilled over from the battleground of ideas into parliaments and boardrooms , onto social
media and onco the streets , often dividing polit ical parties and dividing nations. The second
half of the twenti eth century was dominated by the clash of capita lism and commu nism,
between the superpowe r blocs led by the Un ited Scates and the Soviet Union , represent ing
starkly different app roaches co solving the economic prob lem. Early in the twenty-first
century, we still hear the echoes of the conflicts of the twentieth cent ury, so many of wh ich
were about competing answers ro the economic problem .

Yer, today there is probably more common grou nd betwee n nat ions tha n ever before about
solving the econom ic p roblem . Most nations adopt an approac h based on the operat ion of
markers, where the ch oices of indivi duals determ ine whar goods and services are produce d ,
and businesses determi ne how co produce those goods and services. On the surface at lease,
the argument for the market-based app roach appears ro h ave won the battle of ideas of the
twentieth century, and almost all nat ions now focus on ihow they can make their market
economy work well.

However, if we scratch beneath the surface we soon find char debates about many issues
are sti ll raging . Why crust the experts who support free tra de and global isation, if chat
only makes some richer at the expense of others;, Shou ld we really leave all of the major
choices about the operat ion of the economy ro indiv idua ls, who are only acti ng in their
own self-inte rest' How do we ensure chat we have things co share togethe r as commu n ities,
like parks and facilities' How much do we need co p rot ect peop le from unsafe p roducts
and d ishonest bus iness cond uce? What is the app ropriate role for govern ments co play'
In orh er words, we cry co identify the c;ircumscances and rhe best responses when markers
fail ro de liver sat isfactory ourcomes.

Stu dying economics allows you ro understand these issues, and see how different countries
find answers co these p roblems. Throughout the Prelim inary Course, our focus is co
understa nd the role of markers in answering the economic p roblem . We have looked at
the deta il of how they operate, and the d ifferent roles played by consumers , business,
govern ment and other organisations. We have also made some comparisons of d ifferent
approaches ro solving the econom ic prob lem.
 Topic 6: Governm ent and the Market Economy

Up unti l now, in ga in ing an overview of how a market economy works, th is book has
looked at ge neral market pri ncip les and take n two key elements of rhe market economy
- labour markers and financial markets - as detailed stu d ies of how ma rkets work . We
saw char in both cases, if markers were left to themselves , they could produce some major
prob lems - unfair pay and harsh working cond it ions in the labour marker , and peop le
losing their savings because of badly manage d banks in financial markets . Governme nt s
intervene substa nt ially in both types of markets in orde r to achieve better economi c
results rhan what wou ld be achieved by the marker alone . Opin ions about rhe extent of
government int ervention in markers have change d over the years. In rh e final quarter
of the twenti et h century there was a m arked shift away from government interve nti on .

In this final section we focus specifica[ly on rhe role chat govern ments play in influencing
markers.

Chapter 14 looks at some of rhe prob lems chat occur when an economy relies on market
forces alone to determine outcomes of pro duction, dist ribut ion and consumpt ion. Markets
can fail by producing roo much or too little of a good or service, by concent rating market
power in the hands of a few firms , by causi ng environmenta l damage or by creating unfair
or unstable outcomes.

Chapter 15 examin es rhe role chat governments aim to play in ma.rker econom ies,
in clud ing an overview of the d ivision of power between the d ifferent levels of govern ment,
t he relationsh ips between them, and rh e overall size of the publ ic sector. We review rhe
policy options availab le to rhe governme nt ro addr ess different kinds of marker failure
and how this impacts upon resource allocation, income d istribution and the economic
performa nce of the Austra lian economy.

Chapter 16 examin es some of the methods chat govern ments use ro improve market
outcomes, with a particula r focus on the federal government's budget . We consider how the
government gene rates revenue, ident i fies its spending priorities and changes the budget
outcome to achieve irs objectives . Chapter 16 concludes with a d iscussion of the factors
t hat influence the p rocess of maki ng government po licy in Austra lia.
 The Limits
of Markets

14.1 Why governments intervene

14.2 Market failure in the provision of goods and services
14.3 Market failure in income distribut ion
14.4 Market failure in externalities
14.5 Market failure in the abuse of market power
14.6 Market instability: the business cycle

14.1 Why governments , intervene

T he free operation of market forces does not always achieve the most desirab le econom ic
and social outcomes . Under a complete ly free marker (laissez-faire) system , some important
com mun ity nee,ds and wants may nor be satisfied. Some individuals may be unable to
earn enoug h money co live, and inequal it ies between people and regions may worsen . Ar
rimes, the marker may cause econom ic instab ility. Because of these factors, the governme m
intervenes in rhe marker in order co achieve a better allocation of resources, a more
equitab le d istri b ution of income and greate r econom ic srabi lity. This chap ter exami nes
rhe lim its of th e operat ion of rh e free marker, while Chapter 15 considers rh e role of
govern ment int e rvention.

T he main po int in th is chapt er is that markets are not perfect. Th ey are very effective ar
determi n ing what goods and services our economy produces, in what quantit ies and how
production is organised. No othe r system of econom ic coordination has produced the level
of prospe rity, inn ovation and satisfact ion of mate rial wanes that we enjoy today. But not
all economic decisions can be left to market forces. Marker s consider private economic
interests, nor b.roader social inte rests. We live in a society, not jusr an economy. We
need governm ents, nor only co help mark ers funct ion , but to sometimes change marker
ourcomes when they are not sarisfacrory. Th e challe nge is co find rhe right balance. Too
mu ch gove rnm ent intervent ion may stifle innovation , efficiency and grow th. Too little
may leave us exp osed co instabi lity, inequality and a lack of basic community facilit ies.

Th e p roblem that economises call ma r ket fai lu r e occurs because the operat ion of market
forces creates unfavourab le or inefficient outcomes. Mark et failure can arise in the prov ision
of goods and serv ices, income distribution, externaliti es, the abuse of mark er power and
economi c instability . Governments seep in co solve problems caused by market failure.
 Chapter 14: The Limits of Ma rkets I
"There are some things that money can' t buy, but these days, not many... We live at
a time when almost everything can be bought and sold. Over the past three decades,
markets - and market values - have come to govern our lives as never before ... The
reach of markets, and market-oriented thinking, into aspects of life traditionally governed
by non-market norms is one of the most significant developments of our times.
"Consider the proliferation of for-profit schools, hos pitals, and prisons, and the
outsourcing of war to private military contractors ... Or conside r the pharmaceu tica l
companies' aggressive marketing offprescription drugs to consumers in rich co untries ...
[The] uses of markets to allocate health, education, public safety, national security,
criminal justice, environmental protection, recreation, procreation and other soc ial goods
were for the most part unheard of thirtyyears ago. Today, we take them for granted.
"Why worry that we are moving toward a society in which everything is up for sale?
For two reasons: one is abo ut inequa lity; the other is about co rruption ... as money
comes to buy more and more - politica l influence , good medica l ca re, a home in a
safe neighbourhood rather than a crime-ridden one, access to elite schools rather than
failing ones - the distribution of income and wealth looms larger and large.r. Where all
good things are bought and sold, having money makes all the difference in the world ...
"The great missing de bate ... is about the role and reach of markets. Do we want a
market economy, or a market soc iety?"
-Michael Sandel, Harvard University Professor of Government,
What Money Can't Buy: The Moral Limits of Markets, 2012

14.2 Market failure in the provision of

goods and services
T h e market may fail to provide certai n necessary goods and services ,
or it may be more desirab le rhar they are nor prov ided by rhe pr ivate The two
charac ter istics of
socto r. Goods and services wirh public good characte ristics are one
pub lic goods are
such area of marker failure . A publ ic good is a good which, once that they are
prov ided, is difficu lt to prevent anyone from using, regardless of non-excludable Free riders are groups
or individuals who benefit
wh ether they pay for irs use. Examples of pub lic goods includ e clean and non-rival .
from a good or service
air, street lighting, nat ional defence and pub lic par ks. If it is nor without contributing to
poss ibl e to exclude people from rhe benefits of these goods, it will not be poss ibl e ro the cost of supplying the
co nvince peop le to pay for them. good or service. As a
conseque nce , the good
In orher words, pub lic goods are non-excludab le and will attract free r iders who benefit or service is Iikely to be
wi thout contribut ing towards their costs. Clearly, there is no incentive for firms to produce under-supplied in relation
t hese goods if consumers wi ll not pay for them. As a resu lt, a free market is like ly ro to the total demand.
unde rsupp ly a public good relative ro demand for that good, or no t supp [y a pub lic good
at all. For th is reason, the governme nt ge nerally provides public goods.

Public goods are also n on -rival-rhar is, one perso n 's enjoyment of a public good does not
d imin ish the potentia l for others to also enjoy the good. If the government spend s money
on pollution cont rols and environmenta l policies to improve air qua lity in a city, this
benefit is valuab le ro everyo ne and one perso n's enjoyment of clean air does no t dimi n ish
t he next person's. The same might be said of orher publ ic goods, such as street
lig ht ing and pub lic broadcasting . "No we can't.
I went there yesterday
Markers may somet im es produce an inadequate quantity of an so now it's all used up
and there'sno part(
item, such as health care or art . These items are known as left . Sony!
me rit goods, because they have ben efits ro the commun it y
t hat go beyond the indiv idual who enjoys them d irectly.
A high-quality health care system and a p lace for pe rforming
arrs such as rhe Sydney Opera House are both considered
to be mer it goods in that rhey benefit the who le society.
Governme nt s play a role in prov iding mer it goods, eithe r
d irectly (th rough operating or fund ing mosr hospitals) or
ind irectly (th rough financ ial support for arts groups).
I
The Ma rk et Econo my 2020

Just as the market sometimes produces too lictle of an item, it may also p roduce too much .
Items char bring harm co the commu n ity are known as demeri t goods, and these include
tobacco, alcohol, addictive drugs and gambl ing . Because these items have negative effects,
the ir p roduct ion and sale may be restricted (for examp le, a license co sell alcohol, and fines
for supp lying alcoho l co peop le und er 18 years of age), heavily taxed (as wich tobacco and
gambling) or comp lete ly prohibited (such as dangerous illicit drugs).

Governments p rovide a range of collective goods and services char benefit the who le
commun ity. For exampl e, the government provid es a defence force because national defence
would not be provided by pr ivate enterprise , nor wou ld it be desirable for it to be in private
hands. Other examp les of collective goods provided by government include education, heal eh
services, roads, railways, national parks and historic monum ents. Not all collective goods
provided by the government are publ ic goods - for example, a pub lic transport service is
not a publ ic good because peop le have ro pay co use it, making ic excludable.

Governments somet im es prov ide goods by operati ng as a natura l monopo ly. A natu ral
mo n op oly is a market structu re in which goods ca n only be efficiently provid ed by one
supp lier, usually because an enormous investment in infrascructure is required . A natura l
monopoly occurs where it would be inefficient for compecicion ro operate . Exampl es
includ e rail networks, because of the huge investment in buying land and laying down
rail crack, and wacer and electricity distribution networks, because of the cost involved in
pip ing wate r and distr ibuti ng power to homes. Governments may maintain ownership or
regu late monopolies because of concerns that private owners wou ld have monopoly power,
leaving consum ers with little choice bur ro pay whatever price che monopo list sees for
the ir good or serv ice. Governments char operate natura l monopolies generally cry co sec a
fair price char ensures consumers cover che costs of providing the good or service bur are
nor exploited by excessive pr ices.

The ABC: an example of a public good

The Australian Broadcast ing Corporat ion is one of Australia 's best known and widely trusted
institut ions. Surveys by Roy Morgan and Essential Med ia in 2018 found that 54 per cent of
Austra lians express t rust in the ABC, ahead of all other med ia organisations; the only institut ions
with higher publ ic trust levels are the police and the High Court . It is also, in econom ic terms,
an unusual examp le of a publ ic good . The ABC was founded in 1932, and it now includes four
d igital television channe ls, three Aust ralia-wide radio netwo rks, 53 local radio stations and
one of the country 's most popu lar websites. The ABC's ro le, acco rding to its legislation, is to
provide "innovat ive and comp rehensive broadcast ing services ... that cont ribute to a sense
of national identity and inform and enterta in, and reflect the cultural diversity of the Australian
commun ity" - in other words , publ ic good benefits .
The existence of the ABC demonstra tes that the med ia is more than just another business. It is
important for democracy and good government that peop le can access accurate and reliable
media reporting. This is expensive, and commerc ial broadcast ing networks may be reluctant
to invest the money requ ired for investigat ive journa lism , regional coverage and quality cont rol.
Although there are co ncerns from time to time about government intervent ion, overall the ABC
operates independently, which can reduce the risk of bias arising from the comme rcial interests
or editorial views of media proprietors .
The ABC also provides a broadcas ting service throughout the entire country, includ ing to areas
where it is not profitable for commercial media to operate. For this reason, the ABC is particularly
important to regional Australia. The ABC invests in local drama product ion, and provides training
for many journ alists who later work in commerc ial broadcasting or newspape rs. Overall, the
ABC performs a wide range of funct ions that would be unlikely to happen in its absence. The
national audience ac ross the ABC 's television, radio and on line channels in any one week was
estimated at 70 per c ent of the adult population on average in 20 18.
 Chapter 14: The Limits of Markets I

1 List TWO examples of a public good and TWO examples of a merit good in
your local community.
2 Outline the government's role in the provision of public goods and merit goods
in the economy.

14.3 Market failure in income distribut.ion

Whi le rh e marker economy is generally efficient in answering rhe question of what and
how ro produce, th is will often involve social costs. Left ro operate without any governme nt
inr ervention, free markets tend to produce substa nti al inequality in the d istribution of
in come. Ofte n , this inequa lity will widen over rime, because once peop le b ecome wealthy,
t heir wealth rend s ro gene rate more wealth. Once they own land and resources, wealthier
peop le rend ro become more wealthy because rh ey can earn rent and inte rest from their
Relative poverty refers to
factors of production, and from rh e growth in the value of the ir investments. Simi larly,
those whose standard of
t hose who hold wealth are likely ro have rh e greatest opportunit ies for develop ing their living is substant ially lower
ski lls and finding rewardi ng employment. than the average fo r the
econo my as a who le, and
T h ere are particular g roups with in Ausrra lian society char are susceptib le co inequality and is often defined as a level
pove rty. Th ese di sadvanta ge d g rou p s inclu de chose with low ed ucation levels, migra nt s of inco me below 30 per
from non-E nglish-speaking backgrounds, Indigenous Australians and sing le-parent cent of average earnings.
fam ilies. In Austra lia, rh e most common form of poverty is relat ive p ove r ty, whereas few
peop le live in ab so lute pov er ty . Abso lut e poverty refers ro a situation whe re individuals
have only just enough incom e ro enab le chem ro surv ive, whereas relativ e poverty refers
ro the living standards of rhe poor in compa rison with the rest of rhe popu lation.

Inequality can easily become entre n ched in a marker economy. For examp le, a chi ld
growing up in a low-income family may nor have the access ro the same educat ion or
job opportu n ities as a chil d in a wea lthy family. T heir parents may have less education
and may nor be as ab le ro help with hom ework. Financial pressures may mean char their
parents cann ot afford ro suppo rt chem ro the end of th eir high school educat ion or th rough
unive rsity, and rhe fear of a large student debt may deter chem from furthe r stu dy. Without
furthe r education or tra in ing, they risk being stuck in lower-pa id jobs for all of their life.

Governme nt s can act constructively i n this situation. Wh ile they can n ever remove all
t he factors char cont ribute ro inequa lity, they can imp rove opportu ni ties for people in
d isadvantaged g roups. Univ ersal access ro free ed ucation unti l the completion of high
school, special educationa l assistance programs and scholarships, living allowances for
stu dents, and measures ro help mature-age peop le ent er high er ed ucatio n are all ways in
wh ich govern ments can help address rhe effects of income inequal ity. Th ese measures can
improve social mob ili ty (t hat is, reduce rhe extent ro which peop le who are born int o a
pa rticu lar socio-econom ic class are likely ro stay there all the ir lives).

Concern over economic inequa lity was a major reason why rh e role of governments
in. economies expand ed greatly during the twentieth century. In rh e aftermath of rh e
Depression and rh e Second World War, industrialise d countries such as Austra lia
esta blished a "we lfar e sta re" - a comprehensive system of welfare ben efits such as rh e
age pension, unemployment benefits , free access ro health care, and subs id ised access ro
orher government services such as transport and housing. Th e welfare state was intended
ro create a more equa l society.

T h e welfare state grew th roughout th e second half of the twenti eth cenmry, owing to an
ageing population, much high er levels of unemp loyment , an increase in sing le-parent
fam ilies and highe r numbe rs of stud!ents in tertiary educat ion . By rhe 1980s, rh e cost
I
The Ma rk et Econ om y 2020
Externalities are external
costs and benefrtsthat
private agents in a market
do not consider in their
decision-making process.
For example, airlines
and passengers do not
consider aircraft noise
when negotiating airfares.
Ill
of social security programmes was rising and chis was attract ing a back lash from peop le
arguing char the welfare system was coo gene rous and char ic was creating incentives co
drop out of the labou r marker. As a result, govern m ents bega n co reduce welfare benefits
and imposed obligations on people receiving incom e support co keep apply ing for jobs,
co enro l in train ing or co partic ipate in work schemes. Welfare benefits for ouc-of-wo .rk
peop le of worki ng age have gra duall y become more restricted in recent decades. Ac t he
same time, gove rnm ents have increased fami ly benefits payments co Austral ian hous eholds
and che ageing populat ion has increased the cosr of che age pension . Th e government's
role in redist ribut ing income remains one of ics mosr impo rtant functions in the economy.
1 Dist ingu ish betw ee n ineq uality and poverty .
2 Outlin e met hods availa ble to t he governm ent to influence the distribut ion of
income in th e economy .
3 Explain how th e free market can cont ribute to income ineq uality.
14.4 Market failure in externalities
Markers cake inro account the economic and social concerns of the ind ividua l selle rs
and buyers, bur do not account for any side-effects chat are nor di rectl y reflec ted in che
price mechanis m of supp ly and demand . In reality, an exchang e in the marker economy
will often affect people othe r chan chose who are involved in the transaction . Because
these conseque n ces affect chose "outsid e" che transaction, they are called ex tern alities .
Excernali cies are a form of marker failure because they occur where che p rice mechanism
fails co represent the true social coses or benefits of production.
Somet imes exte rna lit ies can de liver benefits co th ird parties, and th ese are called posit ive
externali ties . For examp le, if an eco-courism business cleans up a po lluted river in order
co offer whicewacer rafring expeditio ns, th is will create a positiv e exte rnal icy. All membe rs
of che public visiti ng che area can benefit from tlhe cleaner water as a resu lt. Anoth er
example is how the who le economy benefits from h igher labour productivity as a resl.lllt
of increased completion races for un iversity students and for app rentices hips.
Nega tive exter n alit ies, on che other hand, have harmfu l effects on the economy and on
society. Usua lly when we calk about negative externalities we are look ing at che adverse
spill-over effects char production and othe r economic activ ities have on the environment .
A commo n form of excernalit y is po llu t ion , which occurs when the natural environme.nt
is degraded in some way. For examp le, a compa ny ma y decide co reduce its freight coses
by transpo rting its goods by road rather than by rail. Th e use of semi-trai ler trucks may
result in subscancial damage co roads in char area and add co noise and air pollution. 1n
turn, chis may cause damage co cars because of pot holes, loose scones and increased risk
of accidents, d iscomfort through noise levels of trucks, and respirato ry probl ems from
worsened air quality. In this sicuacion, che comp any generates a negative excernality,
because society bears the cost of the damage co che roads, che noise and che air pollut ion .
Environm enta l damage is one of the most important' negati ve excernalicies of the operation
of the free market .
Exampl es of negative externa lities in Austral ia include:
• contr ibucion co increased carbon dioxide and global warm ing caused by the burning
of fossil fuels, such as from coal-fired power stations and motor vehicles
• the loss of biodiversity that occurs because of land clearing (for examp le, for
agr icultu re, forestry produces, or excavations mad e for mini ng operat ions)
 Chapter 14: The Lim its of Markets I
• soil erosion and increased soil salinit y relate d to forestry and farm ing pract ices
• water po llut ion resultin g from t he d ischarge of chem icals and waste p rod uct s inro
river systems related to m ining and agricul tural operati ons.

1 List TWO nega tive exte rnalities assoc iated with the prod uct ion or u se of motor
veh icles .
2 Expla in how external ities arise in a market economy .

Climate change:
a negative externality
Climate change is recogn ised as one of the greatest long-term
challenges facing the global economy. Scientists believe that climate
change is caused by human act ivit ies that result in the emission
of greenhouse gases such as carbon d ioxide (CO2) . Whenever
fossil fue ls such as coal, gas or oil are burned for electric ity or '--""" --..._
transportat ion, they emit carbon dioxide, cont ribut ing to climate
change . Ot her causes of climate change include deforestation and
some agricultural pract ices and indust rial processes .
Acco rding to the United Nations' Intergovernmenta l Panel on Climate Change , which
brings together the world's leadiing climate scientists, global temperatu res are on
cou rse to increase by 2°C in the next two to three decades as a result of climate
change , cont ribut ing to an increase of between 3 and 6°C by the end of the century.
This will result in rising sea levels , increased droughts , increased heatwaves, more
unpredictable weather patterns and a greater incidence of d iseases such as skin
cancer.
Climate change is a typical examp le of a negative externality. While ind ividuals and
businesses pay the market price of energy product ion and other activities that produce
carbon diox ide, th is only reflects the private costs faced by compan ies in produc ing
such energy. Individuals and businesses do not pay for the long-term cos t imposed by
energy use - greenhouse gases and climate change . Because individuals do not feel
the impact of the ir cho ices on climate change, they are less likely to make consc ious
cho ices to use more environmentally friendly sources of energy.
Government policies aim to ensure that externalities are reflected in the costs
of specific goods and services, so that the price mechanism can reflec t the true
econom ic and soc ial costs of product ion. Several of the policies that governments
have implemented to address climate change have sought to intervene in the price
mechanism to reflect the cos ts of carbon emissions. One example was the carbon
tax that was in operation between 20 12 and 20 14, which imposed a price on carbon
emissions for the 500 largest poll uters in Australia.
As part of the internat ional Paris Agreement , the Aust ralian Government comm itted
to an emissions reduction ta rget of 26-28 per cent on 2005 levels by 2030. Initiat ives
to achieve this target focused on the energy secto r have proved cont roversial. Two
examp les of policies proposed by the Government but then abandoned are a Clean
Energy Target which would set an annual ta rget for low emissions energy generation,
and a National Energy Guarante·e, which would set dual requirements for energy
providers to meet Aust ralia's emiss ion reduct ion target, and minimum requirements for
reliable energy supp ly. As the need for emissions reduct ions becomes more pressing
in the 2020s , Aust ralia is likely to see many more market interventions to address the
externality of carbon emissions.
I
The Market Economy 2020

14.5 Market failure in the abuse of

market power
Because of the coses involved in p roducing, disrr ibur ing and market ing goods and services
in some markers, only a small number of firms wi ll surv ive. This may create a market
srrucrure where there is imperfect competition - whether in the form of an oligopo [y,
monopoly or a monopo lisrically competitive structure. In this marker situat ion, the market
will produce a sm aller quantity of goods at a highe r price. For examp le, a monopolist wi ll
often restrict its production in order ro charge a h igher price and maximise its profirs .
Simi larly, oligopolisrs may find chat engag ing in price competit ion is futi le, since their
compet itors are likely ro march any price curs . Instead of reduc ing prices, they will
compete with advert ising, brand packaging and produce differentiation - acrivir ies char
hold little real benefit for consume rs.

Firms in highly · concentrated industries possess substantial market power, which makes
ir easier for rhem ro explo it their customers. Some of the ways in which firms may abuse
the ir market power include:
• Mon op ol isacion , which occurs when a firm uses its dom inant market position co
elim inate existing competition, or prevent new firms from entering the marker. For
example, it m ight engage in temporary price cutting rhar is aimed at eliminat ing
compet ition, rathe r rhan beneficing rhe consumer . The government has histo rically
operated many monopol ies in Austral ia in order co p rotect consumers from rhe
Visit the webs ite of the abuse of m onopoly power by private firms.
Australian Competition &
Cons umer Co mm ission
• Pri ce di sc rimi n at ion , which occurs when a firm sells rhe same type of good or
(ACCC) - service in different markets at d ifferent prices. Examp les of pr ice d iscriminat ion
the gove rnment agency include peak and off-peak pr icing for telephone calls, "early-bird" pricing for airl in e
whose role is to protect tickers, as well as concession p rices for movie tickers offered co students . In each of
consumers from the
these examp les, businesses attempt ro charge different prices ro different consumers
abuse of market powe r
by businesses - at
according co their wi lling ness and capacity co pay. Generally, a firm wi ll attempt
www .accc.gov.au co charge highe r prices co consume rs chat it be lieves have a highe r willi ngness and
abi lity co pay, bur lower prices co consumers chat it chinks are less wi lling and ab le
Exami ne a rece nt
activity of the ACCC , co pay. The g reater the deg ree of marker powe r enjoyed by a business, the g reacer
identify ing t he reasons the ability for the firm ro engage in this prac tice .
for interve nt ion , and
the act ions take n by
• Excl usive d eali ng, which occurs when a firm sers condit ions for supply chat
the A CCC to add ress exclude retailers from deali ng with othe r competito rs. Under the Competitionand
market fa ilure . ConsumerAct 2010, supp liers are p rohib ited from imposi ng on their customers an
obl igat ion not co purchase goods or services from other supplie rs. This prohib ition
is enforced srricdy by che Austral ian Competition and Consumer Commission
(ACCC). The ACCC and rhe Competitionand ConsumerAct are d iscussed in further
deta il in Chapte r 15.
• Collu sion and ma r ket shar in g, which occu r when firms gee rogerher and agree
on a pricing and market-sharing arrange m ent (often known as a carte l) chat
reduces effect ive compet ition betwee n rhem , and rends co inh ibit rhe entry of new
compet ition into the market. Carte ls may attract cri minal pena lties under t he
Competitionand Consume,·Act.

1 Outline the impact of a firm's misuse of market power on consum ers.

2 Propose TWO po licies the government could use to reduce the abuse of market
pow er by ifirms.
 Chapter 14: The Limits of Marke ts I

ACCC cleans up
detergent cartel
One of the mos t impo rtant cases of ant i-competi tive
conduct by major Australian bus inesses began with
a series of friend ly soc ial phone calls between the
heads of Australia's leading dete rgent makers which
became the means for sharing confident ial pricing
informa tion and d riving up profits at the expense
of consume rs .
As a resu lt, the ACCC filed c ivil proceed ings in the
Federal Court, alleging tha t illegal cartel conduc t had
been undertaken by three majo r laundry detergent
producers , Colgate, Cussons and Unilever, and the
Australian superma rket Woolwo rths . Those three
compan ies own 83 per cent of Aust ralia's laundry detergent industry (with popu lar
brands such as Cold Power, OMO and Radiant), a market that turns over nearly
$500 million per year in sales. Th e ACCC c laimed that the produce rs colluded to
stop sell ing standard liquid concentrates in favour of "ultra concentrates ", which
cost less to produce . However, t hey agreed not to change prices, in a de liberate
act to avoid pass ing sav ings onto consumers and boos t prof its .
Agreements between compet ing producers to maintain certa in price or supp ly levels
(known as price or supp ly fix ing) are cons idered anti-compet itive conduct , and are
proh ibited by the Competition and Consumer Act (2010). The Federal Court in 2016
ordered Colgate to pay $18 million in fines and pay $450 ,000 towa rds the ACCC's
legal costs (Unilever was given immunity in exchange for provid ing evidence for the
prosecu tion). Woolworths was also imp licated for its phasing out of the standard
dete rgent concentrates , and was ordered to pay $9 mill ion fo r know ing ly engag ing
in anti-compet itive conduct.

14.6 Market instability: the business

cycle
In examinin g mark er failure in this chapter, we have so far looked at specific proble ms in
Business cycle refers to
ind ividual markets char operate withou t fluctuations in the level
gove rnm ent intervention. Th e final Output of economic growth due
example of mark er failure occurs at a to either do mesti c or
much broader level, across rh e ent ire international factor s.
economy. Thi s is the problem of the
boom-bust behaviour of economic activity
in the business cycle, shown in Figure
Boom Recession
14 .1, which can create sig nifi ca nt
economic problems. Th e business cycle
, '' , '\ Economic growth trend
describes rh e t end ency of economic ,
g rowt h rates in a mark er economy co
fluctuate between boom periods of hig h Time
economic g rowt h and bust periods of
ha rsh recession. Figure 14.1 - The business cycle

Wirhour any govern ment intervention,

a free-mark et economi c sysrem is likely to experience severe flu ctuati o ns in rhe level
of economic activ ity, making it difficult to achieve the governm ent's goal of sustai n ing
econom ic growt h . Market forces can br ing on boom per iods where excess dema nd for goods
I
The Market Economy 2020

and services causes price increases (infla tion ), which brin gs substantial economic prob lems.
High inflation can disrorr business decision maki ng, reduce consu mers' purchasing powe r
and force an increase in inte rest rates, wh ich can rh en cause a recession - a severe downturn
in the level of economic act ivity. Recessions increase unemploy ment, business failures and
othe r econom ic and social problems.

In order ro achieve a stro ng and stab le level of economic growth , and ar the same rim e
minimise the harmfu l effects of inflation and unemp loyment, the gove rnm ent int ervenes in
our economy through what are known as econ omic sta bi lisat ion pol icies. Th ese pol icies,
also known as mac roeco n omic po licies, include fiscal po licy and m on etary po licy. T hese
pol icies aim ro he lp the economy maintain a susta inab le rare of economic growth .

Govern ment Govern ment

macroeconomic microeconomic
polic ies polic ies

Ill Entire economy

Individual fi rms
and industries

Ill Fiscal policy

Monetary policy

Figure 14.2 - Government polic ies

Competit ion policy
Trade policy

Th e aim of macroeconom ic policy is ro count erba lan ce rhe busi ness cycle so as ro stabil ise
rhe level of economic growt h . D uri ng periods of excessive g rowth, where there is a risk
of high inflation, rhe gove rnm ent cries ro reduce econo mic act ivity by spending less,
increasing taxac ion or raising interest rates. By slowi ng down a fast g rowth rare, the
gove rnm ent aims ro keep rhe economy growi ng for longe r. Similarl y, if rhe econom y is in
recession , the gove rnm ent tries ro stimulate growt h with increased gove rnment spending,
rax curs and low interest rates. In thi s way, the gove rn ment arremprs ro smooth fluctuatio n s
in rh e bus iness cycle and promote long-te rm sustai nable grow th. Macroeconomic pol icy
measures are therefore designed ro have an impact on the economy as a who le.

Th e govern menc also uses microeconomic reform po licies, which are designe d ro improve
work pract ices a.nd productivity levels with srrucrura l adjustment of individua l firms and
industries . In the next rwo chap ters we will examine how government pol icies of both
t ypes, shown in Figure 14.2, operate in a marker economy.

1 Identify THREE economic problems associated with large fluctuations in the

business cyc le.
2 Distinguish betw een the roles of macroeconom ic and microeconom ic policies.
3 Outline THREE act ions the government co uld tak e to stab ilise the economy in a
boom period .
 Chapter 14: The Limits of Markets

1 Market failure occu rs whe n markets operating without governm ent intervention
produce outcomes that are inefficient, unfair or create instability. The government
intervenes in the market to deal with the prob lems of market failure.

2 A major way in which governme nts deal with market failure is to provide public
goods . These are goods that are desired by the comm unity but will not be
provided by business firms because consumers do not have to pay for these
goods to receive their benefits .

