Untitled Lesson

Economic Growth

What the Syllabus says

• Aggregate demand and its components: Y = C+I+G+X–M
• Injections and withdrawals (I+G+X; S+T+M)
• The simple multiplier: k = 1/(1–MPC)
• Measurement of growth through changes in real Gross Domestic
Product
• Sources and effects of economic growth in Australia
• Increases in aggregate supply – improvements in efficiency and
technology
• Trends in business cycle

But also:

Examine economic issues
• Examine the arguments for and against increasing economic growth rates

Apply economic skills

• Identify and analyse problems facing contemporary and hypothetical
economies

• Calculate an equilibrium position for an economy using leakages and injections

• Determine the impact of the (simple) multiplier effect on national income

• Explain the implications of the multiplier for fluctuations in the level of
economic activity in an economy

Revisiting Year 11 Work

Income = Consumption + Savings
Or
Y = C + S

Average Propensity to Consume

Average Propensity to Consume = Consumption = C
Income Y

If I earn $1000 and I spend $500 of that income, my APC is.....

C = 500 = 0.5
Y 1000

Average Propensity to Save

Average Propensity to Save = Savings = S
Income Y

Marginal Propensity to Consume

• The Marginal Propensity to Consume (MPC) calculates what

proportion of each extra dollar we earn is spent on consumption.

• It’s about the CHANGE in our consumption based on a CHANGE in our
income. It looks like this:

MPC = Change in Consumption = C
Change in Income Y

An example

1. Jacinta’s income increases by $200 per week. In response, her
consumption expenditure increases by $125. What is her MPC?

MPC = C = 125 = 0.625
Y 200

Marginal Propensity to Save

• The Marginal Propensity to Save (MPS) calculates what proportion of
each extra dollar we earn is saved

• It’s about the CHANGE in our savings based on a CHANGE in our
income. It looks like this:

MPC = Change in Saving = S
Change in Income Y

An example

1. Li-ling’s income increases by $150 per week. In
response, her savings increase by $90. What is her
MPS?

MPS = S = 90 = 0.6
Y 150

2. Calculate her MPC

MPC = C = 60 = 0.4
Y 150

Notice that
MPS + MPC = 1

Recap Circular Flow

• Put in RBA info

What is Economic Growth?

• The increase in the volume of goods and services that an economy
produces over time.
• It can be measured by the annual rate of change in real GDP.

Not
quarterly
(Although
figures are
released
quarterly)

It’s about
the change
that has
occurred –
not the
amount

Adjusted
for inflation

Australia‘s Economic Growth (Annual)

2019

2.3

2020

-0.3

2021

-1.4

Measures you might come across

• Annual Economic Growth Rate – Annual GDP growth is calculated based on
the financial year (1 July – 30 June).

• Quarterly economic growth – the ABS releases data every 3 months that
shows growth over the previous quarter. Eg: The Australia economy grew by
0.2% in the December quarter (2018)

• Year-on-year growth – the quarterly figures can also be used to calculate
year-on-year growth. This is a measure of the growth seen in 1 year between
one quarter and the corresponding quarter of the year before. Eg: September
GDP data shows the economy has grown by 2% over the last 12 months

Just be
aware

Australia‘s Economic Growth (Quarterly)
Last 3 years

Australia‘s Economic Growth (Quarterly)
Last 10 years

Australia‘s Economic Growth (Quarterly)
Last 25 years

Nominal v Real GDP

• Nominal GDP – Is the
value of GDP at
current prices
without an
adjustment for
inflation

• Real GDP – the value
of GDP adjusted for
inflation

Explanation

GDP is used to measure
economic growth, or, whether
there has been an increase in
output for an economy. If
Consumption has increased, we
want to know whether
consumers have actually
purchased more g&s, OR,
whether there has simply been
an increase in the price of what
they have purchased.

Example

In March, Aust produced
$2000 worth of apples

In April, Aust produced
$2,100 worth of apples

Were more apples
produced?

OR.....

Did the price of apples
simply go up?

Producing Apples

Year 1 = $1000 worth of apples
Year 2 = $1200 worth of apples

These are NOMINAL prices. We want to know whether
more apples were produced, or, did their prices simply
go up? That is, what was the REAL increase?

