| Supply Factor |
Theoretical Link to Growth |
Evidence |
| Interest Rates |
When interest rates increase producers will need to use more of their revenues and profits to repay existing loans. They will also be discouraged from taking out new loans, and so investment rates may fall. As such any increase in the cash rate will lead to higher costs of production, and this in turn may mean a decrease in aggregate supply.
|
Interest Rates increased in 1999/2000 (up to 6.25%) and the economic growth subsequently fell to 1.8% (the lowest for the period) in 2000/01. A similar situation was seen in 2005/6. The cash rate was increased several times, and as costs of production increased the rate of growth fell to 2.1%. (In this case the supply side impact is the same as the demand side impact, so you can use the same examples. However, you should note that the impact on aggregate demand will always be far more significant than the impact on aggregate supply.)
|
| Wages |
Wages are another very significant cost of production. When wages increase businesses are faced with the prospect of paying more to produce the same level of output. Once again, with the increase in production costs it is possible that aggregate supply will decrease. Producers will tend to consider the real unit labour costs, as an increase in wage levels can be sustained if productivity levels increase at a similar rate.
|
Real unit labour costs represent the difference between the increase in wages and the change in inflation. If wages grow at a rate faster than inflation, then real unit labour costs will be positive. In the period 2003-2006, wages consistently increased at a rate faster than inflation. As a result, the rate of economic growth fell during this period, eventualy falling to 2.1% in 2006.
|
| The Exchange Rate |
As the value of the Australian dollar increases, the impact on aggregate supply may be very positive. Around 80% of all imports are used in the production process, and so when the dollar is strong we are more able to purchase these productive imports. This equates to lower costs of production, and hence aggregate supply may increase.
|
During the Asian economic crisis of 1997/8 the Australian Trade Weighted Index (TWI) increased due to strong gains against the Asian currencies. Partly as a result, we were more able to purchase productive resources and growth during this period increased to 4.5% (1997/8) and 5.3% (1998/9). (You should remember, however, that an appreciation of the dollar can cause aggregate demand to fall due to a decrease in exports. As such, in 2005/6 the dollar appreciated, but economic growth actually declined.
|
| The Participation Rate |
Labour is an important productive resource. As more people are encouraged to enter the labour force it means that businesses will have access to more resources (ie more people). Therefore, any increase in the participation rate should lead to an increase in aggregate supply, and therefore an increase in GDP.
|
Strong growth in the Australian economy has seen the participation rate increase during the last 10 years. The impact of this on the economy tends to be much slower, however the increased availability of the labour resource has undoubtedly contributed to our decade of strong growth.
|
| The Price of Raw Materials |
Raw materials are those products which are used to produce other goods and services. If the price of raw materials increases, businesses will be making a lower margin on each item. This may mean that they are less willing to allocate productive resources to these items, and so aggregate supply may decrease.
|
Raw material prices fell in 1998/9 (by 1.0% - due in part to the increase in the value of the AUD) and growth at that time peaked at 5.3% (the highest for the period). However, in 2000/01 raw materials increased by 14.4%, and this corresponded with growth of only 1.8% (the lowest for the period). The high price of raw materials in 2005/6 also contributed to the lower rate of growth seen at that time. The high cost of petrol was particularly damaging to the economy at that time.
|
| Company Tax Rates |
Again, the company tax rate represents a significant cost of production. If the tax rate falls then it is probable that company managers will see the possibility of making a higher profit. As such they should allocate more resources to the production process, and aggregate supply may increase.
|
As part of the restructuring of the tax system in 2000, the company tax rate was progressively lowered to 30% from 36%. As a result, the Australian economy returned to strong growth quickly – growing by 3.9% in 2001/02. In recent years it has been suggested on several occasions that the rate of company tax should be cut even further, as it is believed by some that this will help to ensure that economic growth is sustained in the medium term. |
Unit 1
Unit 3
