2.3 Macroeconomic objectives
To what extent is inequality an essential ingredient of capitalism?
- Capitalism relies on property rights, therefore those with ownership rights will receive more from the capitalist system than those without - Capitalism is meritocratic and therefore rewards those with the greatest skills the most - Although inequality may be an essential ingredient of capitalism, it is the degree of inequality that is important - is inequity present.
Why a market system may not result in an equitable distribution of income:
- In a very capitalist system there is private ownership of most of the factors of production. Therefore it is possible for some individuals to become very wealthy (factory owners etc) - In a very capitalist system there will be minimal government intervention. Therefore there will be low taxation and low spending on benefits (pension, unemployment benefits) and benefits in kind and this can lead to a large percentage of the population being poor Neoclassicals economists argue that redistributing income from the wealthy to the less well off is be avoided because: - High corporation taxes discourages entrepreneurial activity (why set up a business if corporation tax is high) - High corporation taxes decreases Investment (Less profit left after tax to reinvest in machinery etc) - High income tax is a disincentive to work (why work hard to earn more if a large part of it will be taken away by high income tax)
Common causes of cost push inflation
- Increase in cost for raw material - Cost of imported raw material rise - Power of trade unions increase which increases wages
Issues with measuring inflation
- May not reflect the inflation felt by an income group - Improvements in quality is not taken into account - Changes in consumption patterns - Volatile prices - Not a good predictor of future inflation
Whether economic growth is beneficial for a country's population depends upon:
- The type of products that are produced (guns or bread) - Distribution of income (who receives the benefit of the extra goods produced? - few or many). - Whether the extra goods produced was because of an increase in the amount of working hours (therefore loss of leisure time) or an increase in productivity (no loss of leisure time) - Whether pollution has increased.
Reasons why individual's income may vary:
- Unequal ownership of the factors of production (factory owners have high incomes) - Differences in skills - Differences in human capital - Differences in length of hours worked - Differences in the difficulty of the job done
Consequences of deflation
-Rising unemployment -Falling investment -Falling consumption and increased savings - Increased debt burden on households
How can unequal income distribution affect economic development?
-Unequal allocation of society's resources can cause social unrest (riots etc). -High income inequality results in a small group of powerful elites not interested in fairness or progressive taxation to redistribute income. -The poverty cycle will trap generations in poverty (covered later in the course)
Types of structural unemployment:
1 Regional unemployment 2.2 Sectoral unemployment 2.3 Technological unemployment
Examples of things that can increase potential growth:
1. An improvement in technology which increases the quality of resources 2. Investment in human capital 3. Investment in infrastructure 4. Policies to encourage competition
Social consequences of unemployment
1. Increased crime rates (high unemployment = low incomes = greater temptation for crime) 2. Family breakdown (financial strain of unemployment puts enormous pressure on families) 3. High level of indebtedness as individual's income does not cover expenditure.
What is a Gini index?
A Gini index is the ratio of the area between the line of equality and the country's Lorenz curve: Therefore, the deeper the bow of the Lorenz curve, the more unequal the distribution of incomes. The higher the Gini Index number the greater the income inequality in the country.
Explain the Lorenz curve and provide an appropriate diagram.
A Lorenz curve shows the proportions of income earned by any given % of the population. The distribution of income is commonly measured using quintiles. On a Lorenz curve, if income were distributed equally, the line would be straight at 45 degrees from the origin (dotted line).
Actual growth shown in new classical model
A diagram showing SRAS and AD AD shifts to the right Real GDP against price level
Lorenz Curve
A graphical way of depicting the distribution of income within a country. The further away from the diagonal line the curve is the greater the inequality of distribution of income.
Indirect tax
A tax on expenditure. A tax on goods and services.
What causes potential economic growth
Change in quality and quantity factors of production
Measuring unemployment
Claimant count: The number of people claiming unemployment benefits The labour force survey: Government surveys the population to identity the unemployment and employed
What is deflation caused by?
A. An improvement in the supply side of the economy e.g productivity improvements/technological progress shift the LRAS outwards. This results in a higher output and employment at a lower price level and can be beneficial to an economy. B. Weak demand. This type of deflation results in falling output and increasing unemployment and is harmful to an economy. It can lead to a negative spiral.