Consumer Price Index (CPI) Year 1 = 100
Consumer Price Index (CPI) Year 2 = 110

Nominal Price Yr 2

Real Price Yr 2

Year 2 prices

Year 1 prices

We can use this information to work out the value of the
apples in Year 2, at Year 1 prices

=

1200

Real Price Yr 2
=
110

100

1200 x 100 = 110 x Real Price Yr 2

Real Price Yr 2 = $1090

Therefore, the REAL increase in apples is only
$90 – not $200

Rearrange the Equation

Simplifying it

We will use the following formula to calculate real GDP

The previous example was just for ONE product. We are more
interested in the total output for the WHOLE economy. That is, GDP.

Let’s do an example

Year

Nominal GDP

CPI

1

$400b

100

2

$600b

105

600b

105

$571.43b

What does this mean??
This means that while the
economy has grown
between Yr 1 and Yr 2,
total output has not
increased by $200b (as
suggested by Nominal
GDP figures)

Total output has in fact
grown, in REAL terms by
$171.43b

Yr2

Yr2

Yr2

Yr2

Calculate Real GDP in Year 2

Now you do some

Year

Nominal GDP

CPI

1

$600b

100
2

$1000b

102
1

2

3

Year

Nominal GDP

CPI

1

$400b

100
2

$1000b

105

Year

Nominal GDP

CPI

1

$1200b

100
2

$1500b

105

Calculating Rates of Growth

Economic Growth =
100
x

Real GDP (previous year)

Real GDP (current year) - Real GDP (previous year)

Example

Economic Growth
2018
=
US$1860 billion - US$1808 billion

US$1808 billion

x 100

=
2.9%

Example

Economic Growth =

100

x
Real GDP (previous year)

Real GDP (current year) - Real GDP (previous year)

Economic Growth
Year 2
=
US$1200 billion - US$1100 billion

US$1100 billion

x 100

=
9.1%

Year

Real GDP

1

$1100b
2

$1200b

2006

Let’s Practice!

2015

EQUILIBRIUM
AGGREGATE SUPPLY = AGGREGATE DEMAND
TOTAL LEVEL OF INCOME = TOTAL LEVEL OF SPENDING

Y = AD

Aggregate Demand

Import Spending

AGGREGATE DEMAND – TOTAL EXPENDITURE IN THE
ECONOMY

AD = C + I + G + (X –

M)

Aggregate Demand

Consumption

Investment

Government
Spending

Export Revenue

Import Spending

AGGREGATE SUPPLY – TOTAL INCOME IN THE ECONOMY

AS

= C + S

+ T

Aggregate Supply

Consumption

Savings

Taxation

SUBSTITUTING FOR AD

Y

= C + I + G + (X –

M)

Aggregate Supply

Consumption

Investment

Government
Spending

Export Revenue

Import Spending

SUBSTITUTING FOR AS

C + S + T

= C + I + G + (X –

M)

Consumption

Investment

Government
Spending

Export Revenue

Import Spending

Taxation

Savings

Consumption

REARRANGING

S + T

+ M

=

I + G + X

Investment

Government
Spending

Export Revenue

Import Spending

Taxation

Savings

Leakages

Injections

CAUSES OF GROWTH

Demand Side

Short term, volatile, rapid change

AD=C+I+G+(X-M)
 Income Levels
 Interest Rates
 Income Inequality
 Interest Rates
 Change in Government Policies
 Government Spending and Taxation
 Exchange Rate

Supply Side

Long term 5 – 10 years

AS determined by how many resources,
factors of production an economy has
and how efficiently they are used.
 Gain more resources
 Become more efficient in use of resources

 Microeconomic Reform – increased competition between
firms move resources to more efficient industry

 Improve Educational Quality – a more skilled labour force
will have increased productivity

 Improve Technology – results in cheaper production and
reduced labour costs.

