Chapter 11 Tragakes IB SL Economics
Determinants of Shift in AD - Investment
Change in business Confidence Change in interest rates Change / improvements in technology Changes in business tax rates Changes in business debt Changes in legal structure and regulatory laws
Determinants of Shift in AD - Consumption
Change in consumer Confidence Change in interest rates* Change in Wealth* Changes in personal income tax rates Changes in household debt *caused by something other than changing price levels
Determinants of Shift in AD - Exports minus Imports
Change in national income in foreign nations Changes in exchange rates Changes in trade regulations (increased / decreased protectionism)
Determinants of Shift in AD - Government Spending
Change in political priorities Attempts by government to purposely intervene to change AD
Changes in SR Equilibrium
Changes in AD or SRAS will effect the SR Equilibrium and thus the Business Cycle. Increase in AD - increasing price level and an increase in real GDP and corresponding increase in employment. Decrease in AD - decreasing price level and decrease in real GDP and a decrease in employment. Increase in SRAS - decreasing price level and increasing real GDP and increased employment. Decrease in SRAS - increasing price level and decreasing real GDP and decrease in employment. Shifting AD and / or SRAS may result in fluctuations in Business Cycle
Implications of CFI no. 1
Circular Flow can illustrate how GDP can be calculated by totally all expenditures GDP = C+G+I+(X-M)
Keynesian Model Assumptions
Critical of Classical/Monetarist Assumption that economy is self correcting - constantly moving toward equilibrium Wages are flexible only when increasing - NOT decreasing - therefore economy will not automatically remain at the natural rate of unemployment in the Long Run. unions, long term contracts, minimum wages laws, etc..., Product prices may fall but not easily (sticky) lower prices reduce profits (given wages not decreasing)- monopolies and oligopolies have no incentive to lower profits
Output Gap
Difference between actual and potential GDP
What is the Business Cycle
Fluctuations in the growth of real output, consisting of alternating periods of expansion (increasing real output) and contraction (decreasing real output), are called business cycles, or economic fluctuations.
Types of Unemployment
Structural, Frictional, Seasonal, Cyclical
Frictional Unemployment
arises from peoples voluntarily leaving their job in search for a new one. Is considered inevitable & short term and is this not a serious concern for economists.
Total vs. Per Capita GDP
per capita - total GDP divided by population of country.
What is Aggregate Demand
the total quantity of aggregate output (real GDP) that all buyers want to buy at different price levels, ceteris paribus. Including Consumers Government Business firms Exports - Imports
What is Aggregate Supply
the total quantity of goods and services produced in an economy (real GDP) over a particular time at different price levels.
Problems with measuring unemployment - Overestimation of unemployment
- people working in the underground (informal) economy may be technically considered "unemployed" by government. Reasons was national unemployment averages may be misleading. Unemployment can vary dramatically between: regions genders ethnic groups age groups occupations
"Bad" Deflation
- reduction of AD as shown by leftward shift of AD on Keynes Graph.
What are the Strengths of GDP
-comparing one year to the previous reveals economic growth -GDP growth can indicate rising employment and income levels -GDP growth per capita can indicate increasing access to goods and services by citizens. -"real" GDP can allow accurate comparisons to production of previous years. -Per Capita GDP allows for comparisons between nations of different sizes.
Implications of Keynesian Theory (Draw and Explain)
1. In the Keynesian model, an economy can remain for long periods of time in an equilibrium where there is less than full employment (i.e. a recessionary/ deflationary gap), caused by insufficient aggregate demand. 2. Increases in AD will not necessarily cause increases in price level in the Long Run (this in contrast to Classical/Monetarist model)
Poverty
Absolute poverty, relative poverty,
Consumer Price Index
CPI - measures the change in price of a basket of goods and services consumed by an "average" household. The prices of the goods/services for this year are then compared to previous years. When used - CPI compares prices to designated "base year" CPI also compares monthly and quarterly rates of inflation
Causes of Inflation
Demand Pull, Cost Push
Define GDP
Gross Domestic Product: the market value of all final goods and services produced in a country over a year.