How a combination of actual growth and potential growth can lead to higher GDP without higher inflation? Draw Kenysian model
AD1 to AD2
Diagram showing cost push inflation (New classical)
AS = SRAS
Potential growth shown in Keynesian diagram
AS curve shift to the right AD curve drawn
Define absolute and relative poverty. How are they determined?
Absolute poverty is when there is no access to basic necessities needed to sustain life (i.e. clean water, food and shelter, medical needs, etc.). A minimum income to cover the above is called the poverty line by the OECD. Absolute poverty is determined by measuring the proportion of the population below that poverty line (% of population). Relative poverty is when living standards are well below the observed average in an economy. Relative poverty is determined by using the median income of a country. Those far below the median level are considered poor (e.g. 50% below the median).
Measuring inflation
Consumer Price Index (CPI)
Types of economic growth
Actual growth/short tun growth - an increase in rGDP An increase in the amount of goods and services actually produced by an economy over time. Potential growth/Long term growth - an increase in potential output An increase in the amount an economy can produce
How does the income of the richest 10% compare to that of the poorest 10% among countries in the world? Which Gini coefficient would indicate a more equal economy and which would indicate a more unequal economy?
Actual income equality ratios of the highest to the lowest decile range can be estimated to be between 40 and 5 (the top 10% earn 5 to 40 times more than the bottom 10% of the population). The Gini coefficient ranges from 0 to 1. Economies with a highly unequal distribution of income would have a Gini coefficient of about 0.60-0.65, while economies with a more equal distribution of income have a Gini coefficient of around 0.25.
Improved health and life expectancy
As a result of GDP growth people can afford healthier diets, higher quality medical care, and access to sports facilities.
Lifts people out of poverty
As it increase standards of living Depends on inequality
Deflation trap
As prices are falling consumers delay purchases in the expectation of lower future price. This decreases demand and therefore cause unemployment (demand deficient). Unemployment (linked to the above) As demand falls in the economy, unemployment increases (labour is derived demand). This decreases households' income and therefore demand falls further, feeding deflation (the trap is complete). Firms decrease their investment. Due to falling demand firms reduce their investment, which leads to lower demand and therefore increased unemployment, therefore falling demand etc The value of debt held by individuals and firms increases in real terms The real cost of government spending increases (social security costs increase in real terms), however, tax revenue falls due to increased unemployment. This cause government budget deficit and increases the national debt.
Explain and illustrate the deflationary spiral.
Assume deflation in the SR due to decreased investments and exports. AD shifts leftwards from AD1 to AD2 and the average price level falls. The equilibrium has shifted from 'a' to 'b'. This leads not only to a decrease in output and a decline in the disposable income of households, but also to increased unemployment. As workers are laid off, production costs fall (SRAS1 to SRAS2), leading to another decline in the average price level. The equilibrium has shifted from 'b' to 'c'. New drops in AD (AD2 to AD3) discourage future investment and consumption spending, letting deflation continue to spiral downwards.
Proportional taxes.
The proportion paid in tax is constant for all income levels.
Which is worst, demand pull inflation or cost push and why?
Cost push as it decreased AD, economic growth, increase unemployment and causes inflation Whilst demand push increases economic growth, and decreased unemployment
Types of unemployment
Cyclical unemployment Structural unemployment Frictional unemployment Seasonal unemployment Voluntary unemployment Real wage unemployment
Actual growth shown in PPC
D to B
Not a good predictor of future inflation
CPI measure the increase in prices that consumers are experience now, but tell us little about future prices
Advantages of Indirect Taxation
Can be used to reduce externalities (increase price of goods with large externalities) Does not increase disincentive to work Unavoidable
Evaluate Progressive taxes
Can reduce the income of the rich and provide the funds necessary for government to provide benefits (see below) and benefits in kind (free education, healthcare etc) to the poor. Progressive taxes can lead to a redistribution of income, benefitting people with lower incomes. However, they may also discourage harder work (i.e. entrepreneurial risk-taking).
