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ECON1002 S EMES TER 2NOTES

Ge o r g i aHa t z i s Le c t ur e r :J a ne tDz a t o r|T u t or :Ga r yMu r p hy

Table of Contents CHAPTER1-ECONOMI CS:FOUNDATI ONSANDMODELS..........................................................................4 L1.THREEECONOMI CI DEAS...........................................................................................................................................4 L2.SCARCI TY, TRADEOFFSAND DECI SI ON MAKI NG.....................................................................................................4 L3.ECONOMI CMODELS..................................................................................................................................................5 L4.MI CROECONOMI CSANDMACROECONOMI CS.............................................................................................................5 CHAPTER2–CHOI CESANDTRADEOFFSI NTHEMARKET....................................................................6 L1.PRODUCTI ON P OSSI BI LI TY F RONTI ERSANDREALWORLDTRADEOFFS..................................................................6 L2.COMPARATI VEADVANTAGEAND T RADE...................................................................................................................7 L3.THEMARKETSYSTEM..............................................................................................................................................7 L4.THELEGALBASI SOFAS UCCESSFULMARKETS YSTEM...........................................................................................8 CHAPTER3–WHEREPRI CESCOMEFROM:THEI NTERACTI ONOFDEMANDANDSUPPLY...........8 L1.VARI ABLESTHATI NFLUENCEDEMAND.....................................................................................................................8 L2.THESUPPLYSI DEOFTHEMARKET.........................................................................................................................11 L3.MARKETEQUI LI BRI UM: PUTTI NG DEMAND ANDS UPPLYTOGETHER......................................................................13 L4.THEEFFECTOFDEMAND AND SUPPLYSHI FTSON E QUI LI BRI UM............................................................................13 CHAPTER4–GDP:MEASURI NG TOTALPRODUCTI ON,I NCOMEANDECONOMI CGROWTH........14 L1.GROSSDOMESTI CP RODUCTMEASUREST OTALP RODUCTI ON................................................................................14 L2.DOESGDPMEASUREWHATWEWANTI TTOMEASURE? ....................................................................................16 L3.REALGDPVSNOMI NALGDP ................................................................................................................................17 L4.CALCULATI NG THEECONOMI CGROWTH RATE.......................................................................................................17 CHAPTER5–THEFI NANCI ALSYSTEM ANDBUSI NESSCYCLES...........................................................17 L1.LONG RUN ECONOMI CGROWTH I STHEKEYTO RI SI NG L I VI NG S TANDARDS.........................................................17 L2.SAVI NG, I NVESTMENTSAND THEF I NANCI ALS YSTEM............................................................................................18 L3.THEBUSI NESSCYCLE.............................................................................................................................................20 CHAPTER6–LONGRUNECONOMI CGROWTH:SOURCESANDPOLI CI ES.........................................21 L1.ECONOMI CGROWTH OVERTI MEAND AROUND THEWORLD....................................................................................21 L2.WHATDETERMI NESHOW F ACTECONOMI ESGROW? .................................................................................................21 CHAPTER7 ,TOPI C6–UNEMPLOYMENT.....................................................................................................22 L1.MEASURI NG UNEMPLOYMENTAND LABOURFORCEP RODUCTI VI TY.........................................................................22 L2.COSTSOFUNEMPLOYMENT......................................................................................................................................23 L3.TYPESOFUNEMPLOYMENT......................................................................................................................................23

