13 Our economy ‘Interest rates to rise’; ‘The Australian dollar steady’; ‘Unemployment rising’; ‘Consumer spending falling’; ‘Inflation rate at ten year low’. Stories with headlines such as these regularly appear in our media. You could be forgiven for thinking that such issues have very little impact on your lifestyle. However, whether you can find a job, afford to buy a car, take an overseas holiday or obtain a loan depends on events in the economy. The ‘health’ of the economy affects us all. focus On completion of this chapter, you will have learned to assess changes in our economy, how these changes relate to existing trends in the economic cycle, and to explain the implications of these changes for consumers and businesses. outcomes A student can: 5.4 Analyse key factors affecting commercial and legal decisions 5.5 Evaluate options for solving commercial and legal problems and issues 5.7 Research and assess commercial and legal information using a variety of sources 5.8 Explain commercial and legal information using a variety of forms 5.9 Work independently and collaboratively to meet individual and collective goals within specified timelines.
Transcript
13Our economy
‘Interest rates to rise’; ‘The Australian dollar steady’; ‘Unemployment rising’; ‘Consumer spending falling’; ‘Inflation rate at ten year low’. Stories with headlines such as these regularly appear in our media. You could be forgiven for thinking that such issues have very little impact on your lifestyle. However, whether you can find a job, afford to buy a car, take an overseas holiday or obtain a loan depends on events in the economy. The ‘health’ of the economy affects us all.
focusOn completion of this chapter, you will have learned to assess changes in our economy, how these changes relate to existing trends in the economic cycle, and to explain the implications of these changes for consumers and businesses.
outcomesA student can:5.4 Analyse key factors affecting commercial and legal decisions5.5 Evaluate options for solving commercial and legal problems and issues5.7 Research and assess commercial and legal information using a variety
of sources5.8 Explain commercial and legal information using a variety of forms5.9 Work independently and collaboratively to meet individual and
collective goals within specified timelines.
glossaryappreciation: an upward movement of the Australian dollar
(or any currency) against another currencybalance of trade: the difference between the money
received by a country when exporting goods/services and the money paid to other countries when importing goods/services. If more is imported than exported, there is a negative balance of trade
business cycle: the cyclical fluctuations in the level of economic activity that an economy goes through over time
Consumer Price Index (CPI): measures quarterly changes in retail prices of about 80 000 goods and services purchased by most consumers. It is used as an indicator of Australia’s inflation rate
default: the inability to repay borrowed moneydepreciation: a downward movement of the Australian
dollar (or any currency) against another currencydepression: a severe contraction in the level of economic
activity resulting in many business failures, high and sustained levels of unemployment and sometimes
falling pricesfinancial institutions: those organisations
such as banks, credit unions, insurance companies and
managed funds which borrow some money
from households and business firms and
lend it to others
foreign debt: the amount of money a country has borrowed from overseas sources
foreign exchange earnings: money from other countries that flows back into a domestic economy
foreign exchange (forex or fx) market: this market determines the price of one currency relative to another
foreign exchange rate: the ratio of one currency to another; it tells how much a unit of one currency is worth in terms of another
inflation: a general rise in prices, causing money to lose its value
interdependence: consumers, businesses or governments relying on other consumers, businesses or governments for assistance, i.e. being mutually dependent on each other
interest rate: the annual cost of borrowing credit or the annual return on invested savings; the price of money
purchasing power: the actual quantity of goods and services that may be bought with a given amount of money
real income: what an income will actually purchase in terms of the quantities of goods and services, after allowing for the effects of inflation
recession: a relatively mild contraction in the level of economic activity resulting in reduced spending, rising unemployment and a slow rate of economic growth
specialisation: when people perform one specific jobterm: the length of time allowed to repay a loan
New Concepts in Commerce270
13.1
Economic linksOne important feature of our modern commercialworld or economy is the high degree of special-isation that exists. This means that people per-form one specific job. You specialise as a mechanic,electrician, nurse, computer analyst and so on.
Specialisation has two main advantages. Thefirst is that more goods and services can be pro-duced in the economy. Secondly, consumers have agreater range of goods and services to choose from.
Because of specialisation, we rely on other people toproduce the goods and services we need and want.There is interdependence between individuals,between businesses and between individuals andbusinesses. Just think of all the people you have reliedon to provide you with all the goods and services youhave consumed in your lifetime. Consumers andbusinesses are also dependent on the government.
When a person is employed bya business, the employer relieson this person to provide labour.In return, the employee relies onthe business for income. Whenconsumers have some money,they will want to buy goods andservices. They will rely on theproducer to make the goods andservices they wish to purchase.The consumer will pay for thesegoods and services and the pro-ducer will supply them. Some ofthe income earned by theemployee will be taken out as atax payment. This money will bereceived by the government. Inreturn, the government will pro-vide a large range of goods andservices to satisfy society's col-lective wants. The consumerspay their taxes and the govern-ment provides goods and ser-vices.
