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4.11 The measurement of economic growth using changes in Gross Domestic Product (GDP
4.10.3 How changing aggregate supply factors can determine the level of economic activity and macroeconomic conditions
Especially over the short-term we saw that a nation’s level of economic activity (and therefore its material living standards), largely reflect changes in the level of aggregate demand. However, over the longer term, it is impossible to keep on expanding the level of economic activity and GDP simply by spending more. The economy would soon hit its capacity limits and AD would exceed AS leading to inflation. At this point, further increases in national production would depend on new, more favourable aggregate supply conditions to grow productive capacity. However, sometimes there are less favourable aggregate supply conditions limiting AS and the potential level of GDP. Realising that aggregate supply conditions can become more favourable or less favourable, let’s see how they work to affect productive capacity, AS, and the potential level of GDP, along with their impact on other domestic macroeconomic conditions: • More favourable aggregate supply conditions involve producers having access to extra resources or face lower production costs and stronger business profits. This acts as an incentive to make firms more willing and/or able to expand their productive capacity. The potential rate of economic activity, GDP, employment, and incomes can readily increase, without adding to inflation. This thinking is summarised in figure 4.17.
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FIGURE 4.17 How generally more favourable aggregate supply conditions can increase potential rate of economic activity and improve domestic macroeconomic conditions
More favourable aggregate supply factors:
More favourable aggregate supply conditions can include … • In cr e a s e d qua n t i t y a n d q u al i t y of re s ou r c e s available • L o wer produc t i o n co s ts i n clu ding wa ge s , materials • In crease d produ cti v i ty o r efficiency in production • In crease d bu s i nes s profitability • F av ou ra bl e c l i m ati c ev ents • Go v er n m e n t pol ici es l i k e l o w er t a x r a t e s , better i n f ras t ru c t u re , a nd improved education and s kil l s . Increased potential level of economic activity or GDP: More favourable aggregate supply conditions cause businesses to be more w i l l i n g an d/ or a bl e to p ro du ce a n d e x pand thei r o d u ct iv e c a pa c i t y /AS, p r e x pan ding t he pot enti al level of economic activity a nd GD P. Lower unemployment and higher incomes over time: O v er t h e l on ge r-t e r m, favourable aggregate supply conditions cause businesses to become more w i l l i n g an d/ or a bl e to produce goods and s erv i ces . The y a re k eener t o ex pan d t he i r outp ut because it is more p ro fi t abl e , a n d t hey are h en ce l es s l i k e l y t o cl o s e d o w n or m ov e ov e r s eas . T h i s mea ns , s t a ff a re l es s l i k e l y t o l os e t h e i r j o b s and m o re l i k e l y t o e a r n hi g her i n c o m es .
• Reduced inflation: More favourable aggregate supply conditions are u s u all y as s oc i a t e d w i th l o w e r produ c t i on co s ts and b e tt er bu s i ne s s pr o fi t abil i t y. T h i s mea ns t h a t goo d s and services can be sold p ro fi t abl y a t l owe r p r i ces , s l o wi n g t h e i n fl a t i on r ate. Less favourable aggregate supply conditions like reduced access to resources, higher costs, or lower profits, act as a disincentive. They cause producers to become less willing and/or able to produce, contracting productive capacity, the potential rate of economic activity and GDP, employment, and incomes, and adding to inflationary pressures. This is shown in figure 4.18. UNCORRECTED PAGE PROOFS
FIGURE 4.18 How less favourable aggregate supply conditions can decrease Australia’s potential rate of economic activity and weaken domestic macroeconomic conditions
Less favourable aggregate supply factors: Decreased potential level of economic activity or production: Higher unemployment and lower incomes: Increased inflation:
Less favourable aggregate supply conditions include … • Increased quantity and quality of resources available • Lower production costs including wages, materials • Increased productivity or efficiency in production • Increased business profitability • Severe climatic events • The failure of some government policies to adequately cut tax rates, and improve infrastructure, and education and training. Less favourable aggregate supply conditions cause businesses to be less willing and/or able to produce or expand their productive capacity/AS, decreasing the potential level of economic activity and GDP. Over the longer-term, less favourable aggregate supply conditions cause businesses to become less willing and/or able to produce goods and services. They are discouraged from expanding their output because it is less profitable. As a result, some will close down or move overseas. This means staff are likely to lose their jobs and earn lower incomes.
Less favourable aggregate supply conditions are usually associated with higher production costs and reduced business profitability. This means that businesses try to pass on their higher costs to consumers in the form of higher prices. This increases the inflation rate. FIGURE 4.19 As a result of severe weather events including cyclones, floods, fires and droughts over the last five years to 2023, there was the loss of life, personal suffering, property damages to homes, destruction of tourism, farming and mining industries, and huge damage to infrastructure like roads and rail systems. This limited productive capacity and AS, and reduced Australia’s potential rate of economic growth. UNCORRECTED PAGE PROOFS
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4.10 Activities
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4.10 Exercise 1. Define the following terms: a. aggregate supply (1 mark) b. aggregate supply factors (1 mark) c. productive capacity. (1 mark) 2. Giving examples, distinguish more favourable aggregate supply factors from less favourable aggregate supply factors. (3 marks) 3. a. For each of the following events listed in table 4.14, explain how the aggregate supply factor or event could affect Australia’s productive capacity, AS, and our potential long-term level of economic activity and GDP. (12 marks) TABLE 4.14 Aggregate supply events affecting Australia’s long-term rate of economic growth
Event
Explain the way in which the event affects productive capacity, AS and potential GDP i. Efficiency among Australian workers and the productivity of other resources fall to even lower levels. ii. New oil and gas discoveries are made in SA to rival those of the North-West Shelf. iii. Genetically modified (GM) sheep double wool production per sheep per hectare. iv. Severe floods occurred in eastern states during 2019 and 2023. v. Business and government expenditure on new capital equipment and buildings reaches an all-time high. vi. Lockdowns caused by the COVID-19 pandemic during 2020 and 2023. UNCORRECTED PAGE PROOFS vii. Bass Strait oil and gas reserves run out. viii. Soils in the Murray River region become salinated and useless.
ix. Mining in Kakadu causes environmental damage and discourages tourism in the region.
x. New technology leads to higher efficiency and lower electricity costs.
xi. Australia’s population rises to 28 million people.
xii. A compulsory carbon emissions trading scheme (ETS) is introduced to make polluters pay for carbon emissions.
b. Identify and outline how any two of the following could help to increase productive capacity and AS. (2 marks) I. Lower rates of company tax II. Increased education spending III. Promoting stronger competition in markets IV. Building new infrastructure. 4. Examine figure 4.20 showing monthly changes in the number of business bankruptcies in Australia.
FIGURE 4.20 Monthly changes in Australian business bankruptcies (mostly due to losses or low profits) 350 342 300 250 Apr 2021
439 389 431 423 354 313 325
435 419 260 449 400 450 Jul 2021 Oct 2021 Jan 2022 Source: Trading Economics, https://tradingeconomics.com/australia/bankruptcies. a. Referring to the graph, describe the monthly change in the number of business bankruptcies in Australia over the period shown. (2 marks) b. Identify and describe three aggregate supply factors that could contribute to these changes in the level of business bankruptcies. (3 marks) c. Explain how the change in business bankruptcies would affect the levels of AS and Australia’s potential level of economic activity and GDP. (2 marks) d. Giving reasons, outline how you would expect a fall in business bankruptcies (as in early-2022) would be likely to affect each of the following: (4 marks) • AD (and a selected component) • Economic activity • Inflation UNCORRECTED PAGE PROOFS • Unemployment and incomes.