High inflation
Cause economy to go into a boom where high inflation will be experienced If economic growth is caused by a substantial increase in demand for goods and services, rather than an increase in supply, the result can be demand pull inflation. However inflationary pressure can be reduced if potential output increases (AS SHIFTS TO THE RIGHT, AD SHIFTS TO THE RIGHT)
Monetarist's inflation
Caused only by increases in the money supple which are greater than any increase in the output of goods and services
Use a diagram to explain 'bad deflation'.
Demand-side deflation is considered 'bad deflation' because it comes along with a decrease in AD. AD shifts leftwards (AD1 to AD2), leading to a drop in real GDP (Y1 to Y2) and a lower average price level (PL1 to PL2). Fewer workers are demanded as real GDP decreases, resulting in a higher level of unemployment. *SRAS IS LRAS instead
Causes of wealth inequality:
Difference in incomes Inheritance
Distinguish between direct and indirect taxes.
Direct taxes Taxes on income, wealth and firms' profits. Paid directly to the government. The tax is paid into the government's budget and is used to finance a broad variety of government expenditures. Indirect taxes Taxes on goods and services (i.e. VAT), also referred to as expenditure or consumption taxes. Paid to the government by suppliers. Governments can vary the rate charged on different goods and services (i.e. a low tax on necessity goods and a high tax on luxury goods).
Increased incomes
Increases in GDP means that, on average, people have higher incomes. With more income people can buy more and better quality goods and services
Cost push inflation
Increases in companies' costs (labour, raw materials) which are passed on to the consumer in the form of higher prices. Cost push inflation decreases AS.
Name 4 main macroeconomic objective (+ 3 minor)
Economic growth Low unemployment Low and stable rate of inflation Equity in distribution of income Balanced gov budget Sustainable balance of payments Environmental sustainability
How can investment contribute to economic growth?
Economic growth by physical capital investments: Quantity: more machines, tools, equipment, infrastructure Quality: better machines, faster and more powerful computers Economic growth by human capital investments: Quantity: increased labor force (LR growth is unlikely) Quality: improved skills, levels of health Economic growth by natural capital investments: Quantity: reforestation, sustainable rates of consumption Quality: reduced pollution, improved green technologies
Decrease Unemployment
Economic growth means more goods and services are being produced which could lead to an increased demand for labour as labour is derived demand - therefore decreasing unemployment. Depends on whether firms use labour to make more G and S
Increase living standards
Economic growth will raises incomes and therefore increase standards of living HOWEVER GDP per capita is an average it doesn't mean everyone's living standards increase Who gets the extra goods and services - few or many What is produced - guns vs bread
How does PED of product affect where increase in costs of firms go
Elastic PED = passed on to producers Inelastic PED = passed on to consumers
Volatile prices
Energy and good prices can experience large and sudden changes, if recorded can lead to unusual movements in the inflation rate and thus can be misleading for policy makers
Distinguish between equity and equality in the distribution of income.
Equality The state of being equal with respect to a specific factor. For example: each member of society receives the exact same income (regardless of whether this is equitable or not). Equity The condition of being fair and just in what is achievable for an economy. For example: reducing taxes by the same amount for all members of society. This may be equitable but not equal since incomes are different.
Demand side:
Expansionary fiscal policy However: - Government may have to run a budget deficit - If taxes are reduced consumers may not spend the extra disposable income (saved instead) - There is a time lag between the implementation of a policy and its affect - Expansionary monetary policy can also be used i.e. reducing interest rates. However, there is no guarantee that it will have the desired affect on Consumption or Investment
What causes actual growth?
Expansionary fiscal policy: G up therefore more G&S demanded T down therefore more G&S demanded Expansionary monetary policy Increased demand for exports
Discuss how deflation can lead to a redistribution of incomes.
Gains to creditors (lenders): As the average price level falls, the real value of incomes and savings rises. People with fixed incomes, holders of cash, and savers and creditors benefit. Cost to debtors (borrowers): As the average price level falls, the real value of debt owed by debtors rises - they will find it increasingly difficult to pay back loans. Employers that pay fixed incomes are also worse off, as the real value of incomes they need to pay increases.
