Macroeconomics Flashcards
What is macroeconomics?
Macroeconomics is the branch of economics that looks at the performance and behaviour of an economy as a whole, rather than as individual people, markets or businesses.
What are the labels of the axis and lines for a graph in macroeconomics?
Y axis - Price level - i.e currency $ - represented by P
X axis - Real output - i.e GDP - represented by Y
Aggregate demand (AD) - Sum of all the demand in the economy.
Aggregate Supply (AS) - Sum of all the supply in the economy
What happens when the AD shifts outwards?
- The AD shifts outward (AD – AD1) due to increase consumption.
- There is an increase in real output which shows economic growth (Output increases over time).
- Due to the increase in real output - suppliers require more workers so unemployment falls.
- As a result of the Outward shift in AD there is also an increase in price level - This represents inflation
What is the consumption function? What are the components of AD?
Consumption function – AD = C + I + G + (x-m)
C - consumption –> Total spending by consumers on domestic goods/services.
I - Investment –> The addition of capital stock to the economy. This may either be Replacement investment (spend on capital to maintain productivity) or Induced investment (Spend on capital to increase output in response to increased demand).
G - Government spending –> Gv. spending on a variety of goods/services.
X-M - net exports (exports-imports)
How does confidence influence aggregate demand?
Confidence can effect aggregate demand. If people are confident they tend to spend more whereas when they are nervous they spend less.
More confidence - More consumption
Less confidence - Less consumption
Why does consumption change?
Consumption –> Total spending on domestic goods/services.
- Changes in wealth (Not same as income –> Wealth is the value of assets people own)
Two factors influence wealth:
- Change in house prices –> increase in house prices –> feel more wealthy –> increase spending/decrease savings
- Change in the value of stocks/shares –> increase in value –> feel more wealthy –> increase spending/decrease savings
2. Changes in expectations/confidence –> Increased consumer confidence –> increased consumption.
3. Interest rates —> Mainly refers to durable goods
High interest - lower spending –> As it is more expensive to borrow.
Lower interest - high spending –> Less expensive to borrow.
Interests also impact savers
Higher interest - People tend to save more money –> Less consumption
Lower interest - People tend to spend more money –> increased consumption.
- Changes in Income (Money people earn) –> Most significant factor
- Household indebtedness - (the extent to which households are willing and able to borrow money) –> I.e. Easy to borrow + low-interest rates –> consumers are more likely to take on debt.
Why does investment change?
Investment –> The addition of capital stock to the economy –> Money is obtained via ‘retained profits or borrowing.
- Businesses buy more equipment /machinery –> due to increased pressure on existing capacity due to increased consumption (Induced investment).
- Interest rate —-> High interest –> decrease incentive to borrow/increased incentive to ‘retain profits’ in bank.
- Businesses confidence —> A lot of investment decisions are based on expectations of the future.
- Technological change –> Changes in the level of tech in the economy –> forces firms to keep up in order to stay competitive.
- Business taxes and the level of business indebtedness.
Why does government spending change?
Government spending changes depending on the priorities of the politicians and where they beleive the money is best spent.
They could either spend money on…
Education
Roads
Public services
benefits
military
etc.
What factors influence net exports?
Net exports (x-m) - Exports - imports
Exports - money that flows in / Imports - money that flows out
Exports change due to…
- Changes in foreign income
- Exchange rates –> Appreciation –> More expensive for foreigns –> decrease in exports (Visa-Versa)
- Changes in Trade policies (i.e. reduce imports by taxing them heavily - used to improve domestic economy)
- Inflation —> Higher inflation –> less competitive –> More expensive.
Imports Change due to…
- Economic expansion/changes in domestic demand for foreign goods–> increase in imports
- Exchange rate –> Appreciation –> Less expensive to import –> decreased import expenditure (Visa-Versa).
- Trade policies
- Inflation rates in foreign nations.
What is the business cycle? Annotate all the parts of the graph.
- It shows what happens to GDP over time
- It shows that GDP fluctuates - rises and drops
- The overall trend is that GDP grows over time
- Output gap refers to the distance between the trend line and the actual line (Difference between actual and potential output)
The top of the economic cycle - Boom - Postive output gap (low unemployment/high inflation)
The bottom of the economic cycle - Bust (recession) - Negative output gap (high unemployment/low inflation)
Recovery phase —> Economic expansion –> increase in demand –> increase in supply –> increase in employment –> more spending –> cycle continues.
Trough —> The point where contraction comes to an end –> Output doesn’t fall lower –> some people in the economy maintain consumption/demand for exports/ G.v spending/etc.
When is an economy considered to be in recession?
After 2 consecutive quarters of negative growth.
How do changes in confidence influence AD (Chain of reasoning)?
- Increase in consumer confidence - Period of economic growth
- Causes an increase in consumption (i.e people are more confident)
- This increases the value of C (consumption) in the consumption function.
- This leads to an increase in AD.
How do changes in interest rates influence AD (chain of reasoning)?
- Interest rate increase (more expensive to borrow / more favourable to keep money in a deposit due to the interest gained).
- Mortgage payments rise which leads to a drecrease in discretionary income. People have to pay back more for their loans. Or people rather save as it is more beneficial.
Mortgage - A loan to finance the purchase of real estate, usually with specified payment periods and interest rates.
Discretionary income - Income after paying morgage, bills (money you can use for anything).
- Drop in consumption
- Decrease the value for C in the consumption function.
- Decrease in AD
How do interest rates influence Investment/AD? (Chain of reasoning)
Investment - Money spent by buisnesses on equipment and machinery (Capital goods)
- Decrease in interest rates
- Cheaper to borrow - More borrowing
- Increase in investment
- Increase in AD
or
- Increase in interest rates
- Decrease in borrowing (more expensive to borrow)
- Decrease in investment
- Decrease in AD
What happens to investment if consumption increase?
If consumption increases, investment increases in order to accomodate the increase in consumption (factories need to increase output by buying more machinary/land etc.)
Which factor of the consumption function has the greatest impact on AD?
Consumption contributes the most to AD.
What is aggregate supply?
The total quantity of goods and services produced in an economy over a particular time period, at different price levels.
Basically, the sum of the supply curves of all industries.
What factors influence AS?
When AS changes, the potential output of the economy changes.
- Improvement in technology - increased potential output
- Education/training
- Discovery of raw materials
This is demonstrated by the PPF.
What are the two different views of macroeconomics?
- Classical view
- Keynesian
Describe the classical view of economics? What is the view based on?
Classical view
It has a long run (LR) and a short run (SR) aggregate supply curve. (LRAS/SRAS)
The long run is said to be inelastic therefore any deviation (i.e SRAS excedding the LARAS) is temporary.
The long run represents full employment within the economy.
It is based on unrestricted workings within the economy and supports the pursuit of individual interests.
Classical view beleives that output of an economy is determined by supply factors.
Describe the Keynesian view of economics?
Keynesian view
The graph has one aggregate supply curve - LRAS (L - shaped) - which represents supply in the long run.
Keynesian are interventionist therefore, they advocate for government intervention.
In their policies they place emphasis on changing AD to overcome recession and to boost the economy.
How can the position on the AD curve relative to the LRAS curve inform governments on their actions?
As you go along the LRAS curve the slope goes from elastic to a inelastic supply curve.
The position of the AD curve relative to the LRAS curve can inform governments how to intervene.
I.E.