As you can see, people in oureconomy rely on many otherpeople. The economy is anintricate web linking manypeople, satisfying our needsand wants so that we can livemore comfortably.
The flow of moneyMoney is the medium used toexchange goods and services. Ittherefore links the mainsectors within our economy:consumers, employers, busi-nesses and governments.
Economic links between Australian consumers, employers, businesses and governments
Goods and services
Income $
Labour
Spending $
Taxes
$
Taxes
$
(Collective)
Goods
and
services
(Infrastructure)
Goods
and
services
Our economy271
Money is constantly flowing throughout thewhole economy. It is what makes our economy func-tion. Oil is the lubricant that keeps your car enginerunning smoothly. In the same way, money is thelubricant that keeps our economic system working.Without money, we would have to go back to barter.This would result in fewer and weaker linksbetween the sectors and a lower standard of living.
Global trade linksOur economy is linked to the world economy viaexport sales, which generate foreign exchange earn-ings. Foreign exchange earnings are funds fromother countries that come into Australia as a resultof selling Australian goods and services (such aswheat, mineral ores, food products, motor vehicles,tourism and education) to overseas buyers. Becauseof this income, consumers, businesses and govern-ments can import and consume overseas-producedproducts such as computers, machinery, clothing,foodstuffs, music CDs and transport equipment.This helps raise our standard of living.
It is usually better for our economy when exportsales are greater than the amount of imports pur-chased. If imports are greater than exports, thiscreates a negative balance of trade, which canlead to foreign debt. Over time, foreign debt canbecome a serious economic problem.
Export trade — the link between the Australian economy and the world economy
Foreignexchange
Foreignexchange
ExportsImports
Worldmarkets
UNDERSTAND
1 Explain the meaning of the following words by using them in a sentence:(a) specialisation(b) interdependence(c) foreign exchange(d) foreign debt.
2 What is the government’s main role within our economy?
3 Prepare a list of ten people you have relied on today to satisfy some of your needs and wants. Indicate what goods or services they supplied for you. Alternatively, you may wish to use a word-processing package to create a table to record your answer.
4 Jacinta works at Hollywood Hire Video. She buys clothes from JD Fashions. The following diagram shows the interdependence (links) between Jacinta, her employer and JD Fashions. Look at the diagram and then complete the following tasks.
(a) Make a copy of the diagram in your notebook. Alternatively, you may wish to use a word-processing application to construct the diagram.
(b) Some of the words are missing. Select the correct ones from the following list to complete the diagram:
(i) provides labour(ii) pays for goods and services(iii) provides income(iv) supplies goods and services.
(c) If you think of this diagram as a ‘model’ of what happens in the real economy, explain the importance of money.
(d) Explain how using a diagram or model helps you to see more easily the links between different sectors in our economy.
5 Predict what would eventually happen if Australia continually bought more imports and sold fewer exports. Share your answer with the rest of the class.
COMMUNICATE
6 Examine the diagram on page 270. Explain how production, specialisation and exchange are interrelated or interdependent.
7 Draw a cartoon to show how money links the sectors in our economy.
8 Create a diagram to show the flow of money, goods and services within our economy and the world economy. You may wish to use desktop publishing software to present the diagram with text and graphics.
WORKSHEETS
13.1 Economic links — the circular flow of income model
Jacinta
(an employee)
JD Fashions
(a retail
business)
Hollywood
Video Hire
(an employer)
4. 1.
3. 2.
New Concepts in Commerce272
13.2
The business cycleImagine your local shopping centre to be a small-scale representation of the Australian economy. Nowimagine what would happen to the businesseswithin the shopping centre if all their customersdecided to shop at another centre for a day. Economicdisaster! If this situation continued for a month thenthe centre’s businesses would close, employeeswould be laid-off, and landlords and suppliers wouldnot be paid. Eventually, as the‘economy’ plunged into a recession,business owners would lose confidencein the economy’s future. However, atthe rival shopping centre, new busi-nesses would open, many new jobswould be created, landlords and sup-pliers would gain new customers andthe confidence of the local businessowners would soar. The ‘economy’ ofthis shopping centre would boom.
While such an extreme situationwould not happen in reality, the Aus-tralian economy does experience acycle of ‘booms’ and ‘busts’. Theseperiods of high and low economicactivity are referred to as the busi-ness cycle. After a period of pros-perity, business activity graduallyslows until a recession or depressionis reached. Eventually, business picksup again until prosperity is restored.This completes the cycle. These cyclesare a basic feature of our economicsystem.
No economic system works perfectlyall the time under all conditions, andthe Australian economy is no excep-tion. The level of economic activity
does not remain at a constant level. Instead, it fluc-tuates (moves up and down) over time. In otherwords, total production, incomes, spending andemployment rise and fall. The main cause of thefluctuations in the level of economic activity is thechange in the level of total spending — consumerspending (consumption), business spending (invest-ment) and government spending — within theeconomy.
