Preliminary Economics

Topic One: Introduction to Economics

The Nature of Economics

The Economic Problem: Wants are unlimited but resources are scarce
A Market Economy is when all major economic decisions are made by individuals and
business who are motivated by self-interest
A Centrally Planned Economy is where the government structures and runs the market and
makes all economic decisions
Australia operates with a Mixed Economy, with elements of both a Market Economy and a
Centrally Planned Economy

The government intervenes in all steps of the production process:

What to produce? Government acts as a producer,
mostly for public goods e.g. libraries,
parks
Government bans some goods from
being produced, e.g. cocaine
How much to produce? Government limits production of
some goods with taxes etc.
Government encourages production
of some goods with incentives
How to produce? Government regulates hiring of
labour, wages, working conditions etc
How to distribute production? Government decides on individuals
income through income tax

Reasons for government intervention include allocating Public Goods, restricting production
of Demerit Goods, ensuring fair income distribution and promoting economic stability
Capital Goods refer to goods that are purchased to improve productive capacity in the
future, e.g. machinery; Consumer Goods refer to goods that are purchased to satisfy
immediate wants/ needs

Opportunity Cost is the loss of the ability to gain a good when an alternative is chosen
For example, if we can only have 200 pieces of fruit and we currently 150 apples and 50
oranges, the opportunity cost of gaining an extra 50 apples is 50 oranges
 A Production Possibility Frontier demonstrates the concept of opportunity cost
A PPF assumes there are only two goods, technology is constant, quantity of resources
remains the same and are fully employed

In this graph, X demonstrates a point in which resources are not fully utilised by an
economy
In this graph, Y demonstrates a point in which the level of resources increases and hence
more can be produced
Improvements in technology used in the production of one good or re-allocation of
resources used for the production of that good result in a shift on the PPF
A shift shows that more overall goods can be made using the same amount of resources
In the example below using Luxury Goods and Services and Necessities,

Here the production of Luxury Goods has Here the production of Necessities has
been improved been improved
The Operation of an Economy

The Factors of Production are, with the reward in parentheses, Natural resources (rent)
Capital (interest)
Labour (wages)
Enterprise (profit)

The Business Cycle refers to the natural pattern of growth and slowing of economic activity
Over time economies generally experience an overall trend of growth
Boom Recession
Increase in production Decrease in production
Increase in spending Decrease in spending
Lower unemployment Higher unemployment
Higher levels of government revenue Lower levels of government revenue
Higher level of inflation Low level of inflation

The Five-Sector Circular Flow of Income Model demonstrates the operation of an economy
Leakages are consist of savings, taxation and imports and Injections consist of investment,
government expenditure and exports
An economy is in equilibrium when leakages = injections
Changes in the circular flow of income dictate whether economic activity will be rising or
falling

Leakages Injections
Topic Two: Consumers and Business

The Role of Consumers in the Economy

Consumers both provide one factor of production, i.e. labour, and purchase goods and
services
Consumer Sovereignty: Consumers determine what is produced in a market by creating
demand for what they are willing and able to buy
Factors that limit consumer sovereignty include * Marketing (manipulation of what
consumers demand)
* Misleading Conduct (false claims about
products)
* Planned Obsolescence (deliberately
making goods go out of fashion so
consumers seek replacements)
* Anti-Competitive Behaviour (creating
goods that can only work with one other
good)
Utility: the satisfaction received from the consumption of a product

Consumers can chose to save or spend their income

APC (average propensity to consume) is the proportion of the individuals income they chose
to consume and is calculated by C Total Consumption/ Y Disposable Income
APS (average propensity to save ) is the proportion of the individuals income that will be save
and is calculated by S Total Saving/ Y Disposable Income
MPC (marginal propensity to consume) refers to the increase of consumption that results
from an increase in income and is calculated by C Total Consumption of Extra Income/ Y
Extra Disposable Income
MPS (marginal propensity to save) refers to the increase of savings that results from an
increase in income and is calculated by S Total Saving of Extra Income/ Y Extra
Disposable Income
MPC + MPS = APC+ APS = 1