Elastic – Increase in AD – Large increasse in output + less unemployment - minimal inflation. Beneficial
Inelastic - Increase in AD – Small increase in output + no significant change in unemployment – large increase in inflation. Not Beneficial
In what situations should keynesian view be used and in what situation should a classical view be used?
- The Keynesian view is better for viewing policies and changes in AD. Hence, it is often used more in essay style questions.
- The classical view of supply is better to represent the short run aggregate supply.
Why is deflation generally seen as not beneficial?
Some might argue that during deflation people will say ‘Cheaper is better’
However, deflation can discourage people from big purchases becuase the price of goods/services will constantly be cheaper therefore making them beleive that if they wait they can buy the good/service for a cheaper price.
This leads to a reduction in consumption — AD shifts inwards — less economic growth.
What are the main macroeconomic targets?
- Maintain steady positive economic growth - growth target of around 2.5%
- Maintain low and stable inflation rate i.e 2%
- Maintain unemployment low - around 6%
- A favourable balance of payments position (exports and imports).
- Equity (fair) in the distribution of income
- Keep government borrowing low
What are the main types of government intervention?
Demand side policies
- Fiscal policy
- Monetary
Supply side policies
-Supply side policy
What is the definition of fiscal policy?
Fiscal policy involves the government changing the levels of taxation and government spending in order to influence aggregate demand and the level of economic activity.
Taxes may be Direct (income tax) or Indirect (taxes on goods/services).
What is fiscal policy normally used for?
- Stimulate economic growth during a recession - leads to a reduction in unemployment (increase AD)
- Keep inflation low (reduce AD)
- Stabilise economic growth - avoiding a boom and bust cycle.
What are some examples of government spending and taxation? (fiscal policy)
Government spending
- Healthcare
- Military
- Education
- health/fitness/sports clubs
- unemployment benefits
Taxation
- Income tax
- Duty - import tax/excise duty
- Corporation tax
- Indirect taxes (BTW)
- Road tax
Using a chain of reasoning explain the effect of increasing taxation (fiscal policy)?
- Increase taxation - income tax
- Less disposable income for people
- Decrease in consumption
- Drop in AD - shifts inwards
- Decreases inflation and real output (high unemployment)
Using a chain of reasoning explain the effect of decreasing taxation (fiscal policy)?
- Decrease taxation/tax break
- More disposable income
- Increase in consumption
- AD increase - shifts outwards
- Economic growth - less unemployment (high inflation)
What is an expansionary fiscal policy?
Expansionary fiscal policy - Goal to increase AD
- If governments like to encourage greater consumption then can lower income taxes –> more disposable income –> more consumption.
- If governments would like to encourage greater investment, they can lower corporate tax –> higher after-tax profit –> used for investment.
- Governments can increase government spending –> improve or increase public services.
What is fiscal deficit reduction?
Fiscal deficit reduction involves reducing a budget deficit using fiscal policy.
This may involve…
Increasing taxes (Income or corporate)
Reducing government spending
What is the definition of monetary policy?
It is defined as the set of official policies governing the supply of money and the level of interest rates in an economy.
IB –> Only requires an understanding of interest rates.
When we discuss interest rates we are concerned with the central bank who change the ‘base rate’ –> Base rate impacts all borrowing/lending in an economy.
Expansionary/loose monetary policy –> Increase AD
Contractionary/tight monetary policy –> decrease AD.
Using a chain of reasoning explain the effect of reducing interest rates?
- Lower interest rates.
- Pay less for mortgages / Cheaper borrowing costs / people are less inclined to save as the return won’t be as great.
- They have more disposable income
- They increase spendings - more consumption in the economy
- AD shifts outwards.
Using a chain of reasoning explain the effect of increasing interest rates.
- Higher interest rates.
- Pay more for mortgages / more expensive borrowing costs / people are more inclined to save as the return will be greater
- They have less disposable income
- They decrease spending - less consumption in the economy
- AD shifts inwards.
Is it possible to have negative interest rates?
Negative interest rate are possible and they are often used to encourage spending as people would be losing money if they were to save money.
What is the definition of supply side policy?
Supply side policies attempt to increase the output of the economy by bringing about an increase in the quantity of the factors of production or improving the quality of the factors of production.
They can either be market based or interventionist.
What are the different types of interventionist supply-side policies?
Interventionists supply-side policies –> Not controversial as they are needed as otherwise Merit goods would be underprovided.
Long term impact - Shifts out LRAS
- Education + training (investment in human capital) - Investing in schools, universities, training institutions etc. Long term + oppertunity cost
- Research and development - Keep firms up to date with modern technologies in order to reduce production costs. Long term + oppertunity cost
Governments may encourage this by offering tax incentives –> i.e. tax credit (no tax on profits used for R&D)
It can also include the discovery of raw material.
- Investment in infrastructure - Reduces specific unemployment. Roads/ railways/ transport and communication networks.
-
Industrial policies - Tax cuts/ tax allowances/ subsidised lending - promotes growth.
i. e. It allows and acts as an incentive to invest into research and development.
What are the advantages of the supply side polciy?
- No conflict between acheiving economic growth, lowering unemployment and reducing inflation.
- Can appeal to laissez faire governments (letting things go on their own course) once a law has been changed the market can be left to its own devices.
- Training can be done by buisnesses (using tax breaks) without needing government spending.
- Research + development results in more efficient use of avaliable funds. Increased productive efficiency.
What are the disadvantages of supply side policy?
- Can take a long time to see results from education, training, research and development.
- Difficult to predict future needs e.g. training builders might be needed now but maybe it won’t be necessary for the future.
- Education, research and development is costly - High opperunity cost
Taxes are then used to raise money - unpopular decision
What are interventionist supply side policy?
Interventionist supply side governments are active governments.
i.e. government spending to….
subsidising R+D
funding state schools
University fees free of charge.
What are market/ non-interventionist supply-side policies?
Market-based supply-side policies –> Focus on allowing markets to operate freely via the interaction between supply and demand, with minimal government intervention.
‘Incentive’ is very relevant here as many policies aim to increase incentives for harder work/more productivity/more investment by firms into R&D.
I.E changing a law, red tape
Tend NOT to involve government spending.
How is an increase in efficiency represented in a graph?
Increase in efficiency shifts the ‘LR’ curve away from the axis.
Represents an increase in economic potential economic output.
What is the definition of Inflation?
Inflation is a sustained increase the general price level leading to a fall in the purchasing power of money.
How is inflation measured?
The rate of inflation is measured by the annual percentage change in consumer prices.
It is normally calculated by measuring changes in the average cost of buying a basket of different goods and services for a typical household.
Goods are weighted to reflect their importance in the average consumer’s income.
(Basket changes depending on spending patterns)
Example - UK - CPI
What are the problems with measuring inflation using a basket?
- It doesn’t represent all households. I.e. Spending patterns differ between single people and households with children
- Errors in the collection of data –> limit accuracy.
- Changes in price can sometimes be due to improvements in technology/quality, not inflation.
- New products - basket is slow to respond to new spending trends.
- Changing products makes it hard to compare different years
- Countries measure inflation in different ways
Does a fall in inflation mean prices are falling?
Fall in the rate of inflation DOESN’T euqal falling prices
Drop in inflation can represent prices rising just at a slower rate.
What is deflation?
Deflation is the persistant fall in the general price level of goods and services. The rate of inflation is negative.
What are the causes of deflation?
What is the definition of unemployment?
The percentage of the working age population who are actively seeking work and willing and able to work for the market wage rate but unable to find a job.