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L4.EXPLAI NI NG F RI CTI ONALAND S TRUCTURALUNEMPLOYMENT...............................................................................24 L5.LABOURMARKETREGULATI ON AND DEREGULATI ON..............................................................................................24 CHAPTER8 ,TOPI C7–I NFLATI ON.................................................................................................................24 L1.MEASURI NG I NFLATI ON...........................................................................................................................................24 L2.USI NG P RI CEI NDEXESTOADJ USTF ORTHEEFFECTSOFI NFLATI ON.........................................................................25 L3.NOMI NALI NTERESTRATESVERSUSREALI NTERESTRATES.....................................................................................25 L4.DOESTHEI NFLATI ON RATEI MPOSECOSTSON THEECONOMY? ...............................................................................25 L5.CAUSESOFI NFLATI ON.............................................................................................................................................26 CHAPTER9 ,TOPI C8–AGGREGATEEXPENDI TUREANDOUTPUTI NTHESHORTRUN.................. 26 L1.THEAGGREGATEEXPENDI TUREMODEL.................................................................................................................26 L2.DETERMI NI NG THELEVELOFAGGREGATEEXPENDI TUREI N THEECONOMY............................................................27 CHAPTER1 0,TOPI C9–AGGREGATEDEMANDANDAGGREGATESUPPLY........................................28 L1.AGGREGATEDEMAND.............................................................................................................................................28 L2.AGGREGATESUPPLY................................................................................................................................................29 L3.I DEASAND T HEORI ESOFTHEECONOMY................................................................................................................29 CHAPTER1 1,TOPI C1 0–MONEY,BANKSANDRESERVEBANKOFAUSTRALI A................................30 L1.DEFI NEMONEY AND DI SCUSSI TSF UNCTI ONS........................................................................................................30 L2.DI SCUSSTHEDEFI NI TI ONSOFTHEMONEY SUPPL Y USED I NAUSTRALI A TODAY......................................................30 L3.HOW DO FI NANCI ALI NSTI TUTI ONSMAKEMONEY? .................................................................................................31 L4.DI SCUSSTHEROLEOFTHERESERVEBANK OFAUSTRALI A...................................................................................31 L5.EXPLAI NI NG THEQUANTI TY THEORY AND HOW I TRELATED TO HI GH RATESOFI NFLATI ON OCCURRI NG................32 THEEQUATIONOFEXCHANGE.....................................................................................................................................32 MONEYSUPPLYXVELOCI TYOFMONEY=P RI CELEVELXREALGDP ..............................................................................32 CHAPTER1 2,TOPI C1 0–MONETARYPOLI CY............................................................................................ 32 L1.DEFI NEMONETARY POLI CY AND DESCRI BETHEMAI N GOALSOFMONETARY POLI CY I NAUSTRALI A......................32 L2.DESCRI BEHOW THERB AAFFECTSI NTERESTRATES..............................................................................................32 L3.USETHEDYNAMI CAGGREGATEDEMAND AND AGGREGATESUPPL Y MODELTOSHOW THEEFFECTSOFMONETARY POLI CY ON REALGDPAND THEPRI CELEVEL...............................................................................................................33 L5.DI SCUSSTHERB AUSEOFMONETARY POLI CY........................................................................................................34 CHAPTER1 3,TOPI C1 1–FI SCALPOLI CY.....................................................................................................34 L1.DEFI NEF I SCALP OLI CY...........................................................................................................................................34 L2.HOW DOESFI SCALPOLI CY AFFECTAGGREGATEDEMAND AND HOW CAN THEGOVERNMENTUSEI TTO STABI LI SE THEECONOMY? .............................................................................................................................................................35 L3.EXPLAI N HOW THEGOVERNMENTPURCHASESAND TAX MULTI PLI ERSWORK..........................................................35 L4.DI FFI CULTI ESARI SI NG OUTOFTHEI MPLEMENTATI ON OFFI SCALPOLI CY................................................................36 L5.DEFI NEFEDERALBUDGETDEFI CI TAND DEBTAND EXPLAI N HOW THEFEDERALBUDGETCAN SERVEASAN AUTOMATI CS TABI LI SER.................................................................................................................................................37

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L6.EFFECTSOFFI SCALPOLI CY I NTHELONG RUN.........................................................................................................37 CHAPTER1 4,TOPI C1 2–MACROECONOMI CSI NANOPENECONOMY................................................38 L1.EXPLAI N THEMAI N COMPONENTSOFTHEBALANCEOFP AYMENTSAND UNDERSTAND HOW I TI SCALCULATED.....38 L2.THEFOREI GN EXCHANGEMARKETSAND EXCHANGERATES ....................................................................................39 L3.THEI NTERNATI ONALS ECTORAND NATI ONALS AVI NG AND I NVESTMENT..............................................................39 L4.COMPARETHEEFFECTI VENESSOFMONETARY POLI CY AND FI SCALPOLI CY I N AN OPEN ECONOMY ANDI N ACLOSED ECONOMY...................................................................................................................................................................... 40