Most significant factors affecting the levels of consumption and savings are age and income
Other factors include price of goods, price of substitutes, price of complements, tastes and
preferences and advertising
Generally, individuals with higher income have a lower APC than those with lower incomes
Sources of income for individuals include wage, business profits, social welfare, rent

The Role of Business in the Economy

 A Business Firm is an organisation involved in using entrepreneurial skills to combine factors
of production to produce goods or services for sale
An Industry consists of a collection of firms making a similar range of items that usually
compete with each other
The Production Decisions: What to produce?
How much to produce?
How to produce?
How to distribute production?
The goals of a business firm generally include: * Increase profits
* Increase market share
* Meet shareholder expectations
* Maximise growth
* Satisficing behaviour (combination of
above)

Productivity refers to the amount of goods or services an economy can produce (output)
with a given amount of capital, labour, natural resources and enterprise (input) and is
calculated by outputs/ inputs
Production refers to the total amount of goods and services produced
The productivity of a firm is represented by the Long Run Average Cost Curve
The LRAC Curve demonstrates the general trend of a business in which cost of production
gradually lower and hence productivity gradually rises until Technical Optimum is reached,
and from then cost of production gradually raise and hence productivity gradually lowers

The reasons for the initial rise of productivity shown in the LRAC Curve are described as
Internal and External Economies of Scale
 The reasons for the subsequent lowering of productivity shown in the LRAC Curve are
described as Internal and External Diseconomies of Scale
Internal: Within the firm
External: Within the industry
Economies of Scale
Diseconomies of Scale
Topic Three: Markets
Internal A firm is able to take
advantage of
specialisation of labour
A firm is able to invest in
capital
Raw materials can be
bought in bulk
A market can be found
for the firms by-
products
Resources can be put
into research and
development
External Localisation of an
industry results in
benefits e.g. proximity
to skilled labour
The market becomes
skilled and competitive
Internal Management in a firm
loses touch with labour
Bureaucracy can block
decision-making
Problems can arise in
workplace relations
External Pollution from industry
localisation causes
government regulations
Localisation of the
industry causes
transport bottlenecks
Increased demand for
raw materials causes
the prices to rise
 Demand

Demand is the quantity of goods and services that consumers are willing and able to
purchase at a given point in time
The Law of Demand states that the lower the price of a good, the greater demand will be
and vice versa
(Note above assumes Ceterus Parabus, or all other things being equal)

Changes in the price of the good result in movement along the demand curve:
A Contraction occurs when demand decreases
An Expansion occurs when demand increases

Changes in factors other than the price of the good result in a shift in the demand curve:

Factors Affecting Demand of a Good

Increase (Shift to the Right)
Rise in the price of substitute goods
Fall in the price of complementary goods
Expectation that future prices will increase
Consumer taste trend towards the good
An increase in general income levels
An increase in the size of the population
Decrease (Shift to the Left)
Fall in the price of substitute goods
Rise in the price of complementary goods
Expectation that future prices will decrease
Consumer taste trends away from the good
A decrease in general income levels
A decrease in the size of the population
An increase in demand for a good will have a two-
fold effect:
1. Consumers will demand more of a good at
a given price level
2. Consumers are willing to pay a higher price
for a given quantity of a good
A decrease in demand for a good will have a two-
fold effect:
1. Consumers will demand less of a good at
a given price level
2. Consumers are willing to pay a lower price
for a given quantity of a good

Elasticity of Demand refers to the responsiveness of demand for a good in relation to a change in
price
Total Outlay refers to the profit made by the selling of a good, and is calculated by Price x Quantity
Demanded
Elastic Demand is a strong response to a rise in price (lower total outlay)
Perfectly Elastic Demand is when any rise in price would result in demand falling to zero
(represented by a horizontal line on a demand curve)
Inelastic Demand is a weak response to a rise in price (higher total outlay)
Perfectly Inelastic Demand is when the quantity demanded of a good would remain constant
regardless of price (represented by a vertical line on a demand curve)
Unit Elasticity is a proportional response to a rise in price (equal total outlay)

Factors Affecting Elasticity of Demand

More Elastic More Inelastic
Good is a luxury item Good is a necessity
Good has close substitutes Good does not have close substitutes
Expenditure on good makes up a large portion ofExpenditure on good makes up a small portion of
income income
Short-term period after price change Long-term period after price change
Good is not addictive Good is addictive
 Supply