3 Governments may encourage the production of merit goods , wh ich are goods
that w ill not be produced in sufficient quantity because of markeit imperfecti ons.
Merit goods include educat ion and health care.

4 A natural monopoly may exist where it is only feasible for there to be one
producer in certain markets. The government often operates or regulates these
monopo lies, in order to reduce the exploitat ion of market power.

5 A major reason for government intervention is to redistribute income to lower-

income earners to ensure that they enjoy a reasonable standard of living.

6 Externalities are costs and benefits of production that are not 1reflected in the
demand and supply forces of the market.

7 Without government interventi on, firms can behave in a way that is harmful to the
interests of consume rs, such as by collud ing to raise prices, charging excessive
monopo ly prices, engaging in exclusive dealing or price discrimination.

8 The government may reduce the abuse of market power th rough regulatory
bodies such as the Australian Compet ition and Consumer Commiss ion (ACCC).

9 The business cycle refers to the pattern of econom ic growt h, w hich over time
tends to fluctuate between periods of strong econom ic growth and recession.

10 The government can intervene in the business cycle by implement ing econom ic
stabilisation polic ies. These are called macroeconomic policies .
The Market Economy 2020

1 Define the economic meaning of market failure.

2 Distinguish between public goods and merit goods .

3 Exp lain why a market economy might fail to prov ide publ ic goods w ithout
government intervention .

4 Define what is meant by a natural monopoly . Give some examp les of natural
monopol ies in Austra lia.

5 Discuss the impact of government intervention on the distr ibution of income in the
Austra lian economy .

6 Define externalities . Outline how the government might reduce negative

externalities in the Australian economy.

7 Define each of the followi ng types of business conduct:

a) monopo lisat ion
b) price discr imination
c) exclusive dealing
d) collusion and market sharing.

8 Explain what is meant by the business cycle.

9 Examine why the fluctuatio ns of the business cycle can have adverse effects on
the economy .

10 Discuss how the government might reduce the fluctuat ions of the business cycle.

Extended response
Outline the limitations of the "free market". Discuss tihe ways that the government
could intervene in the market to reduce these limitations. Assess whether the
government has been successfu l in responding to these limitations.
The Role
of Government
in Australia

15.1 The structure of governme nt

15.2 The public sector
15.3 The reallocation of resources
15.4 The red istribut ion of income
15.5 Stabilisation and sustainab le growth
15.6 Public enterprises
15. 7 Other roles in t he economy ·

15.1 The structure of government

Governments intervene in rh e economy ro improve on mark et ourcomes, as d iscussed in
t he prev ious chapter. To und erstan d rhe role of government in rhe market economy in
Australia , we first need co understand how governments in Austra lia op erate and what
t hey do .
As figure 15.1 shows, Australia has a three-tiered srruccure of govern ment:
• rh e Commonwealth (or Federal) Government, wh ich has overall responsibility for rh e
economy and has the mosr influence on economic performance
• state governm ents (plus rh e Australian mainland's
rwo self-govern ing terr itories, the Austra lian
Capita l Territory and the Northern Territor y), which
p lay important roles in deve loping infrasrrucmre, The CommonwealthGovernment
delivering govern ment services (such as health and
education) and fostering regional developm ent
• local governments, whose role relates mainly co
local p lann ing, community facilit ies and roads.

Aus tralia has had a federal system of govern ment

sin ce it became a nation in 1901. Und er the
Australia n Constitution, rhe centra l Commo nwealth
Government and the stare gove rnm ents are
ind epende nt of each other, and have d ifferent roles,
alchough they often work rogerh er. In add ition, the
scare govern ments further delegate the ir powers
co local governments, although their role is not Figure 15.1 - The structure of government in Aust ralia
m entio ned in the Consricucion ..
I
The Market Economy 2020
The Australian
Constitution is
the docu m ent that
provides the overall
framework for Austr alia's
system of democrat ic
governmen t and the
relatio nship between the
Commonwealt h (or federa l)
and state governments.
The Australian Constitution sees out the law-making powers of the Commonwea lth and
srate governmems. It sers out the absolute lim its on what governments are able ro d!o.
The Commo nwea lth Government is only able co ace under one of what are described as
constitut ional "heads of power", such as rhe power co make laws rela ring ro foreig n affairs,
defence and the currency. Scare governments hold all othe r powers char are nor spelt our
in the Consti tu tion as belonging ro rhe Commo nwealth . The Commonwea lth shares
responsibility with the sraces for mosr econom ic matters , such as busi ness regu lation,
raxacion, health and education.
The power of the Commo n wea lth Gove rn me nt has gradua lly increased in most areas
since Federat ion . Th is has reflected the evolution of Aust ralia into a single national
economy, with a national approach ro economic issues such as busi ness regulation an d
raxarion . During rhe past century, rhe High Court has adopted an increasingly expansive
inte rpretat ion of rh e scope of the Commo nwealth's heads of power,
allowing the Commonwea lt h ro become increasing ly powerful.
T here have been many comp licated legal arguments about how
the wordi ng of the Constitut ion shou ld be inte rpreted . Much of
this debate has arisen from tensions between the Commo nweal,rh
and state governments.
Over rime, scares have handed more power over co th e
Commonwealth, bur scares play a very important part
in government in Austra lia. When the Commo nwealith
Government wants co implement major economic changes ,
it often needs co secure the support of the states. Recent
years have seen the Commonwealth and scares engaging in
extensive negotiat ions over energy pol icy, indigenous affairs,
school funding and health service delivery. The ma in effect of constitut ional constraints
is that the Commonwealth Government is forced co negotiate with stare and territory
governments when they implement major economic reforms, and gaini ng suppo rt from
six state govern m ents can be difficult .
Whi le scares have a more lim ited role in nat ional economic managem ent, rh ey have
extens ive respon sibilities for the delivery of many government services. Stares operate
rhe health system (althoug h the Commonwea lth has a major role in funding health care
th rough the Med icare system), school education, and infrastructu re such as roads, th e
transport system, electric ity and water utilit ies, and regiona l plann ing . As a result, they
often understand the specific needs of the ir cit ies and regions best.
T he single largest source of revenue for state governments is the Goods and Services Tax,
wh ich is collected by the Commonwealth and then distributed to rh e scares th rough a
comp lex formula (the derails of which are often contested). States rely on other d irect grants
from the Commonwea lth for specific programmes (such as health) under arrangements
chat extend back ro rhe Second World War, when rh e Commonwealth Government cook
over all income t axation powe r from rhe states. As a result , Austra lia has what econom ises
describe as a "vert ical fiscal imba lance", in which rh e Commonwealth has most raxarion
powers whi le t he sraces srill have many expenditure responsibilities. As a result, besides
grants from the Commo nwealth, the state governments have had ro rely on a patchwork of
taxes such as payro ll tax, stamp dury, licenses, and taxes on gamb ling and land ownership.
In recent years, ,rhe NSW Government has sold or leased government assets ro fund large
investments in infrastructure - a p rogram known as "asset recycling".
 Chapter 15: The Role of Govern ment in Austra lia I
T he major items of ex p en ditu r e for ,che NSW Government are shown in figure 15.2.

Environmental protec tion 2% ~

Recreation , cultu re
and religion 2%

General pub lic services 9 %

Social protectio n 9%

Public order and _

safety 10% - Educat ion 22 %

Transport 13 % -

Source: NSW Budget Papers 201~20 Tab le A 1.7 Total : $83.3 billion
State of New South Wales (NSW Treasury) 2019

Figure 15.2 - NSW Government expe nd iture 2019-20

T he Commo nwealth is increasing ly engaged in fund ing services chat were trad itionally
rhe responsib ility of state govern m ents , such as early chi ldhood ed ucation , school
infrasrrucrure , specific health services and road construct ion . Th e Commo nwealth has
increased its involvement in many of these areas in recent years throug h the Counci l of
Ausrra lian Governments (COAG) , wh ich brings the Commo nwealth , scare and territory
governme nt s rogerher. By p rovid ing more fundi ng for these services, rhe Commo nwealth
is able ro exercise more contro l over rh e po licies imp lement ed by the scares. For instance,
the estimated $16.8 billion WesrConnex road project for Sydney that is scheduled
for comp let ion in 2023 received $1 .5 billion in fund ing from the Commo nwealth
Government, as well as a $2 billion concessional loan.

Local gove rn ments are responsib le for local p lanni ng and deve lop m ent decisions,
p rovid ing some local services such as rubb ish collection , road bu ilding an d maintenance ,
and commu n ity facilities such as parks and libraries. Races levied on local p roperty owners
are rhe main source of revenu e for local governme nt s, wit h around a qua rter of fundi ng
coming from Commo nwealth and state grants. Some money is also raised by fees, licenses,
and fines imposed by counci ls (for examp le, building fees, dog licenses and parking fines).

T he nu mbe r of local governme nt s has fallen over time as state governments have
ama lgamated sma ller councils wit h the goal of creati ng more efficient, larger-scale
counci ls. Mose recentl y, the NSW Government reduced the number of local counci ls,
arguing it would generate efficiency benefits for ratepayers. In some areas across NSW ,
rhe amalgamation of councils was comesred by commu n ities and the coun cils themselves
- includ ing in court . Ulr imare ly, just over half of rhe amalgamations went ahead, with
rhe remai ni ng proposals aband oned, many of which were in regional areas.

1 Outline the different responsibilities at the Commonwealth , state and local levels
of government.
2 Discuss the different sources of revenue received by the Co mmonwealth , state
and local levels of government.
IThe Market Econo my 2020

Year
Total public
sector outlays
15.2 The public sector
(% GDP) Th e p u bl ic sect o r consists of Commo nwealth, scace and local
Public sector refers to
1949-50 19.9 governments, as well as government business ente rprises such as the parts of the ,economy
1959-60 27 .1 the Sydney Wate r Corporat ion, RailCorp and Aust ralia Pose. In that are owned o r
1969-70 30 .4 this section we examine che size of the pub lic sector in relatio n co ntrolled by the
1979-80 36 .0 co the economy as a whole, and how this has changed over rime. government. It includes
1989-90 36 .0 all tiers of the go vernment
Two important indicators are publ ic sector ouclays (spending) as a
as well as government
1999-00 40.5 percentage of GD P and public sector emp loyment as a percentage of business enterprises.
2004 -0 5 38 .8 coca! employ me.nc.
2006-D7 39 .8
2007 -0 8 38 .6 Taken as a percencageofGDP , cocal pu b lic seccorouclays shows the proportio n of coral annual
2008-D9 40.9 expenditure by a ll levels of governme nt (Commonwealth, scaceand local - including pub lic
2009-10 42.6 trading enterpr ises) compared with che expenditure for the economy as a whole. Figure 15 .3
2010- 11 40.5 gives an indication of the change in government ouclays as a percentage of GD P over the past
2011 - 12 40.9 half-century.
2012 - 13 40.8
2013 - 14 41.2
As shown in figure 15.3, coral pub lic sector ouclays as a percentage of GDP increased in
2014 - 15 40.9 the second half of the twentieth century. Like orher advanced economies, Australia's pub l ic
2015- 16 41.6 sector grew sign ificancly in the decades after che Second World War but chen stabi lised
2016- 17 40.9 in the past cwo d ecades. So far during the cwenty-firsc century, pub lic sector ouclays have
2017 - 18 40.1 been with in a range of 39 co 43 per cent of GDP. In relative terms, che pub lic sector in
2018- 19(e) 40.6 Australia is small compared with many other industria lised count ries, especially chose in
2019- 20(e) 40.1 Europe. Public sector ouclays fluctuate in response co economic condit ions, bur overall
·Accrua l accounting method used chey remain around the same level as chey were cwo decades ago .
after 1998-99; (e) = estimated
Soun::e: Budget 2019-2020, Th ere have also been changes co the composition of govern ment spendin g. Over ti m e,
Budget Paper 3, Table C.7,
Commonwea lth of Australia governments have tended co spend less on infrastructu re, while spendi ng more on social
Figure 15.3 - Public welfare paymen t s and community services such as health care. Transfer payments are th e
sector outlays largest item, const ituting around one-third of Commo nwealth Government expenditure.
Th ese are funds char are transferred back co househ olds as social welfare payments (such
Public sector as pensions and family benefits), rather chan being spent di reccly on goods and services.
Year workers
(% of total) Anoth er measure of the overall size of the public sector is che p roport ion of Aust ralia n
1965 19.6 emp loyees w ho wo rk in th e pu b lic sec tor. As figure 15.4 illustrates, emp loyment
1975 24.6 in the pub lic sector grew in line with public sector ouclays, peaking at 25.5 per cent of
1980 24 .4 the coca! numbe r of workers in 1985. Emp loymem levels in the pub lic sector declined
1985 25.5 between 1985 and 2000, du ring the period of privat isation of mosr government businesses.
1990 22 .0 Since 2000, pu b lic sector employment has scabili.sed at 16 per cent of che workforce.
1995 19.3 Th e reduct ion i.n the pub lic sector workforce also reflects che practice of governments
2000 16.3 contracting ouc many of th eir act iviti es co the private sector. As a result, many of th e
2005 16. 1 people who perform government services, such as road bu ild ing, delivering job-search
2010 16.5 assistance and information technology services, are n ow doing th ese jobs as private sector
2011 16.6 contracto rs co the government and nor as public sector emp loyees.
2012 16.5
2013 16. 2 Although the p roport ion of Australian workers in che public sector has fallen in recent
2014 16.5 decades, the pu b lic sector's role remains far more important chan it was in che first ha lf
2015 16. 1 of che lase century, because of the factors discussed below.
2016 16.1
2017 16.0 Government 's expanded role after the Second World War
2018 16.0 In the era after che Second World War, governm ents in industr ialised count ries adopted
Sources: RBA 0cc Paper
No. 8; cat. nos . 6248.0 , 6202.0, a more active role in seeking co influe nce che economy's performa nce. This reflected th e
Commonwea lth of Australia influ ence of the Keynesian school of economics, wh ich was dominant between che 1940 s
Figure 15.4 - Proportion and the 1970s . Keynesian theory argued chat government spending could accelerate
of workers emp loyed by the economic act ivit y and help it co achieve full emp loyment levels. However, as this school
pub lic sector

II
 Chapter 15: The Role of Government in Australia I
of chinking lose support, gove rnme nt s changed their policies. By the 1980s , gove rnment s
were seeking co red uce their spendi ng, co curb levels of taxat ion and bor rowing from the
private sector and were seeking co reduce their spend ing because governme nt spending
was g rowing more quickly tha n revenue, leading co excessive borrowing from th e private
secto r. During this rime many government bus iness enterp rises were privat ised.

T h e intervent ionist Keynesian mode l returned co p rominence after th e g lobal financial

crisis in 2008. Governm ents worldwide, includi ng in Australia , engaged more proactively
in. the economy th rough large shore-ter m increases in government spending and borrowing,
co stabilise the bus iness cycle and sup port financial inst itutions at risk of collapsing. In
Aust ralia's case, this rapid increase in government spendi ng helped co avoid recession.
A[chough government spend ing leve ls were reduced in the following years, the slow
recovery in tax revenues left Austra lia with pers istent budg et deficits du ri ng the 2010s.

Provision of government services

As the economy has grow n and living standa rds have imp roved, public expectat ions of
government have kept growing in relat ion co standa rds of health care, educat ion and othe r
government services. People tend co expect that governments will provi de universally
available community services includ ing po lice, water and sewerage, roads, and recreational
facilities. The pub lic also expects co be able co interact with government agencies as simp ly
and efficiently as in other parts of the ir lives, through individual ised, online services.
Governments are also expected co address the problems created by economic g rowth,
in.eluding congestion, pollution and the dep letion of natu ral resources.

The growth of social security

T he development of welfare and social security programs was a major prior ity of Australia 's
first governments following th e federat ion of Austral ia in 1901. Before the introdu ction
of measures such as th e age pension, widows' pensions , child support payments
and un emp loyment benefits, many peop le had co rely on charity co surv ive. By th e
mid-twenti eth century, Austra lian governments embraced the "welfare stat e" vision, where
comprehensive social security programs would support peop le from childhood th rough
co old age. The coses of these p rograms increased - especially as life expectancy grew, the
population aged and unemp loyment races increased. By th e 1980s , governments moved
co more targeted social security prog rams by impos ing means tests on b enefits (so that
wealthier peop le could not claim ben efits). However, social security spending cont inues
co grow, chiefly because of the rapid g rowth of Austral ia's aged populat ion .

T h e size of the public sector has stabi lised at around 40 per cent of the economy since
t he late 1980s. Many taxes have been. reduced or abolished , and spendi ng has been more
constra ined. Nevertheless , at rimes the size of the government may grow. For example,
governments can face p ressures co spend more on certain community services such as health
care (especially as the population ages), co deal with threats co national security th rough
in.creased defence spendi ng, or co dea[ with part icu lar econom ic crises such as instabi lity
in. the financial system and sudden contract ions in economic g rowth.

1 Identify TWO ways to measure th e size of the public sector.

2 Account for trends in the size and com position of government spend ing in
recent years.
I
The Market Economy 2020

15.3 The reallocation of resources

Whe n the govern ment reallocates resources, it changes the pattern of production in t he
economy. It directs resources cowards the p roduct ion of some goods and services chat it
considers desirab le, and away from others chat it considers less desirable. It also attempts
co promote a mo re efficient use of scarce resources in all areas of p roduct ion .

Th e government can affect the allocation of resources in two main ways:

• by influencing the way businesses and consume rs behave in the market through
taxation or spending measures
• by produc ing goods and services itself (for examp le, pub lic goods).
In addit ion , the government's regulatory po licies can influence resource allocacion , such
as by proh ibiting the sale of certain goods (for examp le, fireworks, guns and cigarettes co
people under 18).

Taxation
Th e main purpose of caxacion is co raise revenue co allow for governm ent spendi ng, but
caxesand charges on producers can also be used co infl uence the pri ce of goods and services,
and thus influ en ce consume r demand and prod uction. Because taxes add co coses, the y
can have th e effect of divert ing resources away from certain t ypes of economic act ivit y.
Equa lly, a specially reduced rate of tax, or cax concessions, can attract resources cowards a
specific sector. Often, the influe nce of the tax system on resource allocation is ind irect. By
chang ing prices , tax pol icies may change th e pattern of consumer demand, and ind irectl y
change resource allocation .

Governments can use the too ls of d ir ec t and in direc t taxa tion to achieve the ir resource
allocation goals:
• D irect ca,ces are chose chat are paid by the in dividua ls or business firms on which
they are levied - they cannot be passed on co someone else. Personal income tax is
a di rect cax, as it muse be pa id by the perso n on whom it is levied. Other dir ect
taxes includ e company cax and capital ga ins tax.
• I nd ir ec t taxes are levied on individuals and business firms, but th ey can be passed
on co someone else. An indirect tax is attach ed co a good or service, rather than co
an individual or a company. A sales tax such as the Goods and Services Tax (GST )
is an examp le of an indirect tax, as it is levied on the seller, but it is usually passed
on co the consumer (in part or in full) in the form of a high er price .

Governments use indirect taxes and other charges on items such as tobacco and leaded
petro l co divert resources away from th e production of such goods . H igh p rices on
cigarettes are meant co deter people from caking up smoking and encourage smokers co
quit. Th ey also reflect the hig her health care coses associated with smokers, who have a
much highe r like lihood of several diseases. Similarl y, governments increased the price of
petro l chat contained lead (required for older motor vehicles) in the 1980s co encourage
people co shift co more modern cars chat use unleaded petro l, which has less harmful
environmental consequences (leaded petro l is now banned altogether). Th e use of variab le
road pricing (charging high er road coils during peak travel hours) is another example of
using revenue collection co influence individual behaviour and reduce traffic congestion .

Spending
Government spending can be used codi rectly reallocate resources co a particu lar secror
of the economy, or co influence the decisions of consumers and businesses. Eicher way,
the government · is attempti ng co redress a failure of the market co provide an allocation
 Chapter 15: The Role of Governm ent in Aust ralia I

Encouraging private health insurance

In the late 1990s, the federal government introduced both direct and
indirect taxation measures to boost Australia's declining rate of private
health insurance. The purpose of th is policy was to reduce pressure
on the public hospita l system by encourag ing peop le to use the
private health system . The cost ot the private health insurance grew
into a major expense over time, promp ting the introduct ion of means
test ing in the early 2010s, so that higher-income earners receive a
lower subsidy {or none at all}.
Direct tax surcharge
Higher-income earners who do not take out private health insurance pay a surcharge
on their income tax (called the Medicare Levy Surcharge). There is a 1 per cent
surcharge for singles earning over $gQ,0OO, rising to 1.25 per cent for those earning
above $105,000 and 1.5 per cent for those earning above $140,000. Th e income tax
thresho lds fo r families are tw ice the income level for singles.
Indirect tax rebate
Under previous arrangements, anyone subscribing to private health insurance had been
eligible for a 30 per cent governmen t tax rebate (called the Private Health Insurance
rebate). In 2013, the Commonwea lth Government replaced the flat 30 per cent rebate
with a new income- tested system , and cont inues to reduce these rebates for higher-
income earners over time. Singles {under 65) earning under $90,000 are eligible fo r a
25 .1 per cent private health insurance rebate, while those earning between $90,001
and $105,000 receive a 16.7 per cent rebate , and those earning between $105,001
and $140,000 receive an 8.4 per cent rebate. Singles earning above $140,000 do not
receive any private health insurance rebate.

of resources char firs with rh e commu nity's broader needs and wanes. For examp le, rh e
gove rnm ent may pr ovide:
• fu nd ing for rhe arcs, which m ight ot herwise be unp rofitabl e
• gra nt s for sta rt-up businesses or new g rowt h indu stries char, w irh our a pr oven
crack record, mig ht lack access co finance
• subs idies for relecommun icarfons compan ies such as Telstra co p rovide broadband
services in regional areas where chose services would nor be profita ble
• cas h p ayme nt s ro pr ivate emp loyment search businesses, which find jobs for
unemp loyed p eople.
These spending items, by themselves, may nor be sufficient ro substanti ally change the
al.locat ion of resources in rh e economy. Th ey may, however, be able ro affect t he decisions
of pr ivate businesses and consum ers, w ho make up t he majorit y of rhe Austra lian economy.
Sub sid ies for vent ure cap ita lises, for examp le, mig ht encourage addition al investm ent
from the priv ate sector. Likewise, gove rnm ent spend ing may encourage consumers co buy
certai n goods and services by reduc ing an industr y's coses and, therefore, redu cing rh e
p r ices charged ro consum ers.

Government provision of goods and services

Governm ents sometimes involve themselves directl y in rhe pr oduction p rocess ro achieve
a bett er allocation of resources. Governm ent s have generally p layed an import ant role in
Aust ralia's economy, wit h governments providing a substant ial amount of basic infrastructur e
such as the roads, railways, public transport systems, electricity disrribution and postal and
celecommuni carions networks.
I
The Market Economy 2020

In the m id-twe ntiet h cent ury, it was widely thoug ht th at govern ment s could operate
ent erprises bette r than the pr ivate sector because t hey would have t he interest s of t he wid er
p ub lic in m ind rather t han the aim of making pr ofits. For examp le, th e Comm onwealt h
Bank was establ ished in the 1930s following th e Depr ession era, when it was felt tha t t he
self-int erested b ehaviour of bank s had worsened t he Depression for man y ind ivid uals. 1n
th e late 1940s, t he Comm onwealth Governm ent even atte mpt ed to nat ionalise Aust ralia's
enti re bankin g indust ry.

Th roug h d irect involvement in the mar ket , governm ent s were considered bette r ab le
to pr ovide impor tant goods and services to a large r numb er of people at a lower p rice.
In some cases, 1these businesses were monop olies; governm ent ownersh ip ensured that
mon opoly ownership d id not lead to overpric ing and exp loit ing consumers. H owever,
in th e late twent ieth cent ury, atti tudes sh ifted and it was wide ly felt t hat governm ent s
were inefficient in operatin g th eir ente rprises, and tha t th is inefficiency increased costs for
consum ers. This is because gove rnm ent ent erp rises do not have str ong incentives to make
a p rofit. As a result, g overnm ent s have largely sold! their businesses to the priv ate sect or

The future of the

National Broadband Network
The most significant examp le of the provision of goods and serv ices by governments
in recent times is the building of Austra lia's Nat ional Broadband Netwo rk (NBN),
announce d by the Rudd Government in 2009. The aim of the NBN was to upgrade
Austra lia's commun ications infrastructure , dr ive the uptake of new techno logies and
de liver neair-universal coverage of high-speed broadband throughout Austra lia. By
estab lishing a government business enterprise (NBN Co Ltd) to build the network
infrastructure, Australia went against the trend towards privati sation. At the time,
the govern ment argued that broadband infrastructure is an examp le of a natural
monopo ly I ike water or electr ic ity infrastructure , as large up-front cap ita l costs make
it eff ic ient to have only one network. It argued that without government provision,
many Austra lians outs ide the major cit ies wou ld not get access to high- speed
broadband and wou ld be disadvantaged as a resu lt.
Like many areas of government intervention in the economy , the costs and benefits of
the NBN have been contested. The Rudd Government argued the long-term econom ic
and social benefits of NBN would be very large - reduc ing commun ication costs ,
enabling new business applications, and prov idling better educat ional services and
health care . However, after a review released by the Abbott Government in 20 14, the
NBN plan was changed to create a less comp rehensive network at a lower cost , by
abandoning plans to fu lly replace the old coppe r wire telecommun ications network .
Critics of the NBN have argued that governments should not support specific
techno logies that might become outdated in the future, and that a government-owned
enterprise d isplaces possible private sector investment in broadband infrastructure.
NBN supporters argued that parts of regional Australia would never get fast broadband
under a purely commerc ial model, and that while NBN Co operates the network , private
businesses compete to sell retail services to broad band users (similar to the electricity
market, where compan ies selling electricity to retail customers are separate from the
compan ies that operate the electricity distribution network).
The performance of the NBN and the role of government have continued to attract
controversy . The Prime Minister at that time (Malcolm TurnbulQ claimed that "setting
up a new government company [to build the NBN] was a big mistake ... it was hugely
expensive. And there are many billions of dollars wasted ." Others have argued that the
modified NBN has left Australia with a slower and less reliable network than the original
NBN would have delivered. Even so, connections to the network reached nearly 6 million
in 2019, and the network has resulted in faster broadband services in metropolitan and
regional areas.
 Chapter 15: The Role of Gov ernm ent in Australia I
Privatisationoccu rs when
(k nown as p ri vat isatio n) and reduced their direc t involvement in the provision of goods the government sells public
and services. The re are some exceptions to this tr end , however, such as the expansion of trading enterprises to the
NSW 's large hydroelectric scheme, know n as the Snowy Hyd ro 2.0 . This $,4 billion project private sector.
is to be bui lt by the gove rnm ent -owned Snowy H ydro Ltd .

revi uestions
1 State TWO reasons why the government might reallocate resources in the economy.
2 Outline the d ifferent met hods available to the government to influence the
alloc ation of reso urces in the eco nomy.
3 Discu ss the c osts and benefits of the provision of goods and services by
the governm ent.

15.4 The redistribution of income

Gove rnm ent s intervene in the mark et economy to reduce the level of social inequa lity.
With the reduction in govern ment interve nti on in the economy since the 1980s, Austra lia
has experience d an increase in income inequal ity, somet imes raising concerns that rising
in equality could unde rmin e the egalirar ian character of Austral ian society - the idea that
al[ Austra lians are equa l and shou ld have a "fair go". It is a generally accepted view that
govern ments should act to create a more eq u itab le distribution of income . The main way
in which the governm ent redist ribut es income, as shown in figure 15.5, is throu gh th e
tax at ion syste m and soci al we lfar e p aym ent s.

-
Soci al wel fare
Taxat io n
pay me nt s

Figure 15.5 - The redistribution o f income

Economists d ivide income earners into separate "quinti les", groups that each compris e
20 per cent of th e popu lat ion . Figu re 15.6 shows that th e lowest two qui nt iles of income
d istribution have th eir incomes increased sig nificantl y by governm ent benefits, compa red
wi th the other quintiles.

Average weekly Lowest Second Third Fourth Highest Average

income($) quintile quintile quintile quintile quintile
Private income 223 9.29 1740 2575 4987 2032

After government
608 1292 1898 2645 5022 2242
benefits
So urce: ABS cat no. 6523.0 Household income and income distribution 2017- 18 Table 5.1

Figure 15.6 - Distribut ion of household income 2017- 18

Fig ure 15. 7 shows that gove rnm ent interve nt ion in Australia, by taxing the wealth iest
gro ups more heavily and redistribu t ing income through social welfare payments (or
benefits) to lower socio-economic g roups, dramatically reduces inequality. This is best seen
t hrough a comparison of income dist r ibution before and after governm ent interventio n.
I
The Ma rk et Econ omy 2020

Lowest Second Third Fourth Highest

20% (% ) quintile (%) quintile (% ) quintile (%) 20% (%)
Private income 4 9 15 24 49
Taxes 2 6 11 22 58
Benefits 20 25 23, 19 13
Final income 7 12 17 24 40
Source: ABS cat. no . 6537.0

Figure 15 .7 - Distr ibution of househo ld income , taxes and benefits , 20 15- 16

Figure 15.7 provides furthe r insight into income dnscribucion and the impact of
government po ! icies:
• Gross income inequa lity is severe prior co government intervention (shown lby
the p rivat e income row), wirh rh e hig hest 20 per cent of income earners receiving
almost half of coral private income .
• As income rises, so roo does the level of taxation (shown in the second row).
• Benefits are d istributed across all quartiles, but rh e majority are received by t he
lowest th ree quartil es.
• Income inequality after governm ent interventio n (as measured by final income, shown
in rhe boccom row) is reduced through govern ment interv ent ion.

Taxation
Tax p lays an important role in d istributing income . Governments use taxat ion as a cool co
redistribute income by taxing individuals at different races. To understand th is, considler
the following concepts:
• Tax b ase: this is simply the items chat are taxed. Th ere are thre e main bases for
the imposition of taxes - income, wealth and consumption. In Austra lia, incom e
forms rh e main tax base.
• Ave rage r ate o f tax (A RT ): the proportion of total income earned char is pa id in
the form of tax .
• Marg in al ra te o f ta x (MRT ): rh e proportion of any inc,-easein income that must
be pa id as tax. Th erefore, it represents how m any cents in every extra dolla r earned
char mus e be pa id co the government .

How rhe average rate of tax changes as an indiv idua l 's income increases indicates
whether rh e tax is a:
• P rog ressive tax: Under a progressive rax, higiher-income earners would pay a greater
proport ion of their income as tax rhan lower-in come earners (char is, ART rises as an
individua l's income increases). Personal income tax in Austral ia is a prog ressive tax .
• Regressive tax: Under a regressive tax, higher-incom e earners would pay a smaller
proportion of their income as tax than lower-i.ncome earners (char is, ART falls as an
individual's income increases). The Goods and Services Tax (GST) is a regressive tax.
• P ropo rtio n al tax : Unde r a proport ional tax, all income earners pay the sam e
proportion of their income as tax (char is, ART remains constant as an individual's
income increases) . Company tax in Australia is a proportiona l tax.

Austral ia's p rogressive personal income taxation system - known as Pay-As-You-Go

(PAYG) - is the main instrument of taxation that is used co redistribute income. Under
PAYG, tax payments are regu larly deducted from emp loyees' wages. Th e PAYG system
also requir es almost immed iate tax payments from self-emplo yed persons and indiv iduals
 Chapter 15: The Role of Govern ment in Australia I
wh o derive a large propor tion of t h eir income from invest ment . Under PAYG, rax
payments are regularly deduc ted from employees' wages, and includes rax paid in advance
by self-emp loyed persons and individuals who derive a sig nificant propo rtio n of th eir
in come from investme nt . Fig ure 15 .8 shows the income rax scales th at app ly in th e
2019 - 20 financial year.

