2.3 Macroeconomic objectives Flashcards
What is unemployment
someone who is
- willing and able to work
- actively seeking for work
- unable to find work
and
- of working age (15 - 65)
What is the unemployment rate formula
number of unemployed/total labour force
x 100
What is the labour force
consists of everybody in work plus all people who are of working age but our of work and actively seeking employment
What factors does the labour force make up
employed + self employed + unemployed
What are four errors that make s difficult to measure unemployment
Hidden unemployment
Discouraged workers
underemployment
regional, ethnic, age and gender disparities
What are difficulties in measuring unemployment
the existence of hidden unemployment (those who have given up searching for a job)
part time staff who are not working full time
workers who are overqualified
the existence of underemployment
it is only an average and does not reflect who it is worse for
What are the consequences of unemployment
Loss of GDP
Loss of tax revenuee
Increased cost of unemployment benefits
loss of income for individuals
greater disparities in the distribution of income
What are the four types of unemployment
Frictional
Seasonal
Cyclical
Structural
What is frictional unemployment
short term or temporary, caused by moving between jobs, it is a natural unemployment and not vary alarming
What are possible policies to deal with frictional unemployment
lower unemployment benefits
improve the flow of information between employers and people looking for jobs
What is seasonal unemployment
some industries employ seasonal, constructing, tourism, agriculture
natural, not alarming
possible policies for seasonal unemployment
encourage people to take different jobs
lower unemployment benefits
improve flow of information between potential employers and job seekers
What is structural unemployment
caused by changes in the structure of the labour market or changes in the structure of the economy
changes in the demand for particular new skills - new technologies
changes in the geographical location of industries - relocating overseas
labour market rigidities - minimum wage, powerful trade unions, laws protecting workforce unwillingness of workers to accept lower wage rates
Draw a diagram to demonstrate structural unemployment
cheaper costs of labor, increasing automation in developed countries, demand for manufacturing workers decreases
(wage for manufacturing workers) wage goes down
Quantity of manufacturing workers goes down
Possible interventionist policies for structural unemployment
improve educational systems to train people to be more occupationally flexible
improve occupational mobility by spending on adult retraining programs so that structurally unemployed can gain new skills to match available jobs
giving subsidies to provide trainers or to relocate
support apprenticeship programs for workers to acquire skills
however,
- high opportunity cost
- only effective in the long run
What are market based policies that could deal with structural unemployment
- reduce unemployment benefits to encourage workers to accept available jobs even if wages are lower
- increasing labour market flexibility through labour market deregulation - reducing restrictions for businesses to hire and fire workers, removing minimum wage laws, reducing power of trade unions and increasing flexibility in the labour market, will encourage businesses to take on mroe workers
however,
- disempower workers and empower businesses - can lead to exploitation of workers and worsening of working conditions
- can lead to growing inequity in the economy
What are natural types of unemployment
Frictional, seasonal and structural
they exist even when the labour market is in equilibrium - exists even when the economy is at full employment on LRAS and producing full employment level of output
What is cyclical unemployment
also known as demand deficient
caused by a fall in AD fro G and S in the economy and hence a fall in aggregate demand for labour (AD) as a result of firms cutting back on production
occurs when economic growth slows frown or when economy experiences recession
occurs because businesses are mroe likely to fire workers in times of recession rather than cut their wages, because of downward inflexibility of wages due to minimum wage laws or power trade unions
What is stagflation
when an economy experiences both high unemployment and high inflation
can be caused by a fall in short run aggregate supply
What are solutions to cyclical unemployment
use fiscal pooches to increase AD - lower taxes and increase government spending
use monetary policy to increase AD - lower interest rates and increase money supply
however
high opportunity cost and worsen government budget deficit
possible crowding out, government might borrow to finance budget deficit
there is a time lag between implementing policy and seeing the unemployment fall
could be inflationary
in practice it is no alway easy to identify types of unemployment
What is disequilibrium unemployment
occurs when there is a fall in demand for labour in the economy, but sticky wages prevent the market from reaching equilibrium
What are the economic consequences of unemployment
loss of GDP
loss of tax revenue
increased cost of unemployment benefits
loss of income for individuals
greater disparities in the distribution of income
Possible personal and social consequences of unemployment
increased crime rates
increased stress levels
increased indebtedness
homelessness
family breakdown
What is inflation
a sustained increase in the average price level of an economy
What is deflation
a negative rate of inflation when the average price level in an economy decreases
there is both good and bad deflation
What is disinflation
the slowing down of inflation, prices are still rising but at a slower pace
How is inflation and deflation measured
Using a consumer price index (CPI) - a weighted index that measures the changes in prices of a basket of goods and services consumed by the average household
items that take up a larger proportion of income are given a higher weight