Distribution of unemployment
Geographical disparities, Age disparities, Ethnic differences, Gender disparities
Subsidies for necessity goods (rice, kerosene etc)
Government can provide a subsidy to producers of necessity goods which will lower their price for consumers. The less well off in society will spend a large amount of their income on necessity goods and this will therefore increase their standard of living. However, subsidies are expensive and come with an opportunity cost. Moreover, subsidies come from taxation.
Solving frictional unemployment
Government can provide job centers where jobs are advertised and therefore help people find the job they like quicker Career interviews can be provided to help people identify the kind of employment they would like quickly However, These services are expensive for the government to provide
Evaluate government expenditure and transfer payment policies to promote equity.
Government expenditure policies to promote equity include: Direct provisions of public and merit goods (subsidies) to correct an under-allocation of resources. However, this causes opportunity costs in the government budget. Regulating markets (intervening) to produce a more equitable distribution of income, i.e. minimum wages, food price ceilings, etc. However, conflicts with resource allocation objectives arise. Government transfer payment policies to promote equity include: Transfer payments to improve allocative efficiency, i.e. pensions, student grants, unemployment benefits, etc. Interventionists believe they are needed to protect vulnerable groups, thereby reducing the risk of extreme poverty and automatically decreasing the effects of SR fluctuations in economic activity. Conversely, new classicists consider them to be disincentives for unemployed people to accept work, causing more
Minimum wage
Increases the income of the less well of workers in society. However, a minimum wage above equilibrium may lead to increased unemployment.
Equitable tax systems are likely to achieve an equal distribution of income, reduce poverty, increase productivity and promote other macro objectives. Evaluate government taxation policies to promote equity.
Government taxation policies to promote equity include: Progressive income taxes to redistribute income. However, high income taxes act as a disincentive to work harder and save. Indirect taxes (i.e. VAT) on goods and services to: correct market failures. However, raised taxes increase prices and cause an inefficient allocation of resources. If there are no market failures, then market forces should allocate resources. redistribute income. However, charging the same rate of indirect taxes (%) on all goods and services will not lead to a relative change in relative prices, meaning there is no impact on resource allocation (signals and incentives stay the same). General taxes (VAT) are regressive and lead to an unequal distribution of income.
Long term policies
Governments can use policies other than the redistribution of taxation to decrease inequality, however, the benefit of these will only be felt in the long run: - Increase secondary school and tertiary level completion rates - Retraining programmes- especially to help those people suffering as a result structural unemployment. - Increased level of healthcare- and again the importance of equality of access to healthcare. - A national minimum wage may be useful, especially in countries with a large population of working poor.
Government intervention
Governments use their tax and benefit system to reduce the width of the distribution of income in a society and therefore reduce absolute and relative poverty.
Difficulties associated with measuring unemployment
Hidden unemployment: Some people who look for work for a while may give up, not considered unemployed, lowering unemployment figures Under employment: many people who want full jobs, find part time jobs because they can't find full time jobs = not considered unemployed, therefore lowering the unemployment figures
Costs of Economic Growth
High inflation Causes a Current Account deficit Widens distribution of Income Negative externalities and pollution Loss of quality of life
Uncertainty
High levels of inflation cause uncertainty for businesses (unable to accurately predict their costs etc). Therefore businesses are more reluctant to take risks and to invest in new projects.
Explain actual growth
Higher AD, can result in lower unemployment, and higher inflation
SSPs to reduce cost push inflation:
If cost push inflation is the concern, supply sided policies may be better. Cause of costs push inflation - increasing wages Supply side policy - labour market reform (decrease the power of Trade Unions - reduce/abolish Minimum Wage) Cause of costs push inflation - increased cost of raw materials Supply side policy - policies to encourage competition (trade liberalisation, privatisation
Policies to reduce inflation
If demand pull inflation then contractionary fiscal and monetary policy: 2 disadvantages of using contractionary fiscal and monetary policy: Politicial AD/economic growth down
Why is the PPI useful?
If firm's costs are increasing, it is more likely that they will increase their price in the near future - good predictor of future inflation
May not reflect the inflation felt by an income group
If prices of expensive goods increases, this will increase inflation but low income groups won't be affected
Discuss the risk of bankruptcies from deflation.