Demand Side Growth
Caused by increases in aggregate
demand. Causes inflation

Demand Side Growth
Caused by increases in aggregate
supply. Reduces inflation

TYPES OF GROWTH

Sources of Economic Growth ( Real GDP)

Economic growth can
emanate from either:

1.Increases in Aggregate
Demand

2.Increases in Aggregate
Supply

Price level

Total Output
(GDP)
(National Income)

AD

AD

AS

AS

Q

P

Price level

Total Output
(GDP)
(National Income)

AD

AD

AS

AS

Q

P

AD2

AD2

Q1

P1

Aggregate Demand (C + I + G + (X – M))

• An increase in:
• C
• I
• G
• X
• Will lead to an increase in AD and
a shift of the AD curve to the
right
• This will increase GDP/National
Income
• But it will also be inflationary
(unless accompanied by an
increase in AS)

Aggregate Supply

Price level

Total Output
(GDP)
(National Income)

AD

AD

AS

AS

Q

P

AS2

AS2

Q1

P1

• An increase in AS will lead
to a shift of the AS curve to
the right
• This will increase
GDP/National Income
• But it will not have the
same inflationary effects as
an increase in AD

Increasing Aggregate Demand
Consumption

Possible Policies
• Reduce income tax rates
• Reduce the cash rate/interest rates

Consumers will also increase their consumption if:
• They have high levels of confidence about the current state of the economy and
the future
• They feel that their wealth is increasing (eg house prices go up)

Increasing Aggregate Demand
Investment

Possible Policies
• Reduce company tax rates
• Government policy in the form of subsidies, tax breaks
• Reduce the cash rate/interest rates

Businesses will also increase their investment if:
• They have high levels of confidence about the current state of the economy and
the future

Increasing Aggregate Demand
Government Expenditure

Dependent upon:
• The state of the economy
• Political considerations

Increasing Aggregate Demand
Exports

Possible Policies
• Export incentives
• Sign FTAs

The Multiplier

Therefore...

An increase in any one of these flows will increase GDP

AD = C + I + G + (X-M)

How might the government implement policies to increase any of these
components of GDP?

An example

GDP = C + I + G + (X-M)

GDP = $4b + $2b + $3b + ($7b-$6b)

GDP = $10b

Lets say that the Govt increases G to $5b

GDP = $4b + $2b + $5b + ($7b-$6b)

GDP = $12b

That is, a $2b increase in GDP!

HOWEVER...!

$16b

Construction
companies

Workers

Material
supply
companies

Restaurants

New
appliances

Cars

Holidays

iPhone X

$16b$16b$16b

$6b
$10b

G

C

GDP/Agg D = C + I + G + (X-M)

$16b

Construction
companies

Workers

Material
supply
companies

Restaurants

New
appliances

Cars

Holidays

iPhone X

$16b$16b$16b

G

C

What do you think determines the size
of this 2nd round of spending?

The Multiplier

It’s like a bouncing ball!

G = $2B

C = $1.6B

C = $1.28B

C = $1.024B

C = $0.82 B

C = $0.66B

S = $0.4B

S = $0.32B

S = $0.256B

S = $0.2B

S = $0.32B

The Multiplier

This process is known as THE MULTIPLIER EFFECT

Lets watch the first 2:18 of this video by Mr Clifford to see
how this works.

The Multiplier

This process is known as THE MULTIPLIER EFFECT

Lets watch the first 2:18 of this video by Mr Clifford to see
how this works.

The Multiplier Formula

To calculate the size of the multiplier effect, we can use the following
formula:

K =
1
MPS

The Multiplier: Example

An economy has an MPS of 0.4. Calculate the size of its multiplier

2.5
0.4

1

MPS

1
K =

=

=

The Multiplier

It’s like a bouncing ball!

G = $2B

C = $1.2B

C = $0.72B

C = $0.432B

C = $0.259B

C = $0.155B

S = $0.8B

S = $0.48B

S = $0.288B

S = $0.173B

S = $0.104B

MPS = 0.4

The Multiplier: Example
The Next Step

An economy has an MPS of 0.4. Calculate the size of its multiplier

K = 1 = 1

= 2.5
MPS

0.4

If the government injects $2b into the economy (↑G), what will be
the ultimate change in GDP?

