Economic Issues.

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7 ECONOMIC GROWTH

Economic Growth involves an increase in the volume of goods and services that an economy can produce over a period of time. It is measured by the annual rate of change in real GDP ie. The % increase in the value of goods and services over a period of one year, adjusted for the rate of inflation.

The ABS uses a variety of approaches for measuring GDP in Australia. These measures are known as the GDP(Income), GDP(Production) & GDP(Expenditure) methods. The official measure of economic growth takes an average of these 3 indicators of growth and is known as GDP(A)

7.1 The Components of Aggregate Demand

John Maynard Keynes, developed a theory which stated that the most important influence on economic growth was the total level of spending in the economy - that is, the level of aggregate demand. If households and business firms were generally pessimistic about the future economic outlook, housholds would tend to spend less on consumer goods and save more and business firms would be reluctant to invest in capital goods. This would result in an overall decline in aggregate demand, with falling production and rising unemployment.

The economy is in equilibrium where:

AD = C + I + G + (X-M)

Aggregate Supply = Aggregate Demand

The Circular Flow Model reveals that, based on the aggregate demand equation above, certain economic factors can be identified that are either leakages or injections to the overall level of economic activity. The economy is in equilibrium when leakages(S,T,M) = injections(I,G,X)

An increase in leakages causes a downturn in the level of economic growth, and an increse in injections causing an upturn.

Influences on consumption

Consumer expectations

If consumers expect a higher rate of inflation, higher real incomes or future shortages of goods then they would tend to spend more and save less in the short term and vice versa.

The level of Interest Rates

An increase in the general level of interest rates would discourage individuals from spending their money and therefore encourage them to save, while a decrease in interest rates would encourage spending and discourage saving.

The Distribution of Income

Generally speaking, the more equitable (even) the distribution of income, the higher the rate of overall spending, and vice versa for a more inequitable (uneven) distribution of income. Eg a person with a net income of $200 per week might have to spend it all on basic costs of living, whereas someone receiving a net income of $2000 per week might comfortably save half of that level of income.

Income Levels and Consumption Preferences

The income levels of consumers are the most significant single determinant of how much consumers spend.

·The Marginal Propensity to Consume(MPC) i.e. the proportion of each dollar of income that is spent on consumer goods

·The Marginal Propnsity to save (MPS) i.e. the proportion of each dollar of income that is saved.

Influences on Investment

The cost of Capital Equipment

The cost, or relative cost of capital equipment is influenced by:

·changes in interest rates A fall in interest rates would make it cheaper to borrow funds for the purchase of capital equipment. Interest rates also represent an opportunity cost for firms which own their own capital

·A change in government policies related to investment allowances and tax concessions on capital goods. E.g if gov allowed a business to claim higher rate of depreciation this would reduce tax liability & make it cheaper.

·Any change in the price or productivity of labour (labour being a substitute for capital in the production process) e.g. If the cost of labour increased while the cost of capital remained the same, then the relative cost of capital compared to labour would have decreased, making its use more attractive.

Business expectations

·Any change in expected demand for their products. If entrepreneurs expected a future increase in...
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