What are the challenges involved in measuring/calculating the inflation rate
differences in income distribution (lower incomes spend a larger proportion of income)
changes in consumption patterns (typical goods need to be reviewed or removed at times)
selection of goods (different typical household goods)
changes in quality over time (inflation is only concerned with changes in prices, but there is also quality)
What is a producer price index PPI
focuses more on producers
measures the changes in the prices of factors of production
may be useful in predicting futuree inflation because if prices of Fops rise, cost of production will rise, higher costs
the basket for measuring PPI may include prices of raw materials like crude oil and copper, prices of components ad semi finished goods sold to manufacturers
What are the consequences of inflation
- greater uncertainty ( affects investors negatively, causes anxiety for workers and employers)
- redistributive effects (hits lower income individuals and households harder than higher income individuals and households, benefits borrowers/debtors vs harm savers)
- loss of purchasing power (same amount of income can now buy fewer G and S)
- less savings (uncertainty + loss of purchasing power = less likely to save)
- damage to export competitiveness
What is a stable inflation rate
2 - 4%
What is good deflation
caused by improvements in technology and more efficient methods of production and increased productivity, increases in SRAS and LRAS
What is bad deflation
caused by falls in AD
What are the possible consequences of deflation
high levels of cyclical unemployment - delaying purchases , deferred consumption, lower consumption spending and lower AD, lots of unsold stock, business lay off workers
bankruptcies - lots of businesses may shut down due to decreases AD and making huge losses or not being able to pay back their debts - decreased business confidence and lower investment
effects on debtors - homeowners who have mortgages will see the value of their houses fall relative to the value of their debts - decreased consumer confidence
How are demand pull inflation caused
by changes in the determinants of AD, resulting in an increase in AD
What is demand pull inflation
inflation caused by an increase in AD
potentially in C I G or (X - M)
What is the neoclassical view of inflation
- an increase in AD will always raise the average price level and cause demand pull inflation
because neoclassical economists believe that the economy will adjust itself to reach full employment of output
What do the Keynesian believe of demand pull inflation
they only believe it will happen if the economy is at full employment
not all increases in AD will cause demand pull inflation
it is only when the economy is at full employment producing Yfe will any further increases in AD will cause demand pull inflation
What policies can deal with demand pull inflation
contractionary/ deflationary demand side policies - since it is caused by increases in AD government will use policies to lower AD
What two sorts of policies could deal with demand pull inflation
contractionary monetary policy - central bank will raise interest rates and reduce the money supply
deflationary fiscal policy - will raise direct and indirect taxes and lower government spending (G)
What are the disadvantages of the policies that deal with demand pull inflation
raising taxes and cutting government spending is very politically unpopular - may upset voting population
government budget cuts are not easy because of the governments commitments to the public
long time lags involved in making changes to fiscal policy, making government budget cuts and seeing effects fo these cuts on inflation
higher interest rates will hurt borrows and people who have taken out loans and mortgages
deflationary policies may deal with inflation, but cause higher unemployment and slow down economic growth
What policy is often deemed more effective for managing AD
nowadays monetary police is viewed as more effect in managing AD and fighting inflation this is because central banks are often independent of the government and do not need to worry about being re-elected
What is cost push inflation
inflation caused by an increase in the costs of factors of production and results in a decrease in SRAS
What causes cost push inflation
increases in cost of labour (wage push inflation)
increases in costs of imported capital and raw materials
fall in the value of a country currency as imports become more expensive
Draw demand pull inflation
look kognity
draw cost push inflation
look kognity
What happens during an inflationary spiral
demand pull inflation leads to a higher average price level, which means the costs of production will rise too as workers demand higher wages
these rises in costs or production will then cause cost push inflation causing average price level to rise even further (SRAS - SRAS1)
now with higher wages, workers will spend more causing even more demand pull inflation
cycle continues
govnermnet usually needs to interfers
What policies deal with cost push inflation
supply side policies boost productivity of Fops and increase an economy productive capacity
negotiations with labour unions to match higher wages with increased productivity and hence control inflationary wage pressures
subsidizing industries to moderate increases in costs of production
revaluation of country currency to make import cheaper
however
the effects of the supply side policies are usually long term and do not appear in the short run
subsidizing industries comes at a hug opportunity cost as this is money that could be spent elsewhere
revaluation of currency will hurt export competitiveness
in practice it is not always easy to identify or isolate the exact cause of inflation and so governments will often use a combination of demand side contractionary policies as well as supply side policies
Draw an inflationary spiral
graph
What is the Phillips curve
shows the relationship between the inflation rate and the unemployment rates