Macroeconomic objectives and the Business Cycle
Reducing the intensity of expansions and contractions: this is aimed at making output gaps as small as possible (the dotted line in Figure 8.6(a)), by flattening the cyclical curve. This would lessen the problems of rising price levels in expansions and unemployment in contractions.
Deflation
a sustained DECREASE in the general price level - a decrease in the average price of goods and services throughout the entire economy.
Regressive Tax
as income increases, the fraction (%) of income paid as tax decreases. Taxpayers who earn higher incomes pay a smaller percentage of their income in tax. Increases inequality of after tax income. Example: Sales/VAT taxes are considered Regressive. Some goods and services that are considered necessities are often exempted from Sales/VAT taxes lessening the regressive nature of the tax.
Downward deflation spiral
deflation causes behavior changes that increase deflationary pressures. Since deflation discourages spending and borrowing resulting in further decreases in AD - a major consequence of deflation is continued deflation.
Total factor Payments represents...
the costs to a firm and the income to households.
Seasonal Unemployment
when demand for labor in certain industries changes depending on the time of the year. Examples: farm labor, lifeguards, worker in tourism, etc....
Why is AD curve downward sloping - Income Effect?
when price level increases, people demand more borrowed money which increases interest rates. increasing interest rates lead to a decrease in consumer expenditure on durable goods that required borrowed money to purchase (cars, appliances, etc...). Rising interest rates will also reduce "Investment" by business firms.
What is the Expenditure Method
- measures the total spending on goods and services produced. - Only value of final goods and services - Intermediate goods and goods that serve as inputs for other goods excluded to avoid the problem of "double counting"
Why do we measure national income statistics?
1) measure success / failure of economic performance and policies 2) compare economic progress to other nations 3) Inform future economic policies
Classical Economists Proposals to maximize employment
Abolishing minimum wages Reducing power of labor unions Reducing unemployment benefits Reducing job security and compensation paid by employers that fire workers
Problem of income equity leads to "Redistribution of Income" by governments
According to Circular Flow, household income is directly related to the economic resources in their control/possession. Since there is great inequality in the ownership (and of skills/education) the amount of income varies greatly between households. The inequalities are also passed down to children perpetuating the problem over generations.
Decreases in Aggregate Demand (Keynesian Model)
Assuming Wages do not fall and the economy will not automatically reach full (natural rate of ) employment, in short run and long run equilibrium will settle at a lower level of real GDP.
What are the components of the Expenditure Method?
C - Consumption (Consumer Spending): all purchases by households of final goods and services. I - Investment: spending by firms on Capital goods (includes change in inventories). G - Government Spending: spending by all levels of government on final goods and servicesand factors of production (Note not included in this total are Transfer Payment, payments of money by an individual or group to another individual or group with no goods or services being received in return. X-M - Net Exports: Imports must be subtracted because they represent production outside of the nation.
Transfer Payments
Can creative disincentive to work. HOWEVER... Can create greater income equality and thus increase access to health and education thus improve human capital and promote growth. Will reduce severity of recession (automatic stabilizers)
Government production of Merit Goods
Can improve Allocative Efficiency as merit goods are under-produced by markets.
Determinants of Shifts in Aggregate Supply
Changes in Wages Changes in costs of other resources Change in Business taxes Changes in Business subsidies Supply shocks (war, political conflict, violent weather, or other quick dramatic changes in a firms cost of production)
Government internvention in Market (price ceilings and floors)
Decrease Allocative effeciency and reduce Social Surplus. HOWEVER... Increase access to health and education thus improve human capital and promote growth.
Taxes
Direct Taxes- paid by households/firms directly to government: Personal Income tax Corporate income Tax Wealth Taxes - real property and inheritance tax Social Insurance taxes - paid to government to fund retiree's pensions. Indirect Taxes Sales taxes- fixed percentage of a range or goods/services and then added to price of good / service at time of sale. Tax paid by consumer - only collected by firm. Note: VAT taxes are determined differently be collected in a similar fashion to sales tax. Excise taxes - only applied to specific goods/services. Some part of this will be paid by firm and some by consumer - see microeconomics. Customs Duties / Tariffs - paid on goods and service imported from another nation. Protective tariffs - designed to discourage consumers from buying imported products Revenue tariffs - designed to collect tax revenue on the sale of imported products.