Supply is the quantity of goods that all firms in a particular industry are willing and able to
offer for sale
The Law of Supply states that the higher the price of a good, the greater supply will
be and vice versa

Changes in the price of the good result in movement along the supply curve:
A Contraction occurs when supply decreases
An Expansion occurs when supply increases

Changes in factors other than the price f the good itself result in a shift on the supply curve:

Factors Affecting Supply of a Good

Increase (Shift to the Right)
A fall in the market price of other goods,
making production of these less favourable
Good seasonal conditions
Improved technology
An increase in resources available
A fall in the cost of factors of production
Decrease (Shift to the Left)
A rise in the market price of other goods,
making production of these more favourable
Poor seasonal conditions
Loss of availability of certain technology
A decrease in available resources
A rise in the cost of factors of production

An increase in supply would have a two-fold
effect:
1. Firms supply more goods at a given
price level
2. Firms supply a given quantity of goods
at a lower price level
A decrease in supply would have a two-fold
effect:
1. Firms supply less goods at a given
price level
2. Firms supply s given quantity of goods
at a higher price level
 Elasticity of Supply refers to the responsiveness of supply of a good in relation to a change in price
Elastic Supply is a strong response to a fall in price
Perfectly Elastic Supply is when any fall in price would result in supply falling to zero (represented by
a horizontal line on a supply curve)
Inelastic Supply is a weak response to a fall in price
Perfectly Inelastic Supply is when the quantity supplied of a good would remain constant regardless
of price (represented by a vertical line on a supply curve)
Unit Elasticity is a proportional response to a fall in price

Factors Affecting Elasticity of Supply

More Elastic More Inelastic
Long-term period after a price change Short-term period after a price change
Firm has ability to hold stock Firm does not have ability to hold stock
Firm is running with excess capacity Firm is running at full capacity

Market Equilibrium

Market Equilibrium is a situation where, at a certain price level, the quantity demanded and
quantity supplied of a good are equal
The Price Mechanism is the interplay of the forces of demand and supply to determine
equilibrium price and quantity of a good
Equilibrium occurs when *The market clears
* Quantity supplied = Quantity demanded
* There is no tendency to change

Disequilibrium
- In a situation of excess demand,
consumers will bid up the price of a
good which will lead to an expansion
along the supply curve , a subsequent
contraction in demand (according to
laws of demand and supply) and
equilibrium will be reached
- In a situation of excess supply,
producers will lower prices which will
lead to an expansion along the
demand curve, a subsequent contraction along the supply curve (according to laws of
demand and supply) and equilibrium will be reached
 Changes in equilibrium

1. An increase in demand results in an increase

in equilibrium price and an increase in equilibrium
quantity

2. A decrease in quantity demanded results in a

decrease in equilibrium price and a decrease in
equilibrium quantity

3. An increase in quantity supplied results in a

decrease in equilibrium price and an increase in
equilibrium quantity

4. A decrease in quantity supplied results in an

increase in equilibrium price and a decrease in
equilibrium quantity

Government Intervention in the Market

 A Price Ceiling is a maximum price a government may set for a good, usually to make it more
accessible for the population
It creates excess demand and a shortfall of supply

A Price Floor is a minimum price a government may set for a good, usually to guarantee profit for
the producer
It creates a shortfall of demand and excess supply

Negative Externalities are goods or services that are deemed harmful to society or the environment
e.g. Poker machines
A government pay place taxes on goods that produce negative externalities to increase equilibrium
price, decrease equilibrium quantity and hence discourage use
Positive Externalities are goods or services deemed beneficial to society of the environment e.g.
Arts programs
A government may subside goods that produce positive externalities to decrease equilibrium price,
increase equilibrium quantity and hence encourage use
Public Goods are goods or services which are accessible to the entire population e.g. Street lights
Public goods are not produced by the market because it is not possible to discriminate between
those paying or not, and hence government produce them with funds from taxation

Market Structures
Market Structure Number and Size Product Barriers to Entry Examples
of Firms Characteristics

