The Objectives of Economic Management (HSC SSCE Economics): Revision Notes
The Objectives of Economic Management
Introduction
When governments manage their economies, they must first establish clear economic objectives. These priorities can shift over time depending on economic conditions and political considerations. Economists traditionally group these objectives into three broad categories:
- Economic growth – increasing the production of goods and services
- Internal balance – achieving price stability (low inflation) and full employment
- External balance – maintaining sustainable levels of the current account deficit, foreign liabilities and exchange rate
Understanding these objectives is essential for analysing how governments make policy decisions and evaluate economic performance.
Economic growth and wellbeing
What is economic growth?
Economic growth represents an increase in the total volume of goods and services an economy produces. We measure it using the annual rate of change in real GDP – the percentage increase in the value of goods and services produced over one year, adjusted for inflation.
Real GDP adjustment is crucial because it removes the effect of price changes, allowing us to see whether the economy is actually producing more output rather than simply experiencing higher prices.
Benefits of economic growth
Economic growth delivers several important benefits to a nation:
Higher living standards – When an economy produces more goods and services, more material wants can be satisfied, raising the average standard of living for the population.
Improved employment prospects – Economic growth typically creates more jobs, improving opportunities for the labour force to find work.
Greater government revenue – As the economy grows, tax revenues increase. This provides governments with more resources to invest in public infrastructure and services such as education, healthcare and transport.
Quality of life
Economic growth also contributes to overall quality of life (or wellbeing). Quality of life refers to the overall wellbeing of individuals within a country according to their material living standards and a range of other indicators, such as education levels, environmental quality and health standards.
When an economy grows, more resources become available for important contributors to quality of life beyond just material consumption – including healthcare systems, educational opportunities and environmental protection programs. This broader perspective recognises that wellbeing involves more than just GDP per capita.
Full employment
Understanding full employment
Full employment involves making complete use of all economic resources (land, labour, capital and enterprise). However, economists typically focus on the full employment of labour resources, since underutilised labour means some people are unemployed, creating significant economic and social problems.
Full employment does not mean zero unemployment. Instead, it refers to an economy operating at its non-accelerating inflation rate of unemployment (NAIRU), also called the natural rate of unemployment.
The NAIRU concept
The NAIRU reflects the reality that some level of unemployment will always exist in an economy, even when it's performing well. This occurs because there will always be:
- Frictional unemployment – people between jobs
- Seasonal unemployment – workers in seasonal industries during off-peak periods
- Structural unemployment – workers whose skills don't match available jobs
- Hard-core unemployment – people facing barriers to employment
The natural rate of unemployment is the level that remains after eliminating cyclical unemployment – unemployment caused by the upturns and downturns of the economic cycle. Unlike cyclical unemployment (caused by insufficient demand), the NAIRU results from supply-side factors in the labour market.
Achieving full employment
Governments can reduce unemployment to its non-accelerating inflation rate through successful macroeconomic policies (policies affecting overall demand in the economy). They may also use microeconomic policies (policies targeting specific markets or industries) to reduce the NAIRU over the longer term by improving labour market efficiency.
Benefits of full employment
Minimising unemployment delivers important benefits:
Maximises productive capacity – Full employment means the economy is fully utilising its current capacity to produce goods and services, thereby increasing living standards.
Reduces social and economic costs – High unemployment creates personal and family problems, leads to loss of workforce skills, and increases inequality. Achieving full employment minimises these adverse effects.
Price stability
What is price stability?
Price stability means keeping inflation (the sustained increase in the general price level) at an acceptable level. This doesn't mean eliminating inflation completely – rather, governments aim to maintain inflation at a level that causes minimal economic distortion.
In Australia, the Government and Reserve Bank target an average inflation rate of 2–3% over the business cycle. This target recognises that some inflation is normal in a growing economy, but excessive inflation creates significant problems.
Historical context
High inflation was a major problem for advanced economies during the 1970s and 1980s. From the 1990s until 2022, inflation remained at relatively low levels in most developed countries. However, inflation surged again in 2022-2023, making price stability a renewed priority for policymakers.
Problems caused by high inflation
High inflation creates several economic problems that governments must address:
Erosion of real values – Inflation reduces the real (purchasing power) value of income and wealth, particularly hurting those on fixed incomes or with savings.
Loss of competitiveness – Rising domestic costs of production make exports more expensive and less competitive in international markets.
Exchange rate depreciation – High inflation often leads to currency depreciation, which can further fuel inflation through higher import prices.
Economic uncertainty – Inflation creates uncertainty about future costs, making it harder for businesses and households to make sound economic decisions.
Resource misallocation – High inflation distorts the pattern of resource allocation by encouraging speculation in relatively unproductive assets (like property) and discouraging savings and productive investment that contribute to higher output.