Answer: $2b x 2.5 = $5b

GDP/Agg D = C + I + G + (X-M)

$2b

$3b

The Multiplier: Example
Let’s try one together

An economy has an MPS of 0.3. Calculate the size of its multiplier

K = 1 = 1

= 3.33
MPS

0.3

If the government injects $4b into the economy (↑G), what will be
the ultimate change in GDP?

Answer: $4b x 3.33 = $13.33b

GDP/Agg D = C + I + G + (X-M)

$4b

$9.33b

Notice when the
MPS is lower, the
multiplier is higher

FAQs

Is the multiplier just about a response to an increase in G?

No. It could generally be I, G or X

That’s it. That’s the only FAQ...

The Multiplier: Worksheet

Complete the worksheet on the multiplier

Other stuff to know

•When MPS increases, the multiplier decreases (ie, more savings  less flow-
on effect in the economy)

•Therefore, when MPS increases and the multiplier decreases, the
equilibrium level of income in the economy will fall (as there’s more
leakages)

•Always remember that it is about the level of CHANGE – how much does
saving/consumption change when income changes

•Always remember that MPS + MPC = 1

2009

2012

2011

2010

2013

2013

2015

2014

2013

2016

2017

A Graph!
The Consumption Function

Income

Consumption

$300

$500

$150

$200

$50

As you would
expect, as the level
of income
increases, so does
consumption

$0

Notice that
even when
income is $0,
there is still
some
consumption
expenditure.
This is known
as the Cost of
Survival.

$100

$100

Break-even point

A Graph!
The Consumption Function

Income

Consumption

$300

$500

$150

$200

$50

$0

Calculate:

1. The APC at Y = $300

2. The APC at Y = $500

Explain this result

1. Calculate the MPC as
income changes from
$300 to $500

Role of Aggregate Supply

• Economists sometimes refer to aggregate supply as the economy’s
potential

• Aggregate supply can be increased when a higher level of output can
be produced for the same cost

• Aggregate supply is increased when there is an increase in the
quantity or quality of the factors of production

Factors affecting Aggregate Supply

• Increases in AS can be achieved through changes such as:

• Population growth (increase in quantity of labour)

• Discovery of new resources

• Workers acquiring new skills

• Increased capital

• The adoption of new technology

• Measures to improve efficiency

• Improvements in infrastructure

If AD (C + I + G + (X – M))
growth is primarily achieved
through macroeconomic
policies, aggregate supply
improvements are generally
achieved through
microeconomic policies

Increasing Aggregate Supply

Possible Policies

• Microeconomic reform

• Liberalisation of trade

• Education policies

• Infrastructure improvements

• Productivity improvements

• Privatisation

• Competition Policy

• Labour market reforms

Graphing AS and AD

Price level

Total Output
(GDP)
(National Income)

AD

AD

AS

AS

AS2

AS2

2015

2012

2011

2009

2008

2006

$16b

Construction
companies

Workers

Material
supply
companies

Restaurants

New
appliances

Cars

Holidays

iPhone X

$16b$16b$16b

G

C

What do you think determines the size
of this 2nd round of spending?

Recent Trends in economic growth

The Impacts of Economic Growth on…

ECONOMIC GROWTH
UNEMPLOYMENT

INFLATION

EXTERNAL STABILITY

DISTRIBUTION OF
INCOME AND WEALTH

ENVIRONMENTAL
SUSTAINABILITY

TAX REVENUE

LIVING
STANDARDS

Effects of Economic Growth
1. Higher living standards

Notes

• Eco Growth leads to an increase in
GDP/capita, and therefore...
• Real wages will increase, and
therefore...
• Households will have a higher
disposable income and thus, higher
material living standards

Data/Statistics – Australia

• By 2013, the mining boom is
estimated to have raised real per
capita household disposable income
by 13 per cent, raised real wages by
6 per cent (RBA)

GDP Growth

Effects of Economic Growth
2. Employment

Notes

• Eco Growth creates jobs, leading to
falling rates of unemployment

• Sustained growth will increase
participation rates (as the hidden
unemployed start to re-enter the jobs
market)

