topic 3 Flashcards
draw the circular flow of income
elsewhere
define GDP
the value of total output produced in an economy over a period of time.
define GNI
the value of total output produced in an economy over a period of time and net income from abroad taken into account
state the equation linking GDP and GNI
GNI = GDP + net income from abroad
state 3 ways in which GDP can be measured
- Income: Wages + Rent + Interest + Profit
- Output: sum of 1st, 2nd, 3rd sectors’ outputs
- Expenditure: C + I + G + (X – M)
give and explain the equation for GDP using the expenditure approach
C + I + G + (X – M)
GDP = Consumption (C) + Investment (I) + Government spending (G) + Exports (X) - Imports (M)
what are real GDP and GNI?
Real GDP and GNI is the value of total output produced in an economy over a one year period - and adjusted for inflation
give equation for real GDP
real GDP= nominal GDP/GDP deflator x 100
give the equation for real GDP per capita
Real GDP per capita = Real GDP / the population
define and explain purchasing power parity
a conversion factor applied to GDP and GNI
the rates of currency conversion that equalize the purchasing power of different currencies by eliminating the differences in price levels between countries
The aim of PPP is to help make a more accurate standard of living comparison between countries where goods/services cost different amounts
give a theoretical example of PPP
If a basket of goods costs $150 in Vietnam (once the currency has been converted) and the same basket of goods costs $450 in the USA, the purchasing power parity would be 1:3
It seems like the cost of living is much higher in the USA
However, if the USA’s GNI/capita is more than three times higher than the GNI/capita of Vietnam, it could be argued the USA has better standards of living
Conversely, if the GNI/capita in the USA was less than three times that of Vietnam, it could be argued that Vietnamese citizens enjoy a higher standard of living as they spend less income to acquire the same goods/services
draw and label a business cycle diagram
elsewhere
give 3 reasons why national income statistics are useful for making comparisons between countries
- They provide insights into the effectiveness of government policies
- They allow judgments to be made about the relative wealth and standard of living within each country
- They allow comparisons to be made over the same or different time periods
why is real GDP a better comparison than nominal GDP?
One country may have a much higher rate of economic growth, but also a much higher rate of inflation.
why does real GDP per capita provide better information than real GDP?
it takes population differences into account
compare GNI and GDP
Using real GNI/capita is a more realistic metric for analysing the income available per person than GDP/capita
Limitations of Using GDP data to Compare Living Standards Between Countries and over time
- Lack of information provided on inequality
- Quality of goods/services
- Does not include unpaid/voluntary work
- Environmental factors (creation of externalities)
give 3 other ways in which national living conditions can be measured
The OECD Better Life Index
The Happiness Index
The Happy Planet Index
3 other ways of measuring national living standards
The OECD Better Life Index
The Happiness Index
The Happy Planet Index
happy planet index
wellbeing x life expectancy / ecological footprint
define aggregate demand
the total level of planned spending in the economy by consumers (C), firms (I), government (G), and foreigners (X-M) over a period of time (usually one year) at different price levels
define aggregate supply
the total planned production at different price levels.
state the equation for AD
AD= C + I + G + (X-M)
C
consumption
I
investment
G
government expenditure
X
exports
M
imports
(X-M)
net exports
draw an aggregate demand curve
flashcard 1
what do movements along the AD curve show?
as price level rises, the level of Real GDP falls and vice versa
what are shifts in the AD curve caused by?
changes in any of the AD components (C, I, G, (X-M), ceteris paribus
Why does the AD curve slope downwards? [3]
- The income effect; at a lower PL, consumers are likely to have higher disposable income and therefore spend more.
- The substitution effect; lower PL in the UK= UK goods will become relatively more competitive, leading to higher exports. Exports is a component of AD so AD will be higher.
- Wealth effect; At a lower price level, interest rates usually fall, and this causes higher AD.
state/explain the 6 determinants of C as an AD component
- consumer confidence
- interest rates
- wealth
- income taxes
- level of household indebtedness
- expectations of future PL
explain how consumer confidence affects AD
A boost in consumer confidence increases aggregate demand and a drop in consumer confidence decreases aggregate demand.
explain how interest rates affect AD
higher IR:
- becomes more “expensive” to borrow money
- consumer spending/investment fall
- AD falls
state/explain the 5 determinants of I as an AD component
- interest rates
- business confidence
- technology
- business taxes
- level of corporate indebtedness
define an interest rate
the amount a lender charges a borrower . it is a percentage of the principal (the amount loaned)
state/explain the 2 determinants of G as an AD component
- political priorities (eg. subsidising education, green companies)
- economic priorities (eg. reducing inflation)
state the 3 determinants of X-M as an AD component
- income of trading partners
- exchange rates
- trade policies
explain income of trading partners as an AD determinant
- increasing the incomes of our closest trading partners means those people would buy more of our stuff, so our exports would increase
- AD increases
explain exchange rates as an AD determinant
an increase in the exchange rate will tend to reduce AD as exports will fall and imports increase.
define short run aggregate supply
the short run is the time period where factor costs are fixed (ie the unit cost of land, labour, capital and enterprise are fixed).