Taxable income ($) Tax rate( %)

0- 18,200 0
18,20 1-3 7,000 19
37 ,00 1- 90,000 32 .5
90 ,00 1- 180,000 37
180 ,00 1 + 45
So urce: e Australia n Taxation Office fOC'the Comm o nwealth o f Australia

Figure 15 .8 - Personal i ncome tax scales in 2019-20

Fig ure 15 .8 shows that th e t ax-free th resh old (the income level below w hich no income
tax is pa id) is $18,200. Anyone who earns less tha n $18,200 duri ng the curre nt financial
year pays no tax at al l. Those who earn more th an th e threshold do not pay any income
tax on the first $18,200 earned. Prior to 2012- 13 t he rax-free threshold was only $6000.

T h e lowest margi nal rate of rax is 19 per cent and app lies to ind ividuals who earned
betwee n $18,20 1 and $37,000 for the year. Th is means tha t th ey pay no rax on the first
$18,200, and 19 cents on every do llar earned above tha t amount , up to $37,000 .

A person earning $35 ,000 per The average rate of tax fo r this individual
year has a marginal tax rate of 19 is calcu lated as:
per cent from figure 15.8. The total Tax payable 100
X
tax payable by a person earn ing Total income
$35,000 wou ld be calculated as
follows: = $3192 X 100
$35,000
Tax payable on $0
the first $18,200 = 9.1%

Tax payable on the next $16,800 = Therefore , for someone on an annual

($35,000 - $18,200) multiplied by 0.19 income of $35,000, the MRT = 19 per cent
and the ART = 9 per cent.
$3192
Total tax payable $3192

A person earning $70,000 per year has The average rate of tax for this individual
a marginal tax rate of 32.5 per cent. is calculated as:
The to tal tax payable by a person on Tax payable X 100
an annual income of $70,000 would be Total income 1
ca lculated as follows:
= $14,297
---
X 100
Tax payable on = $0
$70,000
t he first $18,200
Tax payable on the next $18,800 = = 20%

($37,000 - $18,200) multiplied by 0.19 Therefore, for someone on an

annual income of $70,000,
= $3572
the MRT = 32.5 per cent and
Tax payable on the next $33,000 =
the ART = 20 per cent.
($70,000 - $37 ,000) multiplied by 0.325
$10,725
Tota l tax payable $14,297
I
The Market Economy 2020

The next tax bracket covers individuals earn ing baecween $37,00 1 and $90,000 . Th ese
people pay noth ing on the first $18,200, 19 cents in the dollar on income between $18,201
and $37,000 and 32.5 cents in the dolla r on income betwee n $37,001 and $90,000.

The same princ ip les are app lied when calculati ng tax payab le in th e subsequent income
brackets - up co and includ ing th e cop bracket (persons earning $180,001 and above)
where the margina l tax rate is 45 per cent. The above examp les demonstrate the progressive
nature of the persona l income tax system . The person on a higher income (regardless of
the source of char income) pays a higher marginal and average race of tax compared co a
lower-income ea rner.

Australia's Good s and Services Tax (GST) is the most important example of a regressive
tax. The GST is regressive because it is charged as a percentage of the p rice of the good
or service sold, .irrespect ive of a person's income. Even though the GST app lies at a flat
rate of 10 per cent, if calculated as a percentage of an indiv idua l's income, the percentage
of income pa id in tax will fall as income rises. For examp le, an airl ine ticket might be
priced at $200. After the introduction of the GST, che ticket now sells for $220, mean ing
chat $20 is paid in GST by whoever buys the ticker. For someone earni ng $400 a week,
the $20 pa id in GST represents 5 per cent of th eir weekly income . This is much larger
than the burden on someone earning $2000 a week - because $20 represents only 1 per
cent of their week ly income . Even though both consume rs pay the same amount of cax,
the average rate of tax is much hig her for the lower-income earner. This makes the GST
a regressive tax .

Social welfare payments

The Commonwealth Government redistributes it s taxat ion revenue co lower-income earners
via socia l we lfar e pa yment s, also known as income support payments. These payments
are the other ma jor pol icy instrume nt for reduci ng .income inequa lity in Australia . Social
welfare payme nt s account for around one-thi rd of government expend itu re each year, and
therefore considerab ly impact upon th e d istributio n of income in the economy.

Payments are often mean s te sted, which means chat people on high incomes (or chose with
a large amou nt of assets) may be ineligib le co receive specific benefits, high light ing t he
face chat social we lfare payments are desig ned co redu ce income inequa lity. Means-reseed
payme nt s include un employm ent benefits, family benefits and various pens ions (such as
for aged persons, peop le wit h disabilities and single parents) .

The largest sing le area of social welfare payments is for the age pens ion . Mose Auscralia.ns
rely on the age pension for financial security in their retireme nt , and this will continue
co be the case in comi ng decades even though Australia has had a system of compu lsory
supera nn uation for the past cwo decades. Auscralia.ns now enjoy close co the longest life
expectancy in th e world, and as a result it is projected char the proport ion of Austra lians
over the age of65 will more tha n double between 2015 and 2055 . Th e need co prepare
for the coses of popu lation ageing - in social welfare, health care, housing and other areas
- wi ll be a major po licy challenge for governments in th e com ing years.

1 Calcu late t he marginal tax rate for a person earning $90 ,000. Calculate th is
person 's average rate of tax.
2 Imagine that the government introduces a new "Nostr il Tax" to raise revenue.
Everyone has to pay $500 per year, regardless of their income level, whet her
they breathe through their nose or mouth and no matter how many breaths they
take . Ident ify what type of tax this is (progress ive, proport ional or regressive)
and explain your answe r.
 Chapter 15: The Role of Government in Australia I
15.5 Stabilisat.ion and sustainable growth
O ne of the market economy's major p roblems is chat the race of economic g rowth changes
from year co year, often following an economic cycle of boom and bust. Governments can
play an important role in stab ilising the economy and susta ining economic growth . In the
long run, this will result in higher average levels of econom ic growth and improved living
standa rds. Figu res 15 .9 and 15 .10 show the impact of stabi lisacion pol icies on economic
act ivity - reduc ing fluctuat ions in the business cycle and raising the longer-te rm race of
economic growth. Policies designed co smooch fluctuations in the busi nes.scycle are called
m acroe con om ic po lic ies.

GDP Economic activity

Economic acti vity GDP
,' Long- run
,' Long•r un growth
growth trend
trend

Time Time

Figure 15 .9 - The business cycle w ithout Figure 15 .1O - The business cycle w ith
sta bilisation policies stabilisation pol icies

T h ere are cwo types of macroeconom ic po licies. Mone tar y p olicy rends co operate as
t he main stabilisation policy. Higher int erest rates can curb excessive gr owth , while low
interest races tend co encourage spen ding and business investment, in curn lifting the
growth rate . F iscal po licy also p lays a very important role through the direct effect of
t he government's overall level of spending , taxing and borrowing in a year.

Monetary policy
As d iscussed in chapte r 13, moneta ry policy involves action by the Reserve Bank of
Aust ralia , on behalf of the governme nt , designed co influence the level of int erest races
and the supp ly of money. By influencing these variables , the governme nt is also able co
influe nce the overall level of econom ic act ivity, inflat ion and unemployment.

T he main instrume nt of monetary pol icy is the use of domest ic market ope.racions (DMOs),
wh ich involves the buy ing and selling of government securities by the R eserve Bank in
order co affect the cash race in the sho rt-te rm money market and influence the level of
interest races in the economy. As the imp lementation of monetary po licy ihas already been
d iscussed, we will confine our discussion here co the impact chat a tighten ing or loosening
of monetary pol icy might be expected co have on the economy.
• T ig h t mone tar y po licy: If the government wished co slow down the level of
econom ic act ivity, it could do so by tightening monetary po licy and putt ing upward
pressure on inte rest races. High inte rest races reduce demand for money and dampen
consume r and investment spend ing, resulti ng in a lower level of economic act ivity.
Th is drop in aggregate dema nd wou ld reduce inflationa ry p ressures , but can lead
co a rise in cyclical unemployment.
• Loose mone tar y po licy: If the government wanted co increase the level of economic
act ivity, it could do so by loosening monetary policy by putting downwa rd pressu re
on interest races. Lower interest races wou ld increase the deman d for money and
boost consumer and investme nt spending , resulting in a higher level of economic
I
The Market Economy 2020
Government business
enterprises (GBEs)
are businesses owned
and managed by a
govern ment at either
the Comm onwealth or
state level.
Corporatisation occu rs
when th e government
encourages public trading
enterp rises to operate
independent ly from the
government as if they
are private businesses
in order to improve
efficiency and profitability.
II
acriviry. This rise in aggregate demand would reduce cyd ical unemployment, but
ir mig ht also lead to a rise in infl at ion .
Mon etary po licy can be eith er tighte ned or loosened depe ndin g on whet her rh e
govern ment wishes to dam pen or boost the level of economic activ ity. The effect of a
change in monetary po licy on the level of economic activ it y is nor felt immed iately - ir
can take around 6 to 18 month s for its full effect to be felt in the economy.
Fiscal policy
Fiscal pol icy pla ys an important role in influencing economic grow th and unemploy ment,
especially when rhe economy is in a downturn. The role of fiscal pol icy in influe ncing
economic act ivit y is examin ed in more detai l in chap ter 16.
1 Outline the role of monetary policy in the Aust ralian economy.
2 Explain how an increase in interest rates can reduce inflationary pressures in
the economy.
3 Imagine that it is 2025 and you are an adviser to the Reserve Bank Governor.
She has asked you to give your urgent advice on whether interest rates should
be increased , decreased or left the same. Economic growth is currently low at 1
per cent, inflation is 2 per cent and falling, the Reserve Bank cash rate is low at
3 per cent and economic growth in China and the world economy remains low .
Write a not e to the governor giving her your advice .
15.6 Public enterprises
Pub lic enterpr ises have been an important part of the role of governm ents th roughout
Australian history. However, as we saw in section 15. 3, thi s role has changed in recent years.
There has been a clear shift towards minimisin g the role of governm ent in the economy, and
rhe governme nt's direct role in production has been substantia lly cur back.
Many government busine ss enterprises (GBEs), wh ich are also known as pub lic trading
ent erp rises (PT Es), have been sold off ro the priva 1te sector th rough a p rocess known as
privatisation. Some of rh e major govern ment businesses chat have been p rivatised are
Medibank Privat e, the Commonwealth Bank , Qanta s, Federal Airp orts, and Telstra (lby
the Commo nwealth Government) and the GIO , t he TAB and Stare Bank of NSW (lby
rhe N SW Stare Government) . In these cases, ir was felt that the compani es woul d be ru n
more efficientl y as private rathe r than governm ent business ente rprises.
Most of those gove rnm ent- owned ente rprises th at have not been priva ti sed, such as
Austra lia Post, have und ergo ne a process of corporarisarion, whereby public enterp rises
act as private busin ess enterprises, with ind epende nt managers that are accountable for
perform ance and limited govern ment involvement in business operat ions.
The mai n remain ing gove rnm ent business enterp rises are:
• Austral ia Pose
• Austral ian Rail Track Corporation
• state rail, bus and ferry autho riti es (althoug h these have been partia lly p rivatise d
in Victoria and N SW)
• state electricity autho riti es (althoug h these have been p rivatised in some states)
• uti lities such as water (and gas in some areas)
 Chapter 15: The Role of Government in Australia I
• research and development orga nisarions such as the CSIRO
• ed ucatio nal inst itutions (though un ivers ities are increasingly ope rate d li ke
busi ness ente rp r ises).

As discussed earlier in this chapter, the N ationa l Broadband Netwo rk is an unusua l

exampl e of a relatively newly esta blished , large-sized government busi ness ent erprise.

Reforms to GBEs over the past rwo decades have seen significant improvements in both Competition is the
pr ices and productiv ity in a numbe r of industries. Increased levels of compe t ition due ro pressure on business
the opening up of markers (such as the electricity and telecommunicat ions industries ) have firms in a market
seen prices fall significantly. Th e same is true of areas where government ownership has been economy to lower prices
or improvethe quality
reduced or eliminated. Th e rail freight industry has seen charges fall by alm ost 50 per cent, of output to increase
an d Australia has most recently seen call charges fall by more than a th ird in cerrain areas of their sales of goods and
the relecommunicario ns industry. Reforms to G BEs have not always reduced prices, however; services to consumers.
pr ices in rhe water supply, gas and urban transport sectors have risen in recent years.

1 Visit the website of one of the fo llowing government business enterprises.

Using informatio n from the website, outline the key functio ns of the GBE and
analyse its performance.
• Australia Post at www .auspost.com .au
• NBN Co at www .nbnco .com .au
• Sydney Water at www .sydneywa ter.com.au
2 Distinguish betw een privatisation and corporatisation .
3 Discuss the arguments for and against th e privatisation of Australia Post.

15.7 Other roles in the economy

In add it ion to chose already mentioned, governments have othe r, smaller functions in rh e
economy chat aim ro make markers produce bette r outcomes in the longer term . Thes e
include ensu ring a workab le level of competit ion in rh e economy, prorecr ing consume rs
from unfair bus iness conduct and prorecr ing the natura l environment.
For more information on
the activities of the ACCC ,
Competition policy visit its website:
www. accc.gov.au
One of the major aims of government policy relating co business firms is co ensure chat
markers operate efficiently. Govern m ents aim ro promote w o rk ab le c om pe titi o n in
Aust ralian industry - char is, the max imum level of competition compatible with rh e
marker structu res and specific conditions of an indust ry. Government po licies assume char
competition will produce a more efficient use of resources, lower production coses, lead
to product inn ovation and lower p rices for consumers.

How ever, rhe goal of increasing competit ion must be balanced against the goa l of achieving
economies of scale. Sometimes it may be necessary to have very few firms in an industr y.
T h ose firms can produce on a larger scale and achieve the lowest possib le long-ru n average
costs of product ion .

T he appropriateness of certain marker strucrures depends on rhe specific features of an

industry. For examp le, in th e moror vehicle industry , very large output is needed in order ro
ach ieve the economies of scale necessary ro compete in a fiercely competitive world marker.
I
The Market Econ omy 2020

Governme nt s the refore encouraged g reater concencrarion in rhis sector in order ro help
Austra lia's mocor vehicle industry survive rhe pressure of overseas compet it ion. However,
these efforts were not successful and moto r vehicle p .roducrion in Australia ceased in 2017.

Workab le comp etition po licies attempt co achieve a situat ion where markers are
co nces cable . Th is means char entry barriers ro industries shou ld be kept co a mi ni mum
by eliminating !business practices char restrict potentia l competition. Th e Competitionand
ConsttmerAct 2010 (previously the Trade PracticesAct 1974) sees our a code of behaviour
for firms, which outlaws certain practices char would rend ro work against the idea of
Australi an Competition workab le compet ition . Th e Act is adm inistered by the Au str alian Competit ion and
and Consumer Co nsumer Comm iss ion (ACCC), wh ich mon ito rs competition policy and upholds
Commission (ACCC) is consumer prorecr ion legislarion .
Australia's compet ition
watchdog, which ensures
Consumer protection
that businesses do not
engage in anti-competitive Mose of the resp onsib ility for co n su me r pr otect io n now lies with rhe Commonwealth
behaviour. Government. The mosr important means by wh ich consumer interests are protected
is through the Competitionand Consumer Act and the ACCC. Th e aim of consumer
prorecrion legis.lacion is co ensure fair bus iness conduct by prohibiti ng pract ices that
restrict competition and impos ing penalties on firms char breach rhese guidelines. Som e
of the conduct char is proh ibited includes price fix:i ng betw een competito rs, misleading
advert ising, price d iscrimination and mergers that will substantia lly reduce compet ition
in a marker.

In 201 1 most of Austra lia's consumer protection laws were consolidated into a nat ional
system called t he A11st1·a/ianCom11me,·Law. Thi s replaced rh e Trade PracticesA ct chat
had been in effect since 1974, as well as scare-based Fair Trad ing Aces. In addition co
consolidat ing these older laws, rhe new legislation conta ins several new prov isions that
stre ngthe n warranties for consumers , provide addit ional product safety regulations and
give consume rs protect ion from unfair contract ter ms.

Th e Commonwea lth Governm ent also exercises some influence over rh e pric ing policies
of large firms through rhe ACCC, although it does nor directly cont rol the specific leve l
of prices in an in dustry. Th e ACCC has several roles :
• mon itori ng prices and conduct ing inqu iries into pricing structures
• recomme nding changes ro industries
• giv ing a firm or industry negat ive publ icity where it finds there is overcharg ing.

Th e ACCC has largely adopted a "hands-off' actitude cowards industry regulat ion ,
progressively re moving industries from its pr ices mon itoring system unless th ere is
evidence that th e industry lacks an adequate level of compet ition. In gene ral, most
consumer prote<:tion measures occur through a "co-reg ulato ry" m ix of industry codes
(enforced by industries themselv es) and laws. In s,ome cases, such as financial services ,
consumers have stronger protections because of rhe sign ificant risks ro consume rs of
losing large amounts of money if the ir finances are nor prorecred. For example, following
revelations of m isconduct during rhe Financial Services Royal Comm ission, a new
ob ligation on mortgage brokers was introduced in 2019, requiri ng chem ro acr in the best
inte rest of borrowers in relation co home loans (rath er than putti ng th eir own comme rcial
inte rests ahead of borrowers when advising them on mortgage loans).
 Chapter 15: The Role of Government in Australia I
Environmentalprotection
O ne of the most comp lex aspects of gove rn ment int ervention in the economy is how it
dea ls with the impact of economic activ ity on the enviro nment co ensu re envi ronm ent al
sust ainability . Environment al impacts have become a more sign ificant issue for
governments in recent decades, with increasing awareness of climate change and rh e
long-term environmenta l impacts of economic deve lopment in industries such as mi n ing,
energy, forestry and consrrucr ion . The environmenta l debate has also shifted cowards
t he wide r issues of land manageme nt in Australia resu lting from farming acriviries - in
pa rticu lar, water shortages, soil erosion and rising salinity levels.
Renewable resources
T here are rwo underlying issues in rhe environmenta l debate . The first concerns the use of are inputs into the
re n ewab le and n on -ren ewab le reso urc es . Both industria lised and developing countries production proc,ess that
are rapidly deplet ing the world's srocks of non-renewab le resources (such as oil and coal). reproduce themselves ,
Environmentalists argue that at th e current rate of energy consumpt ion, resources will be ensuringthat present
depleted within a matter of generations. Th e governme nt can contribute cowards sustainable consumption of these
resources does not
en ergy use by supporting alternat ive energy sources and g iving incentives co reduce rhe use
necessarily reduce
of fossil fuels. In recent years, a numbe r of po licies and initiat ives ro suppo rt sustainable the ability of future
en ergy have been proposed and imp lemented (while some have also been a bandoned). generations to consume
them (e.g. timber and fish).
Aust ralia introduced a carbon tax ro reduce greenhouse gas emissions in 2012, bur this
was abando ned after a change of government in 2014. Similarly, the Commonwealth
Non-renewable
Governme nt esta blished rwo environ m enta l agencies in 2011: rhe Austra lian Renewab le
resources are inputs to
En ergy Agency, co improv e the supply and compet itiveness of renewable energy production where the
te<:hnologies, and the Clean Energy Finance Corporation (CEFC), wh ich uses an allocated stock of the resource is
$10 bill ion ro invest in renewab le, low-po llut ion and energy-efficient t echnolog ies. In permanently depleted in
2013, the newly elected Abbott Governme nt attempted co abo lish both age ncies, but had the process of production
co abandon rhis p lan after the Senate b locked p roposed laws abo lishing chem. and consumption (e.g.
petroleum and coal) .
A further examp le of a cont ested policy is rhe Renewab le Energy Target (RET) estab lished
in 2010. Th is esta blished a legislated comm itment ro increase rh e proportion of renewable
energy co 23.5 per cent by 2020. T his target was achieved in 2019 (with rhe po licy
expiri ng in 2020).

Even after a decade of policy changes, Austra lia srill does not have an overall po licy
framework ro encourage the take-up of renewab le energy and co rransirion rhe economy
from carbon-int ensive energy sources. In 20 18, deep divisio ns emerged with in rh e
Turnbull Government over a proposal for a Clean Energy Target (a recommendation from
Australia 's chief scientist, Alan Finkel) and a National Energy Guarantee (wh ich wou ld
create orher incentives for renewable energy sources). Eventually, these divisions saw both
policy proposals abandoned whi le also leading ro Prime Ministe r Turnbul 1being removed
by h is own parry. Prime M inister Score Morrison avoided new po licy commitments relating
co eithe r renewab le energy or reduci ng carbon em issions.

T he second major environmenta l po licy concern is rhe extent ro which the price mechanism
does not reflect ex te rn alit ies involved in p roduct ion - that is, the enema ! coses and
benefits of production that are nor reflected on a firm's balance sheet. Externalities
(p revious ly d iscussed in section 8.5) often involve air and water po llut ion . T he use of
energy resources such as coal and oil leads ro huge emissions of carbon dioxide, which
is a gas chat causes climat e change. Climate change is now regarded as rh e greatest
environment al threat in rh e world, with potentially devastat ing consequ ences for futu re
generations. In add it ion , po llut ion th rough indust rial output, toxic waste, chem ical spills
and untreated sewerage threate ns one of rh e mosr valuab le resources of all - water. Both
atmospheric and water po llution are ext remely serious issues because their consequences
cann ot be contained - the whole wod d will experience th e impact of the deterioration of
t he global environment.
I
The Market Economy 2020

Austra lia's response to climate change has been at che cent re of econom ic debate du ri ng
recent years. In 2012, the Labor Government introduced a tax on carbon emissions of $23
per ton ne for rh e 500 Austra lian compan ies who e mitted the largest amount of carbon .
Fo r more i nformatio n This tax was regarded as a "marker-based mechan ism" in that ir created a p rice incentive
o n curre nt govern ment for businesses to change their production p rocesses and busi ness operat ions.
pol icies to improve the
natural envir onment , In 2014, rhe carbon tax was abolished by the Abbott Government and replaced with an
visit t he websi te of Emissions Reduction Fund (ERF), a comm itment of$2 .6 bill ion over 10 years to d ireccly
t he Departm ent of t he
subsidise measures ro reduce carbon emissions. The ERF is intended to reduce emissions
Environmen t and Energy:
by five per cent below 2000 levels by 2020, throug h rh e government paying compa n ies ro
www.environment.gov.
au reduce em issions (or absorb carbon emissions) via reverse auctions described as a "carbon
buy-back". The ERF provides incentives for abatement activ it ies such as revegetat ion
and land management, soil carbon, forestry, energy efficiency, recycling, cleaning up
power stat ions, dean ing up waste coal mine gas and clean ing up landfills . Aust ralia also
partic ipates in .int ernational efforts to reach agreement on reduc ing carbon emissions
th rough the Un ited Nat ions Climate Change Conference . In 20 15, the United Nations
Framework Con vention on Climat e Change (UNFCCC) summ it concluded the Paris
Agreement, to which Austra lia became a signatory . Under rh e Paris Agreement, Austra l ia
committed ro red uce irs emissions by 26- 28 per cent on 2005 levels by 2030. In 2019,
the Commonwealth Government ann ounced a Cl imate Solutio ns Fund , p rovid ing an
additiona l $2 bi llion to the ERF, ro cont ribute to meeti ng Austra lia's emissions reduct ion
targets . However, critics of rh e po licy have suggested rhar the policy alone will not resl.lllt
in the levels of emissions reduction required to meet its target.

Austral ia's manage ment of irs wate r systems has also been hotly debated during the past
decade . Extended periods of drought have intensified debat e over how to balance rhe needs
of household and industria l water users across different regions, while also min im ising
environmental harm . In 2007 concerns around low wate r levels in the Murray-Darl ing
Basin led the Commonwea lth Government ro creace a nat ional wate r management p lan .
In 20 14 an updated Water Recovery Srraregy p lan was released, proposing overall cuts in
water allocat ion s from the Murra y-Darl ing river system of 2750 billion litres. However,
recent reviews found mixed results on the effectiveness of these reforms . An investigat ion
on rh e ABC program Four Corners in 20 17 also alleged widesp read water theft lby
irrigators in northern New South Wales, involving tampering with wate r mete rs. T he
ongoing debate over rhe Murra y-Darling river system has high lighted rhe difficulti .es
involved in man aging scarce environmenta l resources in Australia.

1 Exp lain what is meant by workable competition and outline how the Australian
Com petition and Consumer Com mission promot es workable com petition in
the economy.
2 Discuss options availab le to the government to influence the impact of
econom ic act ivity on the environment.
 Chapter 15: The Role of Government in Australia

1 The Australian Constitution sets out the law-mak ing powers of the
Commonwea lth and state governments .

2 There are three tiers of government in Australia: Commonwealth (federal), state

and local governments.

3 Throughout most of the twentieth century, the public sector 's role in the economy
increased as it met grow ing demand for government intervention.

4 The public sector constitutes around 40 per cent of the Austral ian economy,
but only around 16 per cent of employment. The size of the public sector
fluctuates in response to economic condit ions, but overall it is around the same
level as at the beginning of the 2000s.

5 The government reallocates resources through its mix of taxat ion and
spending policies , which can be targeted to achieve spec ific goals.

6 The government redistributes income through a range of taxat ion measures

and social welfare payments to peop le w ithout adequate incomes.

7 A tax can be either progressive, proportional or regressive, depending on how the

average rate of tax changes as an individual's income increases.

8 The government may reduce t he fluctuations of the business cycle through the
use of economic stabilisation policies, namely fiscal and monetary policies.

9 Government business enterprises (also known as pub lic trading

enterprises) are government-owned businesses that provide goods and services
for the community . Many GBEs have been privatised dur ing recent decades .

10 The government also pursues other economic and social objectives , including
consumer and environmental protection . The main consumer protection agency
is the Australian Compet ition and Consumer Comm ission.
The Market Economy 2020

1 Ident ify wh ich t ier of the governme nt (local , stat e, Commonwea lth or a mixture of
these) has respons ibility for each of the followi ng areas:
a) pub lic order and safety g) highways
b) defence h) customs
c) taxat ion i) suburban streets
d) health j) electr ic ity
e) tertiary education k) libraries
f) high schoo ls I) rubbish collect ion .

2 Explain how the size of the public sector can be measured in Australia .

3 Discuss how the government can use taxat ion and spend ing measures to
reallocate resources in the economy .

4 Briefly exp lai n how the government redistributes income in the economy.

5 Using the concept of the average rate of tax , disting uish between progress ive,
proport ional and regressive tax.

6 Calculate the tax payab le and average rate of tax for the follow ing individuals:
a) Silas, who earns $74,000 per year
b) Linus, who earns $148 ,000 per year.

7 Define what is meant by social welfare payments . Give th ree examp les of soc ial
welfare payments .

8 Summarise the main policies that are used for econom ic stab ilisation.

9 Define what is meant by a government business enterprise . Give some examp les
of government business enterprises in the Aust1ralian economy.

10 Ident ify some of the other socia l and econom ic goals that the government may
wish to achieve .

Extended response
Explain why a government might want to redistribute income in the economy. Describe
how the government wo uld achieve th is. Identify which tier of government wou ld be
most effect ive in red istributing income .
Government
in Action

16.1 The Budget

16.2 Revenue and expend iture
16.3 The impact of budget outcomes
16.4 Influences on government po licies

16.1 The Budget

In the previous chap ter, we reviewed the mai n met hods char gove rnm enr s use ro address
t he p roble ms of marker failure. Th is chapte r conti nues with a deta iled analysis of rhe
govern ment's most versat ile cool - fiscal policy. Fi scal p olicy is a macroeconomic po licy
char involves the use of taxat ion and spending powers through rhe Com monwealth
(or federal) Budge t in order co achieve certa in econom ic object ives. Th ese include
stabi lising the level of econom ic acrivi ry, maint aining low inflation, reducing rh e level of
unemp loyment and achievi ng ge neral pol icy goa ls relati ng ro the dist ri b ut ion of income
and Australia's place in the global econo my.

T h e best way co unde rsta nd the role of rhe Com monwealth Govern ment is co examine irs
revenue and expenditure activ it ies, shown in the ann ual Budge t . Th e Comm on w ealt h
Bu dg et is an official document, present ed in May each year, rhar sees out th e government 's
revenue and expend iture p lans for the coming year. By varying irs inte nded expend iture
(G) and revenue (T ), the govern ment can influence rhe overall level of econom ic activity
and have a sig nificant infl uence on rh e level of inflatio n and unemploy m ent .

16.2 Revenue and expenditure

Commonwealth Government revenue
Fig ure 16.1 shows rhac rhe Comm onwealth Governm ent budgeted for revenue of $514
bi llion in rh e 2019- 20 financial year. N inety- t hree per cent of the Com monwealth
Gove rnm ent 's revenue comes from raxarion sources. The sources of taxat ion revenue are
divide d int o d irect taxes (for examp le, persona l income rax and company tax) and indirect
taxes (for examp le, sales raxes).
I
The Market Eco nomy 2020

Incometax (imposedon individualsand companies}

Income rax mak es up 68 per cent of coral government revenu e. As the name suggests, it
is imposed on t he incomes earn ed by both indivi dua ls and compan ies.
• Per son al income tax makes up almost 46 per cent of Comm onwealt h Govern me.nc
tax revenue . Und er rhe Pay-As-You-Go (PAYG) system, rax pay ments are deducted
regu larly from rh e pay cheq ues of wage and salary earners. Self-emp loyed perso ns,
and chose who derive a large proportion of their income from investments, also
pay income tax t hrough th is system . Personal income rax is prog r ess ive in nature.
T his mea ns char h igher income earn ers are taxed propor tionate ly more tha n lower
income earne rs.

$ %of $ % of
2019-20 Revenue 2019-20 Expenditure
million total million total
Income tax - made up of: Soc ial secu rity and welfare 180,125 36.0
Individuals 234,100 45.6 Health 81,777 16.0
Compan ies 100,600 19.6 Education 36,350 7.0
Superannuat ion 9750 1.9 Defence 32,243 6.0
Fringe benefits 4040 0.8 Genera l pub lic services 23,614 5.0
Petroleum resource rent tax 1290 0.3 Other econo mic affairs 9297 2.0
Total income tax 349,780 68.1 Transport and commun icat ion 9038 2.0
Other t axes - made up of : Fuel and energ y 8171 2.0
Excise and customs duty 45,260 8.8 Public orde r and safety 5919 1.0
Sales tax' 69,630 13.6 Housing and community
Major bank levy 1610 0.3 amen ities 5907 1.0
Agricu ltural levies 551 0.1 Recreation and culture 3849 1.0
Other taxes 9765 1.9 Mining, manufactu ring and
Total indirect t ax revenue 126,815 24.7 cons truct ion 3422 1.0
Total tax revenue 476,596 92.8 Agriculture , forestry and fishing 2871 1.0
Non tax revenue 37,168 7.2 Other purposes 98,287 20.0
Total revenue 513,763 100.0 Total expenses 500,872
Source: Budget Paper No . 1, Statement 4: Revenue, Tab le 10, pages 4- 20 ; Stat emen t 5: Expenses and Net Capital
Investme nt. Table 3, pages 5-7 . ·includes GST revenues allocat ed to sta te and t erritory governments

Figure 16 .1 - The Comm onwealth Budget estimates 2019-2 0

• Co mpan y tax account s for nearly 20 per cenr of govern ment revenue, imposed at
a flat rate of 30 per cent on rhe net profi t of bot h private and public corporations,
before an y dis rribu rion is made ro t heir sha reho lders (businesses wit h a tu rnover
of under $50 million pay a reduced rare of 27 .5 per cent ). Businesses also pay a
fringe benefits tax (cont ributi ng arou nd 1 per cent of government revenue) for
the non-cash benefits (company cars, d ining out, ere.) chat rhey p rovide for their
emp loyees.
• A small p ropor tion of income rax (around 2 per cent of govern ment revenu e) is
collected through the rax on superannuatio n cont ributio ns. Th e proport ion of
revenue collected from rhe tax on supera nnua ti on contri butions has grow n over
recent years and is likely ro continu e ro g row in rhe future .

