The nature and purpose of macroeconomic activity
Macroeconomic activity can be defined as the production, income and expenditure that takes place across the whole economy. Production refers to the total value of goods and services that are produced in an economy. Income refers to the total incomes that have been earned by those who have contributed to the production of those goods and services and expenditure refers to the total spending undertaken on the goods and services being produced.
This cycle of production, income and expenditure occurs because it provides a means by which economic prosperity and living standards can be advanced for people in society. However, living standards can be measured in both material and non-material terms.
Material living standards relate to the physical enjoyment that people derive from the use of goods and services that are provided in the economy. This is most commonly measured by the level of (and changes in) real GDP per capita (person). This involves dividing the total value of real production that has taken place in an economy over a period of time (i.e. real GDP) by the total population. It provides a rough guide as to the average income or spending power (or share of production) enjoyed by Australians.
Non material living standards refer to the range of factors that affect our quality of life, with the exception of those factors that are commonly measured in material terms (e.g. real GDP per capita or average household wealth). It includes factors like air quality, exposure to crime, freedom of expression, access to natural resources and mental health.
When devising policies, governments are increasingly placing emphasis on non-material factors that impact on our quality of life. This can be seen in the growing emphasis on sustainable economic development (such as recent efforts to find renewable forms of energy), conservation of the natural environment and efforts to combat the mental illnesses, such as depression. The focus on sustainable development, in particular, reflects a greater concern for long term (economic) prosperity of Australians and a greater awareness of the need to ensure that the nation's resources are used in an inter-temporally efficient manner.
Over time, the total value of production, income and expenditure in an economy should be equal. This should make sense because all of the production taking place is measured in monetary terms and must eventually be returned to factors of production (such as workers and owners) in the form of income. In other words, those who provide the factors of production receive payment for those factors when they are used in the production process. All of this income will then eventually be spent (i.e. expenditure) at some time in the future. This spending will be on various goods and services (i.e. production). This process is often characterised by a simple circular flow diagram as shown to the right.
This circular flow is a little more complex in reality. This is because some of the income that is earned by economic agents is redirected away from expenditure on Australian production. These are often referred to as ‘leakages’ and are comprised of the following:
These leakages are not ‘lost’ to the circular flow of income in Australia because they are offset or balanced against ‘injections’ that contribute to spending on Australian production. These injections are comprised of the following:
You should notice that the leakages are very closely linked to injections. In the case of Savings and Investment, any income that is saved will ultimately be directed to financial institutions (such as banks) who will then lend the money to economic agents (such as households and businesses). It is then eventually spent in the economy, often in the form of Investment. This means that Savings detract from (or reduce) economic activity and Investment adds to economic activity.
In the case of Taxes and Government spending, any income that is taken by governments in tax will ultimately be spent in the economy over time. While this may not occur in the same year, the money will be injected back into the economy in the form of Government expenditure. This includes expenditure on infrastructure items such as roads, rail and ports, as well as expenditure on health and education.
In the case of imports and exports, any money leaving the Australian economy in the form of spending on foreign goods and services (i.e. imports) will be balanced to some extent by the money entering the Australian economy in the form of foreign spending on Australian goods and services (i.e. exports).
A more complex circular flow of income will include all three leakages and all three injections. This is summarised in the diagram below:
Over any period of time, if leakages exceed injections we would expect economic activity to be growing at a relatively slow pace. This is because the amount of money leaving the circular flow of income is greater than the amount of money entering the flow. For example, it could reflect an increase in Savings as households become uncertain about the economy (such as the period 2008-9 when Australia experienced a downturn) and a reduction in Investment as businesses too are uncertain. With more money leaking from the circular flow in the form of Savings and no corresponding increase in Investment, the rate of growth in economic activity must slow down. Similarly, if injections are greater than leakages over a given time period we would expect the pace of economic activity to quicken.