If the economy is in a downturn (recession) and incomes are decreasing while the real value of debt is increasing, then there is a high likelihood of bankruptcies among businesses and consumers with high debt. They simply become unable to pay back their loans. Banks and financial institutions are at risk if bankruptcies and difficulties in paying back loans (i.e. on real-estate) become too common in society. This can lead to a financial crisis.
Causes a Current Account deficit
Imports are are income elastic = Current account deficit If a country's growth rate is high, demand for imports is likely to increase. This leads to a deficit in the trade balance and a net inflow of foreign goods. The deficit is accompanied by an inflow of funds from investors abroad, seeking to purchase domestic assets (i.e. factories, real estate and government debt).
Improvements in quality is not taken into account
Improvement in quality may not be accompanied by increase in price there it is not recorded by the index
What measures do governments take to reduce income inequality in the economy?
In the SR: Transfer payments Unemployment benefits Child allowances Subsidies Progressive income taxes In the LR: Improving the quality of, and access to, education/training and health services for the most deprived income groups.
Income
Income is a flow concept. An income must be qualified with a time period, for example $50,000 per year.
Types of direct tax
Income tax - a tax on people's income Corporation tax - a tax on companies' profits
Costs of unemployment to society:
Increase in crime Family breakdown
Benefits of Economic Growth
Increase living standards Lifts people out of poverty Decrease Unemployment Increased incomes Increased tax revenue for the government
Better public services
Increased GDP usually means more employment and therefore more people paying income tax to the government. The government spends this money on public services, such as health and education.
Negative externalities and pollution
Increased economic activity will often lead to increased levels of pollution. Economic growth means that we use up scarce resources more quickly (to produce more goods and services). Depends on how good are produced, if produced sustainably then this might not be a problem
Loss of quality of life
Increased economic growth may have occurred due to increased working hours of the population. This means that their quality of life may be reduced (conflict between living standards and quality of life).
Disadvantages of Direct Taxation
Increases disincentive to work
Inflation can cause unemployment
Inflation can cause unemployment -when it leads to a loss of international competitiveness, therefore a decrease in demand and unemployment - If prices increase more than incomes, people cannot afford to buy as many goods and services. This fall in demand can cause unemployment.
Loss of purchasing power
Inflation erodes the purchasing power of money As the price level increases, the quantity of goods and services that can be purchased with a fixed dollar amount (e.g. $100) falls, i.e. the purchasing power of money falls. People on fixed incomes (e.g. pensioners) will be able to purchase fewer goods and services.
Wage price sprial
Inflation increases, wages increases, increase cost, increase price of goods and services
Loss of International competitiveness
Inflation reduces a country's international competitiveness and therefore affects the B of P nflation causes the price of goods to rise in a country. If inflation is higher in that country than other countries then that country's goods will become more expensive. Foreign demand for their exports will fall. Local demand for imports (which have become cheaper than local products) will rise. This will lead to a worsening Balance of Payments situation.
Evaluate unemployment rate
It is an average and therefore ignores regional, ethnic, age and gender disparities.
Structural unemployment:
It is caused by a change in the structure of the economy which causes a mismatch between the skills of those out of work and the skills needed to fill the available vacant job opportunities
Actual growth shown in Keynesian model
LRAS called AS AD shifts to the right
Potential growth shown in new classical model
LRAS shift to the right AD must be included
More leisure time
Leisure is a normal good (positive income elasticity of demand). The higher your income the more leisure time you can choose to enjoy.
Why is structural unemployment a serious problem?
Long term problem
Costs of unemployment to individual
Loss of income Loss of status Increased levels of stress Increased level of indebtedness
Costs of unemployment to the economy
Loss of output - GDP Loss of tax revenue Greater disparities in the distribution of income Increase in government spending on unemployment benefits
Costs to inflation
Loss of purchasing power Effect on interest rates Increased uncertainty for businesses leading to lower investment Redistributive effects Inflation can erode the value of savings. Loss of international competitiveness. Redistribution effect.
Inequality in the distribution of income
Means that not everyone receives the same amount of income - some have low incomes and others have high incomes.