Goods and Services Tax

T he Goods and Services Tax (GST) is the mai n indi rect rax in Aust ralia. It app lies ac a
rate of 10 per cent ro most items sold in Aust ralia., alt hough basic food is exemp t from
the GST. T he Com monwealth Governm ent's collect ion of the GST makes up around
14 per cent of ics coca) rax collecti on . T hese revenues are automatica lly allocated ro state
and territo ry gove rnm ent s.
 Chapter 16: Government in Act ion I
Excise and customsduties (imposedon the producersof certain goods)
Excise and custo ms du ties are truces based on the quantity of a produce. They p rovide
around 9 per cent of govern ment revenue, main ly from petro l, diese l, tobacco and alcohol.
A[! these goods have a relat ively inelastic demand . This allows the gove rnm ent co apply
a duty or excise, kn owing that th e su bsequent increase in price will only cause a small
cont raction in demand.

Other tax revenue

T h is category accounts for 2 per cent of governm ent revenu e, and covers a who le
range of miscellaneous taxes, charges, fees and fines imposed by the gove rnm ent (such as
fees for Ausrralian passports) .

Non-tax revenue
Non-tax revenu e raises 7 per cent of coca! governm ent revenue and incl udes profits from
gove rnm ent ent erprises, as well as interest, d ividends and royalties paid co tthe governme nt.

Commonwealth Government expenditure

T h e 20 19- 20 Commonwealth Budget outlined p lans for the gove rnm ent to spend $501
bi llion over that financial year. Th e expenditure items shown in figure 16.1 hig hlig ht th e
key responsibi liti es of the Commo nwealth Government. Major spending items include
t he following areas:
• Social secu ri ty and we lfar e - the largest Commo nwealt h Government outlay.
Thi s category represent s t ra n sfer payments (payments aimed at redistributing
income from th e taxpayers co welfare recipients, such as the elderly and
unemp loyed).
• Education - the Commo nwealt h Government prov ides educati on fund ing co
un iversities, vocatio nal educa tion and trainin g providers as well as governm ent
and non-gove rnm ent p rimary and second ary schools.
• Health- whi le the del ivery of healthcare services is prima rily the responsib ilit y of
state and terri tory govern ment s, th e Commonwea lth Government funds Medicare
and the Pharmac eutica l Benefits Scheme as well as contributin g to the fund ing
of publ ic hospitals.
• Provision of infrastructure or so cial ove rhead capital - example s include roads,
rail, pores and com muni cation s networks.
• Pr otecti ng the e n v ironment and pr omo ting e co logi call y susta inab le
d eve lopment - a small area of gove rnm ent expend itu re, which includes
investment in clean energy and low carbon emission techno logies, energy efficiency
measures and better manage m ent of wate r resources.

1 Outline the main sources of government revenue and the relative im portance of
different types of taxation.
2 Describe the main areas of government expend iture and how they might be
linked to the government 's economic objectives.
3 Imagine you are an economic adv iser to the Commonwealth Government.
The Prime Minister wants to increase spe nding on publ ic transport in major
cities, but does not want to raise taxes. Identify alterna tive sou rces of revenue
for the government to fund its new initiatives.
I
The Market Econ omy 2020

16.3 The impact of budget outcomes

Besides rhe individua l instruments of spending and revenue collecrion, the overall ourcome
of rh e budget is in itself an important feature of fiscal po licy. This is known as rhe b ud ge t
out come or fiscal outcome . Th e budg et outcome gives an indicatio n of rhe overall impact
of fiscal pol icy on the stare of the economy. Th ere are th ree possib le budget outcomes:

Balanced budget Planned governme:Jt Planned government

revenue expend iture

Budget surplus Planned governme:Jt Planned government

revenue expend iture

Budget deficit Planned governme:Jt Planned government

revenue expenditure

In Chapter 3, we learnt rhat rhe gove rnment can change the level of economic activity
by changing its own leakages (T) and inject ions (G) in rhe circular flow of income. This
is a key p ri nciple behind government fiscal po licy. Th e ch ange in t h e b ud get outcome
from one year ro the nexr can ind icate a change in government fiscal pol icy srance . Thr ee
srances are possible:
• An ex pan sio n ary fisc al po licy stanc e: W ith an expansiona ry fiscal po licy, t he
government might reduce taxation revenue or increase government expend iture
(or use a comb ination of both), creat ing eit her a smaller surplus or bigg er deficit
than ir had p reviously. Expansionary policy aims ro increase rhe level of economic
act ivity by stimulating aggregate demand. Th is shou ld lead to a reduc t ion in
unemployment since, in order to increase p roduction, firms musr emp loy excra
resources . However, if the economy g rows coo guick ly inflation may rise.
• A concrac t ionary fiscal p olicy sta nc e: Here rh e gove rnment would be p lann ing
to increase taxat ion revenue or decrease government expend iture (or a comb ination
of borh), creat ing eithe r a smaller deficit or larger surplus than it had prev ious[y.
Th is shou ld decrease rhe level of economic activ it y by dampe ni ng aggregate
demand. This would also rend ro reduce inflation, bur ir risks increasing
unemployment if dema nd is red uced roo much .
• A n eu tral fiscal policy sta n ce: Th is occurs when the government does nor change
the budget outcome from rh e previous year··s level. Th erefore, rh e Budget should,
in general, have no overall effect on the level of aggregate dema nd and econom ic
act ivity.

Whe n economists describe rh e srance of fiscal po licy being expansionary, contracr ionary
or neutral , they are usually compa ri ng rh is year's outcome to the outcome of rh e p revious
year. If , from one year to rhe next, we moved from a su rp lus to a balanced budget, ir would
be regarded as expansiona ry, as expenditure has ri.sen in relation to revenue. Likewise,
if we moved from a deficit to a balanced budgec, fiscal po licy would be regarded as
contractiona ry, as expenditu re has fallen in relation ro revenue. This can be confusing,
because if rhe deficit is reduced from $30 bi llion to $20 billion in one year, government
injections are sr.ill g reater than leakages (because there is a deficit), bur in relative terms
ir is contractiona ry (because the deficit is $10 billion smaller rhan the previous year).
In assessing irs impact on rhe economy, we generally tend to pay more attent ion ro t he
budget outcome relative to the prev ious year (t hat is, rh e budget stance), rather than t he
absolute figure o f whether the budget is in deficit or surplus.

II
 Chapter 16: Government in Act ion I
Automatic stabilisers
Even witho ut de liberate decisions by t he govern ment co change it s polic ies from one year
co rhe next, rh e levels of revenu e and expend itu re change automatica lly in response ro Automatic stabilisers are
instruments inhe rent in the
chang ing economic cond itions. Thi s reflects the operation of po licies known as automatic
government's budget that
stabili se r s - po licies chat operate aucomacically co counterba lance rhe trend in rh e level counterbalance econom ic
of economic growth and co stab ilise rhe economy. Th e rwo main aucomacic stabi lisers are activity. In a boom
t he pr ogressive p ersonal income tax system and unemp loyment benefits. Th eir operation period, they decrease
can be illustrated by the following two situat ions: economic activity. In a
recession, they increase
• An increa se in t he level of economic act ivity: Wh en rhe economy is grow ing, economic activity. The
income levels increase, leading co a rise in taxation revenue for che governm ent. most common examp les
Unemploym ent falls, reducing government expenditure on unemploym ent benefits. are transfer payments and
a prog ressive tax system.
The budget ourcome is a smalle r deficit or bigge r surplus. Th e automatic stabi lisers
would lead ro an automatic conrraction in aggregate demand, thus having a
stab ilising effect even without any deliberate governm ent policy act ion.
• A decrease in the lev el of economic ac ti vity : In times of recession , income
levels fall, leadin g ro a fall in taxation revenu e. Unempl oyment rises, increasing
governm ent expendi tu re on un emplo yment benefits . Th e budget outcome is a
smaller surp lus or bigger deficit , thus automatically srimular ing agg regate dema nd
even with out any de liberate change in government po licy.

T h erefore, changes in the actua l budget outcome are the result of rwo components - rhe
au tomatic changes co govern ment revenue and expend itu re brought about by changes in
t he level of economic act ivity (also referred ro as the cyclical componenc of the budget),
and rhe deliberate revenue and expenditure changes initiated by rhe government (called
t he scrucrural component of rh e bud ge t). Th e structural component is rhe key driver of
t he government 's fiscal po licy seance.

1 Distinguish between the budget outcome and the budget stance.

2 Explain how a slowdown in econom ic activity wou ld affect the cyclica l
compo nent of the budget.
3 Identify the impact that each of the following changes in fisca l policy wou ld
have on the level of econom ic growth .
a) A reduction in the budget deficit from $33 billion last year to $29 billion this year
b) An unchanged budget surplus of $12 billion last year and this year
c) A shift from a $15 billion defic it last year to a balanced budget th is year.
I
The Ma rket Econ omy 2020
For more information
about Australian politics,
look at this outstanding
site operated by a
former Victorian High
School teac her, Malcolm
Farnsworth: www.
australianpolitics .com
Also, have a look at the
websites of Australia's
major parties:
Australian Labor Party:
www .alp.org.au
Liberal Party:
www .liberal .org.au
National Party:
www .nationals .org.au
Australian Greens:
www .gree ns.org.au
16.4 Influences on government policies
The process of mak ing government po licy is influenced by many partic ipants, includ ing
businesses , community groups, lobby groups, unions and politica l parties. In chis section,
we exam ine some of che influences on economic polic y in recent years.
Parliament and political parties
In a democratic count ry such as Austra lia, econom ics
The Australian House of
and po litics are closely relate d . Econom ic reform Repre sentatives
muse first be supported by the government in power,
Liber al/Nationa l Coa lition 77
wh ich generally means chat it muse be approved
Austra lian Labor Party 68
by Cabinet - t he committee of senior governme nt
Minor Parties 3
ministers. The structure of government in Australia
requ ires char most major policy changes muse che.n Independ ents 3
be authorised through an Act of Parliam ent . Whil e Tota l 151
some admin istrative changes may not req uire ch e The Australian Senate
support of parliament, measures such as che Budger , Liber al/Nationa l Coa lition 35
taxation reform, industrial relat ions reforms and th e Austra lian Labor Party 26
privatisat ion of government businesses do requ ire t he
Austra lian Greens 9
support of parli ament .
One Nation 2
For a proposed law (a Bill) co be passed through Centre Alli ance 2
parliament, ic muse be supported by a majorit y in boch Others 2
che Lower House (th e H ou se of Rep resentati v es) Tota l 76
and the Uppe r House (the Senate) . Governments are Sou rce : Parliament of Australia,
formed from che po litical parry or coalition chat has as of Septe mber 2019
the support of a majorit y of membe rs in the 151-seac Figure 16.2 - Composition of the
House of Representatives . Governments usuall y have AustralianParliament, September2019
no difficu lties in passing legislation through che House of Representatives , al rho ug h th ere
was a brief period from 20 10 co 20 13 when no pol ir ical parry or coalit ion won a majority
of sears in che House of Representatives for the firsr time in 70 years. Whi le all the state
and terr itory parl iaments in the past thr ee decades have experienced minority governmen ts,
ic was unusual for a natio nal government and ic cook several weeks after che election before
che Labor Parry was able co form a government with che suppo rt of Independent and Gree n
MPs. A minor ity government may result in che detai ls of many pol icies being negociaced
and debated in pa rl iament for legislat ion co be passed . Th e 2019 election also produced
a very close resu lt, with che Coalit ion Government achie ving a majority of jusc cwo sears.
Whi le gove rnments usuall y enjoy majority suppo rt in the House of Representatives, it is
rare for a gove rnment co enjoy a majority in the Senat e. Governments are usually a few
seats short of the majorit y require d co pass the ir legis lation in che 76 -seac Senate. As a
result, they need co secure the support of orher senato rs: the Oppos ition, minor parci.es
such as che Greens or independent senators. Th e 2019 election resu lted in the Coalition
Government falling shore of a Senate majori ty. To win a majority of senate votes, che
Government muse obcain suppo rt from eith er Labor (which has 26 senators), or ac lease
four of the rema ining senators, from che Greens, m inor parries , or indepe ndent senato rs.
le is rare for governments co en joy a majority in che Senate . Th e lase rime chis occurred
was after the 2004 elect ion when the Howa rd Government enjoyed a majority of one voce
in the Senate, al lowing it co pass many laws the Senate had rejected previously, includ ing
che full sale of Telstra and reduc ing controls on media ownership .
 Chapter 16: Government in Act ion I
T h e recent lack of a majorit y in rh e Senate suggests chat most Austra lian voters suppo rt
t he role of the Senate as a balance against rh e power of rhe govern menc. Alth oug h this
slows down the process of deve loping legislat ion , it also result s in a more detailed review
of govern ment pol icies and may curb the excesses of either of the major parr ies.

Governments also need co retain pop u lar suppo rt in order co be re-elected, an issue that
is always on the minds of po litical leaders. This requires them ro work hard at exp lain ing
economic policies and convincing the publ ic that the ir srraregies are rhe most effective
ones available, even if some elements of th em may be unpopular . This p rocess is often
d ifficult, because economic reform can create groups of winne rs and losers. Th is will be
seen in more derai l in rh e HSC Course, wh ich examines Austral ian govern ment economic
policy and irs impacts in much g reater deta il.

Since political parties form governm ents , they p lay a key role in the process of makin g
economic po licy. In Austra lia, federal and state governm ents are usually formed by a single
political parry (such as the Australia n Labor Parry) or a coalition of rhe two conservative
parries, the Liberal Parry and the Natio nal Parry (often just known as "the Coalition Parries").

Policymaking can be a complex process

Withi n po litical parr ies, most decisions are mad e by the parry leadership. Technically,
policy is developed by parry membe rs th rough local branches and scare and federal
conferences. In reality, however, most pol icy decisions are made by e lected po litical
rep resentatives . Althou g h chose representatives have the freedom ro vote d ifferentl y from
t heir own pol itica l parry in parl iament, in Austra lia parry membe rs almost always vore
wi th the ir party.

T h e leader of a politica l party is ul timately responsible for makin g economic po licy

decisions, although parry leaders differ in rh e extent ro wh ich they involve min isters
and othe r memb ers of parliaments in makin g decisions. Th e process of dec ision-making
in. gove rnments has tended co becom e more centralis ed in rhe Prim e M inister's Office
or rhe Premier's Office over recent decades. Decision-maki ng power rends co rest in rh e
hands of a small numbe r of sen ior govern ment ministers and senior pub lic servants.
N everthe less, political parr ies have a significa nt influ ence over rh e decision s of their leader
because all leaders depe nd upon the support of the other members of rh e party in order
co remain rh e leader. Since 2010, rh e govern ment MPs have removed their party leader
(t h e Prim e Min ister) on four occasions: 2010 (Rudd ), 2013 (Gi llard), 2015 (Abbott) and
2018 (Turnbull).

II
I
The Ma rk et Econ om y 2020
11
For more informa tion, visit
the following webs ites:
The Business Council of
Australia:
www.bca. com.au
Australian Industry Group:
www.ai group.com.au
The Australian Chamber of
Commerce and Industry:
www.au strali anchamber.
corn.au
MineralsCouncil of
Australia:
www .mine rals.org.au
Australian Governmen t
Register of Lobbyists:
lobbyists.pm c.gov.au
11
For more informa tion
on the activities and
cam paigns of the union
movement , visit the
webs ite of one of the
following organ isations:
Australian Council of Trade
Unions:
www .actu .org.au
Unions NSW:
www .unio nsnsw.org.au
National Tertiary Education
Union:
www .nteu .org.au
Business
Business g roups have a significant voice in government pol icy decisions. In part, this
reflects the fact that in a market economy, successful and grow ing businesses are cruc ial
for a nation's prosperity . It also reflects the public influence that busi nesses can have in
publ ic debates, as well as the financial influe nce tha t businesses have over politica l parties .
Politica l parties receive limited pub lic funding to conduct election campaigns, and th ey
now rely on large donations from busi nesses to fund the ir campaigns. Businesses are
involved in lobbyi ng governments and cont ribute to policymak ing across a wide range of
issues that may affect their activ ities. Political parries are somet imes accused of chang ing
the ir policies because of the financial cont ri but ions of busi ness groups. Recent years have
seen several mem bers of the NSW parl iament resig n because of receiving illegal campa ign
donations from businesses, in part icular property develope rs (who benefit directly from
government app rovals for construct ion projects).
Businesses ded icate significant resources to lobbying governments . Austral ia has three
peak business groups. The Business Counci l of Australia represents the chief execut ives of
app roximately 100 of the largest compan ies in Aust ralia. T he Austra lian Indust ry Group
represents businesses from a wide range of indust ry sectors including manufacturing an d
informat ion tech nology. The Austra lian Chamber of Comme rce and Industry represent s
chambe rs of comme rce across Austra lia, includ ing sma ller businesses . Some bus iness
groups represent the interests of a particular busine ss sector, such as the Minera ls Counci l
of Australia , the Austra lian Bankers ' Association and the Hous ing Indust ry Association .
Lobby ists gene rally represent indiv idua l companies and advocate for the interests of those
specific firms on issues such as tax, regu lation , privatisation, outsourc ing of government
services and spending programs. Lobbyists are often former Members of Parliament or
former staff of government ministe rs, who understa nd the po licymaki ng p rocess and
how to influence it. Concern about a lack of openn ess about the influence of lobby ists
prompted the Government to create a Lobbying Code of Conduct and an official Register
of Lobbyists in 2008 .
Unions
Un ions are amongst the largest organ isations by membership in Austral ia. However, t he
influence of un ions has declined as their membe rship has fallen from a peak of 55 per cent
of the workforce in the 1970s to around 14 per cent . Unions mostly represent the inte rests
of the ir membe rs in ind ividua l workplaces, but they are also involved in consu ltations
with governments on many po licy issues. For example , the Hea lth Services Union (HSU)
is often involved in publ ic debates on health pol icy as well as the role of health worke rs.
Unions part icipate in pub lic debates and somet imes issue reports on any matters that affect
the interests of t heir members. Mostly, however, they focus on industrial relations issues.
T he peak organisat ion in the Australian un ion movement is the Austra lian Council of
Trade Unions, which coordinates campaigns and po licy advocacy among un ions nationally .
However, important regional groups also exist, such as Unions NSW . Unions have a much
greater input into the pol icy of Labor governments than Coalition governments and th ey
are a major source of donations for Labor Party campa ig ns. They have specific inte rests
in labou r market po licies, specific industry po licies and measures that affect the inte rests
of peop le on lower incomes.
 Chapter 16: Government in Act ion I
Climate and environmental groups
Australia has several interest groups chat advocate for action on climate change and
mo re generally for environm enta l p rotection, includi ng the Austra lia n Conservation The Australian
Founda tion , Friends of the Earth , Greenpeace, th e Wild erness Society and th e World Conservation Found ation
Wi ldl ife Fund . Th ese organisations conduct research, provide educat ional information and is the peak Australian
environmen tal grou p.
lobby govern ments and compan ies around a wide range of issues that have impl icatio ns
Its webs ite is:
on the enviro nment at local, nationa l and g loba l levels. www.acf online.org.au

While g roups such as Greenpeace are perhaps best known for hig h-profile p rotest tactics,
such as blockadi ng forestry workers or nuclear warsh ips , the enviro nmental movement
has helped make the environment an important issue for econom ic po licymake rs.
Politica l parties now compete to dem onstrate the ir commitm ent co the environment,
indust ries such as mining face much tougher environmental sta ndards than in th e past,
and a substantia l amount of mon ey is spent on environmenta l ini tiat ives. Environ menta l
concerns are give n especially hig h pr iori ty by the Austra lian Greens parry, wh ich in recent
years has enjoyed significant influence in the Senate as the th ird largest pa rry in Austra lia.

Welfare agencies
Welfare orga nisations seek to represenc the most disadvantaged people in tihe commun it y-
th e aged, people with disab ilities, carers, unemployed peop le and p eople with low incomes. To find out more abo ut
T h e Australian Council of Social Services (ACOSS) operates as the peak welfare lobby these organisatio ns, visit
gro up. Other types of welfare g roups include com mun ity legal centres and charit ies. the ir websites:
We lfare groups partic ipat e in the pub lic po licy process by participation in governm ent Australian Council of
inquiri es and by lobbyi ng governm ent ministers . Welfare groups can also influence th e Social Service (ACOSS):
policy process by using the media to bring attention co their message a nd pressure th e www.acoss.org.au

gove rnm ent . Legal Aid NSW:

www.legalaid.nsw .gov.au
You mig ht also like to look
The media at charity organ isations
such as:
A[though th e media's main role is co report the news, in reality it can also influe nce
The Brotherhood of
gove rnm ent pol icies. Its role is changi ng with the rise of new social media and other
St Laurence:
platforms. T he media's influe nce operates at many levels, from determin ing which issues www.bsl. org.au
wi ll receive coverage co how issues will be p resented co the pub lic. Political leaders try St Vincen t de Pa ul
to ant icipate how the media wi ll report the ir pol icies. If they think po licies are likely to Society:
face heavy criticis m, th ey may change their plans . Simi larly, polit ical leaders may pursue www.vinnies .org .au
policies that can win positive media coverage, even if the polic ies are of l imited benefit .

T h e d istinction between the reporci ng of fact and the presentation of a write r or

broadcaste r's opinion is often blurred. Some popular media personalit ies are conside red to
be influentia l in shap ing what voters chink about issues and how th ey vot e. Sydney has a
history of stridently opinionated radio personal it ies such as Alan Jo nes and Ray Hadley,
wh o somet imes appear at po litical rall ies and are regarded as an impo rtant influe nce
on th e po licies of Coalition govern ments. Debate about the wide r role of the media in
influe ncing electio ns was reig nited in 2018 , afcer Pri me Minist er Malcolm Turnbu ll was
deposed as Liberal Party leader, following a sustained campa ign against him by Jo nes,
Had ley and parts of Rup ert Murdoc h 's media organisat ion , News Corpo ration. Debate
over the perceived bias of report ing in the media is a longsrandi ng feature of Austra lian
politics, and even the report ing of day-to-day economic news rends co differ betw een
d ifferent media outlets.
I
The Market Economy 2020

Interest groups
People with concerns, interest or expertise relat ing to specific issues often form
Most major interest organ isations to work togeth er towards commo n ends. Some interest g roups have a
groups have their own stro ng local focu s: for examp le, resisti ng a development proposa l or raising an issue of
websites, many of which concern to a local community such as hydraulic fracking of undergrou nd gas reserves ,
contain information about wh ich has become an increasing ly controversial issue in many areas of rural Austral ia in
their own policy interests
recent years. Some interest groups are formed aroun d sing le issues, such as the Aust ralian
and agendas:
Repub lican Movement . Others represent a particu la.r group in the community, such as th e
NationalRoads and
Natio nal Farme rs' Federat ion, the National Union of Students and the National Roads and
Motorists' Association:
www.mynrma .com.au Motor ists' Association. Some g roups play a broade r role in represent ing public interest
NSWAboriginal Land concerns, such as Choice (formerly known as the Austra lian Consume rs' Associat ion) and
Council: GetUp!, an onl i ne pol it ical advocacy group.
www.alc. org.au
NationalUnionof International influences
Students:
www.nus.asn.au Since the early 1980s, int ernational financial markets - in particular, the foreign exchange
Choice: mark et - have eme rged as a sign ificant influe nce on economi c pol icy. Governments are
www. choice.com.au wary of mak ing policy decisions that would be unpopular with int ernational financial
GetUp! mark ets . If financial mark ets lose confidence in the government's economi c management,
www .getup. org.au they could face a fall in the ir exchange rate, highe r inte rest rates on government borrowing,
and negat ive media coverage. Economi c po licy is u nder consta nt scrutiny from financial
mark ets, and th is has tended to result in lower budget deficits, as well as a stronger
commitment to m icroeconom ic reform .

Financial mark et s may force the government to change its policies. For example, during t he
global financial crisis in 2008, international credit mark ets almost collapsed after a major
investment bank went bankrupt . Concerned about the risk of a severe economic collapse,
governments arou nd the world annou nced they wou ld invest trill ions of dollars in buy ing
bank shares, guaranteeing bank deposits and buyi ng securit ies. Whi le th is was an extreme
illustration of governments responding to prob lems in financial mark ets, it demonstrates
the extent to which financial markets can influe nce po licy. Th e influe nce of financial
mark ets has been less noticeab le in recent years because gove rnment pol icies (at least in
Austral ia) have generally been in line with the po licies suppo rted by financial mark ets .

As Austra lia has become more integrated with the g lobal economy over recent decades, it
has also made cho ices that in many ways have weakened the power of national governments .

■
For example, as a member of th e World Trade Organisat ion , Australia is not allowed to
give direct assista nce to exporters (although it can prov ide general industry assistance so
The influence of long as this is not specifically targeted to businesses that are export ing).
international factors
Austra lian gove rnm ents are also influenced by overseas po licy trends, especially in
is often disc ussed in
the publications of other wealthy nations who are memb ers of the Organisat ion for Econom ic Cooperation
international organisations and Development (OECD). Most indust rialised nations face simi lar econom ic issues to
such as: Austra lia, such as the challenges of g lobalisation , an ageing population, growing pressures
WorldTrade Organisation: on government services and pressu res to reduce tax rates.
www .wt o.org
International Monetary Th e impact of internationa l factors on th e Australian economy is examined in much greater
Fund: www .imf.org detai l in the first two topics of the Year 12 Econom ics Course: Th e G lobal Economy and
Wor1dBank: WWW. Austra lia's Place in the Globa l Economy. See you there!
worldbank.org
Organisation for
Economic Cooperation
and Development
(OECD):www .oecd.org
 Chapter 16: Government in Action I

1 Outline how the influence of environmental groups and businesses on the

public policy process has changed in recent years.
2 Consider T HREE important econom ic, health, education or social po licy
issues from recent years. Discuss the ways in w hich these issues reflect the
strength and influence of the diff erent groups in Aust ralian society.
The Market Economy 2020

1 Fiscal policy is presented annually in the Commonwea lth Budget. It sets out the
government's plans for spending and collect ing revenue for the year ahead.

2 A balanced budget is where the expected revenue and planned expend iture
are equal. A surp lus budget is where the expected revenue is greater than
planned expenditure. A deficit budget is whe :re planned expenditure exceeds
expected revenue.

3 The largest component of revenue for the govern ment is income tax , which is
levied on indiv iduals and compan ies.

4 The largest component of government spending is social security and welfare

payments , such as assistance to the elderly, family benefits, and income support
for peop le w ith disabilities and people who are unemployed .

5 The government can implement:

• an expans ionary fiscal policy to boost the level of econom ic activity
• a contractionary fiscal policy to reduce the level of economic activity , or
• a neutral fiscal policy to maintain the current level of econom ic activity.

6 Automatic stabilisers , which include unemp loyment benefits and a progressive

income tax system , are counter-cyc lical components of fiscal policy that reduce
the severity of fluctuations in the business cycle .

7 Policymaking is influenced by interest groups irncluding businesses, unions,

environmental groups and welfare agencies, which all attempt to influence the
government to achieve their goals. The media is also an important influence on
the process of making government policy.

8 The Constitution sets out the limits of the powers of the Commonwealth and state
governments, and in some areas restricts how the Commonwealth Government can
manage the economy.

9 Austra lia's parliament is divided into a Lower house (the House of

Representatives ) and an Upper house (the Senate ). New laws must win the
approval of both houses. The government cannot pass legislation in the Senate
without some support from other senators , which means the government must
often negotiate the details of its policies in order to get legislation passed.

10 International treaties and membersh ip of internationa l organisations can impose

constraints on economic policymaking. For example , Australia 's policy options
to assist local industr ies are limited as a result of Austra lia's membership in the
World Trade Organisation.
 Chapter 16: Government in Action

•
- - --- -- ~~ ~::..:=-..a
rev1ew
1 Explain the three possible budget outcomes.

2 Describe the impact of the fo l lowing fiscal policy stances :

a) contractionary
b) expansionary
c) neutral.

3 Discuss what is meant by automatic stabilisers and how they operate in the
following situations:
a) recession
b) boom .

4 Ident ify what proportion the follow ing expenditure items make up as a proportion
of total Commonwea lth Govern ment expenditure:
a) defence
b) health
c) social security and welfare
d) educat ion.

5 Describe the role of the Parliament in formulating government pol icies.

6 Explain how political part ies influence the publ ic policymaking process and how
the parties themselves decide their policies.

7 Analyse the role played by the media in policy making in Australia. Identify a
policy debate where the media has played a major role.

8 Examine the role played by the Australian Constitut ion in influenc ing economic
policy in Austra lia.

9 Briefly summarise how the powers of the Commonwealth Government have

changed over time.

10 Assess the importance of internat ional factors in influencing government policy

in Australia .

Extended response
Explain what is meant by the Commonwealth Budget and discuss the factors that
influence the budget outcome . Examine the role of fiscal policy in the management of
the Australian economy.

Extension question
Consider a recent major economic policy decision . Assess the impact of political
parties , interest groups , trade unions , business , the media and internationa l factors in
influencing the final policy outcome.
 Key Economic
Skills

A.1 Introduct ion

A.2 Drawing and interpreting econo mics d iagrams

A.3 Equations and calculations in econo mics
A.4 Interp reting econom ic data and information

A.1 Introduction
Economics is. a subject chat requ ires you co understa nd che relationships between
different economic ind icators, such as wage levels, p rices, interest races and consumer
spending, and che role of different actors in the economy such as employees,
For further information stockb rokers, and government agencies. It is a m ix of social science, with an emp hasis
on the Economics
on huma n act ivities and scient ific analysis, where we can cest our theories about how
Syllabus and the
off icial requirements econom ies operate by analysing che relationships be tween different economic indicators.
for skills and
assessments , visit the Studying econom ics is not simp ly about me morisi ng a lot of information. You also
webs ite of the NSW have co learn a range of sk ills co understa nd how modern economies funct ion and co
Educat ion Standards be able co pred ict how changes in one par e of the economy can affect othe r parts. For
Autho rity: www. chis reason, ap p lyin g ec on omic ski lls is central co th e Ye ar 11 Economic s Cour se.
educatio nstanda rds. Each Topic of the Year 11 Course conta ins between cwo and six ski lls, and there are
ns w.edu.au
26 skills in coca! for the whole course.

It is best co learn econom ic skills as you learn che cont ent of che course . For this
reason, each of che econom ic sk ills is listed ac che begi nn ing of each topic area in
chis cexcbook, and t he ski lls are incorporate d int o the chapte r materia l. Th e aim of
t h is chapte r is to reinfo r ce your gra sp of eco no mic skill s because of the crucial
role tha t these skills p lay in econom ic analysis and because che skills you learn in t he
Year 11 Cour se are important bu ild ing blocks for the H SC Course.

Assessment for che Year 11 Economics course is based on four sk ill areas. Knowledge
and understandingof co11rse contentis wor th 40 per cent of che Year 11 assessment . Th e
othe r 60 per cent is d ivided equa lly between th ree ot her compo nent s - each of which
you can stre ngt hen wit h the mate rial in this chapter: stimulus-basedskills (20 per cent),
inquiry and research(20 per cent ), and comm11nication of economicinformation, ideas, and
isst1esin appropriateforms (20 per cent).