Pure Competition Many firms, very Homogeneous No barriers to Fruit and

small products entry vegetables, fish
markets

Monopolistic Many firms, Differentiated Small barriers to Motels,

competition relatively small products entry restaurants

Oligopoly A few firms, Generally High barriers to TV stations,

relatively large differentiated entry airlines
products

Monopoly One firm, large No close Extremely high Water supply

substitutes barriers to entry

Topic Four: Labour Markets

 Demand For and Supply of Labour

The Labour Market is where individuals, who are seeking employment, interact with
employers, who want to obtain the most appropriate skills for their production purposes
Demand for labour is derived because the demand for goods and services determines the
quantity of labour that is required in the production process

Factors Affecting Demand for Labour

Higher Demand Lower Demand
Output Factors Output Factors
Increased general economic activity Decreased general economic activity
Increased aggregate demand for goods/ services Decreased demand for goods/ services produced
produced by firm by firm
Input Factors Input Factors
Increased labour productivity and increased Increased labour productivity and decreased
aggregate demand aggregate demand
Increased cost of capital relative to labour Decreased cost of capital relative to labour
Increased cost of foreign labour/ outsourcing Decreased cost of foreign labour/ outsourcing
relative to labour relative to labour

Human Capital is the total sum of the knowledge, skills, training and experience of workers
that contribute to the process of production
High levels of human capital generally result in a more productive workforce
Occupational Mobility refers to the ease of which employees can move to a job from a
different occupation- low occupational mobility referring to significant difficulty in this being
achieved, high occupational mobility referring to relative ease of this being achieved
Geographic Mobility refer to the ease of which employees can move to the location of a job-
low geographic mobility referring to significant difficulty in this being achieved, high
geographic mobility referring to relative ease of this being achieved

Factors Affecting Supply of Labour

Higher Supply Lower Supply
Higher wage or non-wage outcomes Lower wage or non-wage outcomes
Excellent working conditions Poor working conditions
Low level of training/ education/ skills required High level of training/ education/ skills required
High occupational mobility Low occupational mobility
High geographic mobility Low geographic mobility
 The Australian Workforce

The Australian Workforce refers to everyone 15 and above currently employed or actively
seeking work
Labour Force Participation Rate = labour force (those working + those actively seeking work)
working age population (those 15 and over)
Unemployment Rate= those who are unemployed but actively seeking work labour force
(those working + those actively seeking work)
Types of Unemployment:
Cyclical unemployment is cause by a downturn in the business cycle and is reduced
when there is an upturn
Structural unemployment occurs when there is a mismatch between the skills
demanded by employers and those possessed by unemployed people; often occurs
when new industries are made
Long-term unemployment is when one has been unemployed for 12 months or
more
Seasonal unemployment occurs because of the seasonal nature of some jobs
Frictional unemployment occurs as people change jobs and will always be present,
but can be limited by efficiency of job placement services
Hard-core unemployment refers to individuals who are generally considered
unemployable, e.g. People with disabilities or drug addictions
Hidden unemployed refers to people who are unemployment but not actively
seeking work, e.g. Students or stay-at-home parents
Underemployment refers to people who are unemployed casually or part-time but
seek full-time work
Australia has experienced a significant casualisation of the workforce (a growth in part-time
and casual work) in the last 30 years due to more women working, employers choosing to
run below capacity, employers choosing to avoid paying maternity or sick leave, and
changing preferences
Australia has also experienced a trend towards sub-contracting because employers can
receive work from contractors without having to pay them benefits of a normal employee

Labour Market Outcomes

Income Distribution refers to the way in which an economys income is spread out amongst
the members of different ethnic and socio-economic groups
Wage is not evenly distributed throughout Australias population
Although not legally allowed, significant wage differences are rpesent throughout different
cultural groups in Australia
Migrants, particularly from non-English speaking countries, tend to get paid lower than non-
migrant equivalents
Above applies to Indigenous Australians
Women also tend to earn less than male counterparts
Real Wages refer to wage rates adjusted to the inflation rate
Nominal Wages refer to the amount of money given to an employee
 Wages differences between occupations are determined by factors such as:
* Occupational mobility
* Level of skills required
* Working conditions
* Bargaining power of employees
* Working conditions