state 5 examples of changes in FOPs
- technology
- skills
- migration
- wage settlements
- commodity prices
describe how indirect taxes would affect the SRAS curve
an effect similar to a rise in production costs (curve will shift left)
state the 2 determinants of the SRAS curve
- costs of FOPs
- indirect taxes
monetarist/new classical view of the LRAS curve (flashcard 3)
LRAS inelastic as wages/prices flexible due to price mechanism:
- all those willing and able to get a job at the WR will have one
- any unemployment is voluntary
SO output will always be at full employment independent of the PL
Keynesian view of the LRAS curve (flashcard 4)
LRAS elastic in long-term – the economy can be below full capacity for a long time unless supply-side initiatives (eg educational changes) are taken
Describe a negative output gap (flashcard 5), or deflationary/recessionary gap:
- actual output (real GDP) is lower than potential output (Yf)
- caused by decrease in AD
describe a positive output gap (flashcard 5), or inflationary gap
- actual output (real GDP) is greater than potential output (Yf)
- caused by increase in AD
state 4 possible causes of shifts in the AS curve over the long run
- changes in the quantity/quality of FOPs
- improvements in technology
- increases in efficiency
- changes in institutions
describe a readjustment to equilibrium in the monetarist/classical model after a drop in AD
- market is at an equilibrium at P1F1
- AD falls from AD1 to AD2. causing:
- P1 to fall to P2
- Yf to fall to Y2
- negative output gap
- demand for labour falls from D1 to D2
- Price mechanism ensures new equilibrium at W2Q2
- lower wages mean lower FOPs, increasing SRAS so curve shifts to right
- new equilibrium found at P3Yf
describe equilibrium in a Keynesian model
- there will be a persistence of deflationary/recessionary gaps: the equilibrium level of output may not equal the full employment level of output
state the assumptions behind the Keynesian model
- wages are ‘sticky downwards’ so workers may refuse lower wages due to trade unions, minimum wage laws, money illusion.
- price mechanism will not work (govt required to take action)
define the money illusion
people think in nominal terms
state the assumptions behind the classical model
- short run unemployment can occur but is a temporary phenomenon; wages are flexible and so will fall, and the labour market will move back into equilibrium
- long run unemployment will be ‘voluntary’
Define unemployment
people above the age of 16, who are able, available and willing to work at the going wage but cannot find a job despite an active search for work
define the economically active population
employed people + unemployed people
give the equation for unemployment rate
numbers unemployed/economically active population x 100
what is the activity/participation rate?
proportion of working age population that are (potentially) active, so either employed or unemployed
what is the inactivity rate?
the percentage of the population of working age that is out of the labour force.
what is the labour force?
the active working age population (16-64yo) that are either in work or able to work and actively seeking work
give a flow diagram for population
population -> population of working age -> labour force/out of labour force (inactive) ->employed/unemployed
define unemployment rate
percentage of the labour force that is not working.
state 2 difficulties of measuring unemployment
- Hidden unemployment, including discouraged workers and underemployment
- average ignores disparities
hidden unemployment
people who are jobless, but official unemployment figures do not include them.
- eg, people who have stopped looking for a job and people who work less than they want to
discouraged workers
people that would like to work and have previously been seeking employment, but have since stopped because they could not find a job.
underemployment
- part time work; where workers would prefer to work more hours but cannot get them
- workers working below their skill levels
economy may be working inside PPC despite low headline unemployment figures
average ignores disparities
the unemployment rate is only an average so does not account for disparities in age, gender, ethnicity and region. For instance, youth unemployement tends to be higher as well as the unemployment rate amoungst ethnic minority groups.
give a pro and a con of unemployment benefits
pro: can make labour market more efficient by enabling better ‘matching’
con: less incentive to find work
what is youth unemployment?
percentage of labour force between 15 and 24 that is unemployed
give equation for youth unemployment rate
no of 15-24yo unemployed/economically active 15-24yo x 100
why is youth unemployment unreliable?
there is an inevitable exaggeration in youth unemployment rates as the activity rate (denominator) is smaller than for the whole population (students are inactive)
what can we use instead of youth unemployment?
NEETs (not in employment, education or training)
state 5 types of unemployment
- classical/real wage
- demand deficient/cyclical
- structural
- seasonal
- frictional
describe the causes of classical or real wage unemployment
caused by real wages being forced above the equilibrium wage rate by actions of:
- government (eg minimum wage laws)
- trade unions
describe how demand deficient/cyclical unemployment happens in the classical view
- AD falls
- causing a NOG
- derived demand for labour falls
- in the short run, wage rate remains fixed; Qs of labour remains at Q1 but the Qd of labour falls to Q2
(wages then fall and employment restored as SRAS shifts right)
assumptions behind classical unemployment theory
- short run unemployment can occur but is a temporary phenomenon; wages are flexible and so will fall, and the labour market will move back into equilibrium
- long run unemployment will be ‘voluntary’
causes of demand deficient/cyclical unemployment
- general lack of AD in the economy
how can demand deficient/cyclical unemployment be fixed? (according to Keynes)
by pushing AD back up, ie through lower interest rates, lower taxes and increased govt spending
describe how demand deficient/cyclical unemployment happens with a diagram in Keynesian view
- AD falls from AD1 to AD2, causing:
- new equilibrium at P2Y2
- NOG - Derived demand for labour falls to D2
- Wage rate stays the same (W1)
- Qs>Qd = unemployment
what did Keynes argue about falling wages?
he argued that if wages fell and workers accepted them, that AD would fall even further, worsening unemployment
what is structural unemployment?
unemployment caused by the decline of industries and the inability of former employees to move into jobs being created in new industries.