II
 Appendix A: Key Eco nom ic Skills

YEAR 11
COURSE
TOPIC SYLLABUS SKILLS

Introduction • Construct and interpret product ion possibility front iers

to Economics • Distinguish between equilibrium and disequilibrium situations in the c ircular flow of
income mode l
• Explain how an economy might return to an equ ilib rium situat ion from a
d isequilibrium situation
• Ident ify bias in med ia items on econom ic issues affect ing local, state and national
econom ies
• Ident ify key featu res of an economy through analysis of a variety of informat ion types
and sources
• Work effect ively in groups to invest igate aspects of econom ics and econom ies

Consumers • Analyse the impacts of changes in consumer income levels on the types of
and Business product ion within the economy
• Explain the role of firms in solving the econom ic prob lem

Mark ets • Graph demand and supp ly curves and interpret the impact on the equilibrium of
changes in market forces
• Analyse non-equilibrium market situat ions and propose solutions to them
• Calculate the price elasticity of demand using the tota l out lay method
• Work in groups to investigate and report on the nature of competit ion within a
specific industry

Labour • Compare and contrast the labour market with product markets
Mark ets • Research an outcome of the contempo rary Australian labour market
• Work in groups to investigate the efficiency and equity of labour market outcomes

Financial • Compare and contrast financial markets with product markets

Mark ets • Explain the role of institutions in the operat ion of financ ial markets
• Analyse the impact of financial innovations on individuals and the economy
• Work in groups to investigate the econom ic role of the superannuation industry
• Analyse the factors that influence the level of interest rates
• Predict trends in interest rates in hypothet ical situat ions

Government • Determine whether a spec ific tax is progressive, proport ional or regressive
and the • Interpret Federal Budget data
Economy
• Predict the impact of a budget defic it or surplus on econom ic activity
• Discuss how monetary and fisca l policies can be used to stab ilise
econom ic activity
• Analyse the performance of government business enterprises

Source: NSW Education Standards Authority

Figure A. 1 - Eco nomic skills in the Year 11 Course Skills are

an important
add ition to any
Year 11 Course ski lls can be d ivided into t hree main areas: economist's
tool kit.
• D rawing and int erpreti ng econom ics diagrams
• EqWlt ions and calculations in economics
• Int erpre t ing economic dara and informatio n .
 The Market Econ omy 2020

A.2 Drawing and interpreting economics diagrams

Being ab le to draw and interpret diagrams is have underem ployed or unde r-uti lised resources..
an essenti al skill in rhe Year 11 Course. Some The fronti er shifts out with the d iscovery of
d iagrams, like supp ly and demand and rhe new resources and sh ifts in with rhe deplet ion of
production possibilit ies frontier, are explicitly resources such as the natura l environment.
referred ro in the syllabus. Othe r d!iagrams, such as
chose representing rhe labour mar ker and marker
Food (Units)
failure, are not explic itly referred co in rhe syllabus
bur are neverthe less useful for deepen ing your
und erstanding of how economies operate. Some
d iagrams are useful for represencing the macro-
economy ar the "big p icture" level, wh ile others are
usefu l for analysing the microeco nomic impacts of
changes in specific pares of the economy.

In rhe Year 11 Course, rhe most impo rtant diagram

for understandin g how rhe econom y firs toget her is 0
Clothing (Unit s)
rhe Cir cular Flow of I nco m e diagram - it breaks
down rhe economy into five sectors and looks at how
money moves between ind ividuals, firms, financial Figure A.2 - Production possib ility frontier

intermedia ries, govern ments and che internatio nal Distinguish between equilibrium and
sector. Most of rhe other diagrams used in rhe disequilibrium situations in the circular flow
Year 11 Course are of a microeconomic natu re. of income model
Th at is, they show us rhe relat ionship between
The circu lar flow of income diagram (figure A.3)
specific economic variables - how does a change in can be used ro show equ ilibrium and disequi librium
X impact on Y and 2 ) Th ese diagrams are useful for
situations in economies. If the leakages from the
microeconomic analysis and predicting rhe future household secto r - savings , taxat ion , impo rts -
levels of different economic variables. are equa l to tihe injections into the firm sector -
In th is section , we review rhe skims of the Year 11 investment, governme nt expenditure and exports
Course where d iagrams can be used to help explai n - rhe economy is in equilib rium and will neither
how economies operate. expand nor cont ract. If leakages are greater tha n
injections , rhe economy will contract; if leakages
Construct and interpret produ ction are less tha n in jections, the economy wi ll expand.
possibility frontiers
T he pro d uct ion poss ibi lity
fronti er demonstrated in figu re
A.2 shows us how economies
tra de off rhe production of one
type of good or service for
orher goods or services - rhe
concept of opportun ity cost.
, Individual s )

!'; '·······.......
. Expenditure on goo ds and services

'· · Savings··► ,
~~··
◄··················· Income rewards ........................ _ Businesses

..............;

Financial lnsitut ions) .... Investment ..;

: !

i
J

T he frontier curs the x-axis at

rhe maximum production level ,Taxation •···········► ,Government
L....... sr ·····...Expenditur e •······j
of one good, and the y-axis at
rhe maximum production level
of the ot her good . Econom ies ,
;............... Imports •····► Internati ona l Flow s J-····"··
Exports ...............
.

p roducing ar a po int on rhe

Leakages Injections
fronti er are efficiently using all
thei r resources of production; if Figure A.3 - Equilibrium and the circular flow model
rhey are inside the front ier, rhey

Graph demand and supply curves and
interpret the impact on the equilibrium of
changes in market forces
The basic demand and supp ly di.agram shown
i n figure A.4 is pr obab ly t h e m ost imp o rtant
d iag ram in t he s tud y of eco n omic s. It shows
how, in a market economy, changes in price ensure
chat the quantity demanded is exactly equa l to
quantity supp lied - a situation known as market
equi librium. If prices are coo high, and the re
is an excess of quantity supplied over qua nti ty
demanded, prices will fall, causing an expansion
of demand and a cont ract ion of supply. If pr ices
a re too low, and there is an excess of qua nti ty
demand over quantity supp lied, prices will rise,
ca using an expansion of supp ly and a cont raction
of deman d . An increase or decrease in demand and/
or supp ly will cause a change in t he equi librium
price and equi librium qua nti ty rhar resu lts from
che interplay of marker forces. T he simp le demand
a nd supply d iagram is used co an alyse product
ma rkets for goods and services, and facto r markets
for labour and capital.
Price$
0 Quan ti ty
~ S (private cost)
Figure A.4 - Market equilibrium
Analyse non-equilibrium market situations
and propose solutions to them
No n-equi librium market situat ions can arise for a
number of reasons. If th ere is an excess of supp ly
or demand because p rices are coo high or coo low
co clear the mark et, prices will adjust, causing
expansions and contract ions in dema nd or supply.
Appendix A: Key Econo mic Skills
If the govern ment has brought about a
d isequi libri um situation by imposing a price
ceiling or p rice floor, wh ich has p revented a change
in price, it could respond by removing the p rice
ceiling or price floor and allowing the market ro
move towar ds equi librium (see figure A.5). Th e
govern ment can instead use raxes and subsid ies
ro change the price and qua nti t y levels whi le still
ensuri ng that rhe marker is in equi librium.
Price$
P,
s D
0 o, ~ Quantity
Figure A.5 - Price ceilings or price floors can
cause disequilibrium
If the forces of dema nd and supp ly have produc ed
market equ ilibrium bur not a social equ ilibrium
(because of pos itive or negat ive externalities),
the n the government can subs idise production or
rax production co achieve rhe social equi librium
pric e and quantit y. T his type of marker failure is
demonstrated in figu re A.6 .
Price($)
S (soc ial cost)
p•- ----
Pm1---- ~"'- -+-- >..~
Quantity
Where :
Pm = market pric e Om = market q uantity
Ps = socially op tim um price Os = socially optim um quantity
Figure A.6 - Market failure
 The Market Econ omy 2020

Compare and contrast the labour market investment deman ds of individuals, businesses
with product markets and gove rnments. Add itiona lly, financial markets
T he labour market is different from mosr product are different from p roduct mark ers because they
markets in four main ways . First, in product tend to be more volat ile, have g reater impacts on
markets, firms supply and ind ividuals demand orher sectors of the economy, and are conseque ntl y
goods and services. In labou r markets, by contrast, subject ro g reater p rudential sup ervisio n by the
indivi duals supp ly labour and firms demand labou r gove rnm ent and is agencies.
- so their roles are reversed . Second , labou r dema nd
Share price S
d iffers from demand for goods and services because
it is a derived demand. Th ird , labour supp ly is
D s
d ifferent from supply of mosr goods and services
because ir is ge nerally less responsive to changes
in wage levels compare d with p ri ces in product
Pe ········ ·····
markets, and its shape can be backwar d bend ing if
ind ividua ls desire certa in income levels, regardless
of th eir hour s of work (nor shown in diagram) .
Finall y, labour market out comes are less likely s D
ro represe nt the influ ence of market forces alone
0 Quantity
because of the stro ng influ ence of insrirutional of shares
factors that affect wages such as tra de un ions,
employer associations, ind ust rial tr ibuna ls and Figure A.8 - Equ ity market

gove rnm ents. For example, a m in imum wage will

affect the operatio n of deman d and!supp ly forces in
rh e labour market, as shown in figu re A.7 .
Wage rate $
D S (wor kers)
w.
s D (firms)
Q, Oe 02 Quan tity of
labour
Figure A. 7 - Labour market wit h a minimum wage
Compareand contrastfinancialmarkets
with product markets
Finan cial markers share some si mi larit ies with
p roduc t mark ers. Financial markers have 'buyers'
who demand finance, "sellers" who suppl y finance,
and a "price" of finance (such as interest races,
d ividends and exchange races) chat influ ences
demand and supp ly. T herefore, we can examine
financial markets using the sam e demand and
supp ly diagrams chat we used for product mark ets .
However, financial markets are d ifferent from
p roduc t markers because they are also a fac to r
ma rket for capita l. Th erefore, che demand for
finance is derive d from the cons umption and
Analyse the factors that influence the level
of interest rates
Int erest rates are the "price" of money in the money
mark et. As int erest rates rise, rhe demand for
money falls because it coses ind ividuals, businesses
and govern ments more money ro borrow funds ..
Inte rest races tend to have littl e or no impact on
the supply of funds (savings) . In Austra lia, int erest
races are indirectly influe nced by the Reserve Bank,
which sets rh e cash rate in rhe shorr-rerm money
mark et. T his can be represente d in rh e money
mark et diagram (figu re A.9) in which rhe Reserve
Bank can increase (or decrease) the supply of funds,
shifting rh e S funds line to rhe right (or left) and
therefore moving rhe interest rate down (or up) .
Interest rate
Dfun d s
cash rate
r•
D funds
0e Qu antity of
fund s
Figure A.9 - Short -term money market
 Appendix A: Key Eco nomic Skills

Predict the impact of a

budget deficit or surplus on Individuals +---- Income rewards ---- , Busine sse s )
economic activity
The circular flow of income diagram
Expenditure on goods and services __j J
(figu res A.10-A .11) can be used co show Savings + Financ ia l Instituti ons) - Investment
how the government's budget can affect
che level of economic acriviry. A budget
Governments
defic it will mean rhac government
i njecrions (expenditu re) are greater t han
Imports --. Intern a ti onal Flow s )- Exports ---'
leakages (taxation), wh ich will result in
greate r coral income, expenditure and Leakages Injections
production - shown in rh e diagram
as bigger flows betwee n rhe different Figure A. 1O - Budget deficit and higher economy activity
secto rs of the economy. A budg et
surplus will mean chat government
Individual s ) • ····················· Income rewards •······················· Bu sinesses )
i njections (expenditur e) are less rhan
leakages (taxation), which wi ll resu lt Expenditure on goods and services •···· .......i ••••!! '
i n lower coral income, expend iture and
production - shown in rh e diagram as '·· Savings ··► Finan ci al Inst itut ions) ....Investment ..)

11·· · · · ►
sma ller flows betwee n the different
sectors of the economy. l...
.... Govern ment s )-·····
• ·····
j
Discuss how monetary and fiscal
policies can be used to stabilise ······ Imports ,
····► Internat ional Flow s }·· ··· Exports ..................)
economic activity Injections
Leakages
Th e circular flow of income diagram
can also be used (figures A.12- A.13) Figure A. 11 - Budget surp lus and lower economy activity
co show the impact of mon etary
po licy on economic activ it y. (For fiscal
po licy, see the preceding exp lanation).
Individuals J• ······
····
· ··Income rewards ························ Businesses )

Comraccionary monetary policy (higher .......... t Expe nditure on goods and services ....
~ ~. t
i merest races) will result in lower levels
of consumption and investment, and • Savings •·► Finan cial Inst itut ions)- .. J
wi ll reduce income and production.
Expansionary mon etary po licy (lower '·· .... Taxation ........,► Govern ment s } ······ Expenditure
inr eresr races)will result in highe r levels
of consumption and investment, and
,....... ······ Imports ····► Internat ional Flow s )··· ··· Exports ..................)
wi ll increase income and production.
Leakages Injections

Figure A.12 - Contract ionary monetary policy reduces econom ic activity

Savings + Financial Institut io ns

Taxation ---+ , Governm ent s )-- Expend iture

Imports -+ Intern a tio nal Flow s }-- Exports

Leakages Injections

Figure A.13 - Expansionary monetary policy increases economic activity

 The Market Econ omy 2020

A.3 Equations and calculations in economics

Compared with natural sciences, rhe "mathematica l" dema nd . As incomes increase, so coo will raxar ion
component of economics is relatively srraighrforward, levels, spendi ng on imports and savings - leaking
involving only a handful of calculations and equatio ns. money our of the economy. Eventually, these
But compared with orher humanities (essay writing) leakages will increase enough ro equa l injections
subjects, like histo ry and Eng lish , stu dyin g and the economy wi ll return co equ ilibri um , but
economics does require a greate r understand ing ar a higher level of income and ourput tha n before .
of how numbers operate , or more technically, how
quant itative informatio n can be used co understand S + T+M = l+G+ X
how economies operate . Equati ons and calculat ions
can be used ro exam ine rhe economy as a whole, such
Calculate the price elasticity of demand
as through the circular flow of income equations,
using the tottal outlay method
or co quant ify specific economic ou tcomes, such as
elasticity and unemploym ent. In this section, we Along rhe demand schedule , we can calculate price
review rhe skills of the Year 11 Course char require elastic ity of demand by examini ng rhe relat ionship
equatio ns and calculat ions. between price changes and changes in coral outlay
by consumers .. Total outlay is simp ly the price
Distinguish between equilibrium and mu lt ipl ied by rhe quantit y demand ed ar each price
disequilibrium situations in the circular flow level. As pric e rises, what is happ eni ng ro coral
of income model outlay? If it is rising, demand is inelast ic; if it is
The easiest rest of whethe r the economy as a falling, demand is elast ic; and if dema nd rema ins
whole is in equilibrium or not is provided by the unchanged, demand is un it elastic.
injections and leakages equation - if coral injections
Price$ Quantity Total outlay Elasticity
equa l rota! leakages, the economy is in equ ilibrium;
demanded (price x
if not, rhe economy is in disequilibrium . Note (units) quantity)
rhar specific secto rs of rhe economy need nor be in
5 50 250 .......
. .. inelastic
equ ilib rium. For examp le, iris possible for savings
ro be less tha n investment and for rhe economy co
6
7
45
40 1
270 •·········· inelastic
280 i· ·········•Unit elastic
sti ll be in equi librium , so long as another injectio n , 8 35 280
•···········elastic
such as exports, is greater rhan rhe leakage in rhar 9 30
!;~} ·········••elastic
secror, such as imports. 10 25

Savings Investment
+ Taxation _ + Government expend iture Elastic ity and tota l outlays
+ Imports + Exports
Price 1" Revenue 1" Inelastic

S+T+M l +G+ X Price 1"Revenue ,&, Elastic

Leakages - Injections Price 1"Revenue Unit elastic

Explain how an economy might return Research an outcome of the contemporary

to an equilibrium situation from a
disequilibrium situation
Using rhe leakages and injectio ns equatio ns,
you can identify how an economy may return
ro equi librium from a d isequilib rium situat ion .
For examp le, if an injection such as investment
increases, injections will be greater rhan leakages
and the economy will be in disequi librium . Hig her
investment will cause a rise in tota l expenditure ,
and force suppliers to run down their stocks and
employ more labour in order co meet increased
Australian labour market
Two important labour mark et outcomes requ ire a
calculat ion. The first is the labour force part icipatio n
rare, which is che coral numbe r of peop le emplo yed
or unemp loyed, d ivided by rhe working age
popu lat ion . T he second is the un emplo yment
rare, which is rhe coral num ber unemp loyed.,
divided by rhe labour force. In researching labour
mark et ourcomes, you may need co calculate these
percentages from raw figures .

Labour force Labour force 100
Participation rate Working age population (15+) x - 1-
(%)
Unemployment Number of persons unemployed 100
rate(%) = Total labour force x - 1-
Determine whether a specific tax is
progressive, proportional or regressive
A rax is progressive, proport ional or regressive
depe nd ing on what is happeni ng to an indiv idua l's
average rare of tax (ART ) as their income rises.
If ART is rising, rhe rax is prog ressive; if ART
is constant, the rax is proportiona l; if ART is
A.4 Interpreting economic data and information
Ou r srudy of econo mics wou ld be incomp lete (and
fairly boring) if we on ly ever looked ar d iagrams,
equations and economi c theories without reference
co how econo mi es operate in th e real world.
Analysin g rh e nature of economic relatio nships
a nd the perfo rm ance and structure of economies
in the real world is centra l ro the Year 11 Cou rse.
In broad terms, the Syllabus hi gh lights rh e
i mporranc e of research ing information from a
var iety of sources; analysing , synth esising and
eva luati ng that inform atio n; and be ing able to
co mmunicat e economic informat ion, ideas and
issues . In the final section of this chapte r, we
look at the key ski lls in rh e Year 11 Syllabus that
requ ire both indiv idua l research an d group work
a nd how you can find, interpret and ex p lain
e con o mic data and informa tio n .
In what follows, we focus o n t he use of
che I nterne t and webs ite s, highligh tin g the
i mpacr of rh e informatio n revolutio n on econo mic
research met hods and techn iques. As recentl y as
a decade ago, we wou ld be d irecti n g you ro less
accessib le, more costly, and more ob scure sources
of information. T he Inte rn et offers a superior
a ltern at ive - cheaper, more accessib le information
is on ly a "click" away. T he Int ern et is not perfect ,
a nd you need ro know your way around ro find
che most reliab le and up-to-date informatio n , bur
i t sure beats wait ing for the local li brary ro open
o n Sun day mornin g!
For each of rhe key skills highlighted in the Year 11
Syllabus, we have identified a range of usefu l
websites and information on how to best use them.
Th ere are six broad categories of websites that
we discuss - laresr news, Australian Governme nt
Appendix A: Key Eco nomic Skills
fall ing, the rax is regressive. T he average rate
of tax is calcu lated as coral rax paid d ivided by
income . For exampl e, persona l income tax in
Austra lia is p rogressive because average tax rates
rise as incomes increase. Th e Goods and Services
Tax, by contrast , is regressive because peop le on
highe r incomes spend a smaller proport ion of
their incomes on consumption and therefore pay a
smaller proporri .on of the ir income as tax .
Average rate Total tax paid
of tax(%) Income
sites, financial insritur ions, communit y sector
orga nisations, int ern at iona l orga n isat ions and
educationa l bodies .
Identify bias in media items on
economic issues affecting local, state
and national economies
Th e websites of media orga nisations tend to be
updat ed regula rl y, especially those that have major
pub lications or b roadcasti ng services. News items
are usually orga nised by date of pub lication and
some, like rhe Austra lian Broadcasting Corporat ion
(ABC), have web pages that are updated round rhe
clock with the laresr breaki ng news. Australia's
media probab ly has less explic itly biased reporting
than rhe Un ited Scates and rhe U K (e.g. cable
television netwo rks like Fox and MSNBC in
rhe Un ited Stat es, or The Daily Mail, The Sm1
and The Mit-ror in rhe UK). Neve rthe less, ther e
are several sources of bias in media report ing in
Austra lia - inclu di ng newspaper headlines (which
are often misleadi ng and sensational), selective
facts (omi ttin g other important information) , the
use of emotional language and imagery, and bias
in op in ion sections of websites or newspapers . To
sharpen your ski lls in identify ing media bias, you
could choose a cu rrent econom ic issue in Austra lia
and find reports relat ing ro that issue on sites such
as thos e below. You cou ld consider the different
ways in wh ich rhe issue is presented, what facts are
selected by different reporters and whethe r th ere is
any bias in th eir reports.
Australian Broadcasting Corporation:
www .abc. net.au
Sydney Morning Herald : www .smh.com.au
II
 The Mark et Econom y 2020

10 TIPS FOR INTERNET ECONOMIC RESEARCH

1 Know what you are looking fo r. If you just start surfing without a cl ear sense of direction you may find
that hours have passed with few results.
2 Start with the off icial national or international organisations respons ible for that issue or policy area
- such as the Reserve Bank, the Treasury, the Australian Competit ion and Consumer Comm ission or
the World Bank.
3 Generally, give priority to webs ites of well- known organisations :such as governmen t departments ,
international organisations, major newspape rs, financial institut ions , commun ity sector organisations
and educationa l institutions. They tend to have more reliable and up-to-date information.
4 Check out econom ics biogs to see if there is discuss ion or debate about the issue. Australian academ ic
John Quiggin has a well regarded biog that includes links to many of the best biogs from around the
world - see htt p://johnquiggin.com/
5 If you are having difficulty fi nding general introduc tory information, the UK econom ics education
website econ .econom icshelp .org may be a useful guide.
6 Some sites charge for access to articles or pub lications. For the purposes of the Year 11 Course,
noth ing you need to know (or probab ly even want to know) requires expensive material. Often you can
down load summaries, main features, first chapters , etc ., for free, or you can sign up with a newspaper
at no cost fo r a limited access to articles (for examp le, 10 per month).
7 If you find useful information, bookmark it under an econom ics tab. You might want to come back to it
in the future, but if you haven't made a note of where you discovered the information , then you might
never make your way back to it.
8 Once you 've identified somet hing impo rtant, you might want to print it out. That gives you a permanent
record in case your compu ter freezes up or you forget where you found some useful information.
9 If you find a good source, such as an article or report, use its bibliographyor references to chasedown
further specific information. It might also be useful to look at similar information by a particular author who
may be an expert in the area, o r similar information from the same organisation such as a research centre.
10 Sometimes you don 't find the material you are looking fo r quickly - experiment with different search
terms and be patient, as your skills in searching and find ing the right econom ics information get better
with practice .

The Australian: www .theaustralian.news .com.au but be prepa red to only find information on
high-i ncome cou nt ries that are O ECD members
Australian Policy Online: www .apo .,org.au
(and a handfu l of othe r econom ies). Th e Worl d
The Economist: www .economist .com Bank has the g reatest coverage in terms of count ries,
wit h count ry snapshots and informat ion on curre nt
The Guardian: www .theguard ian.com .au econom ic issues. Th e Int ern at ional Monetary
Fund p roduces hig h qua lity reporrs about global
Work effectively in groups to investigate
economic conditio ns such as its biannual \Vorld
aspe cts of economics and economies
EconomicOutlook.
U ndersta nd ing the st ructu re and performance of
mode rn economies is a key ski ll of the Year 11 Organisation fo r Econo mic Cooperat ion and
Development: www .oecd .org
Course. W hile there are many sources of informatio n
on ot her economies, it is best to use data from World Bank: www .worldbank .org
int ernationa l orga nisat ions because t he informat ion
International Monetary Fund: www .imf.org
is more easily compa rable to oth er econom ies
and because t he econom ic ind icators they report
are measured by int ernatio nal sta ndards. For the
most up -to-date and comprehensive stat istics and
reports, visit th e website of th e O rga nisatio n for
Econom ic Cooperation and Development (OE CD ),

Analyse the impacts of changes in
consumer income levels on the types of
production within the economy
Consumer income levels are rhe sing le mosr
i mportant factor infl uencing rhe coral level of
consumption by indi viduals. Th ey are also an
i mporrant factor influencing the type of goods and
serv ices individuals consume, and hence , the types
of p roduct ion by business firms. H ig her income
ea rners rend to have very d ifferent consume r
demands compa red with lower income earn ers.
Ana lysis of the relationsh ip betw een consu mer
i ncome and expendi cure patterns is rare and hard to
find. It is unlikely that you will randomly stumble
onto good research or a useful publication via search
engines . Instead, check our rhe Austral ian Bureau of
Srar isrics' HouseholdExpenditrmSurvey pub lication,
which derails the expenditure habits of different
i ncome groups. Getti ng there is a little tricky: go
co the website of rhe ABS, the n go ro "Statistics"
i n the left hand colum n, rhen "Catalogue number ",
the n 65; select Consumer income and expenditur e,
the n "6530.0 - Hous ehold Expenditur e Survey,
Austra lia: Summary of Results" . Additionall y, the
Commonwea lth Treasury produces publicat ions
a bout consumption and income patterns in
che economy.
Aust ralian Bureau of Statistics : www.a bs.gov.au
Commonwea lth Treasury: www.treasury.gov.au
Explain the rote of firms in solving the
economic problem
Busin ess firms are central ro solving rhe economic
problem. Whi le their decisions are constra ined by
che pattern and level of consum er demand, p lus
che rules and regulations set by govern ments, it
is business firms that u ltimate ly d ecide what is
produced , how much is produced, how ro produce
a nd (ro a lesser extent) how to dist ribute production.
Findin g informat ion on the product ion of goods
a nd services by businesses is relatively easy. Th e
D epart ment of Industry, Innovation and Science,
che associated Minister, and business groups such as
che Business Council of Australia have informat ion
on the contributio n of business ro our economy. You
mi ght also like to visit rhe "about us" sections of
che websites of specific businesses ro learn about the
contribution of firms at rhe micro level.
Department of Industry, Innovation and Science:
www.indu stry.gov.au
Business Council of Aust ralia: www.bca.com.au
Appendix A: Key Econom ic Skills
Work in groups to investigate and report
on the nature of competition within a
specific industry
Th e intensity of competition between firm s within
a part icularly industr y can be measured in a
number of ways: the number of firm s, the mark er
share of firms , che barriers ro entry and exit, and
rhe level of product differentiation. Th e "mark er
structu re" of an industry is in turn influe nced by
rhe nature of rh e good or service, the potential or
need for econom ies of scale, gove rnment po licies
and historical factors . Th e best scarring p lace for
choosing an ind ustry to examine is the website of
Australia's competition watchdog, rhe Australian
Competit ion and Consume r Commiss ion . Its
website has information on the pri nciples of
compet ition and the ind ustries or business firms ir
is monitorin g . To examin e rhe natur e of competit ion
between firm s, you should also consult rhe websites
of the main firm s in the industry that you choose.
Aust ralian Competition & Consumer Comm ission:
www.accc.gov.au
Research an outcome of the contemporary
Australian labour market
The two mosr important ourcomes of the
Austra lian labour market are wages and the level
of unemp loymem. You can access labour marker
statist ics from rhe website of the Australian Bureau
of Statistics (ABS) - the "Key Nat ional Indicators"
link on the homepage will g ive you headline
srarisrics, bur for further dera ils you will need
ro consult "Labo ur Stat ist ics in Brief" (catalogue
6 104.0) or "Australian Labour Mark er Statistics"
(catalogue 6105 .0). T he Department of Jobs and
Small Business website has some statistics and
reports about labour market outcomes. You may
also consu lt other organ isations that specialise
in labour market economics . Th e Cent re of Full
Emp loyment and Equit y (at Newcastle University)
focuses on unemployment . T he National Institute
of Labour Stud ies (at Flinders University) focuses
on a range of wage, workplace and ind ust rial
relations outcomes of Australia's labour mark er.
Department of Jobs and Small Business :
www.jo bs.gov.au
Centre of Full Employment and Equity:
http:// e1.newca stle.edu.au/c offee/
National Institu te· of Labour Studies :
www.f linders.edu .au/ sabs/nils/
 The Mark et Economy 2020
Work in groups to investigate the efficiency
and equity of labour market outcomes
Th e challenge of find ing a balance between
econom ic efficiency and equity (or fairness) in the
labour marker has been an area of ongoing debate
in Austra lia. At many times in Austra lia's history,
debates about labour market outcomes have moved
from the workp lace ro rhe pol it ical arena - and
even onto rhe srreers . In what remai ns one of
rhe most conte nti ous areas of economic po licy in
Australia, emp loyer and un ion organ isatio ns seek
ro p romot e the inte rests of worke rs and businesses,
often arguin g char the "nati onal interest" is best
served by adopt ing the ir perspective on what the
labour market shou ld look like . As you examine
rhe websites of the following labour mark et (or
"industrial relat ions") organ isations, rry to see
both sides of the argument abom the efficiency
and equ ity of Austra lia's labour m arker outco mes.
H. R. Nicholls Soc iety : www .hrnicholls.com.au
Austral ian Chambe r of Comme rce and Industry :
www .acci.asn.au
Austral ian Counci l of Trade Unions:
www .actu .org.au
Explain the role of institutions in the
operation of financial markets
Australia's financial sector is regulated by four main
organ isations, and their act ivities are somet imes
coordi nated th rough rhe Counc il of Financial
Reg ula tors. Th e Reserve Ban k of Austra lia
(RBA) condu ces mon etary policy on behalf of the
gove rnm ent , oversees rhe stab ility of the financial
system, contro ls rhe issue of curren cy and regu lates
rhe payments system. Th e Aust ralian Securities
and Investments Comm ission (ASIC) is responsible
for corporate regulation, consumer prorecrion
and rhe oversight of financial services prod ucts .
Th e Austra lian Prud ential Regu lation Auth ority
(APRA ) is responsib le for prudent ial supervis ion
and regu lat ion of all deposit-rak ing institutions,
life and gene ral insurance and superannuat ion
funds . Th e Austra lian Treasury has responsib ility
for advising the gove rnm ent on finan cial stab ility
issues and for rhe legis lative and regu lato ry
framework for rhe financial system. T he websites of
these organ isations are up-to-date , high ly reliable
and conta in lots of useful informa t ion. Th e "about
us" sectio ns have backg roun d information about
rhe organisations' responsibilities and srrucrure.
You will also find informat ion about the ir recent
activ it ies in financial mark ers, speeches by the ir
II
key officials, financial market star isrics, and links
ro the ir publ ications - all of wh ich will help
you understa nd the role of these organ isations in
financial mark ets.
Austral ian Securit ies & Investmen ts Commiss ion:
www .asic.gov.au
Reserve Bank of Austra lia: www .rba.gov.au/
payments-and - infrastructure/
Austral ian Prudent ial Regulat ion Author ity:
www .apra.gov .au
Austral ian Treasury : www .trea sury.gov.au
Analyse the i mpact of financial innovations
on individuals and the economy
Financial inn ovations are improvements in the
operat ions and efficiency of the finan cial sector
of rhe economy. Th ey include innovations such
as Int ernet bank ing, mobile payments, BPay,
Electronic Funds Transfer ar Point of Sale (EFTPOS)
and Automati c Teller Machi nes (ATMs). Financial
innovat ions have influe nced individual financial
p lanni ng; the payments system; and financia.l
markets, such as rhe share market . T he Reserve
Bank 's website has a sectio n on how inn ovations
have affected che pay ments system (t he link is on
rhe hom e page). Consume r perspectives on financia l
sector issues can be found on rhe website of Choice,
an independent organisation p revious ly called the
Australia n Consumers' Association . Th e history
sections (under "about us") for the Austra lian
Securities Exchange and many com mercial banks
and othe r financial institutions dera il the impact
of finan cial inn ovations on the economy.
Reserve Bank of Austra lia:
www .rba.gov.au/paym ents-and-infra structure/
payments- system .html
Cho ice: www .choice.com.au
Work in grol.llpsto investigate the economic
role of the superannuation industry
Superannuatio n p lays a critical role in the Australian
economy because it is an important source of
retirement income in Austra lia, ir allows peop le
ro ind irectly own shares, and ir is a significant
source of finance char can be used for investment
by businesses in rhe economy. Th e int roduct ion
of compulso ry sup erann uation in the early 1990s
has pro mpt ed massive growth in this sector. You
can investiga11:ethe role of superannuation by
examinin g rhe publicat ions of the Association of
Superann uation Funds of Australia. Th e website