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Ch a p t e r1 -Ec on o mi c s :Fo un d a t i o n sa n dMo d e l s L1 .Th r e eEc o n o mi cI d e a s Wh a ti se c o n omi c s ? Ho wc a nt h ee c on o myp r o v i d ef o rt h eu n l i mi t e dwa n t so fc o ns ume r st h r o u g hl i mi t e dr e s o ur c e s . Th e s e c h o i c e swi l lb ema d eb yp e o pl e , s o c i e t y ,fir msa n dt h eg o v e r n me nt . 1 .Pe o p l ea r er a t i o na l  Ec o n o mi s t sa s s u met h a tp e o pl ea n dfir msu s ea smu c ho ft h ei n f o r ma t i o na v a i l a b l et ot h e mt o ma k et h eb e s td e c i s i ont oa c h i e v et h e i rg oa l s .  Ho we v e r , n o te v e r y o n ei sr a t i o n a la ta l lt i me s . 2 .Pe o p l er e s p o n dt oe c o n omi ci n c e n t i v e s  Ec o n o mi s t se mp ha s i s et h a tc on s u me r sa n dfir msc on s i s t e n t l yr e s p o n s et oe c o n o mi c i n c e n t i v e s .  Wh a tmo t i v a t e sp e o p l ea n dfir mst od os ome t h i n g . 3 .Op t i ma ld e c i s i o n sa r ema d ea tt h ema r g i n  Ma r g i n a lme a n sa ne x t r ao ra d di t i o n a lb e ne fito rc o s to fad e c i s i o n .  Ec o n o mi s t sb e l i e v et h a tt h eo p t i ma lde c i s i o ni st oc o n t i n uea n ya c t i v i t yu pu n t i lt h ep o i n t whe r et h ema r g i n a lb e n e fiti se q u a lt ot h ema r g i na lc o s t .  Ma r g i n a la n a l y s i s–a n a l y s i st h a ti n v o l v e sc o mp a r i n gma r gi n a lb e n e fit sa n dma r g i na lc o s t s . L2 .Sc a r c i t y ,Tr a d e Offsa n dDe c i s i o nMa ki n g  Th ewo r l do n l yha sal i mi t e dn u mb e ro fr e s o u r c e sa n dt h e r e f o r ec a no n l yp r o d u c eal i mi t e da mo un to f g o o d sa n d / o rs e r v i c e s .  Th e r e f o r e , s o c i e t ymu s tc on s i d e rt r a d e o ffs–i st h ebe n e fit o fp r o d u c i n go neg o o d / s e r v i c ewor t h p r o d u c i n gl e s so ft h en e x t . 1 .Wha tg o o d sa n ds e r v i c e swi l lb ep r o d u c e d ?  Th eb u yi n gp a t t e r n so fc o n s u me r sh e l pt ode c i d ewh i c hg o o d sa n ds e r v i c e swi l lb ep r o d u c e d .  Wh e na n a l y s i n gt h i sd e c i s i o n , e c o n omi s t su s eo p p o r t u n i t yc o s t s . 2 .Ho wwi l lt h eg o o d sa n ds e r v i c e sb ep r o d u c e d ?  Fi r msc h o o s eho wt op r o d u c eg o o d sa n ds e r v i c e sp r o d u c e d . 3 .Whowi l lr e c e i v et heg o o d sa n ds e r v i c e sp r o d u c e d?  I nt h ema j or i t yo fc o u n t r i e s , i ti sa c c o r d i n gt oh o wi nc o mei sd i s t r i b u t e d .  Ani mp o r t a n tp o l i c yq u e s t i o ni swh e t h e rt h eg o v e r n me n ts h o u l di n t e r v e n et oma k et h e d i s t r i b ut i o no fi n c o memo r ee q u a l . Ce n t r a l l yp l a n n e de c o n o mi e sv e r s u sma r k e te c on o mi e s  So c i e t i e so r g a n i s ee c on o mi e si nt woma i nwa y s : 1 .Ce nt r a l l ypl a nne de c ono my–g o v e r n me ntd e c i d e sh o we c o n o mi cr e s o u r c e sa r ea l l o c a t e d . 2 .Mar k e te c o no my–h o u s e h o l dd e c i s i o n sa n dfir msa l l o c a t ee c o n o mi cr e s o u r c e s . Ce n t r a l l yPl a n n e dEc o n o my Ma r k e tEc o n o my  EG–So v i e tUn i on .  EG–Ma j o r i t yo fhi g hi n c o med e moc r a c i e s .  Un s u c c e s s f u li np r o d u c i n gl o w  Re l yo npr i v a t e l yo wn e dfir mst od e c i d eh o wt op r o d u c e c o s t , h i g hq u a l i t yg o o d s . g o o d s .  Lo wl i vi n gs t a n da r d s .  Th ema r k e td e c i d e sh o wt h e ya r ed i s t r i bu t e d .  Te n dt oh a v eb e e np o l i t i c a l  Th e r ei sc o n s u me rs o v e r e i g nt ywh i c hme a n st h a tt h e 4

d i c t a t o r s h i p s .

c o n s u me r sde c i d ewha tg o od / s e r v i c ei sp r o d u c e d .