- the decline of such industries may be caused by automation and ‘offshoring’ due to globalisation
why would structural unemployment persist?
due to occupational and geographic immobility of labour (ie workers don’t have necessary skills for a different job, and they cannot move)
draw a diagram for structural unemployment
flashcards: NB that labellings need to be SPECIFIC FOR A PARTICULAR INDUSTRY
define frictional (or search) unemployment
unemployment caused when people move between jobs. it will inevitably take time to find alternative work, during which period the worker is ‘frictionally’ unemployed
what affects frictional unemployment?
- the quality of the information available for job seekers is crucial to the extent of the seriousness of FU
- the generosity of benefits can also impact upon the time taken
why may frictional unemployment be a good/bad thing?
if it is too short- underemployment
however, if it is too long- this could become long term unemployment
define seasonal unemployment
unemployment caused by the seasonal nature of employment- tourism, construction, agriculture, skiing, sports, beach lifeguards etc
what is the macroeconomic objective relating to unemployment?
low unemployment
what is the macroeconomic objective relating to inflation?
low and stable rate of inflation (uk=2%)
define inflation
the sustained rise in the general (or average) level of prices
how do we measure inflation?
by using the consumer price index (CPI)
describe the method for finding the CPI
- a typical basket of goods and services is identified annually (from National Accounts)
- Weights are assigned to items to reflect relative importance, or percentage income. this is changed annually
- monthly price surveys are conducted and used to adjust the index
- changes in the index are used to calculate the inflation rate (% inflation)
what are the limitations of the CPI in measuring inflation?
- the basket used in any country represents the purchasing habits of a ‘typical household’, but this will not be applicable to all people.
- there may be variations in regional rates of inflation within a country
- items are removed or added to be more representative of typical demand; however, this limits the ability of analysts to make comparisons from one period of time to another/international comparisons
- prices may change for a variety of reasons that are not sustained- eg seasonal variations in the prices of food and volatile oil prices may lead to unusual movements in the inflation rate and can be misleading
what is a core rate of inflation?
a measure that uses the information of the consumer price index but excludes food and energy prices
why does the CPI exaggerate inflation?
- substitution effects- the CPI disregards the fact that people tend to switch towards cheaper substitutes as prices rise
- quality improvements are disregarded- sometimes as price increases, you get more value for your money (ie the rise is not just due to inflation)
why is the exaggeration of the CPI significant?
economic agents have to use this measure:
- workers/unions; for base pay demands
- businesses; for base price increases
- governments; to set taxes
give the two causes of inflation
- demand pull inflation
- cost-push inflation
describe demand pull inflation with a diagram
- AD increases from AD1 to AD2
- this causes the general price level to rise, and causes a positive output gap
state the difference between anticipated and unanticipated inflation
anticipated inflation= correctly predicted inflation
unanticipated inflation= where actual inflation catches economic agents by surprise (could be higher OR lower than expected)
why is unanticipated inflation problematic?
as it results in a misallocation of resources (allocative inefficiency) by affecting the price mechanism signal
what could be 4 causes of demand-pull inflation?
demand side:
- cut in interest rates
- increased money supply
- higher wages
- inflation expectations
what could be 4 causes of cost-push inflation?
supply side:
- higher wages
- devaluation/depreciation
- increase in VAT
- inflation expectation
why would cutting interest rates cause an increase in AD?
cheaper to borrow:
- encouraged spending and investing
why would devaluation/depreciation cause both types of inflation?
- increases the cost of imports so there will be an increase in cost-push inflation.
- increases domestic demand (exports), so there could be some demand-pull inflation
describe cost push inflation with a diagram
firms respond to rising costs by increasing their prices to protect profit margins
describe the wage-price spiral
- rise in wages causes cost of production to rise
- leading to cost push inflation
- higher incomes cause AD to rise
- leading to demand pull inflation
- higher prices reduce real incomes and unions demand pay rises
what determines the economic costs of inflation?
- the degree of inflation (most costly when it is high/variable)
- unanticipated/anticipated
- whether it is higher in the uk than trade partners
- whether the exchange rate adjusts to restore lost price competitiveness for exporters
state the 6 main costs of inflation
- uncertainty
- redistributive effects
- monetary policy response
- damage to export competitiveness
- increasing inflation expectations (self-fulfilling)
- shoe-leather costs/menu costs
uncertainty as a cost of inflation
loss of business confidence due to high levels of uncertainty:
- decrease in planned investment (component of AD)
- AD falls, lowering GDP
- in the long run, this will harm productivity and health of economy (LRAS may not increase)
why do redistributive effects happen by inflation?
