Page Part Economics and

144 3 the economy

Inflation Deflation
Inflation is a measure of price rises. When the economy Deflation occurs when the prices of most goods and
is experiencing a period of inflation, the prices of most services suffer a sustained fall. If high inflation is bad for
goods and services increase. In order for people to the economy, does that mean that deflation is good for
maintain the same standard of living, wages and salaries the economy? No. Although it might seem good for prices
need to increase at the same rate as prices. Therefore, if to drop, especially due to improvements in productivity
you earn $1000 a week and prices have gone up by 10 and technology, it doesn’t follow that deflation is good for
per cent, your wage needs to be $1100 to maintain the the economy. A sustained deflationary period can lead to
same buying power. expectations that prices will continue to fall. Consumers
put off spending because they believe that prices will fall
Generally wages and salaries do increase to keep up with even further. This may lead to a downward spiral involving
rising prices. People may be paying more for their goods reduced consumption, lower levels of investment, falling
and services, but they are also earning more. This means income levels, rising unemployment and a significant
that people really are no worse off and their standard of decline in economic activity.
living can stay the same.

However, an ongoing period of rising prices can lead to an Consumer price index
overall reduction in buying power, because any increases The consumer price index (CPI) is calculated by the
in wages and salaries are not likely to keep up with price Australian Bureau of Statistics and measures the average
rises. If inflation becomes really high, money can become price rise in a ‘typical’ basket of goods purchased by
worthless because it has little buying power (although this Australian households. Items are given a weighting that
is rare). In Australia an annual inflation rate of 2 to 3 per corresponds to the proportional amount that Australian
cent is considered acceptable and is known as achieving households typically spend on these items. The ABS
price stability. measures about 100 000 separate prices each quarter.

Causes of inflation The CPI weightings indicate how much out of $100 an
Australian household typically spends on certain items.
Inflation can be caused by the following: For example, based on the 15th series CPI in 2005,
■ Not enough goods and services to meet demand. Australian households typically spend 15.44 per cent, or
This leads to producers increasing their prices to $15.44 out of every $100, on food. Of the spending on
maximise their profits, because people are more food, the highest single sub-group is spending on meals
willing to pay the higher prices. out and take-away food at 4.56 per cent, or $4.56 out of
■ The cost of producing goods increasing. If the cost of every $100 dollars.
producing goods goes up, producers have to put up
Consumer price index weightings of household
their prices in order to maintain their profit levels. goods, 2005
■ Seasonal factors. This is particularly relevant to fruit
Item Per cent
and vegetables that are in short supply at certain times
of the year, and airfares during high-demand holiday Food 15.44
times. When items are in short supply or experiencing
Alcohol and tobacco 6.79
seasonal demand, suppliers put up their prices
because people are willing to pay the higher prices. Clothing and footwear 3.91
■ Higher supply of money in the economy. When there Housing 19.53
is more money available in the economy, people have
Household contents and services 9.61
more money to spend and therefore producers put up
prices because people are willing to pay higher prices. Health 4.70
A higher supply of money can occur if governments Transportation 13.11
decide to repurchase government bonds. A lower
supply of money can be caused if governments sell Communication 3.31
government bonds—this will have the opposite effect Recreation 11.55
and should lead to a reduction in inflation.
Education 2.73
■ Expectations of increasing inflation. If consumers
believe that inflation is increasing, they may try to buy Financial and insurance services 9.31
items before the prices increase. This leads to a false Source: ABS, cat. No. 6430.0 Consumer Price Index 15th Series Weighting
increase in demand and can be inflationary. Pattern

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 Managing the Chapter Page
Australian economy 7 145

Winners and losers in a time of inflation

Losers Winners

Unemployed people Pensioners Holders of real assets Borrowers of money

Unemployed people live Pensioners live on a fixed Inflation means the value People who borrow
on a fixed income and income and higher prices of real assets, such as money and pay back a
higher prices mean that mean that they have to houses, goes up. fixed amount are better off
they have to spend more spend more on essentials because the amount to be
on essentials with less with less disposable repaid becomes a smaller
money left to spend on income. portion of their current
other things. income earned.

Bank savings Exporters Workers whose Importers

As prices increase, the As prices increase, incomes are keeping As prices in Australia
relative value of money overseas demand for ahead of inflation rise in comparison to
falls because each dollar Australian goods is likely Strong unions and other countries, the
is unable to purchase as to fall, because Australian powerful employees with prices of imported
much goods and services. goods become more high-level skills (such as goods fall in comparison
Therefore money kept in expensive compared CEOs) may be able to with Australian goods.
the bank loses its value. to goods from other negotiate regular increases Australian consumers
countries. Overseas in wages and salaries to switch to imports.
consumers switch to offset increases in prices.
products from other
countries.

Learning activity 7.6

Inflation
1 How can you maintain the same buying power in d Lidia and Alphonse are retired. They have
times of inflation? $200 000 in the bank. The bank interest received
from this money is their only income.
2 What is price stability and how is it achieved?
5 How is the consumer price index calculated?
3 Explain three causes of inflation and three causes of
deflation. 6 Go to the Australian Bureau of Statistics website.
Click on Consumer Price Index under National
4 For each of the situations below, comment on
Statistics. Find out the following information and set
whether the person would be favourably or
out your findings in a table:
adversely affected during a period of rising inflation.
a the percentage change in the CPI in each of the
Give reasons for your answer.
11 groups for the quarter and for the last 12 months
a Over the past 10 years Rita has been buying real
b the percentage change in the overall CPI for the
estate. She now owns three one-bedroom flats
quarter and for the last 12 months.
and a two-bedroom house. She rents them out.
b Jake is unemployed and his only income is Job 7 Find out the meaning of hyperinflation. Try searching
Search Allowance. for hyperinflation in Germany in 1923, or other
c Five years ago Jacinta borrowed $20 000 from a countries such as Argentina or Russia. Have a class
credit union. Her repayments are $350 a month. discussion on the effects of hyperinflation.