If you decide not to work are you considered unemployed?
If you have chosen not to work — you will not be classified as unemployed. You must be active in the labour market.
Why does the definition of unemployment only concern itself with people that are actively seeking a job?
The definition only concerns itself with people that are actively looking for a job becuase they are the people that need a job for a reason. I.E financially reasons.
This is a problem for the government as there are many consequence if people are left unemployed.
The government assumes that people that don’t have a job but are NOT looking for one, are able to support themselves (Partner that works, enough money saved up etc.)
Why are unemployment numbers lower in developing countries?
In developed countries people claim to be unemployed in order to recessive unemployment benefits.
However, some developing countries might not have benefits therefore, it is a waste of time filling in the necessary forms.
What is the labour force survey?
The Labour Force Survey (LFS) is a study of the employment circumstances of the UK population. (telephone survey)
They call a sample of people and ask them questions about their employment status.
Problem - Sample group can not reflect the entire population
What is the claimant count?
The claimant count – Number of people register at the government for unemployment benefits.
Strict measurment (you have to tick all the boxes) – If you classify you can receive benefits.
Why is long term unemployment problematic?
- Over the lung run people lose their skills.
I.E Technology is ever changing - people have to adjust.
- People lose the habit for working.
- People lose connections at the workplace/industry.
- People lose confidence.
What is underployment? Does it count towards unemployment?
Underployment – working fewer hours then a person wishes to work, or not using all of the persons skills.
I.E
- Working 3 days when a person wants to work 5 days.
- Not using all of the persons skills. Working as a teacher when your a qualified teacher.
If a individual is forced to be underemployed (not their decision) then it counts towards underemployment. If it is a choice then it is not unemployment.
What is a ‘Gig Economy’
People being self-employed but have a contract with a buisness.
I.E - Uber, deliveroo etc.
What are the benefits and disadvantages of a Gig economy?
Advantages:
Flexible - People can work when they want to
offers work to the unemployed
Lower costs for buinesses.
Disadvantages:
No secure income
no minimum wage
lack of protection for workers
What are the impacts of unemployment on individuals?
- Lower standards of living
- A decrease in the chance of future employment
- Stress and health problems caused by unemployment (No adequate nutrition, medicine, etc.)
- Loss of confidence –> Unable to find employment
- Higher debt
What are the impacts of unemployment on communities?
When large proportions of people are unemployed in a community….
- There is more disorder
- Buisnesses struggle - low demand
- Higher crime rates + vandalism
What are the impacts of unemployment on the economy?
Main –> Factors of production not used –> economy is working below it’s potential output.
- Increased crime rates
- More money spent on unemployment benefits (opportunity cost)
- Loss of tax revenue which may lead too…
- Greater pressure on taxpayers due to increased taxes to pay for benefits.
- Increased borrowing which leads to debt. - Less consumption - drop in AD - less economic growth (drop in GDP) - potential recession.
- More uneven distribution of money
Brief summary of the solutions that can be employed to reduce unemployment?
- Increase consumption - lowering interest rates (monetary) - increase AD - more jobs created.
- Decrease taxes or increase government spending (fiscal policy) – increase in AD – more jobs are created – lower unemployment.
- Supply side policy – providing education to reduce structural unemployment
- Reducing unemployment benefits - act as an incentive for people to find a job quickly
- Reducing geographical inability - facilitating transport to locations with jobs
- Government provides schemes to help unemployed to search for work.
What are the different types of unemployment?
- Voluntary
- Seasonal
- Cyclical
- Frictional
- Structural
- Hidden unemployment
What is Voluntary unemployment? How could you reduce it?
Voluntary unemployment is defined as a situation when workers choose not to work at the current equilibrium wage rate.
Due to….
- Child care
- Career break
- Waiting for a better job that is better paid
Solution:
Note - The government isn’t very concerned about these people as it is their choice no too work and this would indicate that they can support themselves financially.
- Reducing unemployment benefits
What is seasonal unemployment? How would you reduce it?
This is when buisnesses close and open during different seasons thus not providing work for the employees year round.
I.E - Ice cream sellers - unemployed in the winter
- Ski instructors - unemployed in the summer
Solution
- Encouraging people to take different jobs in the off-season –> Lower unemployment benefits/improved information
- Supply-side policies - train the workers with skills for new jobs.
What is cyclical unemployment? How could you reduce it?
Cyclical or demand-deficient unemployment.
Cyclical unemployment exists when individuals lose their jobs as a result of a downturn in aggregate demand (AD). (Linked to the buisness cycle)
High unemployment - recession
Low unemployment - economic growth
Solution
Increase AD in order to create more jobs.
For example…
Monetary policy - interest rates
Fiscal policy - taxes / government spending
What is frictional unemployment? How could you reduce it?
Frictional unemployment (search unemployment) occurs when workers lose their current job/students leave education and are in the process of finding another one. (Usually Short Term)
- Not problematic as it assumed workers are aiming to find better jobs where there are more productive –> increase the economic potential
Solutions:
- Provide better information to reduce the search time.
- Create government schemes in order to aids in peoples search for jobs
- Lower unemployment benefits.
What is structural unemployment?
Most problematic out of all types of natural unemployment.
Structural unemployment occurs when certain industries decline/close down because of long-term changes in market conditions.
Problematic —> People lack occupational mobility (skills) and geographical mobility to change jobs.
What is hidden unemployment? How could you reduce it?
This is when people don’t resgister as being unemployed becuase…
- They might have enough money
- They won’t be unemployed for a long time so they don’t bother registering.
- No benefits - LEDCs
Solution:
Create incentives to register.
Facilitate the process i.e removing red tape
What is classical unemployment? What are the different views on how it can be reduced?
A type of disequilibrium unemployment
Classical unemployment occurs when real wages are kept above the market clearing wage rate, leading to a surplus of labour supplied.
The market supplies more workers than the businesses demand.
This could be due to a minimum wage being set into place - price floor.
Solution - Controversial:
- Classical - minimise government intervention - eventually, the market will clear and settle at the equilibrium (No Trade unions/min wage)
Problem with the classical view –> Difficult to reduce union power + minimum wage important for poor and their standards of living –> more inequality.
- Keynesian - more emphasis on boosting demand to reduce unemployment.
Describe the two sector circular flow of income diagram
The circular flow of income shows how money moves through the economy. It can also be used to show how GDP is calculated.
The two sector model is a simplified model of the economy.
- Households –> People who buy the nation’s output of goods/services + owners of all the economy’s factors production.
Basically –> People supply factors and get paid.
- Firms –> hire factors of production –> to produce nation’s output.
Desrcibe the five sector circular flow of income diagram
It shows the movement of money through the economy.
It also shows the money coming into an economy (injections) and all the money flowing out of an economy (leakages or withdrawals).
The five sector model is still a simplified model of the economy.
- Households
- Firms
- Government
- foreign sector / world economy
- Financial market
What are leakages and injections - Circular flow of income?
Leakage - Money gets lost in the economy which leads to a reduction in the circular flow leading to a multiplied contraction effect in production.
Causes: Money is…
- Put aside for future spending, i.e. savings (S)
- Paid to the government in taxation
- Spent on foreign-made goods and services, i.e. imports.
Injections - Injections are additions to investment, government spending or exports so boosting the circular flow of income leading to a multiplied expansion of output.
Causes:
- Capital spending by firms, i.e. investment expenditure
- The government, i.e. (Gvt. spending)
- Overseas consumers buying UK goods and service, i.e. UK exports
When is an economy in equilibrium? What happens when the economy is not in equilibrium?