misallocation of resources due to distorting PM:
- lenders -> debtors
- away from those on fixed incomes/with a weak bargaining power
- tax-payers -> government
redistributive effects (lenders->debtors) as a cost of inflation
- inflation rate becomes higher than nominal interest rate, so real interest rates become negative
- borrowing is cheaper; profits of lenders decrease
redistributive effects (away from those on fixed incomes/with a weak bargaining power) as a cost of inflation
- nominal pay stays the same but real pay decreases; lower purchasing power and income
redistributive effects (tax payers-> government) as a cost of inflation
- as inflation rate rises, tax payers are moved into higher tax bands (despite the fact that their real income is staying the same/decreasing)
- ensures they are charged a higher proportion of their real incomes
monetary policy response as a cost of inflation
- central banks increase interest rates
- AD falls so real GDP falls (output in the country has fallen)
- worse unemployment as firms adjust their production/supply in response to the AD fall
damage to export competitiveness as a cost of inflation
- SRAS falls as cost of production increases
- exports become more expensive and decrease
- imports become relatively cheaper and more attractive, so demand for these increases
- net exports (X-M) falls so AD falls and real GDP falls
increasing inflation expectations as a cost of inflation
- consumers will not delay purchases; AD rises
- greater demand for higher wages
micro costs of inflation as a cost of inflation
shoe leather costs:
- costs that people incur to maximise their cash holdings during times of high inflation
menu costs:
- costs that businesses face when they change their prices
both of these create distractions and opportunity costs, which are detrimental for the economy
difference between deflation and disinflation
deflation- price level is falling (negative inflation)
disinflation- the inflation rate is falling (prices are rising but at a slower rate)
describe good deflation
caused by improvements in the supply side of economy/productivity
LRAS shifts to right so PL decreases and output increases
describe bad deflation
AD falls; decrease in price level; PL falls and output falls; unemployment rises as firms need fewer workers
state the 6 effects of bad deflation
- unemployment
- deferred consumption
- falling consumer confidence/uncertainty
- effect on investment
- costs to debtors
- policy ineffectiveness
- Def
why is some inflation desirable?
- deflation can be harmful
- falling/stagnant nominal incomes cause household confidence to fall; AD falls, GDP falls
- reduces the real value of debt, helping households/firms
unemployment as a cost of deflation
AD falls so firms lay off workers, further reducing AD (deflationary spiral)
deferred consumption as a cost of deflation
consumers delay purchases of durable goods; fall in AD (deflationary spiral)
falling consumer confidence/uncertainty as a cost of deflation
lower AD
effect on investment as a cost of deflation
businesses make less profit/ more losses; increased unemployment and decreased business confidence; reduced investment; negative effect on future economic growth
cost to debtors as a cost of deflation
value of their debt rises
policy ineffectiveness as a cost of deflation
very low/negative interest rates associated with deflation make expansionary monetary policy ineffective, as it is not possible to reduce IR to raise AD
state and explain the costs of unemployment to governments, firms, the economy and the individual
Individual:
- loss of income
- health issues (mental instability, sense of failure, increased stress, marital failure, suicide)
Economy:
- increased crime and vandalism
- increased anti-social behaviour
- increased homelessness
Government:
- increased spending on benefits
- less tax revenue
- increased spending on retraining
Firms:
- loss of sales revenue
- loss of output/production
what did the Philips curve lead to?
a theory expressing a trade-off between inflation and unemployment
what did the Philips curve state?
it showed an inverse relationship between inflation and unemployment. as unemployment decreased, inflation rose
what did the Philips curve state?
it showed an inverse relationship between inflation and unemployment. as unemployment decreased, inflation rose
draw the short run and long run Philips curve, explaining the LRPC
the long run Philips curve is always at the natural rate of unemployment
what is stagflation and when does it happen?
the simultaneous increase in inflation and unemployment. it can only occur when there is cost push inflation.
define economic growth
an increase in real GDP/GNP over time (typically a year)
distinguish between short run and long run economic growth
SR:
- caused by an increase in AD
- ca only be sustainably achieved if there is a NOG
LR:
- caused by an increase in LRAS
- Supply side and efficiency improvements shift the LRAS (and the PPC) to the right- resulting in an increase in the potential growth rate
describe short run economic growth using a diagram
- caused by an increase in AD
- only happens if there is a NOG
- causes a movement from inside the PPC toward the PPC boundary
describe long run economic growth using a diagram
- takes place if there is an improvement in supply capacity of economy (ie improvement to FOPs)
- LRAS shifts to the right
- PPC shifts outwards
NB: there also needs to be an increase in AD in order to realise the extra potential output
give 4 effects of boosting LRAS (long run economic growth)
- higher growth of GDP
- lower unemployment (higher derived demand for labour)
- reduced inflationary pressure
- improved trade performance (reduced inflationary pressure improves IC)
why are supply side improvements better than changes in AD?