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 Page Part Economics and
146 3 the economy

Case Study The destruction of Australia’s banana crops

‘Banana prices rose 250 per cent.’

In 2006, cyclone Larry hit Northern Queensland and There was hope amidst the devastation for fruiterer
destroyed around 80 percent of Australia’s banana crops. David Lazzaro. ‘You have droughts and you have hail
The devastation meant there was a shortage in bananas storms that can wipe out crops, but there’s always
that would not be eased by imports because banana another area that will pick up the slack, that can increase
imports are banned due to the risk of exotic pests. production or carry a place through that down time.’

As bananas are a very popular fruit (Australians consume

an average of 15 million bananas a week!) there was
Learning activity 7.7
intense lobbying to overturn the ban on banana imports.
However, the then Federal Agriculture Minister Peter
McGauran said there was ‘absolutely no prospect’ of 1 Why did the destruction of Australia’s main
the ban being lifted and people should show sympathy banana crop lead to increased inflation in 2006?
for the growers. 2 Why do you think the increase in banana prices
The shortage in supply meant the price of bananas resulted in the increase in prices of other fruit?
went up considerably. According to Prime Minister 3 Do you think the number of people buying bananas
John Howard, ‘banana prices rose 250 per cent’.
would drop as a result of this increase?
The higher price of bananas also led to an increase
in the prices of other fruit. 4 Why do you think bananas are no longer
extremely expensive?

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 Managing the Chapter Page
Australian economy 7 147

Employment The unemployment rate is measured by the proportion

of the total labour force (that is, both employed and
The government’s objective of full employment is where unemployed) who are unemployed. The unemployment
everyone who wants to work can have that opportunity. rate is calculated in the following way:
However, in a modern economy such as Australia’s it
is not really possible to have full employment. Many Number unemployed
× 100%
economists argue that some unemployment is actually Total labour force
good for the economy. In Australia an unemployment rate
of 4 to 5 per cent is considered acceptable and is known
as full employment.
Causes of unemployment
Unemployment may be caused by a number of economic
The labour force is the number of people aged 15 and factors. When economic growth declines, this may lead
over who are either employed or actively seeking work. to reduced consumption of goods and services, less
According to the Australian Bureau of Statistics, to be spending and a drop in business investment. In addition,
considered employed you must be aged 15 and over and some businesses may find that they can no longer operate
have worked for at least one hour a week for pay, profit, competitively and therefore close down. These factors
commission or payment in kind. You are also considered may reduce the demand for labour, resulting in a higher
employed if you performed unpaid work in a family unemployment level. Evidence of this can be seen in 2008
business. and into 2009, when unemployment in Australia rose from
about 4.5 per cent as businesses started to lay off workers.

There may be a decline in certain industries, including

10 820
replacement of jobs by new technological processes,
a shift to offshore production, company relocation and
10 800 restructuring and other changes in the way that goods
and services are provided. Evidence of this can be seen
through the 1980s and 1990s when many Australian
’000

10 780
manufacturers closed down or moved offshore.

10 760
Trend
Seasonally adjusted
Learning activity 7.8
10 740 Employment
April July Oct Jan April
2008 2009
1 The government’s objective is to attain full
employment. What does this mean?
Figure 7.14 The number of employed persons declined in the first part of 2009.
2 Are all people who are not employed, unemployed?
Explain.
Unemployment
3 Examine the following situations and comment
According to the Australian Bureau of Statistics, to on whether the person is officially unemployed
be considered unemployed you must be aged 15 and
according to the Australian Bureau of Statistics.
over, you must not be employed, you must be available
a Rob works two hours a week at Hungry Jack’s.
to start work and you must be actively seeking work.
b Jim does not have a job but he is looking for
This involves such things as applying to prospective
employers, answering job advertisements, cold-calling, work on the Internet.
using Centrelink touch screens and other job-seeking c Instead of working, Van stays at home to raise
methods. his children.

Just because you are not employed, it does not mean 4 Using the information on the following page and
you are unemployed. Not everyone who is ‘not working’ is information you can gain from the Internet, make up
unemployed. Consider retired people, domestic partners, a scenario about a person who has lost his job and
students, people with injuries and illnesses and those who the consequences suffered as a result. This can be
choose not to work for other reasons. completed in groups or individually.

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 Page Part Economics and
148 3 the economy

Consequences of unemployment

Personal effects
■ poverty
■ loss of self-esteem
■ reduced standard of living
■ de-skilling
■ lack of motivation
■ illness
■ drug and alcohol addiction
■ depression
■ sense of worthlessness

Figure 7.15 Unemployment can lead to poverty.

Economic effects
■ loss of production
■ cost of unemployment benefits
■ cost of employment programs
■ cost of crime and other social issues

Figure 7.16 Unemployment can lead to a loss of production.

Social effects
■ family breakdowns
■ social isolation
■ social inequalities
■ rejection
■ increased crime rates
■ withdrawal from society
■ detachment and alienation

Figure 7.17 Unemployment can lead to increased

crime rates.

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