• Under-employment figures will start to
improve

• Higher rates of growth are usually
associated with the creation of more
highly paid and highly skilled jobs

Data/Statistics – Australia

• Unemployment fell to lows of 4% in the
period just before the GFC as mining
investment increased and economic growth
levels were at their highest

• Pre-COVID growth rates of less than 3%
were leading to declines in the
unemployment rate, but underemployment
rates have been on the rise over the same
time period

• Significant demand and supply shock
pushed up Un significantly during height of
COVID pandemic

GDP Growth

The Relationship between Economic Growth and Un
Okun’s Law

• The relationship that exists between economic growth and
unemployment is known as Okun’s Law (after Arthur Okun)
• It states that for unemployment to fall, the rate of economic
growth must exceed the sum of productivity growth and the
growth in the size of the labour force
• For example, for a decrease in Un to occur, then:

Economic Growth
(Eg: 4%)
>

Productivity Growth
(Eg: 2%)
Labour force growth
(Eg: 1%)
+

• Okun’s law provides the theoretical basis for the Australian
government wanting to achieve a growth rate of around 3-4% in
real GDP as this should lead to a fall in unemployment

The Relationship between Economic Growth and Un
On a Graph

• An increase in aggregate demand (or
aggregate supply) leads to an
increase in Real GDP from Y1 to Y2.
• As the demand for labour is a

derived demand (derived from the
demand for goods and services) the
increase in GDP leads to an increase
in employment (decrease in
unemployment)

Effects of Economic Growth
3. Increased tax revenue

Notes

• Economic growth that leads to
higher real GDP can increase tax
revenue for the government.
• This revenue can then be used to
provide social and economic
infrastructure and fund the welfare
system

Data/Statistics – Australia
•In the period before the GFC,
government revenue increased
substantially on the back of
company and income tax revenue
increases. This enabled significant
tax cuts for middle and high income
earners and the introduction of
numerous family payments

Effects of Economic Growth
4. Inflation

Notes

• Higher levels of economic growth can
result in increases in the CPI

• This is particularly true if spending is
growing at times when the economy is
close to full capacity and the growth in
aggregate supply cannot keep up with
the growth in aggregate demand

• Inflation is therefore a side-effect of
economic growth.

• The aim: a ‘sustainable rate of
economic growth’

Data/Statistics – Australia

• During Phase 1 of the Mining Boom,
the economy was close to full
capacity, leading in labour shortages
and wages growth of approximately
4%. Inflation was as high as 5% in
the period just prior to the GFC
• With slower economic growth pre-
COVID, inflation was been below the
RBA’s target for a period 5 years.

Inflation

Effects of Economic Growth
6. External Stability

Notes

• Economic growth is often
accompanied by higher disposable
income, resulting in higher levels of
imports
• If the economy is growing faster
than it’s trading partners, unless
exports keep pace with the growth
in exports, this can lead to a
worsening CAD

Data/Statistics – Australia

• During the first phase of the mining
boom, Australia’s trade balance (or
BOGS) worsened with the high level
of imports – not only of consumer
goods but also mining machinery

GDP

Effects of Economic Growth
7. Income Distribution

Notes

• Economic growth may lead to a
widening in the level of income and
wealth inequality
• This is because the economic
benefits of growth flow
disproportionately to higher income
earners or owners of capital
• Benefits are skewed towards skilled
workers and away from unskilled
workers

Data/Statistics – Australia

• Australia’s Gini coefficient rose to its
highest levels in the period before
the GFC (Mining Boom Phase 1)

GDP

Gini
coefficient

Effects of Economic Growth
8. Environmental impacts

Notes

• Economic growth can potentially
have a negative impact on the
environment
• If growth continues without
consideration given to the
environment it can result in
pollution, depletion of non-
renewable resources and land
degradation

Data/Statistics – Australia

• Australia has one of the worst
carbon emissions per capita in the
world (2nd highest in the OECD)

In Summary

Sustainable rates of
economic growth
3-4%

If Economic growth is too low

Unemployment

Less tax revenue

Lower living standards

However, high levels of growth can lead to:

Inflation

Income and Wealth Inequality

Environmental degradation

Worsening trade balance