Wage differences within an occupation are determined by factors such as:

* Geographic labour mobility
* Productivity of labour
* Capacity of the firm to pay

Non-Wage Outcomes refer to benefits employees can receive in addition to wage/ salary
Employers often chose to give employees non-wage outcomes to attract labour or as an
incentive to increase productivity
Common non-wage outcomes include * Salary packaging, where employees receive gifts e.g.
cars, laptops
* Bonus payments passed on performance
* Shares in the firm
* Improved flexibility for employees
Award Rates are a minimum wage rate within an industry as determined by Fair Work
Australia
Collective Agreements are wage rates organised within a firm between employees and
employers and must exceed award rates for the industry
Common Law Contracts are wage rates organised through negotiation between an individual
employee and employer and must exceed award rates for the industry
Topic Five: Financial Markets

Financial Markets

Financial Markets create products that provide a return for those who have excess funds and
make those funds available for those who need additional money
Primary Financial Markets facilitate the creation of financial assets e.g. shares or bonds and
involve direct transactions between investors and companies
Secondary Financial Markets facilitate transactions between two investors involving financial
assets that have already been issue on a primary market
The main financial markets in Australia are the share market, the debt market, the derivates
market and the foreign exchange market
Australias domestic financial markets have become more global in recent times; this is
especially apparent through the presence of the Australian dollar in foreign exchange
markets, Australia playing a larger role global debt markets and increased foreign investment
in Australian equity markets

Financial Products

Consumer Credit allows consumer to make purchases in advance of actual payment, usually
in the form of credit cards or personal loans
Housing Loans (mortgages) are long term loans to purchase property, requiring periodic
repayments with interest; offered by banks and mortgage originators
Bonds are long term securities where lenders receive fixed payments from the issuing
institution
Shares are equity securities that give their owner a percentage share in a company; owners
receive dividends based on the companys profits
Financial Futures and Options are contracts to trade a financial instrument (e.g. a share or
bond) at a later date for a certain price

Financial Regulators

Reserve Bank of Australia (RBA)

Australia's central bank; overall management of the financial system
Responsible for monetary policy, payment systems regulation and stability of the financial
system
Three main objectives according to its charter: stability of Australia's currency, maintenance
of full employment and ensuring economic prosperity and welfare of Australia n people
Conducts monetary policy on behalf of the government- influences the cost and availability
of money in Australia by determining the general level of interest rates
Primary aim of achieving a sustained low inflation rate while encouraging economic growth
Decides how much money will be printed based on consumer demand (actual production of
currency is done by The Mint)
Responsible for the payments system ; 'Banker to the banks'; has an exchange settlement
account with all Australian banks
Oversees dealers in the foreign exchange market
 Provides banking to the governments
Acts as a source of financial advice to the government
Australian Prudential Regulation Authority (APRA)
Responsible for supervision and regulation of all deposit-taking institutions (ADIs), insurance
providers and superannuation funds
Encourages behaviour by institutions to meet obligations to the people who place money
within them
Provides assistance and recovery to ADIs that experience financial difficulty
Australian Securities and Investment Commission (ASIC)
Responsible for corporate regulation, consumer protection and oversight of financial services
Aim of protecting investors and consumers
Power to monitor, investigate and act in situations where the integrity of the financial
system has been undermined by illegal or unethical dealing
National regulator of consumer credit and security markets
Is not responsible for stopping companies making losses or people investing in high-risk
enterprises
Australian Treasury
Responsible for advising the government on financial security issues and constructs
legislative and regulatory framework for the financial system
Main source of economic policy advice for the government; fiscal policy
Influences budgets, method of tax collection, regulatory setting for financial markets etc

Demand for Funds and Liquidity

A liquid asset refers to the ability to be sold rapidly, with or no loss of value, at any time
(always buyers and sellers)
Cash is the most liquid asset
There are three motives for holding liquid funds (cash in this example)
- Speculative motive- holding cash in the belief it is less risky than holding other assets,
e.g. shares
- Transactions motive- holding cash because it will be needed in future exchanges
- Precautionary motive- holding cash as a precaution in case it will be needed in future
events, e.g. unemployment