What are the limitations of GDP/GNI (Why can they not accurately measure standard of living)
Doesn't measure the intrinsic value to society of the goods produced (cigarettes or weapon's production versus education or vaccinations) Doesn't accurately communicate information about changing quality of life/standard of living. Doesn't measure the value of leisure time increases. Does not communicate the distribution of income - thus the per capita average may provide a misleading picture of the actual goods and services being accessed by people. Includes exports which may help provide employment but are not goods and services available to people. Doesn't account for negative externalities - in fact the costs of cleaning up pollution are included in GDP Doesn't account for resource depletion (sustainability of production) Doesn't account for differing price levels in various countries (unless adjusted for Purchasing Power Parity)
What is the Aggregate Demand Curve
Downward sloping - illustrating the inverse relationship between price levels and real GDP. As Price Levels increase then real GDP decreases.
Different Levels of Macroeconomic Equilibrium - Full Employment
Equilibrium real GDP (Ye) is equal to potential GDP. Unemployment is equal to "natural rate" of unemployment.
Different Levels of Macroeconomic Equilibrium - Recessionary (Deflationary) Gap
Equilibrium real GDP (Ye) is less then full employment GDP (Yp). Equilibrium has settled below the potential of the economy - unemployment is more than the "natural rate" of unemployment. There is not sufficient Aggregate Demand present for firms to fully employ economic resources - specifically labor.
Different Levels of Macroeconomic Equilibrium - Inflationary Gap
Equilibrium real GDP (Ye) is more than potential GDP (Yp). Total Aggregate Demand at Ple, is greater than the potential output. Too much AD results in unemployment being less than "natural rate" of unemployment.
Equity in the Distribution of Income
Equity - condition of being "just" or "fair" Equality - state of being equal (the same). Equal may not mean equitable. Equity usually interpreted to mean greater income equality than would otherwise would result from market - as opposed to extreme inequality. Related to "What to Produce" allocation question.
Potential Issues with Shifting AD or LRAS
Fall of SRAS can increase both higher prices and low levels of real GDP - Stagflation (high inflation combined with high unemployment). Increasing SRAS can increase real GDP without the pressure on price level caused by increasing AD.
Why we measure Green GDP
GDP Overestimates value of output. Ex: if a country experiences an oil spill, the funds spent to clean up the pollutants are added to the value of national output.
Difference Between GDP and GNI
GDP is the total value of all final goods and services produced within a country over a time period (usually a year), regardless of who owns the factors of production. GNI (or GNP) is the total income received by the residents of a country, equal to the value of all final goods and services produced by the factors of production supplied by the country's residents regardless where the factors are located
Converting Between GDP and GNI
GNI = GDP + income from abroad - income sent abroad GNI = GDP + Net income from abroad (also called "net property income from abroad" or "net foreign factor income")
Gini Coefficient
Gini Coefficient - summary measure of income inequality illustrated with a Lorenz Curve. Gini Coefficient = Area between diagonal line and Lorenze Curve / entire area under diagonal the closer the Gini Coefficient is to 1 - the greater the level of inequality there is in the society. The closer to 0, the greater the equality of the society. NOTE: Gini Coefficient is very inexact since is it only measuring the respective areas. One cannot tell if there is greater inequality at the top or bottom of distribution range - only the total measure.
Lorenz Curve
Graphic representation of the degree of income inequality in an economy - The percentage of income accessed by various percentages of people in the society. Diagonal line illustrate income equality.
How do we measure green gdp
Green GDP = GDP − the value of environmental degradation − P 6 where P = expenditures to correct environmental degradation
Relationship between green gdp and gdp
Green gdp is likely to be lower than gdp and will grow more slowly
Problems with measuring unemployment - hidden unemployment
Hidden Unemployment - people who perhaps should be considered unemployed. Unemployment rate underestimated. Discouraged workers - those who have given up looking for work. Part workers are counted as "employed" even if "underemployed" either because of job / part time status People who are receiving job training are not part of labor force, thus not counted as unemployed even if they are only in school because they cannot find a job. People forced to retire against their will are not included in the labor force.