two curves (SRPC) and (LRPC)
What does the Phillips curve show
there is a possible trade off between the unemployment rate and the inflation rate in the short run
What does the LRPC show
the vertical at the natural rate of inflation therefore there is no trade off between the unemployment rate and the inflation rate in the long run
What is the natural rate of unemployment
is the rate of unemployment that exists when the economy is producing at the full employment level of output (Fyfe)
What happens in the short run Phillips curve during cost push inflation
curve may shift outward, resulting in stagflation caused by a decrease in short run of aggregate supply due to factors including supply shocks
What is economic growth
an increase in real GDP over time
a growth in the size of the economy and the amount of economic activity
How is economic growth calculated
real GDP2 - real GDP1/ reaal GDP
x 100
How would economic growth due to an increase in actual ouptut be shown on a PPC
Economic growth due to an increase in actual output caused by a decrease in employment, increase in productive efficiency
point B will move to a point closer to the PPC, due to actual output
How would economic growth due to potential output be shown on a PPC
Economic growth as an increase in potential ouput/productive capacity caused by an increase in quantity and quality of resources, PPC shifts outwards, the entire curve
How is short run economic growth caused
increase in AD
AD outwards to AD1
y to Y1
or a positive supply shock (increase in SRAS)
SRAS to SRAS1, real GDP increases on AD
Draw short run aggregate growth
look Kognity
draw long run economic growth
look kognity
Long run economic growth
caused by a potential output or productive capacity of an economy
When PPC shifts outwards
LRAS outwards to LRAS1
what is the importance of investment in capital
in capital physical capital (building new machinery, roads), human capital (education health) natural capital (conservation parks)
this leads to increased productivity w
leads to an increase in the economy’s productive capacity and potential output in the future
leads to increase in quantity and quality of resources, leading to economic growth
What are the causes of economic growth
- reduction of unemployment
- increase in productive efficiency
- increase in the quality and or the quality of resources
investment can trigger all three causes of economic growth
What is the impact of economic growth on living standards
improves the material standards of living, makes life easier and more pleasurable
government collects more tax revenue - spend more on public and merit goods improves standard of living
however
economic growth may lead to more stress, more leisure time, more family breakdowns, increased inequality in the distribution of income, more pollution, more crime, more greed, increased suicide rates - while standard of living may’ve improved, quality of life may deteriorate
Impacts of economic growth on unemployment
will create new job opportunities whether it is demand or supply driven, helps lower cyclical unemployment
however
economic growth can lead to the decline and collapse of certain industries due to improvements in technology or increased trade with the outside world, could create structural unemployment
What is the impact of economic growth on inflation
if economic growth is driven by increases in SRAS and or LRAS it will exert a downward pressure on the average price level due to expansions of the economy’s productive capacity and potential output
however
if the economic growth is short term and only driven by increases in AD, it may be inflationary if the economy is operating at full employment or close to full employment - may lead to demand pull inflation
How does economic growth impact the distribution of income
economic growth leads to a rise in peoples income - the government collects more in tax and hence can spend more on public and merit goods and on bridging the gap between the rich and the poor
however
sometimes the benefits of growth are only reaped by the rich and higher income households, especially if the governments tax policies favor the rich while the poor barely benefit from this economic growth - may actually worse the distribution of income and wealth
How does economic growth impact the current account of the balance of payments
if economic growth is driven by increase in exports - this will improve the current account of the BOP
if economic growth leads to increase in productivity and efficiency of country’s export industries - this will improve the current account of the BOP
however
economic growth often also leads to increased demand for imports which may worsen the current account of the BOP
How can economic growth impact sustainability
is all about producing and consuming more - depletion of non renewable resources, increased greenhouse gas emissions - which can be a threat to sustainability
this threat may be diminished if wealthier and more educated citizens stat demanding policies and developing technologies that promote sustainability
What is equity vs equality
equity - more fairness in the distribution of income
equality - where everyone receives the same income - may destroy incentives
Why do market systems not always result in equitable distribution of cinema
due to unequal ownership of the factors of production, individuals have different types of incomes based on what they own
What is the Lorenz curve
a curve that shows the line of absolute equality - shows how far away a country is, the further away, the more unequal distribution of income
cumulative percentage of total income vs the cumulative percentage of total population
What s the Gini Coefficient
derived from the Lorenz curve
it is the country’s area over the total
What will the value of the Gini Coefficient always be
between 0 and 1
0 shows absolute equality and 1 shows the absolute inequality
the higher the Gini coeffienct/index, the more unequal the distribution of income
Absolute poverty vs relative poverty
Absolute poverty - having no access to the basic necessities to sustain life