The benefits of holding cash funds are that they are available for immediate use and the
avoidance of capital losses
The costs of holding cash funds are that they can be affected by inflation and the lost
possibility of capital gains

Supply of Funds

There are four characteristics of money:

- It is a medium of exchange for goods and services
- It is a measure of value to compare goods and services
- It is a store of value to measure the worth of goods and services over time
- It is method of deferred payment to allow a system of lending and borrowing to develop
 Money supply refers to the total amount of money in an economy
Physical currency makes up approximately 5% of total money supply
Credit is not included in the money supply
Money supply can be measured with three main indicators called financial aggregates:
Money Base= Currency + Bank Deposits with RBA
M3= Money Base + Bank Deposits
Broad Money= M3 + NBFI Deposits- NBFI Deposits in Banks
Consumer Price Index (CPI) refers to the change in price of necessities per month
Headline Inflation refers to a measure of inflation by taking into account the CPI of a range of
items
Underlying Inflation refers to a measure of inflation that does not include volatile items

Interest Rates and Domestic Market Operations

Interest rates are the cost of borrowing funds expressed as a percentage of the total amount
borrowed (in other words, the cost of money)
Interest rate differential is the difference financial institutions charge between the borrowing
rate (return given to those who place funds in financial institutions) and the lending rate
(amount charged by financial institutions to those who borrow funds) and is how they make
profit

Factors Affecting Interest Rates

Upward Pressure
High demand for capital goods, leading to
increased levels of borrowing
High inflationary expectations, reducing the
value of financial assets
High international interest rates, resulting in
more funds moving offshore
Downward Pressure
Low demand for capital goods, leading to
increased levels of savings
Low inflationary expectations, raising the
value of financial assets
Low international interest rates, resulting in
less funds moving offshore

Essentially lower supply of fundsupwards pressure on interest rates; higher supply of

fundsdownwards pressure on interest rates
 There is a 12-18 month time lag between the first and last steps of tightening/ loosening
monetary policy
Topic Five: Government Intervention in the Marketplace

The Government and the Economy

Market failure occurs when a non-regulated market fails to provide favourable outcomes,
such as The production of demerit goods
Income inequality
A lack of public goods
Anti-competitive business practices such as Monopolisation (using a dominant
market position to eliminate competitors), Price Discrimination (selling the same
product for different prices depending on the time of day/ year, age of consumer
etc), Exclusive Dealing (dictating that retailers may not sell goods from a firm's
competitors), and Collusion (competitors agreeing on pricing and market-share
agreements).
Environmental degradation
For these reasons, the government intervenes in the economy
There are three tiers of government (national or Commonwealth, state, local)
The Commonwealth Government receives income through income, business and goods and
services tax
State Governments receive direct grants from the Commonwealth government, as well as
direct income from payroll tax, stamp duty, licences and taxes on gambling and land
ownership
Local Governments receive state and federal grants, as well as revenue from strata rates,
fees, licences and fines

The Government as a Producer

The Public Sector refers to the parts of the economy which are owned or controlled by all
levels of the government, including Government Business Enterprises (GBEs)
 The size of the public sector in Australia can be measured through total annual public sector
outlays as a percentage of GDP or through the percentage of total employees employed by
the public sector
The size of the public sector increased significantly between the Great Depression and the
1980s, in line with the popular Keynesian economics which teaches that high government
spending is necessary to promote economic growth
Towards the end of the 1980s, this school of thought lost support due to the high taxation
levels necessary to provide high government expenditure and the proportion of total GDP
spent in the public sector declined
In response to the global financial crisis of the late-2000s government expenditure on the
public sector rose again
Privatisation refers to the selling of GBEs to the private sector- recent examples include
Qantas, Telstra, international airports, TAB
Corporatisation refers to the encouragement of GBEs by the government to operate like
private sector businesses, as if they were independent to the government
Remaining GBEs include Australia Post, MediBank Private, most public transport, utilities etc.