Explain and illustrate on a diagram the Long Run Aggregate Supply (Classical Model)
Horizontal section reflect "downward" inflexibility of wages and prices. Vertical section illustrates that wages and prices are flexible when increasing.
Who are the economic actors?
Household - any group of people living together as a decision-making unit Firm - An organization that combines the factors of production to produce goods and services
Why is AD curve downward sloping - Wealth Effect?
If price level rises, then the "real value of wealth" falls. People will spend less because they feel worse off.
What are the examples of leakages and Injections in terms of Imports and Exports?
Imports and Exports leakage - Households use some of their income to purchases goods and services from outside their nation. Since these payments do not go to the firms of the original nation this is considered a leakage from the circular flow. injection - Spending by foreign citizens on goods and services produced by our nation is considered and injection.
The inability of the economy to move into the long run (Keynes)
In the Keynesian model, inflexible wages and prices mean that the economy cannot move into the long run. Inflexible wages and prices are shown graphically by a horizontal section of the Keynesian aggregate supply (AS) curve
Impacts of changes in long-run equilibrium (or why in the long run aggregate demand influences only the price level)
In the monetarist/new classical perspective, changes in aggregate demand can influence real GDP only in the short run; in the long run, the only impact of a change in aggregate demand is to change the economy's price level. Increases in aggregate demand in the long run are therefore inflationary (cause inflation).
Why the LRAS curve is situated at the level of potential GDP (or why inflationary and deflationary gaps cannot persist in the long run)
In the monetarist/new classical perspective, recessionary (deflationary) and inflationary gaps are eliminated in the long run. This ensures that in the long run the LRAS curve
What flows are equal in an economy
In the simple circular flow of income model, the expenditure flow is equal to the income flow and the value of output flow.
Implications of CFI no. 3
Increases / decreases to any of GDP components will have eventually have a much larger total effect on the GDP as monetary flows continue.
Implications of CFI no. 2
Increases / decreases to any of the components to GDP = C+G+I+(X-M) will impact GDP as a whole.
Demand Pull Inflation
Increases in AD beyond full employment level of GDP equilibrium. Too much money chasing too few goods.
Productivity Improvements
Increases in quality / quantity of physical capital (technological advancements · Improvements in quality of labor · Improved methods of production (assembly line)
Connect the Costs of Production to their respective factor incomes
Land - Rent Labour - Wages Capital - Interest
Shifts in Long Run Aggregate Supply - Keynes and Classical/Monetarist
Long Run Changes in AS illustrate changes in Potential GDP - see PPF 1. Increases in Quantity of Economic Resources - economy is now capable of producing more goods and services Capital and Land primarily 2. Improvements in Quality of Economic Resources Capital and Human Capital 3. Productivity Improvements methods of production 4. Institutional Changes - privatization, nationalization, regulatory changes, etc... 5. Changes in the amount of the natural rate of employment
Long-term growth versus short-term economic fluctuations
Long-term growth in the business cycle diagram, showing increases in potential output corresponds to rightward shifting LRAS or Keynesian AS curves Using the business cycle diagram again (page 231), we see that in an expansion there is growth of real GDP, though this is usually followed by a contraction, involving negative growth or declining real GDP.
Personal and Social consequences of unemployment
Loss of self esteem Increased personal debt levels Increased health problems Family breakups Crime homelessness
Consequences of Poverty
Low Standards of Living Lack of access to health care and education Higher infant/child mortality Poor health Social problems - crime, drug use, etc.
Causes of Poverty
Low incomes Unemployment - particularly structural unemployment. Low levels of human capital - poor education systems / resources and / or poor health. Limited levels of land/capital ownership. Discrimination - sex, ethnicity, etc. Geography - mismatch between people and available jobs. Age Limited availability of merit goods - education, housing, medical care, etc.. Poverty - poverty trap/cycle.
At any Price Level other than Pe, economy is in disequilibrium.
Market forces would force price level back to equilibrium. If price level is above equilibrium, there is an excess amount of real GDP supplied putting downward pressure on prices. If price level is below equilibrium, there is an excess amount of real GDP demanded, putting an upward pressure on prices.
