ECONOMICS TOPIC 2

The operation of an economy

The production of goods and services goods and services are the outcome of the production
process. Goods are tangible e.g. food, cars and electronics. Whilst services are intangible acts
that are of benefit to us e.g. medical aid.
Factors of production involve any resource that can be used in the production of goods and
services. The main types are natural resources (land), capital, labour and enterprise.
Factor of production Reward
Land/Natural resources any sources Rent (goes beyond renting property, covers all
provided by nature that are used in the income rewards from productive use of
production process (soil, water etc.) natural resources)
Labor both physical and mental used to Wages (including salaries, commissions etc.)
produce goods and services (human and
mental effort)
Capital produced by means of production Interest (the price of capital, opportunity cost
(machinery, tools, equipment,infrastructure) for investing in capital is gathering interest in
the bank.
Enterprise organizing other factors of Profit (income received over and above all
production (entrepreneurship, risk taking rewards from other factors of production
behavior that combines the other three
factors of production to produce goods and
services)

The distribution and exchange of goods and services

GDP (Gross Domestic Product) Total amount of goods and services produced in an economy
over a given period of time (in a given year)
Market economies provide people with income as a reward for their contribution to the
production process.
Owners of natural resources/capital/entrepreneurial skill receive income based on their value
of input. Workers are paid according to the value of labour.
Wages are influenced by how much they work, skills and expertise, educational qualifications
and bargaining power in wage negotiations with employers.
Barter are non-cash exchange of goods and services.
The Business Cycle
The business cycle are the fluctuations in the level of economic growth due to
domestic/international factors involved. Over time economies usually experience an overall
trend of growth in their output. Cyclical pattern of growth reoccurs in market economies whilst
cyclical flows cause significant disturbances for both individuals and businesses.

The red line represents the trend level at which growth is preferred.
Recession
Expenditure, output, income and
employment levels are at a minimum
Decreased inflation due to rising
unemployment and cutting of prices to
clear inventories
Expansionary policies- stimulate
spending and economic activity
Decreased employment and spending
leads to lower quality of life
Decreased investment, production and
demand for labor
Decreased living standards-health
problems, less education opportunities,
increased crime decrease quality of life
Increased exchange rates-low economic
activity discourages investment, thus
less demand, meaning more weakening
of the currency.
Boom (Peak)
Expenditure, output, income and
employment levels are at a maximum
Increased inflation due to shortage of
labor and other resources
Contractionary polices- Lower inflation
and preservation of environment
resources to stabilize activity
Increased employment and spending
leads to high quality of life
Increased investment, production and
demand for labor
Increased living standard as poverty
levels fall
Decreased exchange rates-high
economic activity encourages
investment, therefore theres increased
demands and that adds value/levels
the currency with international
currency.
Business cycles describe the upward/downward movement and also note upswing and
downswing are not the same as peak/recession.

Mini summary of effects

Recession
Falling production of goods and services
Falling levels of consumption and investment
Rising unemployment
Falling income levels
Falling quality of life

Boom
Increasing production of goods and services
Rising levels of consumption and investment
Falling unemployment
Rising income levels
Rising quality of life

An overview of the economy: the circular flow of income

The economy is divided into 5 sectors:
Individuals/Households: All individuals who earn rewards (wages, rent) for selling factors of production
(inputs) Income either goes to spending, saving, paying tax or purchasing imports.

Business/Firms: All private businesses/enterprises that produce and distribute goods and services. They
buy resources from the household sector and make income payments in return.

Financial Institutions- Private Sector-Part of Domestic Sector: All financial institution (banks etc.) that
assist in borrowing and lending of money necessary for saving money and investing to occur. Financial
institutions mobilize savings so they can be used for investment. Saving represents a leakage (money is
not being circulated) in the economy, thus decreased expenditure, production, demand and income.
Investment represents an injection in the economy therefore it brings finances to businesses. Savings are
very necessary for investments as it builds up capital therefore it improves future productivity.

Governments- Public sector part of domestic sector: Satisfies collective wants of the community
(roads, railway, schools). Tax represents a leakage, as it reduces available funds for consumption and the
level of economic activity. Government spending represents injection, as it provides income to
government and private employees.

Overseas/International Trade and Financial Flows: Include all transaction with the rest of the world
(exports, imports, international borrowings/lending). Imports represent leakages, as money is being
withdrawn from domestic economies and paid to overseas businesses. Exports represent injections, as
money is being spent in domestic economies from overseas businesses.
Injections: go into the circular flow model of income, they are those flows of money that increase
aggregate income and the general level of economic activity, injections include: investment, government
spending and exports.

Leakages: items that remove money from the circular flow of income, decreasing aggregate income and
general level of economic activity, these include savings, taxation and imports.

Equilibrium: Equilibrium occurs when sum of leakages equals sum of injections:

Disequilibrium occurs when sum of leakages does not equal sum of injections:

S+ T+ M > I+ G+X:
-More leakages
-decrease in income, expenditure, output thus there will be a recession
-leakages will fall due to reductions on S, T and M but a lower level of equilibrium will occur
S+T+M<I+G+X
-More injections
-increase in income, expenditure and output thus there will be a boom.
-leakages will increase due to higher income and S,T,M, but a higher level of equilibrium will
occur,

Government has a large level of influence on circular flow

They can change levels of taxation and revenue

They can either stimulate or dampen the economy through controlling of leakages and
injections.
 Economies: their similarities and differences
CHINA & AUSTRALIA
Economic growth
Economic growth is a quantitative measure of the increase in real Gross Domestic Product over
period of time
Australia is a developed or advanced economy meaning it has not experienced rapid economic
growth in recent decades (averaging 3.2%)
China is an emerging/developing economy and has been one of the fastest growing economies
in the world (averaging 10%)
Australias economic fortunes are linked to the fortunes of Asian economies e.g. China

Quality of life
Quality of life is most often measured through the Human Development Index (HDI)
HDI measures improvements in income, health, life expectancy and average year of schooling
The closer to 1, the higher the HDI

Distribution of income
Distribution of income refers to how evenly income is spread through the economy
This is commonly measured using the Gini-Coefficient which measures inequality
The closer to 0, the more even distribution of income
Australia 33.5 & China 44.0

Environmental sustainability
Economic activity is only acceptable if it does not damage the environment in the short and long
term.
Australia has one of the highest per-capita emissions in the world but has a much cleaner
environment than China
China has created enormous environmental damage, with severe levels of fair pollution,
poisoned river systems and widespread health problems arising from exposure to pollution and
toxic chemicals
Australia and China both rely heavily on fossil fuels
Both countries are depleting their waterways
Both countries are experiencing soil degradation and soil salinity
Australia has signed up for the Kyoto Protocol while China has not
Australia has cleaner air and water and higher environmental regulations while China has 10 of
the most polluted cities in the world
The role of government in health care, education and social welfare
Although Australia is a mixed economy and China is a planned economy, both have similar
approaches to the role of government
Primary and secondary education is provided by both governments although Australia also has
the options of private education
Australia subsidises healthcare through Medicare while the Chinese government provides free
healthcare
Australia also has private health insurance while China does not
The Australian government provides transfer payments (unemployment benefits, low income
family assistance and pensions) to ensure a minimum standard of living
Although not as developed, the Chinese government is starting to provide greater social welfare
particularly for the elderly and those living in rural areas.