of Indust ry Super Funds has informat ion about
some of the largest superannuat ion organisat ions,
and the APRA website has informa t ion about the
regulation of supera nnuati on.
Assoc iation of Superannuat ion Funds of Australia:
www.superannua tion.asn.au
Aust ralian Prudent ial Regulation Autho rity :
www.apra .gov.au
Indus try Super Funds : www .industrysuper.com
Predict trends in interest rates in
hypothetical situations
Th e Reserve Bank of Austral ia (RBA) indirectly sees
i nterest rates in Austra lia to achieve its monetary
po licy goals. Th e primary goal of monetary policy
is to achieve an inflat ion rat e of 2- 3 per cent, on
average, over the course of the economic cycle.
Because interest rare changes can rake between
6-1 8 months to have their full impact on inflation,
the RBA's inflat ion rarger is forward-looking,
w hich means ir is mainl y concerned wit h what
the inflation rat e wi ll be in rhe medium rerm.
Th e Reserve Bank makes interest rare decisions
n ow based on its inflation forecasts, as well as a
n umb er of other ind icators of price pressures and
the ge neral health of rhe economy, incl uding wages
growt h, the exchange rat e, economic g rowth and
the level of unemp loyment. Th e Reserve Bank
website contains information chat can be used ro
pre dict future interest rare movements, incl uding
speec hes on t he conduct of mo n etary policy,
statistics and graphs of key econom ic indi cators
an d forecasts , and media state ments. outl in ing rhe
R eserve Bank 's rationale for recenr interest rate
dec isions. You can also visit the websites of financial
int ermediaries, whose market economi ses produce
their own economic forecasts and make their own
predicrions of Reserve Bank decisi.ons regarding
int erest races and monetary policy. Th e "ANZ Live
site" and rhe "Australia and NZ Week ly" of Westpac
Bank are particularly good.
Reserve Bank of Australia: www .rba.gov.au
ANZ : https :// anzlive.secure.force .com
Westpac Bank : www.westpac.eom .au/
about -westpac / media/ reports/ austra lian-
economic-reports /
Appendix A: Key Econom ic Sk ills
Interpret Federal Budget data
Th e Federal Bu dget is the mosr important
document outl ining the Federal Government's
fiscal po licy objectives and strategy for the coming
year. Th e Budget website conta ins all rhe relevant
information - in cluding su mma ry documents such
as the "Budget at a g lance", the Budget Overview
and the Treasure r's Budget Speech to Parliam ent.
Th e Budget website also has rhe detai led Budget
Papers and the Mid-Year Economic Fiscal Outlook.
Economics biogs and major news sires also cover
rhe Budget in dera il. Using these documents,
you should be ab le ro interpret budget dara and
ident ify:
• rhe objec r ives of fiscal policy
• tre nd s in rhe overall budget position
• whet her t he budget is expansiona ry
or contracr ionary
• rhe key revenue and spend ing initiatives
• its likely impact on the economy.
Federal Budget: www .budget.gov.au
Analyse the performance of government
businessenterprises
Recent decades have seen a clear shift cowards
minimising the role of governm ent in the economy,
and rhe gove rnm ent' s direct role in production has
been subsrantia .lly cur back. Many govern ment
business ent erp .rises (GB Es) have been sold off
ro rhe private secto r; many of those chat remain
are being created as business ent erpri ses with rhe
dual roles of gove rnm ent service del ivery and
profit maximisar ion . Analysing the performance of
GB Es can difficult because rhey often have many
competing objectives and have more responsib ilities
rhan most pr ivate sector enterprises. Th e annua l
reports of GBEs like Austral ia Post and RailCorp
are available from the ir websites, and rh ey provide
details of the their performan ces. Th e Produc tiv it y
Comm ission, an indepe nd ent gove rnm ent agency,
also publ ishes occasional reports on the performance
of governm ent business ent erpri ses.
Aust ralia Post: www .auspost.com.au
RailCorp : www .railcorp .info
Product ivity Comm ission: www.pc.gov .au
m
Glossary
Ab so lu te po vert y refers co the comdicio n of people
wich che lowest living standards: in the g lobal
economy, and is measured by an income level of less
chan US$1.25 per day. See also, relative poverty.
Ad vanced ec on om ies refers co h igh income,
indus tri alised or developed econom ies. The group
of advanced economies includes 35 economies across
North Am erica, Europe and the Asia-Pacific.
Aggregate d emand refers ro the rocal demand for
goods and services wichin che economy. Components
of aggregate demand are: consumpt ion (C), invescment
(I), governm ent spend ing (G), and nee exports (X-M).
Aggregate suppl y refers co the coral produccive
capacity of an economy, i.e. the potential oucpuc when
all factors of production are fully utilised .
All oc at ive efficienc y refers co the ,economy's abilicy
co sh ift resources co where they are most valued and
can be used most efficiently. See also, dynd111-i
c effi ciency
d11dtechnicalefficiency.
Apprec iatio n is an increase in cheval u e ofa n economy's
currency in terms of anothe r currency. See also,
depreciati
on.
Arb itration is a d ispute resolucion process in wh ich
an industri al tribuna l hands down a legally bind ing
rul ing co firms and employees. See also , conciliation.
ASEAN -Aus cralia-New Zeal and Free Tr ade Area
(AA N ZFTA ) is a regional trade ag reement in effect
from 2010.
ASEAN Free T rade Area (AFTA) is a reg ional
free crade agreemenc signed in 199 2 char now covers
10 south -ease Asian economies: Singapo re, T haila nd ,
Malaysia, Philippines, Indonesia, Brun ei, Vierna m,
Laos, Myanma r and Cambod ia.
As ia-Pacific Econo mic Cooperati o n (A PEC) forum
is a g roup of 2 1 Asia-Pacific econo mies, includ ing
Australia, chat promoces free tra d e and economic
integrat ion.
Assoc iation of South-Ea s t As ian Nat ion s (ASEAN )
was established in 1967 co reduce regional tensions
and co develop coopera cive appr oaches in deali ng wich
outs ide count ries. Ics members are: Brun ei, Cambod ia,
Indo nesia, Laos, Malaysia, Myan mar, Ph ilippi nes,
Singapore , T ha ilan d and Vietnam.
Aus tra lia-Uni ted Stare s Free T rade Agreement
(AUSFTA) is a bilate ral free trade agreement between
Aust ralia and the Un iced Scares, signed in 2004 .
Aus tra lian Co mpetit ion and Cons umer
Commi ssion (ACCC) is Australia's compet it ion
watchdog whose role is co enforce che Competitiond11d
Co11
s11111
er Aa 2010 and ensu re char businesses do nor
engage in anci-co.mpecicive behaviour
Aus tra lian Council of Tra d e Un ion s (ACTU) is
che pea k trade uni on body in Australia , covering most
crade un ions.
Aus tra lian In d us tr ial Re lat ion s Commi ssio n
(AI RC) is the old! name of che peak industri al tribunal
at the federal level. le has been replaced by Fair Work
Commi ssion. See a lso, indmtrial tribunals.
Aus tra lian Pr u dential Regu lat ion Authorit y
(APRA) is che governm enc body established co
regulate all depos ic-caking insriru cions, life and general
insurance organ isatio ns and superannuation funds .
Austral ian Secu r itie s and Inve s tme nts Commi ss io n
(ASIC) is the governm ent body with responsibilicy
for corporate reg u lation, consumer proceccion and che
oversight of financial service produces.
Au str a lian T rade Comm issio n (Au stra de ) 1s a
governm ent organi sation char assists Australian exporters
co succeed in deve loping overseas markers.
Aus tra lian W orkplace Agreement s (AWAs) were a
form of indiv idual employment contr act betwee n an
employer and an ind ividua l employee that were phased
OUC in 2013.
Aut omatic s tabil iser s are instrum ents inherent in
che governm enc's budge c char counte rbalance eco-
nomic activity. In a boom period, chey dec rease
economic accivicy, and in a recession, chey increase
economic activity . Th e most comm on examples are
cransfer paymencs and a progressive tax system.

Average propen s ity ro consume (APC) 1s
the proporti on of coral income th at is spent on
consumpti on . See also, margi11alpropensity to consrm
ze.
Average pr opensity ro s ave (APS ) is che proportion
of coral income char is nor spent, bur is saved for future
consum pt ion . See also, margi11al
propensity to save.
Average rate of tax is the proportion of coral income
earned tha t is pa id in the form of a cax. See also
margi11alrate of tax.
Award s establish the minimum wage and working
conditions for employees dependi ng o n their indus try,
occupation or workplace. Restru ctur ed and strea mlin ed
awards are k nown as modern awards.
Bala nce of pa yment s is the record of the cransaccions
between Australia and the rest of che world during a
g iven period , consisting of che cu rrem account and the
capita l and financia l account .
Bala nced bud ge t is the budget outcome where
che level of taxation revenue is equal co governm ent
spendi ng .
Bandwagon effect refers ro a situation where
ind ividuals desire a good or service because of its
popularity , i.e. where demand for a good or service
increases as it gains more users.
Better Off Overall Te st (BOOT) is a rest char
ente rprise agree ments must pass in order ro be
approved under the Fair Work Act . It examin es
whether an employee is bette r off than they would be
under the applicable industria l award.
Bilatera l free trad e agreement is an agreement
between two economies ro lower tari ff levels and othe r
trade barriers in order co encourage increased trade
flows. See also, mrdtilateral free trade agreement and
regionalfree tradeagreement.
Br oad m one y is a measure of che money supp ly char
consists of currency in circulation; all bank deposits,
and deposits in non-bank financial intermed iaries
minus their holdings of bank deposics.
Brexir refers ro che process of the Un ited Ki ngdom
ceasing co be a member of the European Un ion,
following a vote of che Brit ish public in 2016.
Budget is che cool of the govern ment for the exercise
of fiscal policy. le shows the government's planned
expe nd itur e and revenue for the next financial year.
Budget deficit is a budget outcome whe re governm ent
spendi ng is g reater than revenue.
Glossary I
Budget surplu s 1s a budget outcome where
govern ment spend ing is less than revenue.
Bu siness cycle refers co fluctuations 10 the level
of economic gr owth due ro either domestic or
internationa l factors .
Bu siness firm is an organisation involved in us ing
ent repreneurial sk ills co combine factors of production
co produce a good or service for sale.
Capi tal is the manu factur ed products used ro produce
C
goods and services, comm on ly described as "the
produced means of production ", Seealso, labour , land,
11at11ral
resottrces
and enterprise.
Capi tal and financial account records che borrowing,
lending , sales and purchases of assets betwee n
Australia and the rest of che world. Financial inflow
has the imm ed iate effect of increasing the supply of
foreign exchange co Australia while financial oucflow
reduces it.
Capi tal ga ins are the profits made by investors who
sell their shares or assets at a price above che level char
they originally pa id for chem.
Capi tal goods are items char have nor been produced
for immedia te consu mpti on bur will be used for the
production of ocher goods . See a lso, cons11mer
goods.
Carbon tax is an environmenta l management policy
where busi nesses must pay a price for each tonne of
carbon dioxide em itt ed through energy or indust rial
production process. le is desig ned co discourage activ i-
ties that contribute co climate change.
Carte l describes a situation in which ind ividual
firms have impl icicly or explicicly ag reed ro restrict
compet ition, such as through agreements ro fix prices,
segregate che mar ker, or limit the quantity of goods
produced .
Cash rare is che interest rare paid on overnigh t loans
in che short cerm money marker. Seealso, interestrates.
Casua lisa r ion of work refers ro the growt h of casual
employment (and the relative decline of full-rime
permanent jobs) as a proportion of the coral workforce.
See a lso, rmdere111pl
oyment.
Centra lised incomes polic y is a system in which a
government or industrial trib una l determ ines wages
and work ing conditio ns for all employees, regard less of
which firm they work for. See also, dece11tralis
ed incomes
policy.
II
I
The Market Economy 2020
Centrally p la nne d ec on omy is an econom ic system
whereby governm ent planners make econom ic
decisions and the re is little scope for indiv idual choice
co influence economic outcome. See also, market economy
and mixed economy.
Cerer is paribus is the concept in econom ics char in
order ro understand the relarionsh ip between two
factors, we need ro ana lyse the imp ac t of one factor on
anothe r factor while assum ing nothing else changes . le
is a Larin phrase char means "other rh ings being equal"
or assumin g char everyth ing else is held constant .
Circular flow of inc ome is a model char describes
how econom ic activity occurs between rhe different
groups in an economy. Saving , taxat ion and spend ing
on imports represent leakages from the circula r
flow, i.e. they decrease the level of econo mic activ ity.
Investment, government spendi ng and export revenue
represent injections into the circular flow, i.e. they
increase the level of econom ic activity .
China -Au stral ia Free T rade Agreement (ChAFTA)
is a bilate ral free trade agreement sig ned in 2015 and
is awaiting treaty processes before com ing into force.
Clean float is an exchange rare syste m where the
Reserve Bank does nor intervene in foreign exchange
markers ro influence the value of the Australian dollar.
See a lso, dirty float and dirtying thef/Mt.
Cl im ate cha nge is the impacts on the natural
environment such as rising tempe ratu res and sea levels
caused by emissions of g reenhouse gases such as carbon
dioxide, nitrous oxide and methane.
Closer Econ omic Relations T rade Agreement
(CERT A) is a bilateral free trade agreement betwee n
Australia and New Zealand , wh ich came into effect
in 1983.
COAG is the Cou ncil of Australian Governm ents ,
rhe body that bri ngs together Commo nwealth, state ,
territory, and local govern ments ro work togethe r on
areas of shared respons ibiliry such as health care, water
management and bus iness regulatio n s.
Collec t ive agreement is a workplace agreement char
is negot iated between an employer and a group of
employees, usually thr oug h a u nion. See also enterprise
bargaining.
Collec t ive bargaining (see enterprise bargaining)
Collec t ive wants are wanes of the whole com mun ity.
Th is will depend on the preferences of the com munit y
as a whole and nor individuals . In Australia , collective
wants such as park s and libraries are most comm on ly
provided by the govern ment. See also , p11blicgood.
Collus ion occurs when firm s agree on a pricing or
marker sharing arrange ment char reduces effective
competit ion betwee n them , and rends co inhibit che
ent ry of compecirors into the marker.
Common Agr icultural Polic y is a scheme used
by economies in the European Union co promo te
European farm production through export subsidies
and rescriccions on imp ort s from economies outside
che EU.
Comparat ive advantage is che economic pri nciple
char nations shou ld specialise in the areas of produce ion
in which they have the lowest opportunity cost and
trade with orhe~ nations, so as co maximise boch
nat ions' sta ndards of living .
Competit ion is the pressure on busi ness firms in a
marker economy t o lower pr ices or improve che qua lity
of outpu t co increase their sa les of goods and services co
consume rs. See also, pure competition.
Competi t iveness (seeintematio11alcompetitiveness)
Complement is a good char is used in conjunct ion
wich another good . For example, DVDs would be a
complement of DVD players.
Conc il iat ion is a d ispute resolution process in which
firms and employees meet co discuss their differences
in the presence of a thir d parry (such as from an
industrial trib unal) who accempc co bring the parr ies
co an ag reement . See also arbitration.
Const icur ion (Australian) is the docu ment char
provides the overall framework for Australia's system of
democratic government and the relationship between
che Commonwea lth (or federal) and scare govern ments.
Consumer goods and se rvice s are items produced
for che imm edia te satisfaction of individual and
commu nity needs and wants . See also, capitalgoods.
Consumer Pr ice Index (CPI ) is a measure of che
movement in the prices of a basket of goods and
services weighted accord ing co their sign ificance for
the average Australian household. It is used to measure
infl ation in Aust ralia. See also, inflation.
Consumer sovere ignty refers co the manner in which
consume rs, collec tively th roug h marker demand,
determin e what is produced and the quantity of
production.
Consumption funct ion is a grap hical representat ion
of the relacionshi.p between income and consumption
for an ind ividua l or an economy. It is usually upward
sloping with a gradient less chan one, and with a
positive y-intercepr .
Contract ing ou c (seeorr.ts
orm:ing)
Contract ionary polic ies are govern ment policies char
accempc ro reduce economic accivicy. Contracrionary

fiscal policy would involve decreasing government
spend ing or increasing taxat ion. Contr acrionary
monetary policy would involve an increase in interest
races.
Convergence (seei11ter11ati
o11alco11
vergence)
Corpora ris acion occurs when the government changes
che rules around how governm ent-owned bus inesses
are operated so char they behave more like private
sector bus inesses, indepe ndent from che governm ent .
See also, privatisatio11
. that consume rs a re willing and able co purchase at
Cos e-p us h inflat ion occu rs when duere is an increase
in production coses (such as oil price increases or wage
increases) that producers pass on in th e form of higher
prices chus raising the race of inflat ion .
Council of Financ ial Regu lat ors is a coordina ting
body for fina ncial marker regu lation that provides for
cooperation and collabo ration among its four members
- che Reserve Bank of Austral ia, the Australian
Prudent ial Regula tion Authority, che Australian
Securities and Investments Commi ssion, and the
Austral ian Treasur y.
Counter -cyclical po licies are economic policies
designed ro smooch fluccuacions in r he business cycle.
Macroeconomic policies such as f iscal policy and
monetary policy are usually used a:s counte r-cyclical
policies.
Credit is loans to individuals , businesses and
governm ents for spendi ng on consu mption and
investment .
Crowding our effec t occur s where government
spendi ng is financed thr oug h borrowing from the
private sector, which puts upward pressure on interest
races and "crowds our" private seccor i nvesrors that
cannot borrow ac the higher races of interest.
Current account is the part of the balance of
payments char shows the receipts an d payments for
trade in goods and services, as well as both primary
and seconda ry income flows between Australia and the
rest of che world in a given time period . T hese are non-
reversible transactions.
Current account d eficit (CAD ) i.s recorded when
che debits in che current account (impo rt s and income
payments co overseas) are g reater than the credits
(export s and income payments from overseas).
Cyclical unemp loyment refers to those persons that
have become une mployed due to a downturn in the
business cycle.
Glossary I
Debt serv 1cmg rat io is the proportion of export
revenue that is used ro make repayments on foreign
debt , and is a common measure of the susta inability of
Australia's foreign debt level.
Decentral ised in comes po licy is a system in which
wages and work ing conditio ns are deter min ed thr ough
negotiations becween individual firms and their
employees. See also, ce11tralised
i11
comespolicy.
Demand is the qua nt ity of a particular good or service
various price levels, at a g iven point in time.
Demand -pull in flat ion occurs when rising demand
causes an increase in prices, often because aggrega te
demand or spend ing is growi ng while the economy is
nearing its supply capacity, so that higher demand leads
to higher prices rather than more output .
Deprec iation (of capita l) refers ro the "wear and tear"
that all capita l goods experience, which causes their
value co fall over rime.
Depreciation is a decrease in che value of an
economy's currency in terms of anothe r cu rrency. See
also, appreciation
.
Deregulat ion is the removal of govern ment cont rols
over an industry that is intended ro make business
more responsive ro marker forces.
Devaluation occu rs when the government (or centra l
bank) lowers the value of a cu rrency that operates with
a fixed exchange race. See also, revaluation.
Deve loping eco n omies are econom ies with a low
level of material well-being and economic development,
and wh ich rend ro have poor health and education
standa rds, weak infrasrrucrure and agricultu re-based
economies.
Dimin ishing ma rg inal ret u rns occu r when a firm
expe riences a decline in add itional ou tput as ic increases
a fu.ccor of prod uction (such as labour) while holding
the amount of other factors of prod uction constant .
Direc t tax is a cax where the person upon whom a tax
is levied must pay che tax because it cannot be passed
onto someone else. For example, income tax. See also,
indirea tax.
Dirt y float is an exchange rare system where the value
of the currency i:s mainly determined by demand and
supp ly in foreign exchange markers , bur che Reserve
Bank occasionally intervenes ro stab ilise che value
of che Australian dolla r du ring periods of excessive
volatil ity. See also, clea11float and dirtying thefloat.
I
The Market Economy 2020
Dirt ying th e floa t is where the Reserve Bank buys
and sells Austral ian dolla rs in foreign exchange
markets co influe nce che value of che exchange rate.
See also, deanfloat and dirtying thefloat.
Diseconomie s of sca le (see internal diseconomiesof scale
and external diseronomj
es of scale)
Discr ibur ion of in come (see incom
e distribrr.tion)
Diver sificarion occur s when a firm eneers a new
indusrry char is nor d irectly relaced co ics exiscing
bus iness operations .
Div iden ds are che profir recurns received by che
shareholders (owners) of a busi ness. See also, profit.
Div ision of lab our (see specialisati
on of labour)
Dome stic Marke t Operation s are actions by che
Reserve Bank in the shore cerm money marker to buy
and sell second hand Comm onwealch Governmene
Secur icies in order co influence che cash race and che
gene ral level of ineeresc races. See also , monetary policy.
Dum pi ng is the practice of exporrin g goods co a
counery ac a price lower chan cheir selling pr ice in cheir
counery of origi n.
Durch d ise ase is a cerm char refers co high commodicy
expore pr ices d riving up che value of che curre ncy,
making orher pares of the economy less compecicive,
leading co a higher currene account deficit and a
greacer dependence on comm odicies. The cerm was
coined in 1977 by The Economistmagazine co describe
che impacc of gas discoveries on che economy of che
Netherlands .
Dynam ic effic ienc y refers co che economy's ab ilicy
co shift resources becween induscries in response co
changi ng pacterns of consume r de mand . See also,
allocativeefficiency,tecf.micalefficiency
.
Eco logically susta in ab le d eve lop mene involves
E conserving and enhanci ng che com mu n icy's resources
so chat ecological processes and quality of life are
maineained .
Econom ic cosr (see opportunitycost)
Econom ic d eve lopm ent is a broad measure of welfare
in a narion char includes ind icarors of health, educarion
and environmeneal quality as well a.s macerial living
srandards .
Econom ic grow rh occurs when chere is a sustai ned
increase in a councry's producc ive capacicy over
rime. This is comm only measured by che perceneage
increase in real Gross Domesric Produce. See also,
GrossDomesticP.rod11a.
Econom ic p olicy mix refers co che combinar ion
of macroecono m ic (fiscal and monecary) and
microeconomic iPOlicies used by che gove rnm ene co
ach ieve ics econo mic objec cives.
Eco nomic pr ob lem involves che quesr ion of how co
satisfy unl imiced wanes wich limited resources.
Eco nomies of sc ale (See internal economi
es of scale and
external eco110111j
es of scale)
Eff icienc y (See allocative efficiency
, technicalefficiency
and d)~iamicefficiency)
Elabora tely cr a n sformed manufacture s (ET M s)
are technologically advanced and high value-added
man ufaccuring p rod uces, such as moror cars, chat
genera lly command high prices on ineernational
markers . See also, simplytransformedmamifaattres.
Elasticit y (See price elasticityof demand, price elasticity
of supply)
Elasticit y of demand (See priceelasticityof demand)
Elasticit y of su pp ly (See price elasticity of supply)
Emerging eco n omies are economies experiencing
che fasresr races of g rowrh in the global economy wich
many undergoing rapid induscrialisacion. Th e g roup
includes China , India , Brazil , Mexico, Egypc and
Poland and many orher econom ies across Asia, Larin
Amer ica, Ceneral and Easrern Europe , che Middle Ease
and Noreh Africa .
Emi ssions crad ing sc h eme is an environmeneal
managemenc policy where che governmene sees a cap
on the amoune of greenhouse gas emissions, requires
companies co have a permic co emi r gases, and allows
permics to be craded between companies, providing an
incencive co reduce emissions.
Emp loyer assoc iation s are organisations chat are
formed co repcesene che ineeresrs of businesses,
especially in industrial relat ions and in lobbying the
governmene .
Enterpri s e involves che orga nisarion of che ocher
faccors of produc cion co produce goods and services.
The enerepreneu r makes che decisions and bears che
risk of the business . The recurn for eneerpri se is profir.
See also land, natrm,I resorm:es
, capitaland labom:
Enterpri s e b argaining refers co negociations becween
employers and employees (or cheir represencacives)
abouc pay and work cond icions ac che level of che
indiv idual firm.
Envir onment is th e rocalicyof the physical environmene
in which human sociecy lives, and includes the land,
wacer, climace and plane and animal life.

Env ironmental management refers co actions co
protect and enhance the narural environment, including
protecting the quality of air, water and soil, preserving
narural environments and biodiversity, ensuring
che sustainable use of renewable and non-renewable
resources, and m inimising che negarrve environmental
consequences of economic activity.
Equilibrium is achieved in an in d ividual marker
when any consu mer who is will ing co pay che marker
pr ice for a good or service is satisfied, and any prod ucer
who offers the ir goods or services at the ma rker price
is able co sell the ir produce. le occur s when q uanticy
demanded is equal co quantity supplied , i.e. when the
marker clears.
Equilibrium level of inco me refers co the level
of income, output and employment at which the
spend ing plans of che various sectors of the economy
are identical co the agg regate production plans of
che economy, i.e. agg regate demand is ident ical co
agg regate supp ly. Alcernacively, it m ay be tho ught of
as the level of agg regate income where coral leakages
from the economy are identical co the coral injections
into the economy.
Eth ical deci sion-mak ing is when busi ness decisions
about production methods, employment and other
man ers are made co improve outcomes for the broader
society and rhee nvironmenc, and nor simply co maxim ise
profits for the firm .
Eur opean Uni on (EU) is an econom ic and polit ical
association of 28 Eu ropean nacions ·char has a single
marker for goods, services, finance and labou r.
Eur ozone refers co the monetary un io n of 19 countr ies
of the European Union .
Exce ss capaci ty refers co che situat ion where a firm
or economy is operati ng below maximu m potential
output. Th is is due co unemployed or under-uti lised
resources, i.e. the economy is prod ucing inside its
productio n possibility curve.
Exch an ge r aces are the price of one c urrency in terms
of anothe r economy's currency.
Exch an ge settlement account s are the fun ds held
by banks wich the Reserve Bank of Australia (RBA)
in order co serde payments with oth er banks and the
RBA.
Expan s ionar y p olicies are policies char anemp c
co increase agg regate economic acriv icy in the
economy. Expa nsionary fiscal policy would involve
increasing govern ment spending or reduci ng taxat ion.
Expa nsionary monetary policy would involve a
reductio n in the interest races.
Exp o rts are goods or services char are produced
domest ically and purchased by overseas consumers.
See also, imports.
Glossary I
Extern al di sec on omie s of scale are che d isadvantages
faced by a firm because of che grow th of the indus try
in wh ich che firm is operati ng, and are nor che resulc
of a firm chang ing its own scale of operatio ns. See also,
internal d.iseconomi
es of scale.
Extern al ec ono mie s of scale are the advantages char
accrue co a firm because of che g rowth of che indus try
in which che firm is operati ng , and are nor the resulr of
che firm changing its own scale of operacions. See also,
internal e,:0110111.i
es of scale.
Extern al s tabil ity is an aim of governm ent policy
char seeks co promoce sustainability on che extern al
accounts so char Australia can service its foreig n
liabilities in the medium co long run and avoid
currency volacilirry.
Extern alities ar e extern al coses and benefits char
pr ivate agents in a marker do nor consider in thei r
decision mak ing process. For example, airlines
and passengers do nor consider aircraft noise when
negoriacing airfares. See also, market failure, positive
externality, negative extemality.
Factor s of pr od uc tion are any resources char can
be used in che p roduction of goods and services. T he
four main types a re nacural resources (or land), capita l,
labour and enterpr ise.
F
Factor marker is a marker for any input into the
prod uct ion process, including land, labour, capital and
enterprise. See also, labourmarket and productmarket.
Fa ir W ork Co mmi ss ion is the governm ent agency
char regulates i.ndus rrial relacions in Austral ia. le
comb ines the fu nccions of an indust rial tribunal (such
as che Industria l Relacions Comm ission) with a role
of educacion and promocion of enterprise barga ining.
Fa ir Wo rk Om b uds m an is che governm ent agency
char investigates complaint s and enforces compliance
wich Austra lia's workplace laws.
Fin an cial aggrega tes are the Reserve Bank of
Austral ia's chree main indicato rs of the money supp ly
- money base, M 3 and broad money.
Fiscal polic y is a macroeconomic policy char can
infl uence resource allocation , redistribute income
and reduce the fluccuarions of the business cycle.
Its instrume nts include governm ent spendi ng and
caxacion and the budge t ouccome.
Fixed exchange rare is when che value of the
economy's cu rrency is officially sec by che govern ment
or che cent ral ban k .
Flexib le peg is an exchange rare system where the
currency's value is fixed ac a pre-announced level, bur
it can be cha nged by the central bank in response co
che forces of supply and demand in foreign exchange
markers.
I
The Market Economy 2020
Floatin g exchange rate is when che value of a
economy's cu rrency is determi ned by the forces of
demand and supply in foreign exchange markets .
Foreign deb t refers to che coral leve l of outs tand ing
loans owed by Austra lian residencs ro overseas
residencs. See also, foreign eq11ity,foreign liabilities, net
foreigndebt.
Foreign d irect inv es tment (FDI ) refers co che
movemenc of fu nds becween economies for the pur pose
of establis hing a new compa ny or buyi ng a substa ncial
proport ion of shares in an exist ing compa ny (10 per
cenc or more). FDI is ge nerally conside red ro be a long-
cerm invesrmenc and che investor norma lly incends to
play a role in the management of the bus iness.
Foreign equit y is the coral value of Aust ralia n
assecs such as land, shares and compa nies in foreign
ownersh ip. See also, foreign debt, foreign liabilities, net
foreigneqttity.
Foreign exchange market (or forex marker) refers ro
che marker in wh ich cu rrencies are traded .
Foreign liabilitie s are Auscralia's coral financial
obligatio ns (foreign debc plus foreign eq uity) ro the rest
of the world. See also, net foreignliabilities.
Free rider s refers co when groups or individuals benefic
from a good or service wirhour conrr ibur i ng ro the cosr
of supp lying che good or service. As a consequence,
che good or service is likely ro be u nder-supplied in
relation ro the coral de mand.
Free trade is a sicuacion where chere are no arti ficial
barriers ro trade imposed by gove rnm encs for the
pu rpose of shieldi ng domestic producers from foreign
compe cicors.
Fricti onal unemp loyment are those who are
unemployed due ro r ime lags involved in the cransicion
becween jobs.
Full emp loyment occurs when ic is no longe r possible
co ach ieve a sustained red uction in unemployment
chroug h stro nge r economic grow th . See also, natural
rate of rmemployment.
Future Fund is a Comm onwealth Governm enc
invesrmenc accounc char receives the proceeds of
budget surpluses and asset sales and invests the m in
order co ge nerate recurns co meet the Comm onwealth
Governm enc's fucure supera nnuacion liabilit ies.
Gen eral Agre ement on T ariff s and Trade (GATT )
G was a multila ceral crade promot ion p rocess char bega n
in 1947. T he final round of GATT negoriacions
fin ished in 1993, and agreed ro replace GATT wich
che World Trade Orga nisat ion in 1995 . See also, World
TradeOrganisation .
Ge ographica l m obil ity refers co che abilicy of labou r
co move between differenc locacions co ga in highe r
wages or improved employmenc oppo rcuniries.
Gini coeffic ienc is a numb er becween zero and one
char measures the exrenc of income inequality in an
economy. le is calcu lated by measuring the deg ree
co which che Lorenz cu rve deviaces from the line of
equality . See also, Lorenz curve.
Globa l ec onom y refers co the sum of the inceracr ions
between the economies of indiv idual councries char are
now increasing ly linked rogecher inco one economic
un it.
Gl obal financia l cri s is describes the period of extreme
volacilicy on world financial markers in 2008 and 2009
char caused the deepest recession in the world economy
since che Grear Depression of the 1930s .
Globa l isati on refers co the incegrarion betwee n
differenc councries and economies and the increased
impact of incern arional influences on all aspeccs of life
and economic acriviry.
Good s and Ser v ices Tax (GST ) is a 10 per cenc sa les
cax imposed on most goods and services in Australia .
Government Bu s ine ss Enterpr ises (GBE s) (See
public tradingenterprises)
Government expend iture is an inject ion in the
circular flow of income. It includes all money char the
governm enc spends ro provide services such as health
and educacion.
Government procurement refers ro the policies and
procedu res for pur chasi ng goods and ser vices for the
use of the govern.menc and pu blic trad ing encerprises.
Gr oss Dome stic Pr od uct (GDP ) is the coral marker
value of all final goods and services prod uced in an
economy over a per iod of rime. Seealso, economicgrowth.
Gr oss Na t iona l Inc ome (GNI ) is the coral income
earned by domestically owned factors of production
over a period of rime. See also, grossdomesticprodttct.
Gr oss W orld P r oduct (GW P) refers ro che sum of
coral output of goods and services by all economies in
che world over a period of rime.
Gr oup of Seven (G7) refers ro che seven largest
industri a lised nario ns who meet annu ally ro disc uss
economic and polit ical issues and wield tremendous
influence over the globa l economy. Its members are
che Un iced Scares, UK, France, Germany, Icaly, Canada
and Japa n.
Gr owt h (See economicgrowth)
G20 is che group of the world's 20 largest economies.
It was formed in 1999 and has played an increasingly