External stability
What is external stability?
External stability (also called external balance) involves a country meeting its long-term financial obligations to the rest of the world, ensuring that external accounts don't hinder internal economic goals such as higher growth and lower inflation.
Australia has historically run large external imbalances, though during recent decades this has not been a major concern. Nevertheless, improving external stability remains a policy goal because lower external imbalance reduces vulnerability to adverse developments in the global economy.
Measures of external stability
Economists use several indicators to assess external stability:
Current account balance – Achieving a sustainable position on the current account of the balance of payments is crucial. The current account shows receipts and payments for trade in goods and services, plus primary and secondary income flows between Australia and the rest of the world. These are non-reversible transactions.
Over the long term, a sustainable current account means balancing payments for imports and other income payments with receipts from exports and other income.
Net foreign debt as % of GDP – Foreign debt should be kept at a level where the economy can afford interest payments. This is often measured using the debt-servicing ratio – the percentage of export revenue spent on making interest payments on foreign debt.
Terms of trade – This reflects the relative prices of Australia's exports and imports. An improvement in the terms of trade enhances external stability because Australia can buy more imports with a given quantity of exports.
Exchange rate – In the short term, the exchange rate measures international confidence in the Australian economy. High volatility in the exchange rate may indicate a lack of external stability.
International competitiveness – Improving Australia's international competitiveness is the best way to maintain external stability over time. More competitive exports help generate the foreign income needed to meet external obligations.
The balance of payments is the overall record of transactions between Australia and the rest of the world during a given period, consisting of the current account and the capital and financial account.
An equitable distribution of income and wealth
The role of government
An important government policy objective is creating a fairer distribution of income and wealth in the economy. Governments recognise that when free markets operate without intervention, they often produce unfair outcomes because some individuals and groups have fewer opportunities than others.
Governments don't aim to eliminate all inequalities between individuals – some income differences reflect different skills, effort and productivity. However, there is widespread agreement that societies should provide for people who cannot provide for themselves.
Addressing inequality
Government policies target several groups requiring support:
Those unable to work – Aged persons, people with disabilities or illnesses, and those unable to find employment need government support to maintain basic living standards.
Reducing income gaps – Governments use redistribution policies to reduce some of the gap between higher and lower income earners:
- Progressive taxation (higher tax rates for high income earners)
- Social security payments for lower income earners, especially families
- Subsidised or free services (healthcare, education)
Improving opportunities – To prevent poverty and social disadvantage passing between generations, governments aim to improve opportunities for all Australians to achieve their potential. This includes ensuring access to quality education and other opportunities regardless of family background.
Policy mix – Specific redistributive policies work alongside macroeconomic policies (to increase growth, reduce inflation and lower unemployment) to address inequality comprehensively.
Environmental sustainability
Economic activity and the environment
Economic activity often creates negative side effects (externalities) such as pollution and depletion of natural resources. As economies pursue growth and other objectives, these environmental costs can become significant.
To address environmental problems, governments establish specific environmental objectives, such as:
- Reducing greenhouse gas emissions
- Improving energy efficiency
- Reducing use of old-growth forests for timber
- Minimising waste and pollution
Government environmental programs
Environmental objectives form part of the government's overall economic management framework. Commonwealth and State governments spend substantial amounts on environmental programs to achieve these objectives.
The shift toward sustainability
Traditionally, governments have been willing to trade off some longer-term environmental objectives for the benefits of increased economic activity in the short term. For example, governments might approve mining projects despite environmental concerns because of the jobs and tax revenue they generate.
However, with growing recognition of the serious impacts of economic activity on climate change, ecologically sustainable development has become an increasingly important economic objective.
Ecologically sustainable development involves conserving and enhancing the community's resources so that ecological processes and quality of life are maintained. This approach recognises that environmental degradation ultimately undermines long-term economic prosperity.
Remember!
Key Points to Remember:
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Economic growth is measured by the annual rate of change in real GDP and delivers higher living standards, better employment prospects, and increased government revenue for public services.
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Full employment doesn't mean zero unemployment – it means reaching the NAIRU, where only frictional, seasonal, structural and hard-core unemployment remain, with no cyclical unemployment.
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Price stability targets inflation at 2–3% in Australia. High inflation erodes real incomes, reduces competitiveness, creates uncertainty and distorts resource allocation.
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External stability involves meeting long-term financial obligations to the rest of the world, measured through the current account, foreign debt levels, terms of trade, exchange rate and international competitiveness.
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Equitable distribution policies aim to support those who cannot provide for themselves, reduce income gaps through progressive taxation and welfare, and improve opportunities through education and other programs.
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Environmental sustainability has become increasingly important, with ecologically sustainable development now recognised as essential for long-term economic prosperity.