4.6 Types of economic indicators

a good idea to keep this five-sector model in your mind as we move to investigate the business cycle of economic activity in the upcoming section.

FIGURE 4.8 Explaining the causes and effects of lower levels of economic activity in an economy

Flow 3 Lower spending or AD is caused by increased leakages relative to injections, leading to surplus unsold stocks of goods and services Flow 4 Collectively, producersFlow 2 There is a drop in the

cut national production sototal value of incomes paid to

the total value of economicthose selling resources

activity (GDP) falls Flow 1 Businesses employ fewer resources including labour, as they reduce output Resourceseses Resources

To come 4.4 Activities

Students, these questions are even better in jacPLUS

Receive immediate feedback and access sample responses Access additional questions

Track your results and progress Find all this and MORE in jacPLUS 4.4 Quick quiz 4.4 Exercise 4.4 Exercise 1. Draw and fully label a five-sector circular flow model representing Australia’s economy. (4 marks) 2. Briefly define each of the following terms used in the circular flow model: (11 marks) a. aggregate demand b. gross domestic product (GDP) c. leakages d. injections e. household consumption spending UNCORRECTED PAGE PROOFS f. business investment spending g. savings h. spending on exports i. spending on imports j. taxes k. government spending.

3. Using the five-sector circular flow model: a. Identify and outline the possible causes of a rise in the level of economic activity, perhaps leading to an inflationary boom. (2 marks) b. Identify and outline the possible causes of a fall in the level of economic activity, perhaps leading to a recession. (2 marks) 4. The five-sector circular flow model is especially useful in understanding the impacts of changes in aggregate demand factors on the economy. The sub-set of 30 short questions listed in table 4.3 requires that you provide concise responses. These are designed to help sharpen your understanding of the nature and workings of the five-sector circular flow model of the Australian economy. See how you go. (30 marks) TABLE 4.3 Understanding the features of the five-sector circular flow model 1. What are the main economic functions of the household sector? 2. What are the main functions of the business sector? 3. What are the main functions of the financial sector? 4. What are the main functions of the government sector? 5. What are the main functions of the overseas sector? 6. Who are the suppliers of resources? 7. Who are the buyers of resources? 8. How are the suppliers of resources rewarded for their efforts, skills, and risk? 9. Who are the demanders of finished goods and services? 10. How might households dispose of the income they receive? 11. What is the main general determinant of the level of C? 12. What are leakages? 13. How is the impact of leakages different from that of injections? 14. What are savings and why are they regarded as a leakage? 15. What are imports? 16. Define what is meant by AD. 17. What are the immediate determinants of the level of AD? 18. What might cause AD to fall? 19. What are three main macroeconomic effects of a rise in AD by $100 million for an economy that has unemployed resources or unused productive capacity? 20. What is the immediate effect of a decision by the business sector to increase its production or supply of goods and services? 21. What is the main cause of an increase in incomes? 22. What may cause some people to receive no income at all? 23. In this model, what is the immediate cause of reduced employment of resources and rising unemployment in an economy? UNCORRECTED PAGE PROOFS 24. What are the likely effects on the economy of AD rising faster than the productive capacity of the country? 25. What is the likely impact on the level of AD of a rise in imports?

26. What are the likely effects of an increase exports?

27. According to the model, what is the general cause of a contraction or recession in the level of economic activity (GDP)?

28. According to the model, what is the general cause of an expansion in the level of economic activity (GDP)?

29. According to the model, what can be said about the values or size of the flows of AD, GDP, and total incomes in an economy in a given year?

30. What is the name of the flow that measures the general level of economic activity in an economy?

Fully worked solutions and sample responses are available in your digital formats.

4.5 The business cycle

KEY KNOWLEDGE • the business cycle

Source: VCE Economics Study Design (2023–2027) extracts © VCAA; reproduced by permission. Look at the news headlines from around the world, most days you quickly realise that it is quite normal for economies to experience instability in economic activity. Often good times follow bad ones, almost like night follows day! To help illustrate instability in the level of economic activity, economists use the business cycle diagram that we introduced earlier in our studies. This is shown in figure 4.9.

FIGURE 4.9 The business cycle diagram illustrating instability in a nation’s level of economic activity 8 Peak or possible boom 6 Slowdown Slowdown Annual rate of change in the level of economic activity (GDP) 0 –2 4 The trough or possible recession Time in years

The trough or possible recession

Cyclical rate of change in the level of economic activity (GDP) Ideal level of economic activity = domestic economic stability Recovery Recovery Peak or possible boom 2 UNCORRECTED PAGE PROOFS –4

Notice that over a period of some years, the pace of economic activity (measured by the quarterly or annual percentage change in the value of GDP) rises and falls. Over a typical cycle, there are four phases, speeds, or rates of GDP growth — the peak, slowdown, trough and recovery: • Phase 1: The peak in the speed of economic activity occurs when GDP is growing at its fastest rate.

Sometimes this is too fast, given the economy’s productive capacity, and there will be a boom: • The peak is caused by strongly rising levels of spending on Australian made goods and services or increasing levels of AD (C + I + G + X – M). • • • • • • • The peak results in firms employing more resources so, typically, unemployment rates are very low and incomes rise. However, if spending grows too fast and outstrips the economy’s productive capacity, inflation will accelerate. This undermines the purchasing power of incomes and hence material living standards. Phase 2: The slowdown occurs when the speed of the rise in economic activity and GDP lessens to rates below those in the peak: • The slowdown is caused by softer rises in sales, spending and AD (C + I + G + X – M). • The slowdown results in firms cutting jobs, so unemployment rises and inflation slows as firms hold prices down to try to clear their surplus stocks of goods. Phase 3: The trough is the lower turning point on the business cycle where economic activity and the rate of GDP growth are at their slowest. If the size of GDP shrinks over two or more quarters (i.e., a 6-month period), this is called a recession: • The trough or recession is caused by very weak or falling levels of spending or AD (C + I + G + X – M). • The trough results in relatively high rates of unemployment as firms cut production, reducing incomes, purchasing power, and living standards. It is even possible that there will be deflation or falling prices as firms discount their prices to clear excess stock. Phase 4: The recovery in economic activity occurs when the growth rate in GDP growth starts to accelerate: • The recovery is caused by stronger rises in spending or AD (C + I + G + X – M). • The recovery results in firms employing more staff, lowering unemployment and raising incomes. It can also mean that inflation starts to pick up. As the economy moves through the business cycle and the speed of economic activity changes, so too do the country’s domestic macroeconomic conditions and living standards — sometimes in a favourable direction, but at other times, negatively. The ideal level of economic activity is somewhere between the peak and the trough. This favoured situation is called domestic economic stability. Here, three things are simultaneously achieved: There is a strong and sustainable rate of growth in economic activity and GDP (where GDP is rising steadily, perhaps by an average of around 3 per cent a year). There is full employment with low unemployment rates of perhaps 4.0 to 4.5 per cent of the labour force. This grows incomes. There is low inflation where general consumer prices are rising slowly by an average of between 2.0 to 3.0 per cent a year. This helps to ensure that incomes keep their purchasing power. UNCORRECTED PAGE PROOFS While we aspire to achieve this blissful situation because it is conducive to better living standards, it is seldom achieved fully.