Investment -Money spent by firms (and governments) to improving the stock of "Capital" resources.
Money spent by firms (and governments) to improving the stock of "Capital" resources.
Sources of Economic Growth
Movement within existing Production Possibilities More effective use of existing Land, Labor and Capital (usually decreasing levels of unemployment) will result in a movement from inside the PPF to a point closer to the curve - this represents increasing levels of productivity. The nation is producing more goods and services with their existing resources. Shifts of the PPF, Outward shift - illustrates increasing quality or quantity of Land, Labor and Capital. Can be due to: increasing amounts / improvements in Capital resources. improvements in Human Capital (education and job training) discovering new reserves of natural resources (natural capital). Inward Shifts - illustrates decreasing quality / quantity of Land, Labor and Capital. Can be due to: Exhaustion of natural resource (natural capital) due to unsustainable production practices. Reduction of job training / educational opportunities. Not replacing Capital as it deteriorates. Note: outward shifts of the curve only increase increasing possibilities of production. The actual point of production still dependent on the levels of unemployment along with efficient use of other economic resources.
Nominal Values vs Real Values
Nominal GDP or GNI is measured in terms of current prices (prices at the time of measurement), which does not account for changes in prices. Real GDP or real GNI are measures of economic activity that have eliminated the influence of changes in prices. When a variable is being compared over time, it is important to use real values.
Why national income statistics (GDP/GNI) do not accurately measure the 'true' value of output?
Only includes legal production that involves a monetary payment that is reported to government, thus Doesn't actually provide a value of ALL goods and services produced - doesn't include "non-marketed" output. (ex. Plumber not reporting his income, me personally repairing my house) Doesn't communicate any changes/differences in the quality of goods and services.
People whose relative wealth will decline during periods of high inflation
People living on fixed incomes - retirees, receivers of transfer payments, etc... People whose wages increase by less than inflation rate People with large cash holdings People who have saved - usually bank interest rates lag well behind inflation rates Creditors - people who have loaned money (unless interest charged is tied to inflation rate - adj rate) People whose relative wealth can increase during periods of inflation
People whose relative wealth can increase during periods of inflation
People who borrow money and whose interest rates are less than inflation Firms that pay others fixed wages People whose salaries increase faster than inflation rate People who hold wealth in non-monetary assets will often gain during periods of inflation or at least not lose to the extent those who hold cash will lose.
Capital
Physical Capital - Machinery, tools, etc... used to produce goods and services. Human Capital - Education / Job training to improve the skills of Labor. Natural Capital - improvements / expansion of Land (natural resources). Divided into two types: "marketable" commodities: timber, oil, tin, etc... ecological resources: clean air, fertile soil biodiversity, etc... Event though these seem not to directly impact GDP, it is important to maintain these to ensure future productivity levels (especially land and labor) and maintain increasing standards of living. While "Consumer Goods" are important in order to increase current standards of living, the greater "Investment" the greater the increases of production possibilities (LRAS)
Factors Preventing Growth and Development
Poverty, Equity of Distribution
Monetarist / New Classical perspective/model Assumptions
Price mechanism plays important role in coordinating economic activities Belief that economy has a natural tendency to move toward Full Employment levels of GDP. Changes in Money Supply will have an impact on output in Short Run and Long Run Price Levels. LRAS curve assumed to be Vertical at Full Employment level of real GDP (Yp) (Potential GDP) In the long run changes in price level will not affect the level of real GDP All resource prices (including wages) change to match changes in the price level Constant costs and profits mean firms have no incentive to increase / decreases production. Economy is "self-correcting" - Thus, Inflationary and Recessionary Gaps are only present in the Short Run In Long Run the only change in Equilibrium would involve Changes in Price Level
Consumption versus Investment - Opportunity costs
Production of increased quantity of Consumer Goods can improve current Standard of Living Production of increased quantity of Capital will result in a shifting of the PPF thus potentially improving future Standard of Living.