SS may improve all 4 indicators (inflation, growth, unemployment and trade performance)
changes in AD lead to 2 indicators improving and 2 worsening.
define trend growth
the smooth path of long run national output- the average historical growth rate over 20-30 years.
define a recession in terms of growth
2 consecutive quarters (3 months) of negative economic growth
define the sustainable growth rate
the annual rate of growth that can be sustained without:
1. causing accelerating inflation (eg rise in AD= short run issue)
2. reducing the ability of future generations to grow.
describe how you would calculate economic growth
- Calculate nominal GDP from a set of data for two time periods
- Calculate the real GDP for each time period using the GDP deflator
- Calculate the percentage change in real GDP between the two time periods
give and explain the consequences of economic growth on living standards
PROS
- Increased incomes lead to better standards of living
- Increased employment
CONS
- Rising aggregate demand causes demand pull inflation and the purchasing power of people on fixed incomes may fall
- Increased income usually leads to greater consumption of demerit goods
- Greater output often requires more time from workers and can decrease leisure time and well-being
give and explain the consequences of economic growth on the environment
PROS
Improvement in the quality/quantity of environmentally friendly technologies\
CONS
Environmental damage caused by negative externalities of production and consumption increases
Resources are depleted more rapidly
give and explain the consequences of economic growth on income distribution
PROS
Decreased levels of absolute poverty
Higher levels of employment mean that there is more tax revenue for governments to redistribute on welfare payments
CONS
Lack of equity in the distribution of income - the rich may get richer and the poor poorer
four sources of economic growth
- natural factors
- human capital factors
- physical capital and technological factors
- institutional factors
natural factors
- anything that will increase the quantity/quality of their natural factors should lead to an increase in potential growth
- quantity can be improved by means of land reclamation
- quality may be improved by fertilisation, better planning of land usage, improved agricultural methods, building upwards
human capital factors
- increase: encouraging population growth or increasing migration levels.
- improved: improving healthcare, education, vocational training and re-training for unemployed, fresh water/sanitation
physical capital and technological factors
includes things like factory buildings, machinery, shops, offices and motor vehicles.
- increase: level of saving, domestic investment, government involvement and foreign investment
- improvement: higher education, research and development and access to foreign tech/expertise
institutional factors
- adequate banking system
- structured legal system
- good education system
- reasonable infrastructure
- political stability
- good international relationships
define equality
situations where economic outputs are the same (or similar) for different people or social groups
define equity
concept of fairness or evenness; an economic objective
meaning of economic inequality
How wealth, assets, or incomes are unequally distributed among individuals and populations.
what could be the effect of economic inequality?
it can hinder economic growth
define income
when FOPs are exchanged for their respective payments
why is some form of inequality in society unavoidable?
because a market-based system remain the most efficient way to allocate resources within a society; however, this is based on ownership of resources, which only a few – typically business owners – have access to. Most work as employees, who typically earn less than business owners.
what are the pros of income inequality?
Individuals who are more efficient at their jobs earn more, individuals who are less efficient receive lower income.
- This allows the market to naturally segregate people into jobs that would suit their skills and needs of society.
- Increased wealth is an incentive to be more productive and have a sense of fulfilment.
define wealth
refers to assets and includes ownership of property, bonds, shares of company, etc
why may unequal incomes lead to unequal distribution of wealth?
because wealth takes time to acquire and requires heavy savings and investment. this generally causes wealth to be usually passed from generation to generation
explain how inequality of opportunity may lead to inequality of outcomes:
Education, healthcare, and job opportunities are not solely based on achievements, hard work, or sensible life choices but on circumstances at birth, like gender, ethnicity, place of birth, parent’s profession/socioeconomic background
function of the Lorenz curve and GINI coefficient
measures the distribution of income within a population
describe Lorenz curve
X Axis: cumulative percentage of population
Y Axis: cumulative percentage of income
- Line of perfect equality: the first 10% of the population have 10% of the income, etc.
- The closer the Lorenz curve is to the line of perfect equality, the more equal income distribution is
equation for GINI coefficient
𝐴/𝐴+𝐵
GINI C=0
no distance between lorenz curve and line of perfect inequality; income is equally distributed
GINI C= 1
no section B; last person in society is earning all the income in society.
define poverty
a state or condition in which a person or community lacks the financial resources and essentials for a minimum standard of living.
define absolute poverty
Internationally-defined level of poverty, where impoverished people earn below a certain level of income and have an unacceptable standard of living. (Currently, the line is at $1.90 per day)
criticisms of absolute poverty
- Can be argued that an arbitrary number does not consider the differences and complexity between countries.
- Just because someone earns above the poverty line does not mean they are no longer in poverty
define relative poverty
Locally defined level of poverty, where impoverished people earn below a certain level of income.
less than 60% of median income
how is relative poverty calculated and what is a criticism of this method?
- Determined by country’s national (average and/or median) income and other specific country factors
- Will need to be changed at regular intervals, to account for inflation
give 2 single indicators that measure poverty
international poverty lines, Minimum income standards
cons of the international poverty line
does not take into account basic facilities, such as sanitation, water, and electricity, and their effect on quality of life.
international poverty line
- Represents a monetary threshold for which an individual is considered to be in poverty
- Calculated by taking the poverty line for each country and the value of goods needed to sustain one adult (basic food, clothing, and shelter changes).