The level of consumer spending plays a significant role in determining the level of economic activity.
Phases of the business cycle
Time
Contraction Expansion
Boom
Recession
Depression
Boom
Economic
growth
(output)
Contraction
Key features
• Falling levels of production
(output)
• Decreasing consumer spending
• Rate of inflation may fall
• Wage rates generally fall
• Interest rates eventually fall
• Level of unemployment rises
Expansion
Key features
• Rising levels of production
(output)
• Increasing consumer spending
• Rate of inflation may rise
• Wage rates generally rise
• Interest rates eventually rise
• Level of unemployment falls
Our economy273
The Great DepressionIn the United States of America especially, 1929appeared to be a golden year. Economic growthand affluence seemed to be entrenched. The UShad never been richer. There was a great rush tobuy shares in companies in order to profit from theexpanding business wealth.
But on 24 October 1929, the euphoria rapidlyevaporated. On ‘Black Thursday’, the New YorkStock Exchange saw share values begin to fallsharply. American factories now found it difficult tosell their goods. Employers were forced to reducewages and dismiss many workers. This meant morepeople had less money to spend, and so the wholeprocess accelerated. US household spending fellfrom $79 billion in 1929 to $46 billion in 1933.
As a result, US businesses cut back productionand investment. Business and consumer confidence
were shattered. Thousands of businesses weredeclared bankrupt. Mass unemployment was nowcommon. Lifetime savings were wiped out whenthousands of banks suspended operations. Farmerswere bankrupt. Families were evicted from theirhomes for not being able to meet their mortgagerepayments. And all the while, the unemploymentqueues grew longer. People who had worked hardall their lives, who had planned and saved for thefuture found themselves financially ruined.
As the US economy toppled, it dragged downother national economies. Like the ripples in apond, the effects of the Great Crash of Wall Streetsoon appeared to touch every country in the world.What began as a financial crisis of confidence in theUSA ended up as the Great Depression of the1930s.
Unemployed men queuing for soup and bread during the Great Depression
New Concepts in Commerce274
The fluctuations of the business cycle do not fallinto a regular pattern. The periods of expansion canvary from several months to several years. A contrac-tion need not result in a recession or a depression ifa recovery begins before the economy falls too far. Forexample, if the Reserve Bank of Australia (RBA)lowers interest rates, this should raise people’s con-fidence in the economy. This aims to encourage con-sumers and businesses to increase spending, whichhelps avoid a downward spiral to recession.
Sometimes there may be a downturn in only onekind of production, for example motor vehicles.However, because of the interdependent nature ofour economy, a change in any direction tends tospread. An increase in business activity can alsospread. An increase in the demand for goods andservices can force production and incomes to rise.
Recession — too little spendingRecessions (and depressions) are caused by lack ofspending, not the inability of the economy to producegoods and services.
Most goods and services are produced before theyare sold. The amount produced depends on howmuch the business thinks consumers, other busi-nesses and governments will buy, which in turn isinfluenced by the level of economic confidence.
By choosing to spend some of your money, yousend a signal to businesses to keep making the prod-ucts you buy. If, however, some products are notbought, the business may cut back on productionand some employees might lose their jobs andincomes. This causes total spending to fall even fur-ther as people’s confidence in the future is shaken.In this way, a recession spreads and economicgrowth is slowed. When a recession becomes wide-spread and long-lasting, it is called a depression.
The key features of a recession include thefollowing:• Income and production are at their lowest level.• Unemployment is at its highest level in the
business cycle.• Wages and salaries either fall or grow very
slowly.
• Consumer demand and, consequently, businesssales and profits, reach their lowest levels. Bank-ruptcies are everyday occurrences and the busi-ness outlook is bleak.
• Businesses have a lot of unused resources andthere is no incentive to purchase new machinery.
• Interest rates remain low. There are few invest-ment opportunities and a reduction in thenumber of creditworthy borrowers.
• The inflation rate tends to stay low.
Changes in Australian business confidence
Nov 1997 Jul 2003
–20
–10
0
10
20
30
Index
A depression is a severe recession.
Our economy275
Booms — too much spendingThe upside of the business cycle is growth and pros-perity. Production, spending and employment rise.Businesses expand, employees are hired and incomesincrease. Consequently, total spending increases evenmore. Consumer and business confidence are high.However, the economy cannot keep producing moregoods and services indefinitely. There is a limit. Whenthis happens, additional spending pushes up prices.Inflation, a general rise in prices, now becomes amajor economic problem and will eventually bring toan end the continued growth.
The key features of a boom include the following:• Income and production are at their highest levels.• There is full employment of labour and all other
resources.• Wages and salaries are relatively high. Employees
are now in a strong bargaining position asbusinesses compete for scarce labour resources.
• Businesses are operating at full capacity. Increasesin consumer demand are met by increases in pricesrather than by increases in production.