Th emo d e r n‘ mi x e d ’e c o n o my  Go v e r n me n ti n t e r v e n t i o ni nt h ee c on o myi n c r e a s e ddu et ot h eSoc i a lSe c u r i t ySy s t e ma n dp r o vi d i n g e q u i t yt ot h ee l d e r l y ,s i c ka n dt h o s ewi t hl i mi t e ds ki l l s .  Mo s te c on o mi cd e c i s i on sr e s u l tf r omt h ei n t e r a c t i o no fb u y e r sa n ds e l l e r si nma r k e t s , b u tt h e g o v e r n me ntp l a y sama j o rr o l ei na l l o c a t i n gr e s o u r c e s . Effic i e n c ya n de q u i t y  Ma r k e te c o n omi e st e n dt ob emo r ee ffic i e n tc o mp a r e dt oc e n t r a l l yp l a n n e de c o n o mi e s .  Th e r ea r et h r e et y p e so fe ffic i e n c i e s : 1 .Pr o duc t i v ee ffic i e nc y–g o o do rs e r vi c ei spr o d u c e du s i n gt h el e a s tnu mb e ro fr e s ou r c e s . 2 .Al l o c a t i v ee ffic i e nc y–p r o d u c t i o nr e fle t sc o n s u me r sp r e f e r e n c e sa n dr e s o u r c e sa r ea l l o c a t e dt o p r o d u c ec on s u me rd e ma n d . 3 .Dy na mi ce ffic i e nc y–n e wt e c h n o l o g i e sa n di n n o v a t i o na r ea d o p t e do v e rt i me .  Effic i e n c i e sa r en o ta l wa y sg ua r a n t e e da ndt h e r ec a nb ei n e ffic i e n c i e s .Ane ffic i e n to u t c o mema ma yn o tb ee q u i t a b l e .  Equi t yi n v ol v e sa‘ f a i rd i s t r i b u t i o n ’o fe c o no mi cb e n e fit s . e r ei so f t e nat r a d e o ffb e t we e ne ffic i e n c ya n de q u i t y .  Th  Vo l unt a r ye x c ha ng eo c c u r swh e nt h eb u y e ra n ds e l l e ra r ema d eb e t t e ro ffb yt h et r a n s a c t i o n . L3 .Ec o n o mi cMo d e l s Ec o n o mi cmo d e l sa r es i mp l i fie dv e r s i o no fr e a l i t yt oa n a l y s et h er e a l wo r l de c o n o mi cs i t u a t i o n. St e p st h a te c o n o mi s t st a k et od e v e l o pamo d e l : 1 .De c i d et h ea s s u mp t i o n st h a twi l lb eu s e di nt h emo d e l .  Al lmo d e l sa r eba s e do na s s u mp t i o nt obes i mp l ea n du s e f u l .  I twi l lb eu n d e r s t o o di ft h ea s s u mp t i o n sa r eo v e r s i mp l i fie d / l i mi t i n gwh e ni tc o me st ot h e f o r ma t i o no ft h eh y p o t h e s i su s i n gt h ea s s u mp t i o n st h a ta r et e s t e du s i n gr e a lwo r l d i n f or ma t i o n . 2 .Fo r mu l a t eat e s t a b l eh y p o t h e s i s .  St a t e me ntt h a tma yb ec or r e c to ri n c o r r e c ta bo u ta ne c o no mi cv a r i a bl e–s o me t h i n g me a s u r a bl et h a tc a nh a v ed i ffe r e n tv a l u e( wa g e s , p r i c e s ) .  Us u a l l ya b o utc a s u a lr e l a t i o ns hi p s( e g , offs h o r i n gl e a d i n gt ol o we rwa g e sf o rAu s t r a l i a nI T wo r k e r s ) .  Tot e s tt h eh y p o t h e s i s , s t a t i s t i c sr e l e v a n tt ot h ee c o n o mi cv a r i a b l e smu s tb ea n a l y s e d . 3 .Us ee c o n o mi cd a t at ot e s tt h eh y p o t h e s i s . 4 .Re v i s et h emod e li fi tf a i l st oe xp l a i nwe l lt h ee c o n o mi cda t a . 5 .Re t a i nt h er e v i s e dmo d e lt oh e l pa ns we rs i mi l a re c o no mi cq ue s t i o n si nt h ef u t u r e . Nor ma t i v eAn a l y s i s Po s i t i v eAn a l y s i s  Wha ti sa n di n v o l v e sv a l u e f r e es t a t e me n t s  Wha tc o ul dbea n di n v o l v e sma ki n gv a l u e t h a tc a nb ec h e c k e df o rf a c t s . j u d g me n t swh i c hc a n n o tb et e s t e d .  EG–Ar e d u c t i o ni nt a x a t i o nr a t ewi l ll e a d  EG–I n d i vi d u a l ss h o ul dr e c e i v er e d u c t i o n s i nt a x a t i o na st h e ya r ea b l et od e c i deh o wt o t oa ni n c r e a s ei ns p e n d i n gb yi n di vi d u a l s . s p e n dmon e yt oma xi mi s et h e i rs a t i s f a c t i o n b e t we e nt h a nt h eg o v e r nme n tc a n .