An economy is in equilibrium when the rate of injections = the rate of leakages from the circular flow.
If leakages rise above injections –> national output will fall –> as there is less income circulating through the economy –> new equilibrium.
If injections rise above leakages –> national output will increase –> as there is more income circulating through the economy –> new equilibrium.
What are the three ways to measure GDP?
Each method should yield the same result.
- Output method - Value of good and services produced in the economy (Value - minus costs of inputs)
Data is usually grouped in different production sectors –> Primary/secondary/tertiary sectors.
- Income method - Measure the value of all the incomes earned in the economy.
- Expenditure method - Value of all spending on good and services in the economy.
It includes AD = C + I + Gv. + (x-m)
What is the definition of GDP?
GDP - The total value of all finished goods and services produced in an economy during one year.
What is the definition of GNP?
Gross national product is the total income that is earned by a country’s factors of production regardless of where the assets are located.
GNI is equal to GDP plus income earned from assets abroad minus income paid to foreign assets operating domestically.
What is the definition of NNI?
Net national income - Measures gross national income (measures the final value of incomes flowing into an economy) minus the depreciation of capital.
Depreciation - Capital loses value due to wear and tear of machinery, damage to capital equipment and new technology can make machinery obsolete.
In practise very difficult to calculate depreciation.
What is nominal and real GDP?
Nominal GDP - Value of GDP at current prices
Real GDP - Value of GDP adjusted for inflation using a GDP deflator.
To compare GDP between different years the value has to be adjusted for inflation becuase inflation will lead to an increase in prices for goods and services thus overstating the value of GDP.
What is GDP per capita?
Easiest national income measurment
GDP per capita - It is the total GDP divided by the size of the population.
More appropriate method than GDP for judging the progress between countries in terms of living standards.
What are national income statistics used for?
- Report card on the performance of a country - Objective
- Used by governments to develop policies
- Used to develop models to predict changes for the future
- Buisnesses can use statistics to forecast future demand
- Method of examining the standard of living
- Used to compare economies.
Limitations of national income statistics?
- Inaccuracies - There is always some sort of error involved in the calculation - larger errors in more developing countries.
- Unrecorded or under recorded economic activity (informal markets)
- Work done at home - painting yourself/hiring someone to paint - results in identical output but different GDP.
- Developing economy - farmers grow their own food.
- Hidden economy - illegal work - i.e drug trafficking - tax evasion. - External costs - GDP figures do not take into account resource depletion - negative consequences on the quality of life and potential impacts on future economic growth.
- Other quality of life concerns - GDP may grow but the peoples standards of living/happiness is less due to long working hours, less free time etc.
- Composition of Output - The output (goods/services) of an economy does not benefit consumers.
What is Green GDP?
Green GDP - Measure of GDP that takes into account enviornmental costs inccured by the production of goods and services. (Air pollution, water pollution, waste disposal etc.)
Green GDP = GDP - enviornmental costs of production.
What is the definition of GNH?
Gross national happiness is a psychological and physiological attempt to measure national happiness as a part of GDP.
It is a measure that is based on 9 domains
List the pros and cons of using GNH as a statistic.
Pros
- It ensures that goverments need to increase happiness instead of economic welfare - meeting the needs of the people.
- 9 domains - provides a more holistic view of the economy and what sectors to improve.
- Better than economic measures as happiness/well-being and money are only correlated up to a certain point - More suited for developed countries.
Cons
- Difficult to evaluate happiness - Subjective - different people have different views on the topic.
- Not very good for comparisons - varies between countries.
- Not very practical to carry out survey as it is - takes months to collect data
- Money and well-being do increase proportionally in the begining as the standard of living improves - more suited for developing countries.
Consequences of cyclical unemployment?
- Loss of confidence
- Greater competition for jobs
- More money spent on unemployment benefits.
- Lower standards of living
- Less tax revenue for the government.
Consequences of structural unemployment?
- Individuals are unemployed with a lack of transferable skills - money invested into re-education.
- More competition for jobs
- More money spent on unemployment benefits
- Lower standards of living
- Less tax revenue for the government.
Consequences of frictional unemployment?
- Less luxurios goods - temporary
- More comepition
- Helps keep inflation down (Good) - No frictional unemployment - people stay in their jobs - higher labour costs - cost push inflation.
- It increase the liklihood for companies to find qualified workers
Consequences of hidden unemployment?
- Less spending/consumption
- Loss in confidence
- Not contributing towards the economy - economy working below potential output.
- Lower standards of living
- Less tax revenue for the government.
Consequences of under-employment?
- Individuals not working to full potential.
- No luxurious goods
- Lower standards of living
- Less tax revenue for the government.
What is the market wage rate?
The market wage rate is determined by the interaction between supply and demand for workers.
Demand curve - Shows the demand for workers by firms in an economy
Supply curve - shows the supply of workers –> total number of workers that are willing and able to work at a given price.
Aggregate Demand/Supply can also be used.
What factors influence the demand for labour?
- Rise in consumer demand for a product which leads to buisnesses needing more workers. (economic growth)
- Increase in labour productivity - labour is more efficient than capital equipment / Opposite - technology (robots) more efficient + cheaper than labour.
- Government subsidy - allows buisnesses to hire more workers.
- A change in price of the good/service that the labour is making.
What factors influence the supply of labour into a market?
- The real wage rate that is offered by an industry - higher wage - more reward - more people willing to work for that job.
- Barriers to entry can limit the supply of labour i.e. High levels of education - lawyer and medicine.
- Improvements in occupational mobililty - More people are trained with a specific skill for a specific job.
- Non-monetary characteristics - Risks/dangers, anti-social hours, etc.
- Net migration of imigrants - more immigrant workers in a market.
Solutions to unemployment using fiscal policy - Analysis points.
Goal increase demand - less unemployment but….
- Some people might not spend even though there is a decrease in taxes (personality, worried about the future, depends on the financial situation of a individual)
- The effect of the tax/government spending is dependent on….
- income and tax boundaries
- size of the decrease in tax
- quantity that is spent by governments - High opperuntity cost - less tax revenue - government spending
- Increase in economic growth/decrease in unemployment is dependent on position of AD relative to LRAS.
Solutions to unemployment using monetary - Analysis points.
Goal increase demand - less unemployment but….
- People might still want to save - poor, unstable jobs.
- Some goods have a fixed interest rate.
- How signifcant will the change in interest rates be?
- Increase in economic growth/decrease in unemployment is dependent on position of AD relative to LRAS.
Solutions to unemployment using supply side policy- Analysis points.
Goal - Shift the supply curve outwards to increase economic growth/ decrease unemployment but….
- High oppertunity cost involved.
- Long term
- Hard to predict skills needed in the future
- How much training is needed to provide the adequete number of workers to increase the economic potential output.
What are the 4 factors of production?
Distinguish between national and domestic?
Macro National income - value of total output
National (reference to national income) = the output that has been produced by factors of production owned by residents of a single country, regardless of the factors’ location within or ontside the country. (GNP)
I.e. Apple’s factories are located in China but they still count to America’s national income.
Domestic (reference to national income) = the output that has been produced by factors of production owned by residents of a single country, within the country itself. This is referred to as GDP.
Distinguish between Gross and Net?
Gross is the total amount exclusive of deductions.
For example:
Gross pay, is the total pay before tax deductions.