• Interest rates are high as loanable funds are inrelatively short supply.
• The rate of inflation rises sharply.
Confidence weakened but still high
For the first time in three years, consumer confidencedropped, due to the Reserve Bank’s decision to increase theofficial interest rate by 0.5 of a percentage point. TheWestpac-Melbourne Institute consumer sentiment index fellby 3 per cent this month but still remains high. Marc Ewan,chief economist for KP Securities, predicted that consumerspending and borrowing would fall by up to 1.5 per cent overthe next two months. A spokesperson for the RBA predictedfurther interest rate increases if inflation stayed high.
UNDERSTAND
1 What is one main cause of recession and depression?2 Total spending consists of spending by which three
groups (sectors)?3 What do you understand by the business cycle?4 Identify the main phases of the business cycle. Use
a diagram to illustrate your answer.5 If our economy grows rapidly, why should we be
concerned?6 Complete the following statements using the
words ‘down’ and ‘up’.(a) During times of recession, unemployment goes
, consumer spending goes , total output goes ,
interest rates go , inflation goes , wage rates go ,
and economic confidence goes .
(b) When the economy is growing rapidly, unemployment goes , consumer spending goes , total output goes
, interest rates go , inflation goes , wage rates go
, and economic confidence goes .
7 Describe the general impact of the fluctuation in the business cycle on:(a) businesses(b) consumers. You may wish to prepare this as a PowerPoint presentation.
E-LEARNING
8 Examine the business cycle for the Australian economy since the late 1950s. (a) Which economic condition is more common,
expansion or contraction?(b) During the 1950s and 1960s, Australia was
referred to as the ‘Lucky Country’. What evidence is there to support such a claim?
To help you, go to www.jaconline.com.au/commerce, choose weblinks and click on the RBA link for this textbook.
INVESTIGATE
9 Prepare a one-page report on living conditions in Australia or the USA during the Great Depression. You may wish to use a word processing package to write the report. In your report, refer to:• the number of people unemployed• effects of unemployment on the individual.
WORKSHEETS
13.2 The ‘ups’ and ‘downs’ of economic growth13.3 Current economic conditions
Interest ratesSaving and borrowingIn society, there are people who have spare money(surplus funds) that they usually save with afinancial institution. When they allow their sav-ings to be used by a financial institution, theyexpect something in return. The interest rate onmoney deposited is the price financial institutionsmust pay for the use of this money. Alternatively,there are people with not enough money (deficitfunds) who need to borrow from financial insti-tutions. They, too, must pay a price for the use ofthis money. The interest rate on loans (borrowings)represents the price. Financial institutions make aprofit by charging a higher rate to borrowers thanthey pay to depositors.
Short-term and long-term interest ratesInterest rates can be classified as either short-termor long-term. For example, you can take out a homeloan with the interest rate fixed for 20 years. Thisis considered a long-term interest rate. You makethe same payments over these years, regardless ofwhether interest rates rise or fall. Alternatively,when you use your credit card or take out a per-sonal loan you are borrowing money at an interestrate that can change in the short term. As a generalrule, short-term interest rates tend to be higherthan long-term interest rates, as shown in thisNational Australia Bank advertisement.
The interest rate charged is always expressed as a percentage; for example, 8 per cent per annum. This means a charge of 8 cents for each dollar borrowed over a year.
Home and personal loan interest rates
National Australian BankIndicator Rates — Personal
• TAILORED HOME LOANSOwner Occupied/Residential InvestmentVariable Rate Eff.10/11/03 6.82%PA
Fixed Rate 1 yr 6.30%PA 4 yrs 6.99%PA
Eff. 10/11/03 2 yrs 6.75%PA 5 yrs 7.20%PA
3 yrs 6.75%PA 10 yrs 7.70%PA
National Base Variable Rate Home Loan(Owner occupied/residential investment) Eff. 10/11/03 6.32%PA
National Tailored Home Loan Package Rates(Fixed for 6 months – 5 years, then variable rate applies)Eff. 10/11/03 Fixed for 6 months 5.54%PA
Fixed for 1 year 5.74%PA
Fixed for 2 years 6.75%PA3, 4 & 5 year terms available at above Tailored Home Loan fixed rates.
Homeowner’s Package Home LoanVariable Rate Eff.10/11/03 6.36%PA(No Longer For Sale)
• TAILORED PERSONAL LOANSEff. 10/11/03 Variable Rate Fixed Rate#1 Fully Secured 9.55%PA 11.00%PA(owner occ. 1st Residential mortgage or term deposit)Eff. 17/09/01 #2 #3 #4 are discontinued from sale#2 Fully Secured other security 13.05%PA
#3 Partly Secured 13.80%PA
#4 Unsecured 14.80%PA
#5 Variable Rate Unsecured (Tiered) Eff. 10/11/03
$5,000–$9,99913.05%PA
(Rate 11, 12, 13)
$10,000–$19,99910.75%PA
(Rate 21, 22, 23)
$20,000+10.15%PA
(Rate 31, 32, 33)
1–5 YRS
#6 Fixed Rate Unsecured (Tiered)
$5,000–$9,99912.80%PA
$10,000+11.50%PA
1–5 YRS
How financial institutions make a profit
Our economy277
The interest rate received by savers also variesaccording to how long the money is deposited for. Asa general rule, long-term interest rates tend to behigher than short-term interest rates, as shown inthis HMC advertisement.