Explain CPI
Measuring be examining the change in a weighted index of the prices of a baskets of goods and services consumed by typical households Every year the Office for National Statistics collects the prices of 650 goods and service from 150 different location. These 650 items are called the basket of goods. Every year the values of goods are collected and compared to the base year (initial year) to calculate the inflation rate
Cyclical (demand deficient unemployment)
Occurs in a recession when demand for goods and services falls in the economy. When this happens the demand for labour will also fall as fewer goods and services are demanded so less labour is needed (demand for labour is derived demand). Remedy: Increase AD so that demand for good increase and therefore the demand for labour increases - Expansionary fiscal policy. However, may cause budget deficit which leads to increased government debt. May contribute to crowding out. - Expansionary monetary policy. However, there is no guarantee that reducing interest rates will have the desired affect on Consumption or Investment
Natural rate of unemployment
Occurs when labour market is at full employment, but there is still some residual frictional, seasonal and structural employment. The economy is at the full employment level of output. Illustrate using Keynesian diagram.
Labour force
People who are of working age, who are not students, homemakers or disabled
Unemployed:
People willing and able to work but who can not find work.
List some possible causes of poverty.
Possible causes of poverty are: Unemployment Low levels of human capital (i.e. poor education, poor health, etc.). Low levels of physical capital and/or land ownership. Discrimination on the job market (i.e. racial, gender, or age discrimination leading to wage gaps). Lack of geographical mobility - poor people will not be able to move to regions where jobs are available. Instead, they will remain unemployed. Limited social services (i.e. lack of merit goods). All of the above reduce incomes and therefore increase the risk of poverty.
Explain the possible consequences of poverty.
Possible consequences of poverty are: Low living standards - associated with greater levels of psychological stress, alcoholism, poor nutrition and poor levels of health. Lack of access to health and education, leading to lower human capital formation, lower productivity and lower incomes. Higher infant, child, and maternal mortality. Higher levels of preventable diseases (the poor are more prone to illness). Social problems - higher rates of crime, drug use, family breakdowns and homelessness. Inability to realize one's full potential may lead to lower economic growth.
Define productivity. Will improved productivity lead to economic growth?
Productivity is output made per input (i.e. quantity produced per hour of work). It can be measured as real GDP/number of hours worked. Improving the productivity of physical, human or natural capital increases actual and/or potential output. Hence, it can contribute to economic growth.
Advantages of Direct Taxation
Progressive (Income tax)
Progressive taxes.
The proportion of income paid as tax increases, as income rises.
Government intervention that could ensure a more equal distribution of income:
Progressive taxation Transfer payments (benefits) Spending on merit and public goods (benefits in kind) Subsidies for necessity goods (rice, kerosene etc) Price controls for basic goods (rice, kerosene etc) Minimum wage
Disadvantages of Indirect Taxation
Regressive Increase prices (inflationary)
Evaluate Regressive taxes
Regressive taxes are a good source of revenue for the government and they also provide an incentive to work. However, income inequality may be promoted.
Widens distribution of Income
Rich tend to get richer before poor get richer Economic growth can also lead to some parts of a country performing significantly better than others, perhaps because of natural resource discoveries or proximity to international markets.
Inflation erodes the value of savings
Savers receive interest on their bank deposits, which increases the amount of money in their account. However, if the rate of inflation is greater than the rate of interest then the value of the savers' deposits will have decreased.
Price controls for basic goods (rice, kerosene etc)
Sets a maximum price for necessity and therefore increases the standard of living for the less well off in society. However, maximum price below equilibrium leads to excess demand.
Increased tax revenue for the government
Should increase tax revenue, more people working and more people paying income tax
Use an S/D diagram to show structural unemployment caused by changes in the demand for particular labor skills.
Structural unemployment, arising from mismatches between labor demand and supply (SL and DL), can be shown indirectly in a product S/D diagram. Decreasing demand for a product in a certain market shifts the demand for labor from DL1 to DL2. The result is a decline in wages in the market from W1 to W2 and a loss of jobs as the quantity of labor falls from Q1 to Q2.
Use a diagram to explain 'good deflation'.