Net is the total amount received after subtracting deductions from the gross amount.
Net pay, total pay after tac deductions.
Distinguish between Real and nominal.
Nominal = the money value/ the value measured in terms of the prices that prevail at the time of measurement. (Not adjusted for inflation/disinflation)
Real = this is a measure of value that takes into account changes in prices over time (adjusted for inflation) It is measured in terms of prices that prevailed in one particular year in the past (called the base year).
Distinguish between total and per capita.
Total (with reference to national income) = the total output in the whole economy.
Per capita (with reference to national income) = total output divided by the size of the population.
Why does the AD curve slope downwards? Why does the AS curve slope upwards?
Downward sloping since individual demand curves slope downwards –> law of demand
Upward sloping since individual supply curves slope upwards –> law of supply
What factors influence AS?
Factors affecting AS include…
Changes in resource prices (avalibility of resources)
Changes in business taxes and subsidies
Supply side shocks (technology, reducing red tape, education etc..)
What is the equilibrium level of national income?
Equilibrium level of national income = this is the level of output (real GDP) where the AD curve intersects with the AS curve.
What is the full employment level of national income?
This is when a level of output (real GDP) with no deflationary or recessionary gap is acheived coupled with socially acceptable levels (5/6%) of unemployment.
What is an inflationary gap?
Inflationary gap = situation where real GDP is greater than potential GDP and unemployment is smaller than the natural rate of unemployment. (Lower than normal unemployment).
Tends to be temporary.
What is a deflationary gap?
Deflationary gap = this is a situation where real GDP is less than potential GDP and unemployment is greater than the natural rate of unemployment
What is disinflation?
Disinflation = a fall in the rate of inflation.
Basically slower increases in prices.
What is the producer prive index and why is it useful?
Producer price index an be used to examine the change in costs of production.
They can be useful as it can be used to predict future inflation (ie cost push inflation)
What are the consequences of inflation?
Consequences of inflation.
Reduction in purchasing power
Drop in consumer confidence - people feel poorer.
Less saving (things are getting more expensive - why would you wait to buy things)
Less exports (due to reduced competitiveness)
What are the consequences of deflation?
Consequences of deflation
- More saving - less spending.
- Unemployment –> falling prices –> people put off consumption –> reduce AD –> Increased unemployment.
- Investment –> businesses make less profit/losses –> lay off workers –> reduced confidence –> reduced investment
- Cost to debtors –> people with loans suffer –> value of debt raises –> profits are low for firms –> unable to pay back.
What are the three types of inflation?
Demand-pull = caused by an outward shift in AD –> change in any of the components of AD
Cost-push = caused by an inward shift in AS –> Increased costs of labour, raw materials, import costs.
Note –> Exchange rate depreciation –> imports expensive –> increases costs.
Monetary growth –> Excessive increase in the money supply –> inflation –> Because more money results in more spending –> Increased AD.
Definition of economic growth?
This is an increase in GDP/real output over a period of time.
Advantages and disadvantages of economic growth?
Advantages
- Possible improved living standards
- Reduced unemployment
- Businesses - Increased revenue –> Increased investment –> economic potential
Both Advantage or Disadvantage
- Higher inflation
Disadvantage
- More uneven distribution of income - usually one social class benefits the most.
- A deterioration of the current account of the balance of payments. (More imports - worse net exports value)
- Negative impact on the environment and sustainability - More production results in more pollution, congestion etc. (No Sustainable development).
- Increase in income from economic growth –> doesn’t always lead to happiness –> i.e. Working hours increase.
- Structural change –> away from primary –> to secondary/tertiary sectors –> Structural unemployment.
What is the definition of equity?
Equity = incomes are ‘fairly’ distributed.
People that desevre to earn more money should earn more money.
This is a normative concept - who decides who earns more money?
What is the definition of equality?
Equality = incomes are evenly distributed (this can be shown on a Lorenz curve diagram/ by using the Gini coefficient)
What is the definition of relative poverty?
Relative poverty = this is defined as living on less than 60% of the mean income in the individual’s economy
This depends on the country you live in.
What is absolute poverty?
Absolute poverty = this is defined as living on less than $ 1 a day
Causes of poverty?
Sources of government revenue?
- Taxes
- Sale of goods and services - mainly in a command economy
- Sale of state owned assets. (Selling comapnies previously owned by governments).
Types of government expenditure?
Current expenditures (paying wages of public sector workers)
Capital expenditures (building roads/ schools/ hospitals)
Transfer payments (unemployment benefits paid using tax revenue from income tax)
What are the three budget outcomes?
If revenue > spending = budget surplus
If revenue < spending = budget deficit
If revenue = spending = balanced budget
What are the strengths of using fiscal policy?
- Good at puling an economy out of a deep recession - when economy is on the horizontal segment of the AS curve.
- Contractionary fiscal policy can be effective in controlling rapid and escalating inflation
What is contractionary fiscal policy?
Contractionary fiscal policy this is used to reduce AD in order to control inflation.
- Increase taxation
- Decrease government spending
What are the weaknesses of using fiscal policy?
- Time lag between implementing the policy and there being an impact on the economy.
I.E. Takes a while to register/notice increased government spending. Spending plans set once a year.
- Problems of inadequate information – inaccurate forecasts may lead to inappropriate policies. (Government failure)
- Political constraints – political factors may lead to unsuitable policies. (Politicians might cut taxes to gain votes.
- Effect of fiscal policy also depends on other factors influencing AD.
- Reduction in GVT spending - negatively impact public services
- Expansionary fiscal policy - greater budget deficit
- Success depends on position of AD curve
What are the strengths of monetary policy?
- Relatively quick implementation - Change on monthly basis.
- No political constraints - National bank - Not linked to government.
- Acheived desired tragets - increase or decrease in AD.
- Lower oppertunity costs.
What are the weaknesses in monetary policy?
- Sometime ineffective due to time lag between recognising a problem and the policy to take effect.
- Limited effect when economy is in deep recession.
- Policies are mainly based on forecasts of the future. Therefore, policies can be inaccurate - government failure.
- Possibly conflict with other government objectives.
What are the different types of market based supply side polcies?
Encourage Competition
Labour market reforms
Incentive-related policies
Policies to encourage competition:
Encourage Competition:
- Deregulation = removal of ‘red tape’ to reduce costs to businesses and improve efficiency.
- Privatisation = transfer of state-owned organisations to the private sector, in order to increase competition and therefore improving efficiency.
- Trade liberalisation = reducing barriers to trade such as tariffs / quotas
- Anti-monopoly regulation = organisations that investigate mergers in order to prevent monopoly power in an economy.
Labour market reforms:
- Reducing the power of trade unions = powerful trade unions - push up wages - increase costs to businesses.
- Abolishing minimum wages = this can help to reduce costs to businesses and make the labour market more flexible
- Reducing unemployment benefits –> Generous Unemployment benefits –> less incentive to work –> don’t contribute towards the economy.
Incentive-related policies
- Cuts in personal income tax = this increases the incentive to work.
- Cuts in business / capital gains tax = to increase the incentive to invest into Capital stocks and R&D.
What is the difference between market side and interventionist supply-side policies?
Market-led policies - designed to make markets work better and give the private sector more freedom. Usually aimed at increasing competitiveness as it can result in more economic potential (LRAS shift outwards).
Interventionist policies - Involve a key role of the government and is used to overcome different types of market failure.
What is the philips curve? What is the histroy behind it?
The Philips curve demonstrates the trade off (relationship) between unemployment and inflation.