Fixed and variable interest ratesOnce you have decided how much you want toborrow, you can select one of two main rates ofinterest for your loan.1. Fixed interest rate — the interest rate is set
(fixed) for the entire term of the loan. The mainadvantages are:• protection from unexpected interest rate increases• predictable payments, which make it easier to
budget.The main disadvantages are:• you cannot take advantage of a fall in interest
rates• an early payout penalty if you want to clear
the loan before the fixed term has expired.2. Variable interest rate — the interest rate moves
up or down over the term of the loan. The mainadvantages are:• if interest rates fall, your repayments reduce
Analyse a tableExamine the NAB advertisement on page 276 then answer the questions.(a) What is the variable home loan rate for owner
occupied/residential investment? (b) What is the fixed home loan rate for owner
occupied/residential investment for ten years?(c) Which is larger, the fully secured variable or fixed
personal loan rate?
Hometown BankTerm Deposit Rates
Interest rates subject to changeat anytime without notice
Short-term and long-term interest rates for term deposits and managed funds
UNDERSTAND
1 What is meant by the terms ‘surplus funds’ and ‘deficit funds’?
2 Explain the difference between fixed and variable interest rates.
3 List the advantages and disadvantages of fixed and variable interest rates.
4 Why is the interest rate often referred to as the ‘price of money’?
5 If you borrow $10 000 for one year at 7 per cent per annum, how much do you pay in interest?
COMMUNICATE
6 In groups of three or four, decide whether you would prefer a fixed or variable interest rate if you were taking out a $250 000 home loan. Give reasons for your selection. Choose a spokesperson to share the group’s comments with the rest of the class.
7 Using newspapers and magazines, make a collage that shows a range of interest rates from a variety of sources.
INVESTIGATE
8 Assume you have $1000 in a Commonwealth Keycard account and you owe $500 on your Commonwealth BankCard. What interest are you:(a) earning on your savings?(b) paying on your credit card?To help you, go to www.jaconline.com.au/commerce, select weblinks and click on the Commonwealth Bank link for this textbook.
WORKSHEETS
13.4 Interest rates — comparing the banks
• you can shorten the term of your loan if youmaintain the higher repayment
• additional repayments can be made withoutpenalty.
The main disadvantages are:• if interest rates increase, your repayments
will rise • you may be forced to increase your repay-
ments if the loan cannot be paid back withinthe agreed term.
Most financial institutions also offer:• Combination loan — the interest is fixed for
an initial period, usually up to 10 years, thenreverts to a variable rate.
• Split loan — where part of your loan is fixedand the remaining portion is variable. Forexample, imagine you borrow $150 000. Youmay decide to fix $100 000 over seven years andleave the remaining $50 000 at a variable rate.
By using either of these methods, you can try toprotect (hedge) against rising interest rates.
One factor that influences the level of interest ratesis the actions of the Reserve Bank of Australia(RBA). In trying to avoid massive swings in the busi-ness cycle, the RBA will adjust short-term interestrates. It raises interest rates to slow down aneconomy that is expanding too rapidly and lowersthem when the economy is heading for a recession.
Rising and falling interest rates will directly affectconsumer and personal financial decisions. Risinginterest rates make saving relatively more attractiveand borrowing relatively more expensive. Fallinginterest rates have the opposite effect. Consequently,the effect of an interest rate rise or fall will dependon whether you are a saver or a borrower.
A rise or fall in interest rates affects consumers and personal finance decision making.
The repayment of debtThe level of interest rates has a direct effect on a con-sumer’s ability to repay a loan. For example, wheninterest rates are low, people are willing to borrow
‘This is good news. Our superannuation fund will
make a better return.’
‘I think we should sell some of our shares and put the
money into a term deposit.’
because they find it relatively easy to repay theirdebt. When interest rates are high, people are reluc-tant to borrow because repayments on loans costmore. Some consumers may even find it difficult tomeet their existing loan repayments, especially ifinterest rates increase faster than the rise in aconsumer’s income. If interest rates rise sharply andstay high for a long period, some consumers willdefault on their loans.
The choice of fixed or variable interest ratesWhen interest rates continually rise, you can pro-tect yourself from having to make larger repay-ments by taking out a fixed loan. Conversely, wheninterest rates fall, your repayments will be lower ifyou select a variable interest rate loan. The diffi-culty you and all consumers face is trying to accu-
rately predict whether interest rates willincrease or decrease in the future.