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L4 .Mi c r o e c o n o mi c sa n dMa c r o e c on o mi c s  Mi c r o e c o no mi c si sh o wh o u s e h o l d sa n dfir msma k ec h o i c e s ,h o wt he yi n t e r a c ti nma r k e t sa n dh o w t h eg o v e r nme n ta t t e mp t st oi n flue n c et h e s ec h o i c e s .  Ma c r o e c ono mi c si st h es t u d yo ft h ee c o n o mya sawh o l ei n c l u di n gi n fla t i o n s , u n e mpl o y me n ta n d e c o no mi cgr o wt h .  Ma n ye c o no mi cs i t ua t i o n sh a v eb o t hami c r oa n dma c r o e c o n o mi ca s p e c t .

Ch a p t e r2–Ch o i c e sa n dTr a d e Offsi nt h eMa r k e t L1 .Pr o d u c t i o nPo s s i b i l i t yFr o n t i e r sa n dRe a l Wo r l dTr a d e Offs  Apr o duc t i o npos s i bi l i t yf r o nt i e ri sac u r v es h o wi n gt h ema xi mu ma t t a i na b l ec o mb i n a t i o no ft wo p r o d u c t st h a tma yb ep r o d u c e du s i n gt h ea v a i l a bl er e s o u r c e s .

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  

Ec o nomi cg r o wt hi st h ea bi l i t yo ft h ee c o n o myt op r o d u c ei n c r e a s i n gq u a n t i t i e so fg o o dsa nd s e r vi c e s . Th i sc a nb ema d ep o s s i b l et h r o u g ht e c h n ol o g i c a la d v a n c ewh i c hwo ul dc a u s et h ePPFt os h i f t o u t wa r d s . Ho we v e r , i t i sa l s op o s s i b l ef o rt h ePPFt os h i f ti n wa r d sa sa ne c o no mye xp e r i e n c e sar e d u c t i o ni n p r o d u c t i v er e s ou r c e s( ma yb ec a us e sb yd i s a s t e r sl i k eflo o d s ,fir e s , wa r se t c ) .

L2 .Co mp a r a t i v eAd v a n t a g ea n dTr a d e  Tr a dei st h ea c to fb u y i n ga nds e l l i n gag oo do rs e r v i c ei nama r k e t . Sp e c i a l i s a t i o na n dg a i n sf r o mt r a d e–a ne x a mp l eu s i n gn e i g h b o ur sa n dt r a d i n gc h e r r i e sa n da p p l e s

Ab s o l u t ea d v a n t a g ev e r s u sc o mp a r a t i v ea d v a n t a g e  Abs o l ut ea dv a nt a g ei st h ea bi l i t yt op r o d u c emor eo fag o o do rs e r v i c et ha no t h e rp r o d u c e r sus i n g t h es a men u mb e ro fr e s o u r c e s .  Co mpa r a t i v eadv a nt a g ei st h ea bi l i t yofa ni n di vi d ua l ,fir mo rac o u n t r yt op r o d u c eag o o do r s e r vi c ea tal o we ro p p o r t u n i t yc os tt h a no t h e rp r o d u c e r s . Ke yp o i n t s : 1 .I ti sp o s s i bl et oh a v ea na b s ol u t ea d v a n t a g ei np r o d u c i n gag o odors e r v i c ewi t h ou th a v i n ga c o mp...