Minimum Income Standards
Level of income that is considered necessary to maintain a basic standard of living, covering essential needs such as food, shelter, clothing, healthcare, and education.
give 2 composite indicators of poverty
HDI, Multidimensional Poverty Index
HDI (Human Development Index)
Based on three main factors: GDP per capita, life expectancy, years of schooling (mean and expected)
MPI (Multidimensional Poverty Index)
- Based on three main dimensions: health, education, and living standards. These have equal weighting in deciding poverty
- A person is considered to be multidimensionally poor if they experience deprivation in at least 1/3 of the indicators
give 4 difficulties of measuring poverty
Imperfect data
Intra-Household poverty
Urban poverty
Disaggregated poverty data
imperfect data
Type of sampling and weighting given to the data may not accurately reflect poverty (household surveys, for example, might suffer from sampling errors, non-response bias, or underreporting).
Intra-household poverty
- Measuring poverty at the level of households ignores individual poverty
- Example: Women may have less resources than men, so they experience a higher level of poverty
Urban poverty
Measurements may be skewed towards rural poverty; sometimes do not account of essential goods and services in the cities (eg transport)
Impact of crime/social tensions, pollution and its health consequences, and low social status for those with informal livelihoods are not taken into account
Disaggregated poverty data
Poverty data in relation to age, gender, and disability is not often produced at a local and international scale
8 Causes of economic inequality and poverty
- inequality of opportunity
- different levels of resource ownership
- different levels of human capital
- discrimination (gender, race and others)
- unequal status and power
- government tax and benefits policies
- globalisation and technological change
- market-based supply side policies
inequality of opportunity
- People living in the same society do not have access to the same opportunities: education, healthcare. This may be due to gender, ethnicity, and parental background, which individuals have no control of.
- These factors can improve an individual’s standard of living and promote social mobility
- However, only those with wealth and high incomes have access to these opportunities, thus perpetuating the cycle of inequality.
Different levels of resource ownership
- Some people inherit wealth in the form of bonds and stock, giving them an income advantages and something to fall back on during unemployment
- They can also increase their wealth at a rapid pace
Different levels of human capital
- Depending on the occupation, there may be an excess supply of labour alongside a low demand for them, which would lower real wage levels. As more people move into such occupations, wages would become less equitable and unfair – desire to lower costs lead to worse working conditions and legal protections as well
- Some may also lack the necessary education and skills to obtain a good job, making it difficult to find a decent earning job; tied to inequality of education opportunities
Discrimination
- Act of treating a person or social group unfairly based on gender, race, age, or disability
- Example: women earn less than men as evidenced by the gender pay gap
Unequal status and power
Unequal status and power refers to inequality based on differences in esteem and respect
-> Cultural beliefs can influence relationship and income as those who are perceived as “better” earn more, even if others have the same or even better abilities and skills
Power is a concept which refers to the capacity or ability to do or not to do something.
-> Those with higher status can take advantage of their circumstances and obtain higher pay jobs, opportunities, and benefits
Government tax and benefit policies
Government policies can favour the accumulation of capital and reward those with capital and higher incomes through favourable tax policy
Wealthy have more opportunities to keep and expand their wealth
Globalisation and technological change
- Potential to increase unemployment rates and create a lack of jobs that were once thriving due to AI replacing them; typically blue-collar jobs
- Trade based on specialisation and comparative advantage has the potential to increase economic growth and incomes, but it can also lead to increase in inequality and poverty
- Countries will manufacture and purchase goods in cheaper countries, therefore local countries can be losers. They can also monopolise the industry, thus widening the gap between the rich and poor.
- Higher profits for multinational firms, increasing inequality.
- Creates inequality for low-skilled workers
Market-based supply policies
- Supply-side policies aim for long-term economic growth by shifting the LRAS curve; typically involves lowering the cost of production, but can contribute to higher levels of inequality through:
- Competition, such as deregulation or trade liberalisation
- Labour reform, reducing the power of unions and reducing unemployment benefits
- Incentive-related policies, such as cuts in personal income or capital gains tax
give 3 impacts of income and wealth inequality
Economic growth
Standards of living
Social stability
economic growth
When a significant portion of the population earns below an acceptance level of income:
- Lower consumption due to low income
- Lower productivity if the workforce is unskilled or there is widespread unemployment; less people to innovate and improve quality of FOPs
- the prospects of future generations will also be reduced
There are significant costs for the government when large proportions of the population are in poverty: tax revenues are lower, benefit payments are larger, the entire economy is less productive, the entire population is less healthy, there may be increased crime rates and political difficulties, and so on.
Standards of living
A loss or reduction of income results in a fall in the standard of living for people affected by poverty
Social stability
Opportunity costs are greater for people in poverty, as they have greater need for basic necessities, while having a lower amount to spend on such needs. This level of despair may lead to social unrest and perhaps a change of government, if people see that their systems do not help.
The role of taxation in reducing poverty, income inequality and wealth inequality
- An effective tax policy evens out the imbalances in income in the country, and can be used to fund state provision of essential services
- Governments can tax the population through their income as it has the ability to redirect money from the upper-class to the lower-class
what is a disadvantage of taxation?
