Economic Growth

Supply Factors and Economic Growth (2)

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 early 2008 (up to 7.25%) and the economic growth subsequently fell to 0.6% (the lowest for the period) in 2008/09. (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.	The wage price index has been relatively stable in recent years, with an average increase of around 4% per year. This has placed some pressure on the ability of producers to meet these costs, and as a result the rate of economic growth has averaged between 2% and 3% per annum. In 2009 the rate of growth fell to 0.6% as the full impact of higher wage costs began to take effect.
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.	The trade weighted index fell to 53.2 in early 2009, after a peak of 73.4 just a couple of months earlier. This significantly increased production costs for firms, and resulted in difficult supply side conditions for domestic firms. The rate of economic growth fell to just 0.6% in that year.
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 remain stable during the last five years, despite the uncertain global economy. The impact of this on the economy tends to be much slower, however the increased availability of the labour resource has undoubtedly contributed to Australia's quick recovery from the global downturn.
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.	The price of raw materials increased by 4.7% in 2007/08, increasing overall production costs for firms. This resulted in difficult supply side conditions, and as a result it is not surprising to see that the rate of growth fell from 2.9% in that year to only 0.6% in the following year.

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