Reallocation of Resources

The government can affect resource allocation by providing funds to or taxing businesses and
setting business practice legislation
Governments can increase or reduce taxes on producers, who hence pass on these on to
consumers through higher or lower prices, which then causes demand to contract or expand
(because the price of the good itself has changed)
Governments can charge Direct or Indirect Taxes- Direct taxes are paid by the individual/
business on which they are levied and cannot be passed on to someone else e.g. Income tax
or capital gains tax; indirect taxes are paid by an individual/ firm but can be passed on to
someone else e.g. GST
The government can provide funding, grants and subsidies to businesses in order to promote
production and/ or expand demand (as businesses will pass on lower prices to consumers)

Redistribution of Income

Although the market mechanism tends to be effective in allocating resources, it often comes
at the cost of social inequality
The main way that the Australian government tries to correct this through the redistribution
of income via the taxation system and social welfare payments
Tax Base: The items that are taxed, i.e. Income, wealth and consumption
Average Rate of Tax: The proportion of total income that is paid in tax
Marginal Rate of Tax: The proportion of any increase in income that is paid in tax
There are three taxation systems- in a Progressive Tax System, higher income earners pay a
greater proportion of their income (ART) than lower income earners; in a Regressive Tax
System, higher income earners pay a smaller ART than lower income earners; and in a
Proportional Tax System all income earners pay the same ART
Australia has a progressive personal income taxation system called Pay-As-You-Go (PAYG)
The government uses tax to redistribute income from wealthier to poorer people, and
therefore making income more equal
 As well as demanding a lower ART, poorer or disadvantaged people also receive Social
Welfare or Transfer Payments
Social welfare payments account for 35-40% of government expenditure

Fiscal Policy

Macroeconomic Policies, also known as Demand Management or Counter-Cyclical Policies,

are policies that influence the economy as a whole
The two macroeconomic policies are Monetary Policy and Fiscal Policy
Fiscal Policy influences resource allocation, redistributes income and reduces fluctuations in
the economy
The Budget is the tool of fiscal policy used by the government to determine planned revenue
and expenditure for the next financial year
There are three Budget Outcomes:
I. Balanced Budget Planned Revenue = Planned expenditure
II. Budget Deficit Planned Revenue < Planned Expenditure
III. Budget Surplus Planned Revenue > Planned Expenditure

There are three Budgetary Stances: Expansionary Stance- An increased budget deficit or a
decreased surplus from one fiscal year to the next. Used
to increase economic activity.
Contractionary Stance- A decreased budget deficit or
an increased budget surplus from one fiscal year to the
next. Used to slow down economic activity.
Neutral Stance- This occurs when the government does
not change the budget outcome from the previous year.
Therefore this outcome should maintain economic activity
(note: does not occur often).
Automatic Stabilisers counterbalance economic activity and are inherent in the government's
budget
The two main automatic stabilisers are the progressive personal income tax system and social
security payments

Effect of Automatic Stabilisers

During a Boom Period
During a boom period, there will be:
- Greater income taxation revenue
(from both individuals and
businesses)
- Greater GST revenue
- Less expenditure on social security
payments
During a Recession Period
During a recession period, there will be:
- Lower income taxation revenue
(from both individuals and
businesses)
- Lower GST revenue
- More expenditure on social security
payments

This will have the effect of increasing the
government's revenue and decreasing its
expenditure (causing an increased budget
surplus or decreased budget deficit), thus
resulting in a contractionary budgetary
stance, and economic activity will contract
and stabilise.
This will have the effect of decreasing the
government's revenue and increasing its
expenditure (causing a decreased budget
surplus or increased budget deficit), thus
resulting in an expansionary budgetary
stance, and economic activity will expand and
stabilise.
 Factors affecting fiscal policy include: - Businesses (make donations to political parties;
business groups e.g. Australian Chamber of Commerce
lobby for certain rights)
- Unions (often consulted when labour policies are made;
lobby for workers rights)
- Welfare Groups (often consulted during inquiries or in
making policy; lobby to increase social welfare
payments)
- Media (media outlets decide which issues will be
reported and how they will be reported; the line
between factual news and opinion is often blurred)
- Other Interest Groups, either representing a single issue
e.g. environmental protection or represent a group of
people e.g. farmers (lobby for certain rights)
- International Influences (the increasingly globalised
Australian economy means that international affairs have
greater influence on domestic markets; free trade;
economy must abide by conditions set by bodies such as
APEC and SEATO)