Consumption versus Investment - Opportunity costs
Production of increased quantity of Consumer Goods can improve current Standard of Living Production of increased quantity of Capital will result in a shifting of the PPF thus potentially improving future Standard of Living. Using PPF is similar to using a LRAS model - both attempt to illustrate the improvement the quality and quantity of Economic Resources used to create larger numbers of goods and services.Productivity - real GDP / hours worked
Other Sources of Potential Economic Growth
Productivity as a Source of Economic Growth Productivity = real GDP / hours worked
Proportional Taxation
Proportional Tax - as income increases, the fraction (%) of income paid as tax remains constant. Flat tax. Example: some nation's personal income tax or social welfare taxes are proportional. Excluding some levels of income from taxation can create a progressive aspect to proportional tax systems.
Draw and Explain Keynesian Equilibrium States
Recessionary Gaps - High levels of unemployment - low levels of production. Inflationary Gap - Attempting to produce beyond full employment GDP - rising price levels. Full Employment - production levels are a maximum without increasing price levels.
Consequences of Deflation
Redistribution of wealth - people on fixed incomes, holders of cash, savers and lenders all gain. Borrowers lose as they have to repay loan with currency that is worth more than they borrowed. Reduction of spending - consumers postpone spending since they expect prices to continue to fall in the future. Reduction of borrowing - since borrower repay loans with "more valuable" money. Increasing bankruptcies - when firms or consumers cannot repay loans. Can harm solvency of banks and other financial institutions, thus potentially leading to a financial crises. Uncertainty Menu Costs
Economic consequences of unemployment
Reduced GDP Reduced income for households Reduced tax revenue for governments Increased transfer payments (unemployment benefits) paid by governments Government funds used to deal social problems arising from unemployment (crime or homelessness) Increased inequality of income distribution. Difficulty of unemployed people to gain future employment - skill loss - long term unemployment can yield more long run unemployment.
Consequences of Inflation
Reduction of purchasing power - assuming wages are not increasing at the same rate as prices. Can be referred to as a reduction in "real income". Purchasing power - goods and services that can be bought with money. Nominal income / money income - the actual amount of salary as measured in units of currency. Uncertainty - economic conditions are much more difficult to predict making it difficult for firms and households to plan for the future. Money Illusion - consumer may believe their salary (and thus purchasing power) is increasing when it is not. Can lead people to spend more which may increase inflationary pressures. See causes of inflation. Reduction in Net Exports - if domestic prices are increasing faster than those internationally. Menu costs - changing prices requires firms to be continuing updating ads, labels, etc... Redistribution of Wealth - because different groups are not affected uniformly by inflation the relative wealth can change due to inflation.
Draw/Explain Keynesian Long Run AS Curve
Section 1 - Economy producing below capacity - unused Land, Labor and Capital could be employed to increase real GDP without putting pressure on wages and prices. Section 2 - Increases in GDP still possible but because firms are not bidding against each other for smaller remaining amounts of Land, Labor & Capital, prices will begin to gradually rise. Section 3 - Economy is at full production (natural rate of unemployment achieved) and cannot produce beyond this level. Any additional attempts to increase production will only increase price levels.
Difference Between Short Term and Long Term
Short run - period of time when prices of resources (including wages) remain stable / constant. Long run - time period when the prices of resources are considered flexible.
Limitations of using CPI
Since most people do not purchases exactly the items (in the same amounts) as the "market basket" the rate of inflation for any one consumer may differ from the stated CPI Prices increases may vary geographically. Consumers may substitute goods/services whose price is not changing as fast for those goods/services used to calculate the market basket. Consumers may alter the percentage of their income spent on various products within market based due the rate of increase in individual goods and services. Discounts store prices may not be increasing as fast as "retail" stores used to calculate the CPI General changes in consumer buying patterns means the market basket goods and services may be outdated. CPI cannot measure quality changes - only price changes. Not all nations calculate their CPI using the same mix of goods/services (for good reason) which may limit the comparability of international consumer price indices Since market basket will be changed over time - the comparability over time may be limited.
Why is LRAS Vertical?
Since wages (and other resource prices) are now changing to match output price changes, firms' costs of production remain constant even as the price level changes. Therefore, as the price level increases or decreases, with constant real costs, firms' profits are also constant, and firms no longer have any incentive to increase or decrease their output levels.