relative poverty - can afford basic necessities but their living standards are well below the average in an economy
What are the possible causes of poverty
- low incomes (lack of ownership of the factors of production)
- unemployment
- lack of human capital
What are the consequences of poverty
low living standards (cannot access what they want)
lack of access to healthcare and education
increased crime rates and conflict and possible wars/revolts
What are direct taxes
taxes on incomes of FOPs (wages, interest, profit and rent) or wealth
they may be used as a mechanism to redistribute income to promote equity
What are indirect taxes
taxes on the expenditure on Goods and services e.g sales tax, VAT, excise duties
What are progressive taxes
a very common way to redistribute income from higher income earners to lower income earners
as income rises, a higher promotion (%) is paid in taxes
How do you calculate average rate of tax
Average tax rate = total tax paid/ total income x 100
How to calculate marginal tax rate
change in total tax paid/ total income x 100
What does progressive taxes mean about income
as income increases, the percentage paid in taxes increases
What is proportional taxation
regardless of your level of income, as the tax rate is fixed/constant, ie.e, taxes are fixed, flat tax rate
What Is a regressive taxation
as income Increases, percentage paid in taxes decreases, taxes fall heavier on low income earners eg, vat, GST, Sales taxes
What taxes help redistribute income
progressive and proportional taxes
however, they also create disincentives to work hard and to harm efficiency n economic growth
How can government expenditure promote equity
direct provision
or subsidization
of socially desirable G and S like healthcare services, education, infrastructure
What are transfer payments
can promote equity,
payments made to low income individuals without any corresponding exchange on change in output
exampels
old age pensions
unemployment benefits
child allowances
What are government policies to promote equity
taxation
government expenditure
transfer payments
How can taxation promote equity
an effective government taxation policy needs to be equitable, economic, convenient and certain
it provides necessary funds for government expenditure
can be a drain on tax payers and can cause disincentives to work
Impacts of government expenditure
costly to tax payers
can hinder economic efficiency - reliance
entails an opportunity cost
Impacts of transfer payments
costly to tax payers
can encourage laziness among work force
entails an opportunity cost
What is inflation
a persistent increase in the average price level in the economy, usually measured by the consumer price index
What are the costs of inflation
Loss of purchasing power - peoples wages and incomes is worth less value, same nominal amount but they can purchase less
Effect on interest rates - interest rates increase due to government and banks, banks will lose money at high rates of inflation because the money is worth less
Creates uncertainty - business and consumer confidence goes down, people dont want to spend
Explain three costs of inflation
kognity essy
What is inflation
a persistent increase in the average price level in an economy, usually measured by the consumer price index
What is deflation
A persistent decrease in the average price level in the economy, usually measured by the consumer price index
What is disinflation
a fall int eh rate of inflation
eg 5 to 4%
What is the target inflation
around 2%
What is good deflation
when aggregate supply increases because of improvements in productivity. Output increases and unemployment falls
What is bad deflation
When aggregate demand decreases, output decreases and unemployment rises
Draw a diagram for falling AD (bad deflation
AD decreases to AD1 on theLRAs curve
Diagram for lower costs of production (good deflation)
SRAS1 shifts outwards to SRAS2 on the AD curve, real GDP increases
What are the costs of deflation
unemployment
effect on investment
costs to debtors
What is producer price index
measures the price of factor inputs
measures what sellers receive and not what consumers pay
taxes, subsidies, distribution costs, retailers profits not accounted for
What is demand pull inflation
an increase in AD leads to an increase in average rice level
What is cost push inflation
as costs rise SRAS will shift inwards casing an increase in the average price level
Diagram of demand pull inflation
AD shifts outwards to AD2, increasing the average price level and real output
Diagram of cost push inflation
SRAS1 shifts inwards to SRAS2, prices increase and real output decreases
What happens in an inflationary spiral
AD1 shifts outwards, raising prices and real output, SRAS1 will shift inwards to reach equilibrium Y1 but prices will increase to P3, then AD2 will shift outwards to AD3
WHAt is demand pull and cost push
demand pull and cost push inflation work together to cause an inflationary spiral . If AD increases causing inflation, wages will also increase causing an inwards shift in SRAS. As a result higher wages will lead to an increase in consumer spending causing a further increase in AD.
Inflation due to monetary growth
increasing the more supply will lead to an increase in AD causing inflation
What do the monetarists argue abotu inflation
that it is caused by excessive growth of the money supply. The money supply should only increase by the same amount as the increase in real national output. If the money supply increases by 5% and the increase in real national output is only 3% then there will be too much money chasing fewer goods causing average price levels to rise
How can you decrease the demand pull inflation
deflationary/contractionary monetary policy
deflationary/contractionary fiscal policy
How can you decrease cost push inflation
Demand side policies can increase unemployment
supply side policies more effective
Explain the main causes of inflation (10 marks)
plan
Evaluate the extent to which demand side policies are effective in reducing inflation
plan