The choice of a personal investment strategyWhen you invest, you want to achieve thehighest return for the most acceptablerisk. Therefore, there will be timeswhen you will switch from one invest-ment product to another. The level ofinterest rates will be one factor you willtake into account when selecting an
investment product. For example, wheninterest rates rise, demand for housing
slows and prices fall. At the same time, savingmoney in a financial institution becomes moreattractive. If you expect this situation to continuefor some time, you may move out of property andplace your money in a term deposit. Alternatively,you might decide to sell some shares because aterm deposit offers a better return for much lessrisk. When interest rates are falling, you maydecide on the opposite course of action.
RBA figures estimate that, in 2004, household debt represented 135 per cent of disposable income. Total consumer debt reached $512 billion.
‘This is bad news. We won’t be able to afford a
home loan.’
Our economy279
UNDERSTAND
1 Why do interest rates vary over time?2 ‘Interest rates are both a reward and a cost.’ Explain
this statement.3 Imagine you are a financial adviser. Write a reply to the
following letter. You may wish to use a word-processing package to write the reply.
4 What benefits or problems are created for people in the following situations when interest rates rise?(a) A small business with a large, variable short-term
loan.(b) A young person with a small, fixed personal loan.(c) A retiree with money invested in a managed fund
with daily fluctuations in rates.(d) A young couple with a mortgage where the
interest rate has been fixed for five years.(e) A middle-aged couple with a mortgage where the
interest rate is variable.
INVESTIGATE
Interpret a table
Use the information contained in the home loan repayment schedule above to answer the following.5 You have just bought your dream home with a
$180 000 loan from a bank. Calculate the fortnightly payments required if:(a) the interest rate is 8 per cent and the loan is for
25 years(b) you wish to repay your loan, which has a rate of
6 per cent, in ten years.6 Imagine you decide to repay your $180 000 loan over
30 years.(a) Your initial interest rate is 9 per cent. Calculate
your monthly repayment.(b) The bank announces a 1 per cent increase in
interest rates. Calculate the new monthly repayment.
(c) If interest rates increase to 12 per cent, calculate how much more you would need to meet your repayments.
7 Calculate the total repayments if you borrow $100 000 over (a) five years and (b) 20 years.
E-LEARNING
8 Banks provide a range of online loan calculators designed to help you make budget decisions before applying for a loan. Use one of these calculators to determine the repayments if you borrow:(a) $150 000 over 15 years(b) $210 000 over 10 years(c) $75 000 over 10 years.To help you, go to www.jaconline.com.au/commerce, choose weblinks and click on the Commonwealth Bank link for this textbook.
Home loan repayment schedule — ANZ First Home Buyers Guide
To calculate home loan repayments using the table, look at the term you want the loan for and at the appropriateinterest rate. Find the figure where the two meet. Multiply this figure by the number of thousands you would like toborrow. This will give you the amount of the fortnightly repayments on the loan.
For example: $100 000 loan at 8% p.a. over 25 years = 100 × 3.5602 = $356.02
Interest rate % p.a. 5 years 10 years 15 years 20 years 25 years 30 years
5% 8.7012 4.8911 3.6471 3.0440 2.6966 2.4764
6% 8.9126 5.1190 3.8915 3.3043 2.9720 2.7658
7% 9.1271 5.3531 4.1448 3.5757 3.2602 3.0692
8% 9.3447 5.5932 4.4066 3.8577 3.5602 3.3852
9% 9.5655 5.8393 4.6768 4.1496 3.8711 3.7122
10% 9.7895 6.0913 4.9549 4.4508 4.1919 4.0489
11% 10.0165 6.3491 5.2408 4.7607 4.5215 4.3940
12% 10.2466 6.6126 5.5339 5.0787 4.8590 4.7461
Home loan repayment scheduleThis table shows how much youcan expect to pay per fortnight,for the amount you intend toborrow.
The table assumes no bankfees or government charges areincurred, interest rates remainunchanged for the full term of theloan, and repayments are madeon time.
InflationConsumer pricesHave you ever heard your parents say that thingswere a lot cheaper ‘when they were young’? Or yourgrandparents telling you that when they were yourage they could go the movies for sixpence (fivecents), and that included an ice-cream!
Money’s true value is its purchasing power —what it will buy. We work to earn money to give usthis purchasing power. However, the money in yourwallet or purse today will buy much less than it didwhen your parents or grandparents were teenagers.Wouldn’t it be great if we could go to the moviesnow for five cents?
When there is a period of continually risingprices — inflation — the purchasing power of ourmoney decreases. This means more money isneeded to buy goods and services. In other words,each dollar buys less and the purchasing power ofmoney has fallen. For example, if prices double, adollar will purchase half as much as it did before.
Inflation cuts the value of the dollar.