For example:
High unemployment - low pressure on wages - workers can’t demand higher wages - less wage inflation. Lower production costs - Lower consumers prices - Price disinflation
Low unemployment - High pressure on wages - very few workers can demand for higher wages - Wage Inflation - High production costs passed to consumers - Price inflation
History
1945 - Fiscal demand management - general tool
AD stimulated - Recession
AD reduced - period of high inflation
They beleived that you could either have unemployment or inflation - Not Both.
1980 - Philips curve relationship broke down - No more relationship between inflation and unemployment.
Monterists + New classical critical with Philips curve.
What do Keynes and Hayack beleive in?
Keynes - In favour of intervention
Hayack - Free market - economy mor efficient - No Gvt. intervention.
What is vertical equity?
Vertical Equity - The equal treatment of unequals.
For example:
Everybody regardless of income must eat.
What is Horizontal equity?
Horizontal equity - The equal treatment of equals.
Example:
Two people earn £15,000 they should both pay the same amount of income tax.
What does the Lorenz curve show? What is the Gini-coefficient?
The Lorenz curve shows whether income is equally or unequally distributed.
X-axis –> Cumulative percentage of the total population
Y-Axis –> Cumulative percentage of the total income
The Gini-coefficient is derived from the graph.
Calculated –> Ratio between the area of the Lorenz curve and the line of perfect equality and the total area beneath the curve. (Areas ‘A’ and ‘B’ shown on the graph)
Either demonstrated as a decimal or percentage
Greater value –> more Inequality
Smaller value –> Lower Inequality
Pros of inequality?
Pros:
- More work - Higher wage – Acts as an incentive to work harder.
People work more for skilled jobs - Doctors
- Inequality is necessary to encourage entrepreneurs to take risks and set up new business
- Trickle down effect
Succesful buisness set up - More inequality - New buisness creates a wide range of jobs - Less inequality.
Cons of inequality?
- Diminishing Marginal Utility of Income - The richer you become the benefit/statisfaction of earning the extra money is reduced (You are already able to afford a comfortable lifetsyle).
- Social problems - Inequality can lead to riots and higher crime rates especially if the people beleive that inequality is caused by unfair allocation of opportunities (monopoly power, inherited wealth).
- High inequality leads to unhapinness - Poorer people will have lower standards of living, less health care, less education etc.
- Inequality leads to a lack of oppertunities - Poorer individuals won’t have the same educational oppertunites.
Causes of Inequality?
- Monopoly power - charge higher prices - more money for wealthy and less for consumers.
- Monopsony power - monopolies can chagre below market wage rate. Lower pay - more inequality.
- Unemployment
- Inherited wealth
How can a market economy lead to inequality?
In a market economy the consumption of goods and services in a household depends on the income. (You need money to get goods/services).
Poor people lack money - deprived of the same range of goods and sevies as an average person - less oppertunity more inequality.
Problems associated with inequality?
1. Consumption and mis-alocation of resources.
- Inquality reduces consumer deamnd
- Investment is skewed towards preferences for rich
2. Risk taking
- It can lead to too-much risk taking which can be dangerous in financial markets
3. Market Failure
- It can deprive people from eduction - limiting human capital.
- Poor people pay higher interest rates relative to their wealth. (I.E - taking out bank loans)
- Unemployment (Less opertunity - less employment)
- Disruption of social cohesion
- Unemployment damages human capital
Impact of poverty?
- Lack of neccesities
- Isolation - social events
- Bureaucracy/lack of information (lots of repetitive form filling)
- Lack of hope/respect
- Lack of decent work
- Stress
- Anxiety
- Ill health
- Increased poverty
What does government intervention depend on?
It is highly dependent on the type of government in power.
Is it an interventionist government (Keynesian view)
or
Is it an Laissez-faire government (Classical view)
Benefits and disadvantages of government intervention to reduce inequality?
Benefits
- Diminishing marginal returns on income.
- Reduce monopoly power - they can exploit low wages + set high prices.
- Ensure inherited wealth is justified (Wealth tax)
- Overcome market failure (Inequality, Lack of positive extenralties, lack of oppertunities, economy not working at potential output).
Disadvantages
- Government failure - wrong information
- How much to intervene to be succesful?
- Higher tax on high income earners - discourage forms to settle in country.
- Reduces incentives to work
- Lack of risk taking by firms and entrapeneurs.
How can government reduce inequality?
- Tax system - Tax higher earners, inheritance tax
- Welfare system - receive payments back (returns), benefits etc.
- Set a Minimum wage
- Use regulations to control monopolies and monopsony.
- Reduce unemployment
What is a negative output gap?
When the level of actual GDP is less than potential GDP. (Working below the economic potential)
Some factor resources are under-utilized e.g. demand-deficient unemployment.
Main problem is likely to be higher unemployment and possible deflation risk
What is a positive output gap?
Actual GDP is greater than the estimated potential GDP
Some resources working beyond usual capacity (shift work & overtime) - Temporary
Main problem is rising demand-pull and cost-push inflationary pressures
Are transfer payments (type of Gov spending) included in injections into the circular flow?
Transfer payments are payments made to an individual which does not result in an increase in output.
I.e. Pensions, unemployment benefits, child allowance.
As this is an example of a transfer in income, rather than income in exchange for output –> this does not represent an injection.
What is property income? What is net property income from abroad?
Property income –> Income earned by assets held in foreign countries.
Net Property income from abroad –> Income earned from assets abroad minus income paid to foreign assets operating domestically
Note –> Difference between GDP and GNP/GNI
GNI = GDP + net property income from abroad.
How does economic expansion impact the B.O.P?
Increased economic growth –> income could increase —> increased consumption (income major determinant) —> Increase in imports as many goods will require imported components
Meanwhile…
Increased economic growth –> inflationary pressure —> exports less competitive —> Lower export revenues.
Hence…
Economic expansion may lead to a deterioration in B.O.P.
Opposite happens when economy contracts
Summarise the conflict in goals during periods of expansion/contraction within an economy.
Growth/low unemployment/Low & stable inflation/Favourable balance of payments.
During a period of Economic expansion…
Economic growth –> Achieved (GDP rises)
Low unemployment –> Achieved (More worker needed to produce growing output)
Low/stable inflation –> Not Achieved (inflationary pressure builds)
Favourable B.O.P —> Not achieved (current account worsens)
During a period of Economic Contraction…
Economic growth –> Not Achieved (GDP falls)
Low unemployment –> Not Achieved (Fewer workers needed as less output is demanded)
Low/stable inflation –> Achieved (inflation falls)
Favourable B.O.P —> Achieved (current account improves)
Difference between durable and non-durable goods?
Durable –> Goods that are used by consumers over a period of time (I.e. cars, computers, mobiles, etc.)
Non-Durable –> Goods that are used up immediately/in a short period of time (i.e. Rice, toilet paper, newspapers, etc.)
Describe the short-run aggregate supply? What is it upward sloping?
Graphically looks very similar to microeconomic supply –> Positive relationship between price & output.
Note –> Short run –> Defined as the period of time when the prices of the factors of production do not change –> Most importantly, the price of labour (wage rate) is fixed.
Hence…
If firms want to increase output –> there is a higher average cost of production (paying overtime) –> illustrated by diminishing returns of marginal/average cost curves –> Increased cost passed on to consumers –> Thus… Postive relationship
What are factors that influence SRAS curve?