Why is SRAS upward Sloping?
Since wages are assumed to be stable in the short run, increasing price levels mean increased profits - thus firms will produce more goods and services at higher price levels than at lower price levels.
What are the examples of leakages and Injections in terms of Taxes and Government?
Taxes and government leakage - Households are required to send a portion of their income to government in the form of taxes. injection - Governments inject spending on goods and services into circular flow.
Taxes and Allocative Efficiency
Taxes that are NOT levied to correct for market failure will reduce Allocative Efficiency even as they might improve income distribution.
Why do we look at per capita figures?
Total measures of the value of output and income (such as GDP and GNI), provide a summary statement of the overall size of an economy. Per capita figures are useful as a summary measure of the standard of living in a country, because they provide an indication of how much of total output in the economy corresponds to each person in the population on average.
Redistribution of Income to promote equity and address Poverty
Transfer Payments - food stamps, welfare payments, unemployment insurance payments, disability pensions, student grants, housing benefits, etc.. Subsidized and direct provision of goods/services - merit goods produced and distributed by government. Education, Health care, transportation, sanitation, etc. Government Intervention in market allocation - minimum wages, food price ceilings, price floors for farmers, etc.. Taxation, direct and indirect
Keynesian Government policies to aid unemployment
Transfer Payments - payments to unemployed workers - Cyclical Investment in Human Capital Improved health care services Government subsidies to encourage hiring
Underemployment
Underemployment - people of working age who are not working full time or at jobs that do not make full use of their skill level / education note - Both unemployment and underemployment indicate "unproductive" use of economic resource of "labor"
Measuring Employment:
Unemployment - people of working age who are actively looking for a job but who are not employed.
Short Run AD-AS Equilibrium
Where aggregate demand equals aggregate supply. Illustrated by an intersection of the SR AS and AD curves. Equilibrium indicates Price Level and real GDP.
Inflation
a sustained increase in the general price level - increase in the average price of goods and services throughout the entire economy.
Progressive Taxation
as income increases, the fraction (%) of income paid as tax increases. Taxpayer pays a higher rate of tax on only the higher levels of income not necessarily on all his/her income. Promotes equality of after tax income. Example: Personal Income taxes frequently built on a progressive structure.
Output method of measuring production
calculate final value of every good or service produced by various sectors of economy (agriculture, manufacturing, banking, etc...)
Good" Deflation -
caused by an Increase in LR AS without an accompanying increase in AD.
Examples of Short Run Changes in AS - NOTE: there is some overlap between factors affecting AD & SRAS (Draw and Explain)
change in weather conditions change in cost of resources (wages, raw materials, etc...) changes in investment
Natural Rate of Unemployment
combination of structural, frictional and seasonal unemployment. Is the rate of unemployment when economy is producing at full potential. If factors occur that reduce this natural rate (due to a fall in frictional, seasonal or structural) then this can be seen as an increase in Potential GDP as it is not possible for the economy to produce more goods and services at "full employment" than previously. This would be indicated by a shift of the LRAS or Keynesian AS curve.
Relative Poverty
compares incomes to income of people to Median Income - usually 50% of median income. Assumes that the meaning of poverty goes beyond simply "surviving". People are poor if they cannot afford a standard of living considered "typical" in that society.
Core Inflation Rate
determined by constructing a CPI leaving out food & energy prices which tend to be more volatile than other prices and thus skew the broader CPI.
Sales / VAT taxes
do not affect Allocative Efficiency as they do not change the relative prices of goods/services but they are regressive and thus reduce income equality.
Why study the Business Cycle?
economic growth represented by potential output line on the business cycle is highly desirable - it gives opportunity for increasing incomes and higher standards of living On the other hand, In the upward phases of the business cycle, the economy often experiences a rapidly rising price level (inflation), which is not good for the economy. In the downward phases, the economy experiences falling incomes and growing unemployment, causing hardship for many people and frustrating the objective of economic growth
Why is AD curve downward sloping - International Trade Effect?
if domestic price level increases while price levels abroad remain stable then exports will be more expensive than domestic goods leading to a fall in exports thus reducing AD. Meanwhile, foreign goods will be relatively less expensive which will increase imports also decreasing AD.