imporra nc role in address ing the reform of che global
financial sysrem and macroeconom ic coordi nacion.
Ir incorpora ces che G7 economies, plus che Europea n
Union, Argencina, Austra lia, Brazil, China, India,
Indonesia, Mexico, Saudi Arabia, South Africa, South
Korea and Turkey.
Hard -core unempl oyment refers co long -cerm
H unemployed people who may be considered
unemployable by employers because of personal
circum stances such as drug use or nnencal or physical
disab ilities.
Heavily Indebted Poor Countries (HIPCs) are a
group of developing cou ncries, mosrly in Africa, char
suffer excreme extern al debt susta inab ility problems.
H idden unempl oyment refers co chose people who
can be considered unemployed but do nor fie the
officia l definicion of unemploymenc and are chus nor
reflecced in the unemploymenc scariscics.
Horiz o nta l integrat ion occurs when a firm rakes
over anot her business involved in che same kind of
prod uct ion, i.e. one of irs competito rs .
Hou se of Repr es ent a tives is the m ain chamber of
che Austral ian Parliame nc. W hen a parry ~oalir ion has
a majoricy of votes in the House of Represencarives,
ir forms a governm ent under a Pr ime Mi nister who
is a lso one of che 150 members of the House of
Representat ives.
Hou seh old sav ing s is the proport ion of coral household
disposa ble income nor spent on consu mpt ion .
Human cap ital is the economic concept char the
supp ly of labour can nor be simply measured by the size
of the labour force, bur also by irs quality, wh ich can be
increased tho ugh educacion and tra in ing .
Human De ve lopment Index (HDI ) is a measure of
economic developmenc devised by che United Natio ns
Development Program. le rakes into account life
expectancy ac birr h, levels of educat ional arrainm ent
and macerial living standards (as measured by Gross
Nat ional Income per capita).
Hystere s is is the process whereby u nemployment
in che current period resulrs in the persiste nce of
unemployment in futu re periods as unemployed people
can lose cheir sk ills, job contacts and morivarion co
work.
Imperfect comperir ion is any marker srruccure char
is nor a perfecrly competitive mar ker, which gives
ind ividual firms the abilicy co influel!lcepr ice levels.
Glossary I
Imp orted inflati o n occurs when there is an increase
in the price of imports eithe r due co inflatio n in the
economies of ou r crad ing pa rtn ers or because of a
depreciat ion of cine$A which resulrs in highe r prices of
consumer imports and imported inputs .
Imp ort s are goods and services char are prod uced
overseas and purchased by domest ic consumers. See
also, exports.
Inclu s ive g rowth refers co che srracegy of accelerating
economic growth by increasing the share of income
co low and middle income earners. Inclusive g rowth
policies include highe r m in imum wages, improving
access co educacion and craining and increase workforce
parr iciparion .
Inc ome is che a mount of money, or ocher benefits
measured in mol!ley terms, wh ich flow co ind ividua ls
or households , usua lly for cheir contr ibut ion co the
produccion process or as a di rect payment from the
governm ent over a period of rime.
Inc ome di str ibut ion refers co che way in which a
economy's income is spread among the members of
d ifferent social and socio-econom ic g roups .
Ind irect tax is a tax char is levied on an aspect of
economic activity other than a person or an organ isacion's
income, such as sales tax. Seealso, direatax.
Indu s tria l di sp ut e occurs when employers or
employees cake ac rion cod isru pr the productio n process
in order co highl igh c a d isagreemenc between employers
and employees.
Indu s tria l rela ti on s refers co the relacionship becween
employers, employees, and thei r representa cives. See
also, indttstrialrelations system. Also known as workplace
relations.
Indu s tria l relat ion s system involves che laws,
insricurions and processes established co manage
relations betwee n employers and employees. The
srrucru re of che indust rial relacions system dete rm ines
the process of wage dete rm inat ion and conflict
resolution in the Australian labour marker. Also
known as workplace relacions system.
Indu s tria l tribuna ls are govern ment agencies
char oversee the ind ustr ial relations system and
arrempr co prevent or resolve workplace conflict
becween employees (usually represented by unions)
and employers (someti mes represented by employer
associations). Fair Work Commi ssion is the ma in
industri al cribun al in Aust ralia
Indu s tr y is the collection of firm s involved in ma king
a similar range ofirems char usually compete wich each
ocher, such as the fina ncial services indust ry or the car
industry.
I
The Market Economy 2020
I ndu str y p olicy involves measures co support che
development of key indust ries and increase che
competiciveness of domesr ic indusrries aga insr foreign
competito rs.
I nel as ti c de mand (Seepriceeldsticityof de111d11d)
I nel as cic sup ply (See priceelasticityof supply)
I n fant ind us cry argume nt refers ro che argu ment
that newly established or "infant" i.ndus cries du ring
the early years are nor competitive wich established
industries in othe r countr ies and may need procecrion
from overseas comper icio n in order ro survive.
I nflati on is the sustained increase in the ge neral level
of prices over a period of rime, usuall y one year. Th is is
comm on ly measured by the percentage change in che
Consume r Price Index (CPI).
I nflati on target ing occurs when a cent ral bank
implements monetar y policy with the aim of achieving
a part icular level of infl ation . In Australia , the Reserve
Bank has an inflacion target of2 -3 pe~ cent, on average,
over che course of che econom ic cycle.
I nflati on ary expec tat ion s is where inflat ion may be
perpetuated by the expecra cions of workers and firms
that ic will occu r.
I nfr astr ucture Au s tralia is the expert national body
that advises che Government on nat ion al infrastru ctu re
plann ing .
I njec tio ns into che circular flow model of income are
those flows of money char increase aggregate income
and the ge neral level of economic ac tivity. Th e chree
injections are investment, government spending and
exports . See also, leak.ages.
I ntere st is the reward co che factor of p roduction capita l
for ics use in the produc tion of goods and services. See
also, wages,profit and rent.
I ntere s t rare differential is the diffe rence between
rwo interesc races, eithe r becween cwo economies'
interest races or between a financial inscitucion's
borrowing and lendi ng interest races.
I nt erest rate s are the cost of borrowing money
expressed as a percentage of the coral amo unt borrowed.
I ntermediate goo d s are semi-finis hed goods char
are tran sformed into h ighe r-value goods before sale co
consu mers (for example, steel is an inte rmedia ce good
in the product ion of motor veh icles). See also, cdpitd!
goodsand commnet·goodsdnd services.
I nternal di seco n om ies of scale are che cost
d isadvantages (specifically, the increase in marginal
coses per unit ) faced by a firm as a resulc of the firm
expa nd ing its scale of ope racions be yond a certa in
II
point . Its oucpu c level is above che technical opt imum.
See a lso, externd!diseconomie s of scale.
I nternal ec o nom ies of sc ale are the cost saving
advantages char resu lc from a firm expandi ng its scale
of operacions. The y occur when a firm's output level
is below the tec hn ical opcimum . See also, extemd!
econom iesof scale.
I nternational bus iness cycle refers co fluccuacions in
the level of economic activity in che global economy over
rime.
I nternati onal co mp etit ive ness refers co the abi licy of
an economy's exports co compe ce on g lobal markers.
An economy may be competit ive by selling products of
a higher qualic y or a lower pr ice than its competito rs.
I nt ern ational converge nce refers ro che increasing
similarity of econom ic conditions in differenc
economies during the g lobalisat ion era, in cerms of
economic syscems, performance and structure , and
living standa rds.
I nternati onal div is ion of labour is how the casks in
the production process are a llocated co d ifferent people
in d ifferent coun cries around the world.
I nternati onal M onetar y Fund (IMF) is an
incernacional agency char consists of 188 members and
oversees che srabi licy of the globa l financ ial system.
The major fu nctions of the IMF are co ensure scabilicy
of exchange races, exchange rare adjustment and
converribilicy.
I nvestme nt is a ny current expe nd icure where the
benefits will be obcained in che future. Mose typica lly,
thi s injeccion will involve the pu rchase of capital goods
or the bu ild up of stock or inventory.
)-curve effect is an economic concept char suggests
that a dep reciation of a currency will lead ro a shore-
term decerioracion of Australia's crade balance (as
exporte rs receive lower revenue for a g iven quantity of
exports and impo rr spend ing rises for a given quantity
of imports) and a long-term impr ovement in the trade
balance as exports become more compe cicive and
imporrs less competitive, so that export volumes rise
and import volumes fall.
Jobactive is the federally funded network of
employment serv ices agencies providi ng employers
wich recruicment assistance and helping job seekers
find work.
Korea-Au stra lia Free T rade Agreement (KAFTA)
is a bila ceral free crade ag reemenc becween Australia
and Korea signed! in 2014.
K

Kyoto Pr o toco l is an agreement signed by 187 nations
since 1997 designed co lower em iissions of carbon
dioxide and other g reenhouse gas em issions in order ro
comba c global warming .
Labour is human effort, both p hys ical and mental ,
used to produce goods and services . The return for
labour is wages. See also, land, capital and enterprise.
Labour force consists of all the employed and
unemployed persons in the count ry ac any given ti me.
Also known as the workforce.
Labour force p ar tic ipa t io n race (LFPR) (See
participation rate)
Labour on-c os ts (Seeon-costs)
Labour market is where individua ls seeking
employment interact with employers who want ro
obtain che most appropriate labour ski lls for the ir
productio n process.
Labour marke r pol icies are microeconomic polic ies
char are aimed at infl uencing che operation and
outcomes in the labou r market, incl uding industrial
relat ions policies that regulate che process of wage
deter mination , as well as training, educa cion and job-
placement programs co assist che unemployed .
Labour pro d uct iv ity refers co the q uantity of output
produced in a productio n process per unit of labour per
unit of rime. See also, mrdtifactorprodr;cti
vity.
Land is the natural resources used 'CO produce goods
and services. The retu rn for land is rem . See also, capital,
land and enterprise.
Leakages are the icems that remove money from the
circula r flow of income, decreasing aggrega ce income
and the gene ral level of economic ac tivity. The chree
leakages are savings, raxacion and imports. See also,
injections.
Least Deve loped Countr ies (LDCs) are chose
economies that suffer from low living standards (as
measured by GDP per capita levels less than around
US$900 per year) and longer term impedi ments co
economic development.
Liqu idity is the ease wich which a financial assec can
be cransformed into cash so it can be used as a medium
of exchange.
Local conte nt rule s specify char goods must conta in a
minimum percentage of locally made parts ro quali fy
for trade procecrion assistance.
Long term unempl oyment refers co a person being
unemployed for a period of one year o r longer.
Glossary I
Lorenz curve is a graph ical representation of income
distribut ion, plott ing the cumulative increase in
populacion aga ins t the cumu lative increase in income.
See also, Gini coe
fficient.
M3 is a measure of the money supply char consists
of all cu rrency in circulation, bank deposics wich the
Reserve Bank and privace sector deposics in banks. M
Macr oeco nom ic pol icies are policies char affect
the economy as a whole with the aim of minimising
fluctua cions in che business cycle. Also referred ro as
demand management or counte r-cyclical policies.
Mala ys ia-Au s tral ia Free T rade Agreement
(MAFTA)is a bilateral free rrade agreeme nt between
Australia and Malaysia signed in 20 12 .
Manage d exch a nge rate is an exchange race syscem
where the value of the cu rrency is dete rm ined or
substant ia lly influenced by central bank inte rvention
in the foreign exchange marker, bur where che level of
exchange is nor held at a permanently fixed level.
Marg inal p ropen sity to con sume (MPC) is the
proportion of each extra dollar of earned income that
is spent on consump cion. See also, average propensity to
consume.
Marginal pr open sity to save (MPS) is the proportion
of each extra dolla r of earned income that is nor spent,
bur saved for futu re consumption . See also, average
propmsity to save.
Marg inal rate of tax is che proportion of each extra
dollar earned that must be paid in tax . See also, average
,ate of tax.
Market clea ring occurs when chere is equil ibrium in
the marker, i.e. when the demand and supp ly curves
inte rsect, when q uanticy de manded equa ls quantity
supp lied and rhe~e is no tendency for change .
Market economy is an economic system whereby all
major economic decisions are made by ind ividua ls
and privace firm s, which are boch motivated by self-
interesr , wirhour government intervent ion. See also,
centrally planned economy and mixed economy.
Market equili b r ium (seeeqttilibrium)
Market failure occu rs when the price mechan ism
rakes into account private benefits and coses of
production co consu mers and producers, bur ic fails co
rake into account indirect coses such as da mage ro the
environ ment.
Market learn ing (also known as learn ing by doing) is
where a busi ness becomes more efficienc at produci ng
a partic ular good or service as it ga ins more expe rience
producing char good or service. This will sh ift the
business's average cost curve downwa rds and shift its
supp ly cur ve ro th e right .
I
The Market Economy 2020
Mer it goods are goods chat are nor produced in
sufficient quantity by the privace sector because private
individuals do not place sufficient value on those goods ,
i.e. they involve positive externalities that are not fully
enjoyed by the individual consumer. Meric goods include
education and healch care.
Microe co nomic policies are policies that are aimed
at individual industries, seeking to increase aggregate
supply by improving the efficiency and productivity of
producers.
Migration is che movement of people between countries
on a permanent or long cerm basis, usually for 12 months
or longer.
Micr oeco nomic s is concerned with che study of
economics ac the level of ind ividual economic actors or
seccors of industry .
Mixed eco n omy is an econom ic system where the
decisions concern ing production a nd distrib ucion
are made by a comb inat ion of marker forces and
governm ent decisions. See also, market economy and
centrd!l
y pldrmedeconomy .
Mobil ity of labour (See geogmphicdl mobility,
ocC11pdti
ondl mobility)
Monetar y aggrega tes (Seefi11a11cidl
aggregdtes)
Monetar y polic y is a macroeconomic policy char
aims co influence the cost and supply of money in the
economy in order co influence econom ic outcomes such
as economic g rowth and inflation . Th e Reserve Bank
of Australia (RBA) admi nisters monetary policy by
influe ncing che level of inte rest rates.
Monetar y un ion is where two or more count ries share
a com mon cu rrency.
Mone y is the medium of exchange in most modern
economies.
Mone y ba se is a measure of rhe money supply char
consists of all cu rrency in circula cion and all bank
deposits with che Reserve Bank .
Mone y wage (See 110111i11dl
wage)
Mone y su ppl y is the coral amou nt of funds in an
economy char can be used as a medium of exchange ,
a measure of value, a store of value and a method of
deferred payment . Th e Reserve Bank 's measure of the
money supply is M3 .
Monopoli st ic compermon is a ma rker structu re
where the re are many sellers produc ing differenti ated
produces, and chere are no significant barriers co entr y.
Th is is nor the same as monopoly.
Monopo ly describes an industry where the re is on ly
one seller producing a unique produce. T here are high
barriers co entr y, so the monopolise has marker power
and can decerm irne price or oucpu c (but nor boch). See
also, natttrdl monopoly.
Multifacr or pmdu ct ivi ry refers to the quanticy of
output produced in a produce ion process per corn bi ned
input of labou r and capita l per unit of rime. See also,
ldbourprodJ1cti
vity.
Multilateral free tr ade agreement is an agreement
between a numbe r of coun cries, usually in a region, co
lower tariff levels and ocher forms of procection in order
co encou rage increased trade flows. See also, bildteral
f re,etrade agreenzentand regiond!fr ee trade agre,enzenl
.
Multinati onal c<>rporat ions are firms chat sell and
produce goods or services in more than one countr y.
See a lso, tranmational corporations
.
Multi p lier is the grea cer than proporrional increase
in nacional income resulcing from an increase in
aggregate demand .
Na tional Br o adband Netw ork is the opcical fibre
celecomm u nicacions system being bu ilc and operated
by a company chat is owned by the Com monwealch
Governm ent .
N
Na tionalcompe-ciri on p olicy isan agreement betwee n
Australia's Commo nwealch and Stace Governm ents
signed in 1995 to encourage microeconomic reform
chroug houc the Australian economy.
Na tional saving is the propo rrion of national income
not spent by consume rs, firm s or che govern ment.
Na tural mon op oly is a market situation where on ly
one operacor can operace efficiently in an industry,
usually because of ext remely high barriers co entr y e.g.
che capita l cosc of a railway netwo rk.
Na tural rate o f unempl oyment refers co the
level of unemployment at which the re is no cyclical
unemployment, i.e. where che economy is at full
employment . See also, fit!/ employ ment, 11011
-accelerating
inflation rate of rmemplo
y 111
ent (NA / RU).
Na tural reso urce s include all che resources provided
by nature that are used in che product ion process.
Th ese are ofren simply referred to as "land". T he
reward (retu rn) ro che owners of natu ral resources 1s
called rent. See also, ldnd, cdpital,labour,enterprise.
Nec es siti es (fee ,reeds)
Nee d s are ind ividual desires for the basic necessicies of
life, such as food and shelcer.

Negat ive externa lity is an un incended negat ive
outcome of an econom ic activ ity whose cost is not
reflected in the operation of che price mechanism . See
also, positive extemd!ity.
Ne e errors and om iss ion s is che en cry on che balance
of payments char ensu res char che su m of che current
account and che capical and fin ancia l account equa ls
zero.
Net foreign debc refers co che level of oucscanding
loans owed by Aust ralia n residents co overseas residents
minus che level of oucsrandi ng loans owed by overseas
residents co Auscralian residents. See also,fareigndebt.
Net foreig n eq uit y is the value of Australian
assecs such as land, shares and compa nies in foreign
ownersh ip minus che value of foreig n assecs m
Australian ownership. See also,fareign eq11ity
. is a free trade ag reement betwee n che United Scates,
Net foreign liabilitie s are equ al co Aust ralia's
financial obligat ions (foreig n debt plus foreig n equity)
co the rest of che world minus the rest of the world's
financial obligat ions co Australia . See also, net foreign
debt and net fartign eqttity.
Net primary inc ome is a compo nem on the current
account of the bala nce of payments calculaced by
subtrac ting prim ary income debit s from income
cred ics. Primary income deb ics include interesc
payments, d ividends and rent pa id by Australians
on foreign liabilities, wh ile income credits consist of
simil ar payments by foreigners co Austral ians.
Ne t sec o nda r y tran s fers is a com ponent of che
current account chat includes all cransaccions in wh ich
prod uces or financial services are provided without a
specific good or service being provided in return . Th is
includes icems such as aid co develop ing nacions.
New ly indu strial ised countr ies (NICs) refers co
economies char expe rience rapid econo mic grow th
in nacional oucpuc over an extended period , some of
wh ich now have living standards wh ich are sim ilar co
advanced industrialised countries .
No di sa d vantage test is a requ ire ment appl ied co
workp lace agreements co ensure chat emp loyees are not
made worse off unde r an agreement than under thei r
applicable award . This cesc is now known as che Beccer
Off Overall Test (BOO T).
No m inal wage is the pay received by employees in
dollar terms for cheir concribucion co che product ion
process, nor adjus ted for infl ation . See a lso, red! Wdge.
Non -acce lerat ing inflati on race of unemplo yment
(NA IRU) refers co the level of unemployment at
wh ich chere is no cyclical unemployment, i.e. where
che economy is ac fu ll employment . See also, natt,rd!
rate of rmemployment.
Glossary I
Non-e xclu da ble goo ds are goods or services whose
consu mption can.not be restricted co chose willing co
pay for chem, such as clean air and nat ional defence.
The private seccor is generally u nwilling co provide
non-excludable goods because indiv iduals may nor pay
for using chem. See also, fr eeriders,publicgood.
Non-renewa b le reso urce s are inputs co production
where the stock of the resource is reduced in the
process of producrrion and consumpt ion, e.g . petro leum
and coal. See a lso., renewableresottrc
es.
Non-r ival goo d s are goods and ser vices whose
consu mption by one indiv idual does not reduce the
ability of othe r individua ls co also consu me the good
or service. See also , pr,blicgood.
North American Free T rade Agreement (N AFTA )
Canada and Mexico chat has been in effect since 1994.
Non-wage o ut co me s are the benefits char many
employees receive in add icio n co thei r ord inary and
overt ime paymen ts, such as sick leave, superannua cion,
a company car, study leave or arrangements for
employees co work from home for pare of the week.
0
Occ upat ional m obil ity refers co che ab ility of labour
co move becween d ifferent occupat ions co gai n higher
wages or improved employment opportun icies.
Ok un 's Law explains the relacionship becween
une mployment and economic growt h, showing chat
co reduce unemployment, the annual race of economic
grow ch muse exceed the su m of percentage growth in
producciv icy pltts increase in the size of the labour force
in any one year.
Oligop o ly describes a marker structure consisting
of a few large firms producing slightly d ifferentiated
produces. Th ere a re sign ificant barriers co ent ry and
each firm engages in non-price competition .
On -coses are the addit ional coses co business of
employing labour (beyond cheir wage races) such as
sick leave and workers' compe nsacion.
Ope n Market Operati on s (see Domestic Mdrket
Operdtions)
Opp ort un ity cos t represents the alte rnat ive use of
resources. Often referred co as che real cosc, it represents
the cost of sacisfyi ng one wane over an alternative wane.
This is also known as economic cost.
Organisation fo r Eco no mic Coope rati on an d
Deve lopment (O ECD) is an organisa cion of 34
developed count ries chat seeks co promote economic
grow ch and free markers amongst its members .
I
The Market Economy 2020
Out so urc ing occu rs when an oi:ganisarion pays
anocher business co perform a functio n char it does not
rega rd as a core pare of its business focus. Also known
as sub -contracti ng or contracting out .
Outla y meth od (See total outlay method)
p Partic ipati on race refers co the pe rcentage of the
popula cion, aged 15 and over, in che labour force, chat
is eithe r employed or unemployed.
Perfect competit ion (Seepttre competition
) market supp ly will be grea ter chan market demand .
Perfectl y elast ic demand is where consumers
demand an infin ice quant icy of a good or service at
a parti cular price but noching ac all ac a price above
this . This situation can be rep resented by a horizontal
demand curve.
Perfectl y elas tic s uppl y is where produce rs are willing
co supp ly an infinite quantity of a good or service at
a particular price bu r nothi ng at all ac a pr ice below
this . This situation can be rep resented by a horizontal
supply cu rve.
Perfectl y inel as tic d emand is where consumers are
willi ng co pay any price in order co obcain a given
quant icy of a good or service. This situation can be
represented by a vertical demand cu rve.
Perfectl y inel ascic suppl y is whe~e producers are
willing co supply a g iven quantity of a good or service
regardless of price. This situation can be represented by a
vertical supp ly curve.
Phill ips Cur ve is a graphical representat ion of the
theo ry chat the economy faces a trade -off between low
levels of inflation and low levels of unemployment .
Policy mix (See economicpolicy mix)
Polluti on occurs when the natural environment is
degraded in some way, such as by harmful chem ical
substances , noise or untrea ced rubbish .
Portfoli o investment refers co che shore cerm
movement of funds becween econom ies for loans or the
purc hase of small share holdings (less than 10 per cent
of the coral value of a company).
Pos itive externa licy is an un im ended posmve
ourcome of an economic accivicy whose value is not
reflected in che ope ration of the price mechan ism. See
also, negative externality.
Pove rt y (See absol11t
e poverty, relativepoverty)
Precauti onar y motive is the demand for money
for che pu rposes of unp redictable circu mstances and
emergencies for which people need co have liqu id
assecs such as cash.
Pr ice ce iling is a maximu m price sec by rhe
governm ent for wh ich a good, service or facror of
producrion can be sold, usually resulcing in marker
disequ ilibrium as marker demand will be g reater chan
market supp ly.
Pr ice di sc riminari on is when a firm sells rhe same
good or service i n different markers (or ro different
consumers) ac different price levels.
Pr ice floor is a m in imum price sec by che govern ment
for which a good, service or factor of produccion can
be sold, usually r esulcing in marker disequ ilibrium as
Pr ice elast icity of d emand measures the
responsiveness of quanticy demanded co a change
in price. It is calcula ted as the percencage change in
quanticy demand ed divided by the percentage change
in price.
Pr ice ela scicicy of suppl y measure s che responsiveness
of quantity suppl ied ro a change in price. It is calculated
as rhe percentage change in quantity suppl ied div ided
by rhe percentage change in price.
Pr ice mechani sm is che process by which rhe forces
of supply and demand interact ro dete rmin e the
market price ac which goods and services are sold and
the quanticy produced .
Pr ice s tabil ity is a goa l of government economic
policy seeking co restrai n che growth race of the
gene ral price level, essent ia lly meaning low infla cion.
Pr ices and inc ome s po licy is a govern ment
macroeconom ic policy char seeks ro control che g rowth
rare of prices and/or wages and expa nd employment by
impos ing resrraincs on wages g rowth .
Pr imar y financ ial marker s are markers in wh ich
firms raise funds by selling fina ncial assecs, such as
shares or debent u res, ro i nvesrors.
Pr ivate good is a good that is temporarily or
permanencly used up when someone consumes ic and
is easy co exclude people who are unwilling co pay for
its benefits . See also, public good.
Pr ivate sector refers co chose sectors of che economy
char concern private individ uals, i.e. the household, the
firm and che financ ial sector.
Pr ivatisat ion occu rs when the governm ent sells
public trading ente rpri ses co che privace sector. See
also, corporatisation
.
Pr od uce different iat io n is when firm s cry co make
the ir good or service look d ifferent from compecicors
(such as chroug h packagi ng or produce image) co
increase brand loyalty and g ive the firm some deg ree
of price-setting power.