Factor that influence Short-run aggregate supply —> Known as ‘Supply-side Shocks’
- Change in wage rates –> Increase in wages –> Increase costs –> fall in AS.
- Change in cost of raw materials —> Influence costs –> Note –> Change has to be significant to really impact AS.
- A change in the price of imports —> Increase in import prices (due to exchange rates) –> increased costs.
- A change in government indirect tax or subsidies —> Indirect tax (on goods/services) increase –> increase costs –> Fall in SRAS. Increase in subsidies -> reduces costs –> decrease in SRAS.
What are the three different phases of the LRAS curve?
- AS is perfectly elastic at low levels of economic activity –> Increased real output does not impact average price level –> due to “spare capacity” –> i.e. high levels of unused factors (Labour/under-utilized capital).
- AS curve approaches the potential output –> spare-capacity is used up –> factors become increasingly scarce –> High costs for factors –> increased price level.
- Economy reaches full capacity (potential output) –> impossible to increase output as all factors are fully employed –> Perfectly inelastic –> can only increased when the quantity/quality of factors increase.
In general terms how can one increase LRAS?
- Improvement in the quality of the factors of production (Increase in productivity)
- Increase in the quantity of the factors of productions
Possible negative impacts of market-based supply-side policies?
Even though market-based policies may boost economic growth, they may result in…
- Reduction in living standards for low-income/unionized workers –> income inequality.
- Negative impact on the environment if environmental regulations are relaxed.
- Reduction in worker safety if Health/safety regulations are relaxed.
- Deterioration in working conditions if working hours change.
What is the macroeconomic equilibrium level of output?
Macroeconomic equilibrium –> This is when aggregate demand is equal to aggregate supply.
According to New Classical economists, what does the economy automatically do in the long-run? If you know, explain the process?
New Classical –> An economy will automatically (without government intervention) move towards the long run equilibrium. –> Free market.
- Example 1 –> Inflationary Gap
An outward shift in AD –> economic producing higher than the potential (only in short run) –> increased competition for scarce labour/capital between firms –> shown by an increase in price level on diagram –> Cost of production increase –> SRAS shift inwards back to long-run equilibrium
- Example 2 —> Deflationary gap
An inward shift in AD –> economic producing less than the potential –> decrease competition for scarce labour/capital between firms –> shown by a decrease in price level on diagram –> Cost of production decrease –> SRAS outwards back to long-run equilibrium
Important –> Long run equilibrium level of output = Full employment level of income –> Without Gov. Intervention/Only market forces
Explain what happens if there is an increase in AD when the curve is on the perfectly elastic section of the LRAS?
Increase in AD –> AD shifts outwards –> Increase in output but no inflationary pressure.
This happens because…
When Output is far away from the potential output there is spare capacity –> high levels of unused factors of production (unemployment, underutilized capital).
Consequently, an increase increased employment doesn’t result in increased competition for factors of production –> producers don’t bid up the price.
Explain what happens if there is an increase in AD when the curve is on the elastic/inelastic section of the LRAS?
Increase in AD –> Outward shift in AD —> Increase in real output —> increase the price level (inflationary pressure) –> Inflation.
This happens because…
When output is far closer to the potential output –> lower level of spare capacity –> factor of production become scarcer —> More competition for factors –> producers bid up the price –> increase costs which are passed on.
Explain what happens if there is an increase in AD when the curve is on the perfectly inelastic section of the LRAS?
Increase in AD –> Outwards shift in AD –> NO increase in real output –> Inflationary pressure –> large increase in inflation.
The outcome is “Purely Inflationary” —> Inflationary gap –> AD can’t be satisfied by existing resources.
This is because…
The economy is already working at full potential –> Real Output can’t increase —> But price level increase to allocate the scarce resources among competing components of AD (C + I + G + (x-m).
Key difference between Classical and Keynesian?
Keynesian –> Assume that the Long run equilibrium is not at the level of full employment (Potential output) –> Governments have to intervene in order to correct –> Demand-side policies
Classical –> The economy will move the long run full level of employment without government intervention.
What determines the impact of an outward shift in the LRAS curve?
Keynsian
Impact depends on the initial equilibrium position
- AD on the Perfectly Elastic section of the curve —> no impact on real output
- AD on the elastic/inelastic section of the curve —> Real output increases
Classical
- An outward shift in LRAS will always result in an increase in real out
What is the multiplier effect?
Multiplier effect –> Initial change in aggregate demand can have a proportionally greater final impact on the level of equilibrium national income.
What is the marginal propensity to consume (MPC)
The marginal propensity to consume (MPC) measures the proportion of extra income that is spent on consumption.
MPC = ΔC / ΔY
C –> consumption
Y –> Disposable income
Answer will range between 0 and 1
How does one calculate the multiplier?
The multiplier can be calculated using either the marginal propensity to consume (mpc) or the value of the marginal propensity to withdraw (mpw).
Note -> mpw = mps + mrt + mpm
mps –> Marginal propensity to save
mrt –> marginal propensity of tax
mpm –> marginal propensity to import
Hence….
Multiplier = (1)/(1-mpc)
or
Multiplier = 1/mpw = 1/(mps + mrt + mpm)
How does one calculate the increase in National income/output when you know the initial investment and the multiplier?
Change in National income = Multiplier x Initial investment
What factor could influence the multiplier of an economy?
Any change in withdrawals from the circular flow will result in a change in the economy’s multiplier.
This is because mpc measure the domestic consumption. Hence, if for example taxes or imports increase then less money from the initial investment is spent on domestic goods/services as it has left the circular flow of income.
Limitation of national unemployment rate statistics?
Good Evaluation point!
National unemployment rates establish an average for a whole country, which is likely to mask inequalities among different groups.
This could be due to….
- Geographical disparities –> Differences in unemployment between regions.
- Age disparities –> Differences between age groups.
- Ethnic differences –> Ethnic minorities –> lower levels of unemployment –> Educational opportunities/prejudices.
- Gender disparities –> More women unemployed than males in industrialised countries.
What is the ‘pool of unemployment?
The number of people that are unemployed at any given moment.
The pool of unemployment depends on the rate at which people become employed and unemployed.
Examples of inflows and outflows from the ‘Pool of unemployment’?
Inflows
- People losing jobs
- People who have registered
- Left school but do not have work yet
Outflows
- Find jobs
- Retire
- Get back into education
- Stay at home to look after children.
What is disequilibrium unemployment?
Disequilibrium unemployment occurs when there are any conditions that prevent the labour market from clearing, that is, reaching the labour market equilibrium (intersection between demand & supply of labour).
Examples:
- Cyclical unemployment
- Demand-deficient unemployment
Why is cyclical unemployment more problematic than it should be?
In reality, a decrease in demand for labour as a result of downturns in the economic cycle shouldn’t be as problematic.
However, as wages are ‘sticky downwards’ the wage don’t fall as easily which results in a greater decrease in demand for labour.
This is due to…
- Firms not wanting to make workers discontent and reduce motivation.
- Minimum wage
- Trade unions.
What is equilibrium unemployment?
Also known as Natural unemployment
The natural rate of unemployment is the difference between those who would like a job at the current wage rate – and those who are willing and able to take a job.
Caused by structural factors.
Important distinction between demand-deficit unemployment and structural?
Aggregate demand decrease –> increase in unemployment (affects all labour)—> However… –> if demand increase —> unemployment will decrease
However, during structural unemployment….
There is a permanent fall in the demand for one type of labour and requires different solutions.