Connection between Actual/Potential Output and Unemployment
in an expansion, real GDP increases because firms increase the quantity of output they produce; to do this, they hire more labour (and other resources) and unemployment falls. In a contraction, real GDP falls because firms cut back on production; as they lay off workers, unemployment increases.
Cost Push Inflation (Only Classical)
increases in costs of production / supply side shocks accompanied by a decrease in real GDP (note: not referred to as recessionary gap because that term is reserved for decreasing output caused by shifts in AD) Stagflation
Inflation rate
indicates the speed with which the price level is changing. Inflation rate increasing from 6% to 8% indicates an increase in the rate of inflation. Maintaining at 6% would be a stable rate of inflation. Change from 8% to 6% indicates "disinflation" - decreasing rate of inflation. Changes (increases) in price level indicate inflation.
What are the examples of leakages and Injections in terms of Savings and Investment?
leakage - Households do not spend all their income on goods and services - it therefore "leaks" out of original circular flow. Households are assumed to place this savings in Financial Institutions (Banks). injection - Financial institutions make loans to business firms for the purchases of new Capital goods. This "injects" money into the original circular flow.
The relationship between the SRAS and LRAS curves in the monetarist/new classical model
many of the factors that cause the LRAS (and SRAS) curves to shift also cause the AD curve to shift. For example, increases in the quantity of physical capital, affecting AS, result from private and public investments, also shifting AD.
Income Method
measures the total income earned by factors of production. Technically measures National Income which is slightly different from National Output. (See GNI)
Absolute Poverty
minimal level of existence (food, clothing, etc...) measured by an specific amount of daily income. "Extreme" - $1.25 / day "Moderate" - $2.00 / day Note: Most High Income nations set a poverty line above $2.00 / day. Many Low Income nations set poverty line below $2.00/day.
Structural Unemployment
mismatch between skills possess and those desired by market. Can also refer to mismatch between where unemployed are living and where potential jobs are (geography) and / or government policies that interfere with the supply and demand for labor thus decreasing opportunity for people to be hired: minimum wages, labor unions, unemployment compensation programs that discourage firing and thus hiring and unemployment benefits that encourage people to remain unemployed.
Labour Force
number of people of working age who are employed PLUS those that are not employed. Labor Force excludes: retirees, school age children, people with disabilities, and people who do not wish to work. Unemployment rate = number of unemployed / labor force x 100 note: To accurately calculate the unemployment rate economists do not include underemployed or discouraged workers as "unemployed".
Consumer Spending
payments made by households for goods and services. This same amount represents revenue to firms.
Cyclical unemployment
people who become unemployed due to fluctuation of the business cycle. Unemployment increasing during a recession or when there is a decrease in AD (C + I + G + (X - M) ) Demand deficient unemployment.
Producer Price Index (PPI)
price indices created using input prices (or wholesale goods, intermediate goods, etc...)rather than finished goods/services. Are used to predict changes in future CPI rates.
When leakages > injections
reduces size of the circular flow - economic slowdown.
What is the SRAS?
shows the direct relationship between price level and the quantity of real output (real GDP) produced by firms when resource prices (wages) do not change.
When leakages < injections
stimulates growth of the circular flow.
Aggregate Output
total value of the production of goods and services of an nation. Since Circular Flow illustrates that the Income flow from firms to households equals the expenditure flow from households to firms we can use either of these to measure aggregate output. Expenditure Method Income Method Output method of measuring production
Reasons for limited fluctuation of labor costs in short run
union contracts minimum wage legislation resistance to wage reduction negative effects of wage reduction on employees morale
Progressive Income taxes
will improve income equality But may act as a "disincentive" for households to work/earn/save. (Supply Side economics) HOWEVER... Other economists believe that in reality there is not much (if any) negative incentive for people to work/earn/save. Greater income equality may also reduce severity of recessions. Greater income equality can increase access to health and education thus improve human capital and promote growth. Reduce government need to use transfer payments to supplement income of poor.