Measuring inflationIn Australia, the main method of measuringinflation is by comparing changes in the ConsumerPrice Index (CPI). This figure is published quar-terly. It is constructed from statistics that measure
Holden sedan$2800 $30 000
A 3 br. house in St Ives, Sydney would have cost
$18 000$650 000
In 1970 Today
the prices of a wide range of goods and services con-sidered to represent the normal spending patternsof an average household. Items are grouped intocategories such as food, clothing, household equip-ment, tobacco and alcohol, and health expenditure.
The Consumer Price Index is only a guide to theaverage increases in prices. If the inflation rate issaid to be 3 per cent for the year, it does not meanthat all prices have increased by 3 per cent. Someitems may have increased by only 1 per cent, othersby 5 per cent. Some may have even decreased.
(a) What does this graph measure?(b) Describe the trend in inflation since the peak of
the 1970s.(c) Suggest a reason why the inflation rate rose
rapidly during the 1970s. (Hint: Recall what you learned about the business cycle.)
(d) The opposite of inflation is deflation. In what year did deflation occur?
1960–5
0
5
10
15
%
1970 1980
CPI*
1990 2000
*Excludes interest charges,
tax changes associated
with the new tax system
and effects of major health
policy changes.
Sources: ABS; RBA
Australia’s inflation rate
Hyperinflation occurs when inflation rates are extremely high. This occurred in Germany between 1919 and 1923. In 1923, 1 000 000 000 000 marks (the unit of German currency) had about the same purchasing power as 1 mark in 1914. Prices were rising so rapidly that money lost over half its value within an hour, and wages were paid every day. Some employees had to wheel their pay home in a wheelbarrow!
Our economy281
REMEMBER
1 Write the following statements in your notebook, deleting the incorrect term or phrase:(a) Money is used to measure the (variety/value) of
goods and services.(b) What we can buy with our money is called its
(purchasing/performance) power.(c) CPI stands for (Consumer Purchasing Index/
Consumer Price Index).(d) A general (increase/decrease) in (values/prices) is
termed ‘inflation’.(e) The CPI is published every (three months/four
months).(f) One group of people that suffers in times of
inflation is (fixed/variable) income earners.2 What determines the true value of money?3 During the past ten years, Abel’s wages have
increased from $300 a week to $600 a week, which represents an increase of 100 per cent. Abel says, however, that his real wages have increased only 50 per cent. Explain how both these statements can be true.
COMMUNICATE
4 In groups of three or four, determine whether in a period of inflation you would rather be a person who had borrowed money or one who had loaned it.
Select a spokesperson to present your group’s ideas to the rest of the class.
PARTICIPATE
5 As a class, discuss the topic ‘Inflation does not affect all income groups to the same extent. During periods of inflation there are winners and there are losers’. Make a list of the main discussion points on the board.
E-LEARNING
6 Find out what items are included in the CPI. To help you, go to www.jaconline.com.au/commerce, choose weblinks and click onto the ABS link for this textbook. You may wish to prepare this as a PowerPoint presentation.
7 Using your library and the Internet, research countries that experienced hyperinflation during the last 50 years.
Effects of inflationInflation has serious consequences for all sectors ofthe economy. As well, some people suffer more intimes of inflation than others. For example:1. Wage rates. For workers whose main incomes do
not keep up with rising prices, their realincome decreases. Consequently, in spite ofhaving higher incomes, their living standards donot improve. Only the few, whose wage rates risefaster than prices, because their jobs are indemand or have strong trade unions, are able toimprove their standard of living.
2. Fixed incomes. People on fixed incomes, such associal welfare recipients or retirees with super-annuation, find their incomes increase slowly.Their standard of living may fall because theyare no longer able to afford the same level ofgoods and services.
3. Business profits. Inflation creates uncertainty.People do not know whether to spend or save. Somebusinesses may sell less while others may sellmore. Should businesses expand now and be readyfor the future or should they reduce production?
If the Reserve Bank increases interest rates tocontrol inflation, businesses may be reluctant toborrow and shelve plans for expansion. Ulti-mately, this may result in a recession and busi-ness profits will fall even further.
4. Savers and investors. Inflation makes it difficultto maintain financial security. This is because, ifthe CPI increases by 8 per cent in a year, butaverage interest rates paid on deposits are only5 per cent, the money in savings accounts,superannuation funds and managed fundsdecreases in value. If inflation is expected toremain high, saving may be discouraged.
Exchange ratesCountries have their own currency, which they usefor domestic purposes. This means that when trans-actions are conducted on a global scale, one cur-rency must be converted to another. For example, ifyou want to buy a computer software program yousaw advertised on the Internet from a business inthe USA, the US business will want to be paid inUS dollars not Australian dollars. Similarly, if anAmerican tourist visits Australia, he or she will payfor accommodation, restaurant meals and otherproducts in Australian dollars, not US dollars.Therefore, in all global transactions it is necessaryto convert one currency into another. This trans-action is performed through the foreign exchangemarket, commonly abbreviated to forex or fx,which determines the price of one currency relativeto another.