What are some interventionist policies to reduce structural unemployment?
Solutions
- Supply-side policies
- Train the workers with skills for new jobs –> improve occupational mobility –> subsidizes businesses so that they retrain workers.
- Train people so that they are occupationally flexible Transferable skills (general skills).
- Provide subsidies/tax breaks –> encourage people to move –> geographical mobility.
Disadvantages
- High opportunity cost
- Long term
What are some market-based policies to reduce structural unemployment? Disadvantages?
Solutions
- Reduce unemployment benefits –> creates an incentive to find jobs
- Deregulation of markets (removing legislation for hiring & firing) –> increases labour market flexibility and encourages businesses to hire more workers.
Disadvantages?
- The lower level of unemployment benefits –> unemployed experience lower standards of living.
- Labour market regulations needed to protect workers.
-
Are demand-side policies or supply-side policies more effective in reducing unemployment
The success of the policies is dependent on the type of unemployment.
Scenario 1:
I.e. If there is demand-deficient unemployment then using demand-side policies should be suitable to address the issue.
Problems….
- Fiscal –> tax reduction –> no guarantee people spend –> low confidence –> rather save.
- Monetary –> interest rates lowered –> no guarantee it will increase consumption/investment.
- There is always a time lag
Scenario 2:
Economy near/at full level of employment –> supply side policies only successful (demand side –> inflation)
General problem/reality
The economy suffering from several types of unemployment –> they use a mix of both policies
What is crowding out?
Crowding out: when government spending fails to increase overall aggregate demand because higher government spending causes an equivalent fall in private sector spending and investment.
Why does crowding out happen?
It happens because in order finance the increased government spending (in order to increase AD) the government has to either…
- Raise taxes –> reduces disposable income for firms/people.
- Borrow money –> borrows from the private sector —-> private sector buys bonds and no longer uses to money for boy goods and services.
Both factors –> reduced private sector spending which decreases consumption —> can offset an increase in AD from Gov. spending.
Negative impacts of inflation?
- Loss of purchasing power –> happens when prices increase but incomes don’t adjust —> fall in real income –> lead to lower standards of living
- Effect on saving —> Interest rates on savings accounts lower than rate of inflation –> people who rely on interest from their savings will be poorer.
- Effect on Interest rates –> High rate of inflation –> banks raise nominal interest rates –> ensure that real rate that they earn remains positive.
- Effect on international competitiveness –> Goods/services more expensive than foreign producers –> decrease in competitiveness.
- Uncertainty –> Firms discouraged from investing due to the uncertainty created by inflation.
- Labour unrest —> Disputes between unions & management –> worker feel like salaries/wages do not keep up with inflation
What is ‘good’ and ‘bad’ deflation?
- Good deflation –> supply side –> Improvements in the supply side of the economy/increased productivity –> unemployment decreases due to increased output.
- Bad deflation –> Fall in AD –> real output decrease + decrease in price level —> accompanied by increased unemployment
What is the Inflationary spiral?
Inflation has a tendency to self-perpetuate in a cycle.
Economy near full employment –> increase in AD –> demand-pull inflation –> inflation due Increased competition for factors —> consequently workers demand higher wages to compensate which drives costs –> Increase in Cost push inflation —> High wages –> illusion that they are richer/more spending power –> increased consumption
How to reduce Demand-pull inflation?
Demand Pull inflation –> Demand-side policies –> deflationary fiscal/monetary policy.
Problem
- Politically unfavourable –> High taxes/low Gov. spending + High interest unfavourable for people with loans/mortgage.
However, many countries have a central bank which has monetary control –> independent.
Hence –> Monetary policy most important –> Fiscal complication/time lag in government.
How to reduce cost push inflation?
Cost-push inflation –> Supply side —> increase LRAS
What is the difference between discretionary fiscal policy and automatic stabilizers?
Discretionary fiscal policy: A deliberate change to a government policy in order to manage aggregate demand. Such as increase government expenditure on infrastructure.
Automatic Fiscal policy: Automatic stabilisers refer to how fiscal instruments will influence the rate of growth and help counter swings in the economic cycle. No deliberate change to government policy in order to change the level of the AD.
Example -> period of high growth –> tax revenue increase (larger wages/more employed) + less spent of unemployment benefits –> Reduces Consumption + Gov. Spending –> controls growth.
How does one calculate the rate of inflation?
For each year you must:
- Multiply –> (Index x Weight)
- Add all the Weighted indices together to generate the average index.
- Apply Average index values to the following equation (Percentage change)
Note -> Year
[(Index for (X+1) - Index for X)/(Index for X)] x100
How could an economy potentially experience non-inflationary growth when increasing AD?
If AD and LRAS were to increase simultaneously, then any inflation created by AD could cancel by the disinflation created by the outward shift in LRAS –> Non-inflationary growth.
or..
If AD is located on the elastic section of the LRAS curve.
How does one calculate growth rate?
Formula
Growth rate = [(Real GDP in Year 2 - Real GDP in Year 1)] / (Real GDP in year 1) x 100
What are the two main type of taxes that are changed in order to help tackle inequality?
- Direct Taxes –> Taxes imposed on people’s income or wealth and on firms’ profits.
- Indirect taxes –> Taxes which are paid by households and firms when they engage in spending.
How are progressive taxes be used to tackle inequality?
Progressive taxes –> Income rises –> people pay a higher proportion of their income in taxes.
Often used to redistribute income from high income earners to low-income earners.
How can one calculate the average tax rate?
Average tax paid = (Total tax paid)/(Income) x 100
Note–> Remember that a progressive tax system works using tax brackets. For example, the first 10,000 they don’t pay tax but the following 10,000 they pay 20%, etc….
How can one calculate marginal tax rate?
Marginal tax rate = (Change in total tax paid)/(Change in income) x 100
Basically the difference in tax divided by the difference in income.
Can regressive taxes be used to tackle inequality?
Regressive tax —> the rate of tax paid falls as incomes rise.
Indirect taxes (VAT) are a form of regressive tax.
Good for Gov revenue + discourage demerit goods
But…
Worsen Income inequality.
What are proportional taxes? Can they be used to tackle inequality?
Proportional tax –> Proportion of income paid in tax is constant for all income levels.
Hence, not the best for tackling inequality…
But they are useful as they provide people incentives to work harder/take risks as people are able to earn more money if they become richer (taxes don’t increase).
How can governments use tax revenue in order to help redistribute income?
- Transfer Payment –> Provide different types of assistance to groups in the economy to improve their standards of living.
Examples –> child support assistance, pensions, unemployment benefits, etc.
- Government expenditure to provide essential goods/services —> Tax revenue to provide directly or subsidize goods/services that are socially desirable (positive externalities) –> Health care/education/sanitation/ etc.
What are some evaluation points against the intervention of the government using taxes in order to redistribute income?
Classical Economists –> against government intervention because…
- Firms need to pay insurance/social security coss –> firms hire fewer workers –> unemployment.
- High taxes discourage entrepreneurial activity.
- Due to the point previously made, taxes will lower economic growth which has negative impacts.
How does one calculate the real GDP when the Nominal GDP and Inflation are given?
Real GDP = Nominal GDP x Price Deflator
Price Deflator = Nominal GDP/Real GDP x 100
Or…
Price Deflator = 100 / (100 + Inflation rate)
Definition of investment?
Investment is spending on capital goods such as factories & other buildings machinery & vehicles. It is important to note that it is also a component of Aggregate demand in an economy.
Labour force diagram?
