Question A (10 marks)

Discuss the importance of investment to the Australian economy and explain the factors that can influence the total amount of investment spending in Australia.

Attempt 1

Investment is a fundamental aspect of the Australian economy, it makes up 16-23% of Aggregate Expenditure, while simultaneously being the most volatile aspect of AE. Investment helps to fund our largest domestic industry, mining, and is a major driver of the movements in the business cycle.

As we approach the peak of the Business Cycle the RBA may feel the need to reduce economic activity as a whole, including Investment Spending, They do this via an increase in Interest Rates, increasing “the price of borrowed money”, thereby reducing Investment as borrowers must pay increased periodic repayments, on all existing debt, as well as any future debt that they might take on. The opportunity cost of a firm re-investing into itself is also increased as the prospective capital investment must out-earn the interest rate by a significant margin to make-up for how much riskier it is compared to it’s alternatives.

The current economic sentiment can also influence the total amount of investment spending, for example, low profitability, e.g. downturn, could hold back potentially profitable capital investment decisions, reducing planned investment as businesses expect more of the same until they see otherwise like in September 2017 to 2022 where despite historic interest rate lows, we saw below average levels of investment.

Feedback

Hi Zane

What you have done so far is pretty good. However, remember there are more than two influences on levels of business investment. I would deal with business expectations and low profitability as two separate factors. Low expectations e.g. business is expecting that high inflation may push the economy into an economy downturn as predicted by the International Monetary Fund and low profitability e.g. when firms hold low profits it means that they have less money to reinvest back into the firm.

What about government economic policy and risk?

Hope that helps.

Ms Davis

Investment is a fundamental aspect of the Australian economy, it makes up 16-23% of Aggregate Expenditure, while simultaneously being the most volatile aspect of AE. Investment helps to fund our largest domestic industry, mining, and is a major driver of the movements in the business cycle.

To slow down economic activity in a boom period, or fasten it during a Recovery, the RBA attempts to influence the economy, and Total Investment through manipulation of the Cash Rate, a negative relationship between Real Interest Rates and (planned) Investment exist since the I.R represents ”the price of borrowed money” through the cost of periodic repayments. In a high I.R environment Investment is discouraged since it “costs more” to take on the “good debt” necessary for investment. Addtionally I.R represents the opportunity cost of money, since a high I.R provides more, less risky, opportunities to utilise retained profit, e.g. Accumulating in a bank. If the prospective return from capital investment does not exceed the interest rate, and by a significant margin, re-investment into capital goods becomes less appealing due to their inherent risk.

Risk is a key determinant of investment, as companies invest in an effort to get the highest positive return possible, with a acceptable level of risk. Risk varies based on changes in various things, examples include; consumer sentiment, international events, and political decisions. Risk can be thought of as a risk to reward ratio, where significant risk can outweigh potential profitability, and significant profitablility can outweigh potential risk.

Change in Government Policies on taxation change the Expected Revenue, and production costs, this can reduce incentives to invest as the potential reward is artificially reduced. On the otherhand Tax Incentives increase the appeal of investment in a industry that may have been too risky, or not profitable enough in the eyes of businesses prior. Similarily, profitability influences total investment, if profitability is low businesses tend to slow investment into maintaining capital equipment. where as in times of high profitability, they usually re-invest that profit back into themselves to grow the business. Finally, Business Sentiment influences investment decisions as companies may not be confident in the economies future. This can be influenced by perceived levels of economic activity, the current levels of sales / leftover stock from previous purchases, and inquiries from buyers. Business Sentiment as a non-interest rate based factor, shifts the entire Investment-Demand curve, a curve describing the negative relationship between I.R and Demand for Investment, this can affect that relationship, as occured in September 2017, 2022 where despite historic interest rate lows, we saw below-average investment as a result of low Business Sentiment during this time-period.

mention government policies influences (see Government Policies Influences on “Elasticity of Investment”)

“Importance of Investment to Australian Economy”

• Investment Drives production and thus the business cycle
• Investment is a volatile factor of AE contributing between 16-23%
• “Elasticity of Investment” (investment can push economy into inflation forcing intervention from investment influences)
• influences like interest rate
  • Interest Rate & Investment Negative Relationship
  • Interest Rate increases the opportunity cost of money.
  • Capital Investment must be a lot more profitable, otherwise the risk of capital inv. is not worth the payoff.
• Sentiment
  • Bad Busienss Expectations = less investment
  • Less Investment = Decrease Economic Activity

Mention specifics to Australian Economy, e..g. Investment is important due to mining industry,

• Importance only needs 2-3 sentences

• The Importance of investment is not effects / benefits of investment though there is overlap

• What is improtance?????