Supply-side deflation is considered 'good deflation' because it comes along with an increase in LRAS (growth). LRAS shifts rightwards (LRAS1 to LRAS2), leading to a rise in real GDP (Y1 to Y2) and a lower average price level (PL1 to PL2). More workers are demanded as real GDP increases, resulting in a lower level of unemployment
Progressive taxation:
Taxes such as progressive income tax can reduce the income of the rich and provide the funds necessary for government to provide benefits (see below) and benefits in kind (free education, healthcare etc) to the poor. However, progressive tax de-incentivises people from striving to earn more as an increasing amount of their income will be taken in income tax.
Solving structural unemployment
Technological and sectoral can be solved by the government providing retraining to help people find jobs in other industries. Regional can be solved by the government increasing the mobility of labour (making it easier for people to move to areas where there are jobs available) However, These solutions will take a long time to be effective (retaining takes a long time; people will be unemployment a long time before they consider moving).
Changes in consumption patterns
The basket of good used to measure inflation rate may not be representative of the population's spending = inflation rate given by the index will not accurately represent the inflation rate felt by the population
Inequity in the distribution of income
The belief that there is inequality in the distribution of income for reasons that are unfair/unjust.
Explain the relationship between equity and efficiency.
The degree of trade-off between equity and efficiency depends on the economic viewpoint of the government. In the interventionist view, the government intervenes to ensure a reasonable standard of living for all members of the economy. To pay for interventions, governments need income (i.e. taxes) paid by firms and households, risking less growth and more unemployment. Efficiency is traded for equity. In the new classical view, the market forces are most efficient at allocating resources, meaning government interventions should be kept to a minimum. Equity is traded for efficiency.
Equilibrium rate of unemployment
The equilibrium rate of unemployment is the rate of unemployment where real wages are at the free market level (QEWE).
Full employment level of national income
The full employment level of national income is where an economy is at its maximum level of output: AS = AD on LRAS.
Solving cyclical/demand deficient unemployment
The government can solve this type of unemployment by increasing AD in the economy. However, If an expansionary fiscal policy is used to increase AD this might lead to a budget deficit and therefore an increase in the national debt
Full employment
The level of unemployment at which all those who wish to work have found a job
Level fo unemployment
The number of people willing and able to work but who can not find employment
Spending on merit and public goods (benefits in kind)
The other way government might redistribute income from the well off to the poor is through benefits in kind (usually merit goods), which includes healthcare and education. These are funded through the tax system (paid mostly by the well off) and are free to use (or very cheap) by all citizens of a country. Those who are poor can access these services but will not be paying for them through the tax system as their incomes are low.
Unemployment rate
The percentage fo the labour force who are willing and able to find work but who can not find employment.
Economic growth
The percentage increase in real GDP over time
Inflation
The persistent rise in the average price level of an economy
Regressive taxes.
The proportion of income paid as tax decreases, as income rises.
Natural rate of employment
The rate of unemployment that exists when the labour market is in equilibrium (no cyclical or real unemployment). But there is still some residual frictional, seasonal, structural employment.
NAIRU Non accelerating inflation rate of unemployment
The rate of unemployment that exists when the labour market is in equilibrium (no cyclical or real unemployment). Usually made of frictionally, structural and seasonal unemployment.
Frictional unemployment
The time spent between leaving one job and finding another. Remedy: Increase info about vacant jobs Reduce unemployment benefit
Transfer payments (benefits)
These include cash payments such as Unemployment Benefit, State Pensions, Child Benefit, Incapacity Benefit and Working Families' Tax Credit (for individuals with low wages). These transfer payments increase the incomes of individuals/households where it would otherwise be very low. However, if transfer payments such as Unemployment Benefits are too high this can act as a de-incentiviser for the unemployed to find work.
Real wage classical unemployment
This is unemployment caused by real wages being above the equilibrium level. Can be caused by strong trade unions or a high minimum wage. Remedy Reduce the power of trade unions HOWEVER, difficult to do Reduce minimum wage HOWEVER, it is in place to protect lowest paid workers and would worsen distribution of income
Evaluate Proportional taxes
This solves some problems of complex tax systems, such as risks of errors and tax avoidance, which decrease government revenues. However, higher tax rates discourage harder work.
Define transfer payments.
Transfer payments are tax revenues used to redistribute incomes to improve living standards of certain vulnerable groups in the economy. The payment is not an income because it does not represent payment for the production of a good or service (not part of the circular flow and not measured in growth). For example: Child support assistance, old age pensions, unemployment benefits, nutritional subsidies, etc. These transfer payments increase the incomes of households where it would otherwise be very low.