Could be argued that it creates a loss of welfare for markets and desensitises people from working harder; hence, it can be inefficient
3 main types of taxation
Progressive
proportional
regressive
progressive
→ People being taxed higher rates of tax the more they earn
regressive
→ Where the percentage paid in tax rises the less a person earns
Proportional taxes
→ When everyone pays exactly the same percentage of tax
Direct taxes
Taxes that are paid directly to the government from an individual’s income, corporate’s income, and personal wealth
Personal income
Tax on income paid by individuals and sole traders
Varies between country to country, but it tends to be the most progressive tax, especially when people are being taxed higher rates the more money they earn
what does the degree to which personal income tax helps in redistributing wealth depend on
the gap between income before tax and disposable income after the tax is paid. The bigger the difference is, the more taxes equalise income, as high-income earners pay higher average tax than others.
If earners are being taxed higher rates the more money they earn. It can contribute to income/wealth distribution.
Corporate income
imposed on the income or capital of corporations and companies
- Can tax the net profit of companies and dividends of shareholders or on asset/payroll
- Research shows that corporate tax cuts benefit only the top-income earners and make them even richer.
wealth tax
- Tax on entity’s holdings of assets: cash, bank deposits, and real estate
- Seeks to reduce the accumulation of wealth by individuals; wealth inequality has increased in recent decades and is far greater than income inequality
indirect tax
Taxes which are not directly charged on people’s income or wealth; paid indirectly by consumers when they purchase a good
give 4 further policies to reduce inequality
Transfer payments:
- Unemployment Benefits
- Child Allowances
- Old-Age Pensions
Targeted Spending on goods and services:
Universal basic income (UBI):
Policies to reduce discrimination
evaluate the imposition of a minimum wage
define monetary policy
the set of official policies governing the supply of money and the level of interest rates in an economy (usually employed by central bank)
give and describe the two types of monetary policy
Expansionary monetary policy – increase aggregate demand
Contractionary/deflationary monetary policy – reduce aggregate demand
what is the base rate (discount rate or prime rate) of interest set by?
the country’s central bank, which is essentially the government’s bank and the ultimate authority in control of the money supply in an economy.
state the 6 goals of monetary policy
Low and stable rate of inflation and inflation targeting
Low unemployment
Reduce business cycle fluctuations
Promote a stable economic environment for long-term growth
External balance
Real versus nominal interest rates
Low and stable rate of inflation and inflation targeting
Tied in with ‘inflation targeting’, where the bank sets a specific medium-term target inflation rate as a goal
External balance
To achieve an external balance between export revenue and import expenditure
Real versus nominal interest rates
The nominal rate of interest is the rate of interest available in the money market, not allowing for inflation.
The real rate of interest is the rate of interest adjusted for inflation
Real rate of interest = nominal rate of interest – inflation rate
what does expansionary monetary policy involve? what are the results of this?
- lowering the base rate of interest.
- this reduces the cost of borrowing and can lead to increases in both consumption and investment.
- the bank could also increase the supply of money, which would lower its price
what is the trade-off of expansionary monetary policy?
lower unemployment and higher inflation
draw two diagrams to show the effects of expansionary monetary policy
Constraints on monetary policy, including:
Limited scope of reducing interest rates, when close to zero:
- Expansionary monetary policy through cuts in the rate of interest cannot be used for ever
- Eventually interest rates will start to approach zero and there will be no room left for further cuts
Low consumer and business confidence:
- Even though interest rates are reduced, the effect on expenditure may be very much dampened by low consumer and business confidence.
- This is especially the case if the economy is in a deep recession.
Time Lags:
- Take some time to have an effect on the economy, may take a number of months before there is a noticeable effect on AD
- In this time, economic tractors may have changed and the policy may be inappropriate
Strengths of monetary policy, including:
Incremental, flexible and easily reversible:
- Relatively quick to put in place- interest rate is set by the central bank and can be altered quickly when it is felt to be necessary, no political intervention needed before the rate can be changed
- Absence of crowding out
- Ability to make small changes – it is possible to be more precise than fiscal policy and set more exact targets.
what is fiscal policy?
set of government policies that pertains to government revenue and expenditure
give the 3 categories of public spending
Capital expenditures: any spending that adds to the capital stock of the economy (eg upgrading a national highway, building schools or hospitals)
Current expenditures: on-going spending (eg purchases of textbooks in schools or the payment of wages to public sector employees)
Transfer payments: benefits paid to people in the economy for which no goods and services are produced in return (eg unemployment benefits, child support payments)
give 5 sources of government revenue
- payment of income taxes and social security payments by households
- social security payments and corporate taxes by firms
- indirect taxes paid on expenditure on goods and services and tariffs paid on the purchase imported products
- profits or selling of nationalised businesses/industries
- renting out government-owned buildings or land
give the uses of expansionary fiscal policy and contractionary/deflationary fiscal policy
expansionary- increase aggregate demand
contractionary/deflationary- reduce aggregate demand
state the 6 aims of fiscal policy
- Low and stable inflation
- Low unemployment
- Promote a stable economic environment for long-term growth
- Reduce business cycle fluctuations
- Equitable distribution of income
- External balance
describe the 3 ways in which expansionary fiscal policy may be implemented by a government
- greater consumption: lower income taxes to increase disposable income
- greater investment: lower corporate taxes so that firms enjoy higher after-tax profits that can be used for investment
- increase spending in order to improve or increase public services
draw the effects of expansionary fiscal policy on a country’s economy
shift in aggregate demand upwards
what is the trade-off of expansionary fiscal policy?