• Importance is worth at most 2 marks
• she said nothing else

Investment is important to the Australian economy because Investment Spending drives production, Investment as a whole makes up 16-23% of Aggregate Expenditure, and in turn GDP, Investment is very receptive to Consumer & Business sentiment, if there is expectations of a troubling economic future we will have a low Elasticity of Investment, meaning companies may not be willing to take on the Capital Investment neccessary to drive production, ultimately investing their money not into capital, but instead into something more reliable.

to it’s volatility investment changes alot making it a very important factor driving the business cycle, when investment is high we are usually in a boom, unemployment is low, Consumer Spending is high, and aggregate expenditure is hitting it’s 3% target, overall the economy is in a good state.

Question B (10 marks)

Use the aggregate expenditure model and the multiplier process to demonstrate and explain the likely effect of the icnresed mining energy ivnestment on the Australian economy

Danger explain how you got to the model dont just start with a model, model goes in the middle.

• Economics essay, address the question / define first always.

(1) Define Multiplier

• in recent years australia has seen as icnrease in mining causing an increase in ivnestment that could be worth multiple hundreds of illions of dollars

• (as a result of investment we experience the multiplier effect giving as a greater than proportional impact)

• Multiplier = “pay it forward” OR “one mans income is another mans spending” is a good way of explaning why multiplier works

(2) (demnstrate the effects of multiplier) We can make up figures if none provided

• provide figures that demonstrate what your talking about, and make sense, they improve hte point. (e.g. investment = $50m MPC=0.5)

• explain how to calculate it with words, then show equation then calculate the multiplier

• explain how the multiplier shows how the initial increase in income will flow through economy to create greater than proportional effect.

• say this can be seen on the aggregate expenditure model below

• explain the change on the model

• explain the steps (decrease in level of inv. incr. output leading to etc. etc. etc.) explain the effect on the economy

  (maybe mention Macro-economic Objectives since it wants us to talk about “Australian Economy”#ask_davis )

AI-GENERATED

The likely effect of increased mining energy investment on the Australian economy can be demonstrated and explained using the aggregate expenditure model and the multiplier process.

The multiplier effect occurs when an initial increase in investment spending leads to a greater than proportional increase in income throughout the economy. This is because one person’s spending becomes another person’s income, creating a cycle of increased consumption and further economic activity.

Let’s assume that there is an initial increase in mining energy investment worth $50 million. We can calculate the multiplier by using the equation: Multiplier = 1 / Marginal Propensity to Save (MPS). The MPS represents leakages from the circular flow of income, such as savings or imports.

For example, if we assume that MPS is 0.2 (meaning that 20% of additional income will be saved), then we can calculate: Multiplier = 1 / 0.2 = 5.

This means that for every dollar invested initially, there will be a total impact on national output equal to five times this amount (250 million).

To demonstrate this on an aggregate expenditure model, we would see an upward shift in both planned investment (I) and autonomous consumption (C₀). This reflects higher levels of business confidence and consumer spending due to increased mining energy investment.

As a result:

• The level of real GDP increases due to higher levels of consumption resulting from increased incomes.
• Aggregate demand shifts rightwards leading firms across all industries increasing their production levels.
• Unemployment decreases as firms need more workers leading wages rising.
• Tax revenues also rise due to higher incomes which could help fund government projects or decrease govt debt Overall these effects contribute positively towards achieving macroeconomic objectives such as full employment, stable prices ,economic growth & external balance

In conclusion, through its impact on various sectors like job creation ,increased production etc., the significant boost provided by increased mining energy investment has a multiplier effect on the Australian economy. This leads to greater economic activity and positive outcomes in terms of employment, output, and overall economic growth.

The mining industry is extremely capitally expensive, it requires extremely expensive machinary & skilled workers to operate at peak efficiency, and thus a huge amount of investment. Due to an economic process called the “Multiplier Effect” the dollar value impact of these investments flows through the economy providing a greater than proportional increase in income for the economy as a whole. This occurs since “One man’s spending is another man’s income”, eventually, that initial Investment of 50b back as consumption, and since “One man’s spending is another’s income” any consumption re-injected again as slightly less income, based on the Marginal Propensity to consume.

• Increased mining investment = Increase Autonoous Expenditure
• Inflow into the Circular flow of income, which will propogate through economy
• Propagation will be limited by leakages (MPS)
• Multiplier effect () < factor it would increase by
• Final change in income > than investment’