Types of SSPs (interventionists & market based)
Types of interventionists SSPs Investment in Human Capital Investment in infrastructure Industrial policies Types of market based SSPs Labour market reform Incentive-related policies However: Time lags Costly
Seasonal unemployment
Unemployment caused by the changing of seasons e.g. hotel workers. When they are made unemployed in the lean part of the year it is called seasonal unemployment. Remedy: Encourage people to take different jobs in their off seasons, reduce unemployment benefits, increase info about jobs
Explain why a market-determined distribution of income may not be equitable.
Unequal ownership of factors of production.Some households possess more factors of production than others, i.e. land, capital and entrepreneurial abilities. These generate rent, interest and profit income. Prices of factors of production, determined in the market, vary enormously.The amount of goods and services households can buy depends on their income (usually wage), which is determined by the price paid for their factors of production (usually labor). In a market economy, output and income distribution therefore depend on the quantity of factors of production the household possesses, and at what price they can be sold on resource markets.
Wealth
Wealth is a stock concept. It is an amount of money - all of a household's assets less their liabilities.
Sectoral unemployment
When an industry goes into decline. There is a mismatch of skills as the skills workers have are no longer in demand and they may not have the skills currently being sought by employers. Remedy: Retrain the unemployed so they can gain employment in growing industries
Technological unemployment
When new technology (capital equipment) is used instead of people. Serious problem because those made unemployed may not have the skills to find another job easily. Mismatch of skills. Remedy: Retrain the unemployed so they can gain employment in growing industries
Regional unemployment
When unemployment is concentrated in one particular region. Considered a serious problem particularly if labour is not mobile enough to leave for places where job opportunities exist. Often linked to Sectoral unemployment e.g. mining, shipbuilding. Remedy: Make it easier for people to move to where jobs are - no tax on the buying or selling of houses Decrease geographical immobility
The impact of deflation depends upon:
Whether is caused by and increases in AS (good) or a decrease in AD (bad) How much deflation there is - the percentage
Inflation - winners and losers
Winners: People who borrowed from banks on a fixed interest People who own assets Firms who export to countries with rising inflation Losers: Pensioners on fixed incomes Creditors/Lenders Savers (if the interest rates are less than inflation, money being saved will lose value. Therefore inflation may lead to lower savings!) Domestic firms who export
Deflation
a decrease in the general price level of goods and services
Producer Price Index
a measure of the cost of a basket of goods and services bought by firms
Explain cost push inflation
caused by an increase in the costs of factors of production Increases in companies' costs (labour, raw materials) which are passed on to the consumer in the form of higher prices
Types of inflation
demand pull inflation, cost push inflation and monetarist's inflation
Core/underlying rate of inflation
eliminate the effect of sudden swings in the prices of food and oil, for example.
Disinflation
is a decrease in the rate of inflation
Explain demand pull inflation
is caused by changes in the determinants of AD, resulting in an increase in AD. AD increases faster than AS causing more demand for goods and consequently their price is bided up. a consumer boom wherein consumers increase their spending (C) an increase in investment by firms (I) an increase in government spending (G) an increase in net exports; this will cause inflation when there is a shortage of resources (X-M)
Physical capital Human capital Natural capital
to a factor of production such as machines, buildings, computers or roads. It results from investments. Human capital (labor) refers to the skills, knowledge, abilities, health, etc. of individuals in a population that give them the ability to produce economic value. It is a result of spending on education, training, provision of health care, clean water supply, etc. Natural capital (land) refers to natural resources under the land (i.e. minerals, metals, oil, natural gas, etc.) on the land (i.e. soil, lakes, rivers, forests, etc.) or in the environment (i.e. air, wildlife, climate, ozone layer, etc.). Investments are needed to maintain and improve its quality.
Reasons for which a highly unequal income distribution is a barrier to economic development
• poorest are deprived of proper education and health care and therefore less productive • lower consumption and thus lower AD (because rich have a lower propensity to consume) leading to slower growth and therefore slower development • more transfer payments (and possibly lower tax revenue), which restricts public investment