Product mark et is the inceraction of demand for and
supply of che outpurs of production, i.e. goods and services.
Pr od uc tion p oss ib ility front ier is a grap hical
representa cion of all che possible combinat ions of che
production of rwo goods and services (or rwo cypes of
goods and ser vices) char che economy can produce ac
any g iven rime.
Pr od ucti v ity refers co che quanti t y of goods and
services che economy can prod uce wich a g iven amount
of inputs, such as capita l and labour. See also, labour
productivity and mrdtifactorprodttctivity.
Pr ofit is che retu rn co che factor of production
enterprise for its role in the production of goods and
services. See also, intere1t, rent and wages.
Pr ofit moti ve refers co che process by wh ich a business
seeks co max imise profit by using che lowesc cosr
combi natio n of resources and chargi ng che highest
possible price.
Prog ress ive tax sys tem is a cax system where higher
income earners pay proportiona lly more cax. As
income increases, che average race of t ax increases.
Pr opo rti onal cax system is a cax syste m where all
income earners pay proport ionally che same amount
of cax. Th e average race of cax remains consranc as
income rises.
Pr otect ion refers co govern menc p olicies chat g ive
domest ic produce rs an artific ial adva ntage over foreign
compe cicors, such as cariffs on import ed goods .
Pu b lic compan y is an entity whose shares are traded
freely on the share market, and are not subjec t co any
restri ct ions on being transferred co o cher parries.
Pu b lic goo d is an item char private firm s are unwilling
co supply as they are nor available co restrict usage and
benefits co chose willi ng co pay for the good . Because
of this, governm ents should provide chese goods . See
also, private good.
Pu b lic sect or refers co che pares of che economy chat
are owned or controlled by the governm enc. le includes
all tiers of the governm ent as well as governm ent
bus iness enterprises.
Pu b lic sector g oo d s are goods and services provided
by the governm ent such as crain services and hospita ls.
See also, public good.
Pu b lic T rading Ente rpri s es (PTE s) are businesses
owned and managed by a governm enc at eithe r the
Comm onwealch or state level.
Purcha sing p ower pari ty (PPP ) scnes chat exchange
races should adjust co equ alise the pri ce of identica l
goods and services in diffe rent econo mies thro ug hout
che world.
Glossary I
Pure compet ition describes che cheorecical marker
stru ctur e where there are many buyers and sellers.
T hey each sell a homogeneous produce, and there are
no ba rriers co en.cry into the ind ustr y. T hey are price
take rs, as individ ually they have no power co influence
price.
Qualit y of life refers co the overall well-being of
individuals wichi n a councry accordi ng co their material
living standards and a range of othe r ind icators such
as educacion levels, environ mental q uality and healch
standa rds. See also, JtandardJ of living.
Quantitati ve e as ing involves a central bank creat ing
new money electr on ically, and then injecti ng it into
the money supply thr oug h buying assecs, usually gov-
ernm ent bonds , from investors such as fun d managers
and ban ks. By increasing liqu id ity and lowering in-
terest races, qu antitative easing aims co increase bor-
rowing and sti mu late economic act ivity in the private
sector.
Quota s refer co restri ctions on che amounrs or values
of various kinds of goods chat may be imported .
R
Rea l Gr oss Dome stic Pro d uc e is che coral value of
a ll final goods a nd services produced in an economy
over a period of rime, adjusted for cha nges in the
ge neral pr ice level.
Rea l cos t (See opportunity co1t)
Rea l w age is a measure of the actu al pu rchasing
power of money wages (i.e. adjusting nomi nal wages
for the effects of inflacion). See also, 11
omi11alwage.
Rece ssion is the stage of the business cycle where
the re is dec reasing economic activity, defined as two
consecutive qua rters (six month s) of negacive economic
growth, i.e. a fall in GDP.
Regi onal b us ine ss cycle s are fluctuacions in the level
of economic act ivity in a geograph ical region of the
global economy over t ime.
Regi onal free t rade agreement is a mu lcilaceral
agreement between three or more economies wichin
a geog raphic region co lower cariff levels and othe r
forms of protect ion in order co encourage increased
trade flows. See also, bilateral fr ee trade agreement and
11mltilateral
free trade agrtement.
Regre ssive tax system is a tax system where lower
income earn ers pay proporti onally more cax. As
income increases, the average race of tax falls.
Regulat ion is the collection of govern ment rules and
inscitucions char influence che operatio n of markers
and the parti cipa nts in markets.
I
The Market Economy 2020
Relat ive p overt y refers to those whose standa rd of
living is substancially lower chan che average for che
economy as a whole, and is often defi ned as a level of
income below 30 per cenc of average ea rn ings . See also,
dbsol11te
poverty.
Renew able Ene rgy Targe c (RET ) is the policy to
increase Ausrralia's producrion of eleccricicy from
renewable energy such as solar, wind , and georhe rmal
energy co 33,000 g igawacc hou rs per year by 2020 .
Renew able r es ourc es are inputs into the produccion
process char reproduce chemselves, ensu ring char
presenc consum pcion of chese res,ources does nor
necessarily reduce che abilicy of fucu re generarions to
consume these resources in the fut ure , e.g . ti mber. See
also, 11011
-renewable resources.
Rent is the retu rn co che faccor of prod uccion natu ral
resources (land) for irs use in che prod ucrion of goods
and ser vices. le does nor jusr include renc from propert y
but all income rewards derived from rhe produccive use
of natu ral resources. See a lso, -wages,interest and profit.
Rese rve asset s refers to hold ings of foreign currency
and gold held by che Reserve Bank co use in foreign
exchange markers in order co influence the value of the
Austral ian dollar.
Rese rve Bank of Au s cralia (RB A) is Auscralia's
cencral bank . Irs main roles are co conduce monecary
policy and oversee che srabilicy of che financ ial syscem.
Recurn s to p roduc cion are che paymencs made co
faccors of prod uccion co compensace for cheir use. T he
retu rns co productio n include: wages to labour, renc on
land, incerest on capital and profit on enterpr ise.
Revaluarion occur s when che govern ment, or cent ral
bank, increases the value of a currency char operaces
wich a fixed exchange race. See a lso, d evd!11ati on.
s Sala r y (m! wdges)
Saris ficing behav iour is che idea char firms will
accempc co pursue a sarisfaccory level in all goals (profic
maxim isarion, sales maximisation, ere.) racher than
maxim ising any sing le goal.
Sav ings represents che amount of d isposable income
char is not spenr on consumptio n. Savings is a leakage
from che circular flow of income, which is necessary
co fu nd invesrment. The reward for savings is interest .
Sea so nal unempl oyment affects chose persons
unemployed due co the seasonal nacu re of the ir work .
Th eir jobs are only available at certain rimes of the
year, such as fruit picking or being a shopping centre
Santa Claus.
Secon d ar y finan cial marke ts are markers in which
investors trade financial assecs, such as shares or
debentu res, with other investors.
Share is a type of financial asset chat provides an
individual wich ownersh ip over pare of a business or
company.
Sha re market is a market for the sale of equity incerescs
in companies.
Simpl y tran sformed m an ufact u res (ST Ms) are
low-value added manufactur ing goods chat generally
comm and low prices on incernacional markers, such
as socks and singlets . See also, elaborately transformed
11/dlllljdrtl tl'l!J.
Singap ore-Au stralia Free T ra d e Agreement
(SAFTA ) is a bilaceral free trade agreement between
Australia and Singapo re chat was signed in 200 3.
Snob effect refers co a situa cion where ind ividuals
desire a good or service because of ics exclusivity, i.e.
where demand fo~a good or service decreases as it ga ins
more users.
Social welfare pa yment s are payments from the
governm ent co assist people with basic coses of living.
Several ocher cerms are comm on ly used for social welfare
payments includ ing : tra nsfer payments, governm enc
benefits, social secu rity, income suppo rt and Cent relin k
payments.
Spec ial isat ion occurs when an economy concentrates
on prod ucing a pa rti cular sec of goods or services in
wh ich it has a compa rat ive advantage .
Spec ial isat ion o f lab our occurs when che volume of
prod uct ion is large enough for workers co concentrate
on a part icular stage of che production process.
Specula to rs are investors who buy or sell financial
assets with the ai m of mak ing profits from shore term
pr ice movements. They are often crit icised for creat ing
excessive volariliry in financial markers.
Stag f lat ion occu rs when the race of inflacion and the
race of u nemployment rise simulta neously.
Sta ndard s of liv ing refers co the macerial wellbeing
of individuals with in a count ry, usually measured by
Gross Natio nal In come (GN I) per capita . See also,
quality of life.
Scruccura l ch a nge involves cha nges in the patte rn s
of productio n char reflect cha nges in cechno logy,
consu mer demand , g lobal compeciciveness and othe r
factors. le results in some prod uces, processes and even
industri es d isappeari ng , wh ile othe rs emerge .

Structural unem p loyment describes chose persons
unemployed because of a mismatch between cheir
skills and chose sk ills demanded by employers. This
occu rs due co factors such as technolog ical change
and rapid cha nges in consumer demand , where labou r
skills cannot adapt qu ickly enough co such changes.
Srock exchange is an organisat ion chat provides
facilities for investors co crade shares a.nd ocher financial
assecs. See also, sharemarket.
Su b -contracting (see orr.
tsorm:ing)
Su b sidie s are cash payments from the governm ent
co businesses co encou rage produccion of a good or
service and influence the allocat ion of resources in an
economy. Subsid ies are often g ranted co businesses co
help chem compete wich overseas produced goods and
services.
Su b stitute is a good chat consumers may choose
co buy in place of ano ther good , such as butter and
margarine or tea and coffee.
Su pe r annuat ion is a form of saving chat indiv iduals
cannot access unti I chey reach recirennent age.
Su p ply is che quantity of a good o r service char all
firms in a particular industry are willing and able co
offer for sale at d ifferent price levels, at a given point
in ti me.
T Tariffs are caxes on imported goods imposed for the
pu rpose of protecting Australian indust ries.
Tax (See taxation)
Tax ba se is the icems char are taxed by the governm ent ,
such as income, wealth or consumption .
T ax-free thre shol d refers co che !eve.Iof income below
wh ich income cax is nor payable.
Taxation is a leakage from the circular flow model
of income. le refers co the amount of revenue char
che government obtains from diffe rent sectors and
activit ies in the economy.
Techn ical efficiency is che ab ility of an economy
co achieve the max imum level of oucpuc for a given
quantity of inputs . See also, allocative effi ciency and
dy namic effi ciency.
Techn ical op timum is the mosc efficient level of
produccion for a firm . Ac this point, average coses of
product ion are ac their lowest possible level.
Technology transfer occurs when falling global
barriers co crade and financial flows allow developing
economies co access more advanced technology from
overseas.
Glossary I
Term s of trade measures the relative movements in
che prices of a economy's imports and exports over a
period of rime. The cerms of trade index is calculated
as export price index div ided by import price index
multiplied by 100.
T hail a nd -Aust ra lia Free Tra d e Agreement
(TAFTA ) is a bilateral free trade agreement between
Australia and T ha iland signed in 2003.
Total outlay method is a way co calcula te the price
elasticity of demand by looking at the effect of changes
in pr ice on che revenue earned by the producer. If price
and revenue move in the same d irection , demand is
inelast ic; if price and revenue move in the opposite
direction, demand is elast ic; and if revenue remains
unchanged in response co a pr ice change, de mand 1s
unit elastic.
T rade b loc occu rs when a number of count ries join
cogecher in a formal preferential trading ag reement co
che exclusion of ot her count ries.
T rade liber alisa tion is the process of reduc ing
cariffs, subsid ies and ocher barriers co trade in order co
encou rage increased linkages betwee n econom ies.
T rade un ion is an organisa cion char rep resents the
interests of workers, prima rily by seeking co imp rove
cheir wages and working conditions .
T rade Weighte d Index (TWI) is a measure of che
value of the Australian dolla r aga inst a basket of
foreign currencies of major trading partne rs. T hese
currencies are weighted according co their significance
co Australia's trade flows.
T raged y of the co mm o ns refers co a situacion where
che failure of che market co assign coses co ind ividuals
leads co an overu se of resources such as che natural
environment, which have no single owner.
T ran sac t ions mot ive is the demand for money
for day-co-day pu rchases for which people need co
use money.
T ran sfer pa ymen ts (see socialwelfarepayments).
T ran s Pacific Partner s hip (TPP ) is a crade agreement
chat was negociaced among 12 countr ies in che Asia-
Pacific region includi ng Japan and the Un ited Scares
chat was ag reed in 2016. Ics future became unclea r
after che Un ited Scares withdrew from che TPP in
2017, before ic had come into effect.
T ran sa tlant ic Tr ade and I nve s tment Partne r sh ip
(TTIP ) is a possible crade ag reement between che
United Scates and che European Union, for wh ich
negociacions bega n in 2013.
T ran s ition Econo mie s are former socialise economies
chat are now becoming marker economies and are
concentrated in Cent ral and Eascern Europe and Asia.
II
I
The Market Economy 2020
T ran smi ssion mechani s m explains how cha nges
in the seance of monetary policy pass thr oug h the
economy co influence economic objec tives such as
inflation and economic g rowth .
T ran snational Corporat io ns (TNCs ) are g lobal
companies char domin ace g lobal produce and factor
markets . TNCs have productio n facilicies in at lease
cwo countries and are owned by residents of ac lease
cwo count ries.
T rea su r y is the Australian Government depa rtm ent
responsible for developing fiscal policy through the
Federal Budgec, and advising the govern ment on
financial stability issues.
u Un deremployme nt refers co cho-se persons who
are working less than full rime (a.nd therefore nor
unemployed) but wou ld like co work more hours .
Un derly ing inflat ion is a measure of the increase in
che ge neral price level chat removes the effect of one-off
or volacile pr ice movements .
Unemp loyment refers co a situatio n whe re individuals
wane co work but are unable co find a job, and as a resulc
labour resources in an economy are no r utilised .
Unemp loyment race is che number of people officially
unemployed as a percencage of the labou r force.
Union (See t,-adeunion)
Unit elas t icity of deman d is where a change in price
causes a proportional change in qu.ancicy demanded
such chat coral spend ing by consume rs on a good
remai ns unchanged .
Unit ed Nat ions is a global orga n isation of 193
member scacesestablished in 194 5 with a broad agenda
covering che global economy, incernac.ional securicy, the
environmenc, poverty and developme nt, internatio nal
law, and global healch issues.
Uti lity is the satisfaction or pleasure chat individuals
derive from the consumption of goods and services.
V
Valua t ion effect is where an app reciacion (or
dep reciation) of che cur rency causes an immediate
decrease (or increase) in the Australian dollar value of
foreign debt .
Volunt ary export res tra int s are ag reemencs co restrict
che number of ex:ports co anothe r count ry in exchange
for a similar concession from che other natio n.
Wages are che return co the factor of production labou r
for its use in the produc cion of goods and services.
These not on ly i.nclude wages but also salaries, fees,
comm issions and ocher earn ings. See also, interest, profit,
nmt.
Wanes are macer.ial desires of individuals chat provide
some pleasure when they are satisfied. This will depend
on personal preferences. Wanrs are said co be unlimited.
Seealso, colleaive w«nts,
Wage Pr ice I n de x is a measure of g rowth in hourly
races of pay chat is released quarterly by che Australian
Bureau of Scaciscics. le is regarded as the most reliable
indicato r of underlying wage growt h, as che index is
not affected by changes in bonuses or the qua lity or
quantity of work .
Wealth is che value of the stock of assets held by
individuals ac a po inc in rime.
Wealth effect occu rs when an increase in the price of
assets such as property and shares leads co an increase
in consu mpcion . This occurs because rising asset prices
make che owners of these assecs feel wealth ier and so
more willing co spend a g reater a proportion of cheir
income.
Welfare (seeutility, socialwelfarepayments)
Workab le compet it ion is the government's objective
co ach ieve che max imum level of competition wich in an
indust ry char is compatible wich che market structu re
and specific cond itions of che industry, i.e. a sicuacion
where all markets are contestable.
Workforce (Seelabourforce).
Workforce part icipat ion race (See participation,-ate)
World Bank is a financial inscicucion owned by 188
member councries chat assists poorer nations wich
economic development chrough loans (often at little or
no interest races)co fund investment and reduce poverty.
See also, Heavily Indebted PoorCormtries (HIPCs).
World Trade Organi sa tion (W T O) is an orga nisacion
of 161 member count ries char implements and advances
global crade agreemencs and resolves trade dis puces
between nations.
Index
A B
adverti sing 49, 55, 58
age 53 , 8 1, 125 , 127- 129 , 139
ageing of the pop ulation 44, 62, 81, 126,
129- 130,2 13 , 214 , 232 , 250
aggregate demand 120-122 , 149, 150 , 151 ,
172, 234 , 244,245
allocat ion of resources 8, 32, 33, 145, 175 ,
181, 207 , 210,226-227
allocative efficiency 109
All Ordinaries Index 180- 181
Asian economic region 35-36
Australian Bureau of Statist ics (ABS) 55 , 140,
149
Australian Chamber of Commerce and Industry
(ACCI) 162, 248
Australian Compet ition and Consumer
Commission (ACCC) 2 16-2 17 , 236
Australian Con stitution 22 1-222
Australian Council of Trade Unions
(ACTU) 155,159 , 248
Australian Industrial Relations Comm ission
(AIRC) 142, 164
Australian Industry Group 162 , 248
Australian Prudential Regulation Authority
(APRA) 185, 187 , 189- 190
Australian Securitie s and Investments
Commission (ASIC) 185, 189- 190
Australian Securities Exchange 173, 179, 180,
190
Australian Treasury 185, 190
automat ic stab ilisers 245
average cost 67 , 69 , 70
average propens ity to consume (APC) 51 , 52 ,
53
average propens ity to save (APS) 51, 54
average rate of tax (ART) 230 , 23 1, 232
average week ly earnings 10, 136- 137 ,
139- 140, 143
awards 12,164 ,1 65 , 166
bandwagon effect 81
Bank for International Settlements 184
Banking Royal Comm ission 190
banks 24 , 63 , 114, 161, 170 , 172- 176 , 186 ,
187- 190 , 194, 195-204
barter 20
bonds 17, 56 , 173 , 176- 177 , 193 , 194, 195,
200,204
boom 22 , 30, 60, 68,12 1,1 39 , 152,179 , 2 17,
233,245
borrowing 174-176, 193- 194, 197, 199, 196 ,
198, 200-204
reasons for 1 72
borrowing rate 200
brand loyalty 113
broad money 199
budget 12 , 17 1- 172, 190,1 94 , 20 1,209
Commonwealth I Federal Budget 24 1, 243,
246
outcomes 244
budget deficit: 20 1, 225 , 244, 250
budget surplus 244
business 10, 12, 18- 19, 2 1-26 , 49-50, 60-67,
71-75 , 171-172, 174- 179, 193-194 , 198 ,
217-2 18 , 226-228,248
Business Council of Australia (BCA) 162, 248
business cyc le 2 1-22 , 151, 217-218 , 233
business firm 5, 12, 19, 23, 32, 49 , 60 , 63-64,
66 , 67 , 98
business sovereignty 50
C
capital 16- 19 , 56 , 61-62 , 122- 123, 172
cap ital gains 1 79 , 195
cap ital goods 9 , 17, 25 , 63, 200
cap ital-intens ive 19
cap ital market 24, 70, 201
cash payments 34, 64, 143, 227
cash rate 176, 198 , 20 1-204, 233-234
I
The Market Economy 2020
casual employment 153, 155
centra l banks 161, 184, 186- 187
centrally planned economy 30
ceteris paribus 2-83, 84, 98
circular flow of income 23-27 , 244
climate change 41-42, 215, 237-238
common law contracts 164-166
Comm onwealth / Federal Budget 241, 243, 246
compan y tax 226 , 230 , 241, 242
compari ng economies 35-36
compe tition 31-33, 112-1 14, 175-176 , 179,
216, 235-236
Compe tition and Consumer Act 2010 216 , 236
competi tion policy 218, 235-236
comp lement goods 55
consp icuous consumptio n 146
consumer credit 175, 190
consume r demand 18, 31, 55, 57, 60, 61, 81,
84, 108- 109, 119
consume r goods 9, 63, 171, 175
consume r protection 185, 186, 189, 190, 236,
consume rs 5, 12, 17- 18, 22, 27, 30-33 , 49-59 ,
80-86 , 88, 106-1 11, 172-173 , 175, 204,
216-2 18, 226-227
consume r sovereignty 31, 33, 49- 50
consumptio n 22-25 , 50-5 1, 81, 111, 146, 172,
196,1 98, 204,237
contract ionary fiscal policy 244
corporat isation 234
Counc il of Financial Regulators 185
cred it 52,17 2, 175,198 ,1 99
cred it cards 175, 193- 194, 195, 196, 197
cred it unions 24, 174-175
cyclical unemployment 149- 150 , 233,234
D elasticity of demand 87, 89
demand
advertising 55
consumer 18, 31, 55, 57, 60, 61 , 81, 84,
108-109, 119
consumer sovereignty 31, 49
individual 24, 54, 80
labour 21-22 , 73
market 31, 61, 73, 80-83 , 105
market equilibrium 105- 107
necessities 4, 54-55, 57, 80, 81 , 90
product 3D-31, 73
resources 24-25
soc ial welfare 44
tech nology 74, 96
the environment 75
II
dema nd curve 106- 110, 132- 133
decrease in 84-86
factors caus ing shifts 85-86
increase in 85-86
movements along 82-83
shifts of 84-86
slope of 89-90
demand for labour 21-22, 119-124 , 133, 149,
161
demand schedule 82-83
derived demand 119, 120,121 ,1 49 , 161
diminishing marginal returns 132
direct taxe s 87, 226-227 , 241
disability suppo rt payments 20 , 33, 44, 56-57
diseconomie s of scale 67, 69-7 1
disequilibrium 27, 110-1 11
distribution 5, 19, 32-33 , 34, 209
age 81, 85, 127,129
income 20, 33 , 36, 40, 81, 85, 86, 110, 138,
142- 143, 145- 148, 210-2 11, 213-2 14,
229-232
dividends 56, 64, 179, 243
domestic market operat ions (DMOs) 201
domestic sect or 26
E
economic co st see opportunity cost
economic growth 9-10, 11, 21-22, 36-38 ,
63-64, 120, 128- 130 , 145- 146, 151, 180- 181,
217-218,225 , 233-234
econom ic prob lem 3-4, 34, 108, 208 , 217-218
econom ies of scale 67-71 , 235
educatio n 10, 11, 16, 38, 43-44 , 124- 126,
130- 131, 138,1 45, 213,221 , 222,235
efficiency 5, 60 , 61, 66, 69, 109, 178, 184, 210
see also price elastic ity of demand
ela sticity of s upply 100-101
empl oyer associations 158, 162-163
enterpri se 16, 18- 19, 23, 31, 62,1 09, 147,165
environmental groups 249
environmental sustainability 36, 40, 42, 75,
237
equal pay 139
equilibrium
circular flow of income 27
government intervention 109- 111
labour market 131- 133
equity mark ets 173, 183
ethical dec ision making 71-75
excess capac ity 101

excess demand 106, 110, 2 17
excess supply 105-106 , 110
exchange settlement accounts 187 , 20 1-202 ,
204 , 203
expansionary fiscal policy 244
exports 23,25-27 , 38
external diseconomies of scale see
diseconomies of scale
external economies of scale see economies
of scale
externalities 81, 111
market failure in 214-215
F
factor market 31 , 34 , 109 , 172, 198
factor of produc tion 16, 17, 66, 96, 118
factors , consumer choice 54
Fair Work Act 164, 165
family allowance 56
finance compa nies 24, 174, 176 , 18 1
financial flows 23 , 26, 27
financial innovation 196- 197
financial intermediaries 24 , 171, 185 , 199
financial markets 86, 118, 169--192
fiscal outcome 244
fiscal policy 218, 233 , 234 , 24 1, 244 , 245
five-sector circular flow of income model 23
float 179, 181, 182
Foreign Exchange Market (forex) 173 , 175, 182,
189 , 250
freedom of enterprise 31
frictional unemployment 150
fringe benefits 56 , 123, 143, 242
G imports 23-27
geographical mobility 125
global debt markets 182
global financial crisis 22 , 32 , 151, 161, 172 ,
174 , 175,176 ,1 82 , 185,188 ,1 90, 198 , 250
globalisation 71, 74-75 , 250
goods -6 , 8-9, 16-26 , 30-34 , 49 , 50 , 54-55 ,
66 , 80-81 , 85-87 , 91 , 100- 101, 108-109,
111, 21 1-212
Goods and Services Tax (GST) 81 , 222 , 226 ,
230 , 232,242-243
government 12 , 42-44
and migration 128- 129
APRA 189
as borrower 193, 194, 20 1
as lender 198
Australian Treasury 190
Index I
circular flow of income 23, 25-27
climate change 215
co llective wants 4
decision implications 10- 11
fiscal policy 241-252
globa l financial crisis 188
investment 18
labour supp ly/ market 124 , 126- 127, 153,
158-167
market interventio n 20-22, 34-35 , 105,
109--112 , 130 , 175- 176, 183,1 85 , 210- 11,
2 17-2 18
market role 30 , 32- 34 , 42-44
opportun ity cost 5
price elasticity of demand 87 , 90
production influence 34
provision of pub lic goods 36 , 40 , 56-57 , 136 ,
146 , 21 1-2 14
Reserve Bank 186- 187, 189, 201-204
role in Australia 221-240
government business enterprises
(GBEs) 224 , 225 , 228, 234 , 235
grants 34 , 41 , 222, 223 , 227
H
holiday leave 124 ,1 43 , 154
household debt 196
household income 56-57
housing loans 175- 176
human capital 68 , 124 , 140
Human Development Index (HDI) 38-39
I
imperfect competition 113, 114, 2 16
incentive effec ts of inequality 145
income tax 20 , 25 , 33 , 226 , 227 , 230-232 ,
242
Index of Economic Freedom 43
indirect taxes 87, 226-227, 241 , 242
individual demand 54 , 80
industrial relati:ons 12, 34, 142 , 158 , 162,
164-166 , 246
industrial tribunals 158 , 162, 166
industry 60
inequality 145-148 , 232
disequilibrium 27
income 142- 14 3 , 145- 148,2 13 , 229-230
social 229
wealth 40
inequality of opportunity 147
I
The Market Economy 2020

inflationary expectat ions 20 1 financia l 16,9-205

infrastructure 11, 17, 42, 44, 67, 68 , 152,194 , goods and services 19-20
2 12, 22 1, 222,223 , 228 , 243 governmen t 42-43 , 207-253
initi al pub lic offer ing 179 labour 117- 134, 136-156 , 158-167
injections 23, 25 , 26-27, 244 markets 78-9 1
interest groups 47 , 249 , 199 scarce resources 18
interest rates 199 supp ly 95- 103
internal diseconom ies of scale see market economy 30-35
diseconomies of scale market ing 49, 2 16
internal economies of scale see economies means tested 56, 232
of scale media 49 , 166, 212, 246 , 249
International Monetary Fund 36, 39, 161, 184, merchant banks 174
250 merit goods 34, 111, 211
internat ional money flows 26 microeconom ic reform 151 , 218,250
internat ional trade 23 , 26 minimum wage 34 , 158 , 16 1, 164-165
inventory 101
mixed econom ies 32-34, 40, 42
investment 19 , 21-25, 27, 56 , 62 , 71-75, 122,
monetary aggrega tes 199
174- 175, 181, 189- 190
monetary policy 170, 185, 187, 190, 201 , 204,
L 218, 233-234
labour 16, 17-20 , 31, 34 , 56 , 66-68 money 17, 20 , 24-26, 50 , 51, 52 , 54 , 74,1 10 ,
labour force partic ipation rate 125-126 , 150 137 , 171-174 , 177 , 187,189 , 193-206 , 21 1
labour- intensive 19, 122 money supply 199
labou r markets 117- 168 monopo lisatio n 216
law of demand 2-83 monopo listic com petition 112- 114, 2 12 , 216,
law of supply 97 228
leakages 23-27,244 monopo ly 112 , 113
learning by doing 70 mortgage orig inators 174 , 175- 176, 188
lenders 175 , 176, 197-204
N
lending rate 176, 200
National Employment Standards 164, 165
life-cyc le theory of consumpt ion 53
National Farmers Federati on (NFF) 163 , 250
liquidity 175, 194-195 , 196
natural environment 12, 40, 71, 75, 79 , 110,
living standa rds 22 , 35 , 37-38, 43 , 64 , 66 , 68 ,
146,1 98 , 213,233 214, 235 , 237,238
local governments 4 , 22 1, 223 , 224 natural increase 128
long run average cost curve 69-70 natural resources 16- 19, 3 1, 61-62 , 67 ,1 10,

long-term unemp loyment 149 225

necessities 4, 54 , 57 , 80 , 81 , 90
M needs (human/ commu nity) 3, 4, 9 , 11, 16, 44 ,
M3 199 210, 227
macroeconomic policy 2 18, 24 1 negative externa lities 111, 214-215
marginal propensity to consume (MPC) 52 net migrat ion 128
marginal propensity to save (MPS) 52 network extern ality 81
marginal rate of tax (MRT) 230, 23 1 neutral fisca l po licy 44
market/s newly indust rialised econom ies 36-37, 39
business 60-77 non-bank financ ial intermed iaries (NBFls) 173 ,
business cyc le 2 1 199
compa ring economies 35-41 non-wage outcomes 143-144
cons umers 49-59
equilibrium 105-1 15 0
failure 109-1 10, 21 1-2 17 occupational mobility 125, 138

opportun ity cost 5, 6-9 , 16, 17, 108 , 123, 132,
196
outp ut/s 7, 8 , 17, 18, 19-20 , 21, 24-26,30,33 ,
37 , 38,4 1,6 1,64 , 67 , 69-70, 73, 120- 123
outsourc ing 153, 154, 248
p pure market eco nomy 30
part-time employment 136, 153- 154
Pay-As-You-Go (PAYG) 230-23 1, 242
perfectly elastic demand 89-90
perfectly elastic supply 100
perfectly inelastic demand 89 , 90
perfectly inelastic supply 100
permanent building societies 174
planned obsolescence 50
political parties 12 , 208, 246-249
popu lation 5, 8, 18, 36 , 40 , 44 , 64, 81, 85, 86 ,
124-130
popu lation ageing see ageing of thle population
positive externalities 111, 2 14
poverty 22 , 30 , 43 , 146-148 , 213
precautio nary motive 195
price/s 12 , 30-32 , 33 , 38 , 42 , 54-55 , 64 , 66 ,
72-73
see also price elasticity
price ceiling 110, 111
price discrimination 2 16 , 236
price elasticity 89
and the demand curve 82
of demand 87-9 1, 16 1
of supply 100
price floors 110, 111
price mechanism 3 1, 33, 34,105 , 106 , 108,
109-1 10, 214 , 215, 237
price setter 113
price takers 112
primary financial markets 173, 180
private company 178
private sector 18 , 25 , 26 , 30 , 32 , 33, 34, 63,
111, 199,224 , 225 , 228-229,23 4
privatisation 42, 224 , 228 , 229, 234 , 246 , 248
product differentiation 113, 2 16
produc tion decisions 60-62
prod uction possibility frontier 6-9
productiv ity 17, 62, 66-68 , 121-122
product market 30, 3 1, 108, 109, 1 19, 124, 136 ,
139 , 198, 200
profit 16, 18, 25, 3 1, 56, 64 , 72 , 73 , 96 , 137,
174, 179,227
progressive tax 33 , 230, 245
proport ional tax 230
Index I
public compa ny 178
public goods 111, 21 1-212 , 226
public sector 26 , 159 , 209, 224-225
public trading enterprises (PTEs) 224 , 229, 234
pure compe tition 105, 112- 114
Q
quality of life 116, 19, 22, 36 , 38 , 39 , 144
quantity demanded 82-84 , 87-9 1, 105,
106- 107, 132
quantity supplied 97- 100, 105, 106-107 , 132
R
real labour costs 137
real wages 137,161 , 200
recent unemployment trends 151
recession 2 1-22 , 86 ,1 26 , 151,180 ,1 88 , 217,
218,225 , 245
redistribution of income 33 , 8 1, 229-232
regressive tax 230 , 232
relatively elastic 87-89 , 100
relatively inelastic 87-89, 90 , 91, 100, 101, 243
rent 10, 16, 17, 18, 19, 23 , 56 , 2 13
research and development 11, 68 , 70, 235
Reserve Bank of Australia (RBA) 51, 172,
184,185 , 186- 187 , 190,193 ,1 95 , 20 1,233
s
salary packaging 143
satisfic ing behaviour 64 , 65
save/ saving 11, 17, 24 , 25 , 27 , 50-53 , 54 , 171,
177,179
savings 17, 18, 22, 23-25 , 27 , 50-53 , 56 ,
145- 146, 171- 174, 194,1 97 , 198 , 200
seasonal unemployment 150
secondary financia l markets 173, 180
securities 173- 174 , 175, 176, 179 , 180, 185,
189- 190,200-20 4,233 , 250
shareholders 64 , 65 , 72 , 178 , 179- 180, 181
share market 173 , 177, 178- 18 1
shares 17, 56 , 72 , 172,173 ,1 77 , 178- 181, 183,
189,195 ,1 97
short-term money market 176 , 20 1, 202 , 204,
233
snob effect 8 1
social costs 109 , 110,1 11,1 45 , 147,2 13 , 2 14 ,
215
socially optimurm quantity 110
social welfare payments 56
specialisation 67 , 68, 154
II
I
The Market Economy 2020

spec ulation (financial markets) 18 1, 184 Australian w orkforce 127-1 28

spec ulative mot ive 195 business cycle 22
standard of living 16, 44, 53, 66 cyc lical unemp loyment 149
state governments 222 , 223 , 234 education and skills 125 , 130
st ruct ural change 15 1 equilibrium 2 7, 132
st ruct ural unemployment 149 frict ional unemployment 150
sub-co ntracting 153 , 154 hard-co re unemployment 150
subsid ies 34 , 42, 111, 124 , 227 hidden unemployment 150
substitut e goods 85 , 86 long-term unemployment 149
superannuation 24 , 44 , 52 , 54, 56 , 123 , 124 , output of firm 120
143 , 155 , 165, 172- 174, 177 , 185,1 89 , 242 seasonal unemployment 150
superannuation funds 24, 173, 174 , 177 , 183, st ructu ral unemployment 149
185, 189 types of 149- 150
supply 95-1 02 underemployment 150
supply curve 97- 101 unemployment rate 39 , 149 , 150, 15 1, 153
supply schedule 97 unions 12, 75 , 126 , 143, 158 , 159--160 , 162 ,
T 165 , 248 , 250
tax 12 , 20 , 23 , 25 , 26 , 33 , 34 ,4 3 , 50 , 51, 8 1, United Nations Framewo rk Convention on
85 , 86 , 87 , 111, 123 , 2 15 , 218, 222 , 226- 227 Climate Change (UNFCCC) 238
taxat ion 230- 232 unit elastic 87 , 88 , 100
technical optimum 67, 69 , 70 utility 4, 54 , 55, 132 , 146
time lag 120
total outlay 88-89
w
wage differentials 125 , 138 , 142
trade unions 75 , 158 , 159 , 160
wages 16, 17, 23, 56, 72, 119, 136-139 , 158,
transactions motive 195
161
transfer payments see social welfare
wants 3-4, 8 , 9, 16, 25 , 3 1, 49 , 54, 66,1 08 , 2 10
payments
welfare agencie s 24 7, 249
u welfare state 2 13 , 225
unemployment 22 , 25 , 33 , 36 , 4 4, 56-57 , 63 , workable compet ition 235 , 236
148- 150 workforce 62, 12 1- 122 , 125- 126 , 127-1 30 ,
and employment 39- 40 155 , 159
and the frontier 8 work ing age popu lation 125 , 128