Exchange ratesForeign exchangedealers around theworld are constantlybuying and sellingeach other’s cur-rency. In this way,the price or value ofeach country’s cur-rency is established.This value or price iscalled the exchangerate.
The foreign exchange rate is the ratio of onecurrency to another; it tells how much a unit of onecurrency is worth in terms of another. For example, ifA$1 = US$0.70, that means one Australian dollar isworth 70 US cents. Conversely, one US dollar wouldbe worth A$1.43 (US$1 divided by A$0.70 = A$1.43).
Effects of exchange rate fluctuationsExchange rates fluctuate over time due to variationsin demand and supply.
Such fluctuations in the exchange rate have posi-tive and negative effects on Australian consumers
The worldwide volume of foreign exchange trading is estimated at US$1.3 trillion per day — that is, US$1 300 000 000 000!
and businesses. For example, suppose that thevalue of the Australian dollar falls from US$0.70 toUS$0.60. This downward movement of one cur-rency against another is called a depreciation. (Ofcourse, this means that the value of the US dollarhas increased against the Australian dollar, withone US dollar being worth A$1.66.)
Australian dollar fluctuations 1985 to 2003
The impact of this currency fluctuation is twofold: 1. A depreciation lowers the value of the Aus-
tralian dollar in terms of foreign currencies.This means that each unit of foreign currencybuys more Australian dollars. However, oneAustralian dollar buys less foreign currency.Therefore, a depreciation makes our exportscheaper on international markets but prices forimports will rise.
0.60
0.70
0.80
0.90
1.00
1.10
0.50
0.40
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
30
40
50
60
70
80
Australian dollar and TWI
monthly
Key:
TWI
US$
The value of the Australian dollar against a collection of currencies
from Australia’s major trading partners (Trade Weighted Index)
The value of one Australian dollar against the US dollar
US$
Source: RBA
In 1983, Australia floated the Australian dollar. This meant that the market forces of demand and supply set the value of the Australian dollar. Prior to 1983, the exchange rate for the Australian dollar was set by the government.
The foreign exchange rate determines the ratio of one currency against another.
Our economy283
UNDERSTAND
1 What is meant by the term ‘exchange rate’?2 Write out the following exchange rates as sentences.
(a) A$1 = US$0.85(b) A$1 = US$0.70(c) A$1 = US$0.63(d) A$1 = US$0.52 Do the rates (a) to (d), when taken sequentially, show the Australian dollar depreciating or appreciating?
3 Calculate the value in Australian dollars of one US dollar for each of the rates in the previous question.
4 Examine the graph of the Australian dollar fluctuations on page 282. Describe the exchange rate trend of the Australian dollar against the US dollar from 1997 to 2003.
5 What effect do (a) depreciation and (b) appreciation have on the price of exports and imports?
6 Using the following table of Australian dollar conversions, calculate the value of the transactions listed below.
(a) Karen is visiting a friend in the USA and she wants to change A$1000 she has saved for her trip. How many US$ will Karen receive?
(b) Alicia wants to buy a Japanese kimono she has seen advertised on the Internet. The kimono is priced at Y7000 (7000 yen). What will the kimono cost in Australian dollars?
(c) Marshall received a dividend of NZ$1200 from a New Zealand company in which he owns shares. How much is the dividend in Australian dollars?
COMMUNICATE
7 In groups of three or four, explain the possible impact of currency fluctuations on Australian businesses and consumers. Select a spokesperson to present your group’s ideas to the rest of the class.
8 In groups of three or four, predict what would happen if a domestic firm borrowed US$5 million offshore just before a massive depreciation of the Australian dollar against the US dollar. You may wish to prepare this as a PowerPoint presentation. Include graphics to enhance the presentation of information.
INVESTIGATE
9 Forex rates can be found in the business sections of most daily newspapers. Access this information and record the value of the Australian dollar against five other currencies over a three-week period. Comment on the trend.
WORKSHEETS
13.5 Topic test — our economy
Currency Exchange rate (A$)
US$
Yen
NZ$
0.72
74.0
1.16
Depreciation, therefore, improves the inter-national competitiveness of Australian exportingbusinesses, which in turn affects profitability.However, imported goods, overseas travel andforeign shares and invest-ments will cost more, soAustralian consumers areworse off.
2. A currency appreciationhas the opposite impact. Anappreciation raises the priceof Australian dollars in termsof foreign currencies. There-fore, each unit of foreign cur-rency buys fewer Australiandollars. The result is that ourexports become more expen-sive and the price of importsfalls.
An appreciation, there-fore, reduces the inter-national competitiveness ofAustralian exporting busi-nesses, which in turn affects
profitability. However, imported goods, overseastravel and foreign shares and investments willcost less, so Australian consumers are betteroff.