lower unemployment and higher inflation
what is the main aim of fiscal policy?
to close deflationary/recessionary and inflationary gaps
Strengths of fiscal policy
- targeting of specific economic sectors
- government can invest their funds in areas of the economy that they believe will benefit the most from the investment
- can give tax cuts to the people that they think need them the most - government spending effective in deep recession as it increases AD
constraints on fiscal policy
- political pressure
- govt spending/taxation often influenced by political rather than economic factors
- eg deflationary fiscal policies may be needed but may be blocked by political parties who do not want to raise taxes for fears of losing votes - time lags
- changing fiscal policy takes time
- tax rates cannot be changed quickly as they will need to go through democratic processes and take time to gain approval
- it will take time before aggregate demand shits as people have to recognise and react to the fiscal changes - sustainable debt
- govt may have to run budget deficits in order to fund expansionary fiscal policies and over time this may accumulate into unsustainable national debt
define government debt (known as federal debt in the US)
accumulation of all the budget deficits over the years and represents the total amount of money that a government owes to its creditors, both domestic and foreign
how is government debt usually expressed?
as a percentage of GDP so shows the percentage of annual national output that the government owes
give the main negative effect of having high levels of government debt
increase in debt servicing costs, which is the amount of money needed to make payments on the principal and interest on a loan in a given time period. the government will spend more of its budget on interest costs
give the 4 main negative effects of increasing debt servicing costs
- may lead to crowding out of private investment.
- as interest payments increase as a percentage of government budget expenditure, this may have a damaging effect on other areas of spending. benefits and services provided by the government may need to be cut
- if the government wishes to maintain the same levels of benefits and services, this may require higher tax rates. but this may lead to falling output and incomes (deflationary)
- may decrease ability of government to respond to emergencies (eg natural disasters or military actions) - if debt is too big, they will have fewer fiscal options available.
give the 5 main goals of supply side policies
- Long-term growth by increasing the economy’s productive capacity
- Improving competition and efficiency
- Reducing labour costs and unemployment through labour market flexibility
- Reducing inflation to improve international
competitiveness - Increasing firms’ incentives to invest in innovation by reducing costs
define supply side policies and their goal
policies designed to increase the long-run aggregate supply in the economy by increasing the quantity/quality of factors of production
give 3 types of market based policies
policies to encourage competition, labour market policies, incentive-related policies
(1) policies to encourage competition
- deregulation
- privatization
- trade liberalization
- anti-monopoly regulation
deregulation
- if governments have placed many regulations on the operations of businesses then this may increase their costs of production, thereby reducing potential output in the economy
- examples include environmental laws, health and safety regulations of laws concerning working hours, leave and holidays
- a reduction in no/severity of regulations will help to increase aggregate supply
privatisation
- the sale of public government-owned firms to the private sectors may render them more efficient so may increase potential output of the economy
- nationalised firms tend to have goals such as maintenance of employment or provision of a service to an isolated market so may operate inefficiently
trade liberalisation
- elimination of subsidies, tariffs, and quotas leads to free trade
- exporting firms need to be more efficient and increase investment in order to compete with foreign firms
(2) labour market policies
- reducing the power of labour unions
- reducing unemployment benefits
- abolishing minimum wages
reducing the power of labour unions
this will reduce the ability of unions to negotiate higher costs of labour and therefore lower the costs of production to firms and increase the number of workers that firms may hire
reducing unemployment benefits
people will have more of an incentive to find jobs that are available
abolishing minimum wages
decrease cost of labour and increase aggregate supply
(3) incentive-related policies
- personal income tax cuts
- cuts in business tax and capital gains tax
personal income tax cuts
higher taxes may act as a disincentive to work, as people would prefer to substitute more work for more leisure time rather than pay higher taxes on the extra income. so if taxes are reduced people may work harder and be more productive
cuts in business tax and capital gains tax
if businesses are able to keep more of their profits then they will have more money available for investment.
- research and development
- addition of capital stock to economy (increase in a factor of production )
limitations of market based supply side policies
equity issues, time lags, vested interests, environmental impact
equity issues
- labour market reforms may lead to a possible reduction in living standards for low-income or unionised workers
- reduction in household income taxes may benefit higher earners more than those on lower wages
- reduction in corporate taxes increases the net profits of companies so may lead to increased income inequality
leading to increased income inequality
time lags
time lags involved before the effects of the policies are filtered through to increased potential outcome
vested interests
if privatisation is not carried out in a transparent manner, and nationalised industries are sold below their true value to individuals with connections. also, the industries may enjoy monopoly power
give 5 types of interventionist policies
- education, training
- improving quality, quantity and access to health care
- research and development
- provision of infrastructure
- industrial policies
provision of infrastructure
infrastructure may be deformed as the large-scale capital which is needed for economic activity to take place.
includes roads, electricity, water supply, airports, internet and public transport
industrial policies
developing policies that support and encourage the development of industry eg implementing anti-monopoly laws, supporting export companies, helping grow small and medium enterprises
give 2 limitations of interventionist supply-side policies
costs:
- opportunity cost
- may increase govt debt
time lags
Strengths of supply-side policies
Market based—improved resource allocation, no burden on government budget
Interventionist—direct support of sectors important for growth
