Macroeconomic objectives

economic growth

an increase in real GDP

short term economic growth

• changes to any components of AD causes short term economic growth

  • illustrated by shift right in AD

• can also be illustrated by PPC

  • increase in production causes a point inside the curve to move to a point closer to the curve

  • this is an increase in real GDP

long term growth

• caused by any improvements to determinants of LRAS

  • illustrated by right shift of LRAS

  • or shift outwards of PPC

calculating economic growth rates

• measured by change in real GDP between 2 time periods

  1. calculate nominal GDP for 2 time periods

  2. calculate real GDP for each period using GDP deflator

  3. calculate percentage change in real GDP between 2 time periods

living standards - impact of economic growth

• positives

  • increased income leads to better SOL

  • increased employment resolves negative social impacts of unemployment

• negatives

  • rising AD causes inflation

  • increased income leads to greater consumption of demerit goods

  • greater output requires more time from workers, decreasing wellbeing

environment - impacts of economic growth

• positives

  • improvement in quality/quantity of environmentally friendly technology

• negatives

  • environmental damage caused by negative externalities of production

  • resources depleted more rapidly

income distribution - impact of economic growth

• positives

  • decreased levels of poverty

  • higher levels of employment, more tax revenue for govs to distribute on welfare payments

• negatives

  • lack of equity - rich may get richer, poor get poorer

employment

• economic use of labour as a factor of production

unemployment

• someone not working but actively seeking work

labour force

• all workers actively working, plus the unemployed

• non labour force: all those not seeking work

full employment

• ideal situation where everyone in the economy willing to and able to work has a job

measuring unemployment

• ILO labour force survey, claimant count

• unemployment rate = no. actively seeking / total labour force x 100

• employment rate = no. in employment / population of working age x 100

difficulties in measuring unemployment

• underemployment

  • these people are working

    • they want to work more hours, they’re working in a job that requires lower skills than they have

  • often a result of cyclical or structural unemployment

• hidden unemployment

  • when workers lose their jobs, attempt to get a new one for a while, then give up

  • unemployment rate would be much higher if this was shown

• unemployment disparities

  • unemployment rate is an average

  • doesn’t provide insight into ethnic, gender, etc disparities that exist in an economy

labour market equilibirum

• when demand for labour DL = supply of labour (SL)

• diagram has wage rate on y-axis, quantity on x-axis

• different causes of unemployment cause disequilibrium of labour market

real wage unemployment

• when wages are inflexible at a point higher than free market equilibrium wage

  • because of minimum wage laws, higher wage creates excess supply of labour

real wage unemployment diagram

• market equilibrium at WeQe

• government impose minimum wage (NMW)

• incentivised by higher wages, supply of labour increases from Qe to Qs

• facing higher production costs (increased wage), demand for labour decreases from Qe to Qd

• at wage rate W1, there is excess supply of labour equal to QdQs

structural unemployment

• when there’s mismatch between jobs and skills in economy, no need for a specific type of worker anymore

structural unemployment diagram

• labour market equilibrium at W1Q1

• demand for labour shifted left from DL to DL1

• wages fell from W1 to W2, quantity of workers in the industry reduced from Q1 to Q2

cyclical unemployment

• caused by a fall in AD, as output falls, firms lay off workers

cyclical unemployment diagram

frictional and seasonal unemployment

• seasonal unemployment: as certain seasons end, labour is not required until the next season

• frictional unemployment: when workers are between jobs, short term unemployment

natural rate of unemployment

• lowest achievable rate of unemployment

• frictional + seasonal + structural unemployment

costs of unemployment

• government

  • receive less tax revenue, higher expenditures in the form of welfare payments

• individuals

  • suffer emotional (stress, self esteem, isolation) and financial (risk of poverty, debt) consequences

• firms

  • harder to find workers to employ once the economy starts to recover

• economy

  • contracts as there is higher level of inefficient use of available resources

inflation & deflation

• inflation: sustained increase in average price level of goods in an economy

• deflation: fall in average price level of goods in an economy

• disinflation: average price levels still rising but at a lower rate than before

measuring inflation using CPI

• average price level measured by checking prices of a “basket” of goods that an average household purchases each month, this turns into an index (CPI)

  • household expenditure survey conducted to determine what goes in basket

  • goods in basket weighted based on proportion of household spending

  • each month prices for these goods are gathered from many locations, and averaged

  • price x weighting determines final value of that good in basket

calculating inflation rate using CPI

• CPI = cost of basket in year x / cost of basket in base year x 100

• inflation rate = new CPI - old CPI / old CPI x 100

limitations of using CPI

• provides a level of inflation for the average basket

• CPI doesn’t capture quality of products in basket

• CPI only measures changes in consumption on annual basis

• CPI is prone to errors in data collection

  • based on survey, which is small and may be inaccurate

demand pull inflation

• caused by excess demand in economy

• if any of 4 components of AD increase, AD curve shifts to the right

• at original price AP1, there is now excess demand in economy

• as prices rise, there is contraction of AD and extension of SRAS

• prices for goods increase from AP1 to AP2

cost push inflation

• caused by increases in COP

• if COP increases, SRAS curve shifts left

• at original price AP1, there is now excess demand

• as prices rise, contraction of AD and extension of SRAS

• prices for goods increase from AP1 to AP2

costs of inflation

• firms

  • uncertainty, rapid price changes create uncertainty and less investment

• consumers

  • decreasing purchasing power

  • decrease in real value of savings

  • decrease in real income

• government

  • decrease international competitiveness of export industries as countries exports are more expensive

  • economic growth slows

• workers

  • demand higher wages to compensate for reduced purchasing power

demand side deflation

• equilibrium at APY

• any factor which decreases non price determinants of AD causes AD curve to shift left

• shift causes fall in AP to AP1

• new equilibrium at AP1Y1

consequences of demand side deflation

• government

  • decrease in output = fewer workers required = unemployment increases

• consumers

  • lose confidence = consumption falls = rGDP decreases

• debt

  • debt feels more burdensome as value of any debt is worth more

• firms

  • lose confidence, delay investment

• bankruptcies

  • falling output and prices = reduced profits for firms

• exports

  • falling prices are attractive to foreigners = increased exports

supply side deflation

• increase in productive capacity of economy

  • increase in quality/quantity of FOP

• any factor which causes increase in SRAS causes SRAS to shift right

• causes fall in AP to AP1

consequences of supply side deflation

• unemployment

  • decrease in costs, output of firms increase

  • more workers required

• consumers

  • rising output, falling prices, more confidence, more consumption

• debt

  • still feels more burdensome

• firms

  • rising output, falling COP, more confidence, more investment

• exports

  • falling prices cause more international competitiveness, exports increase

costs of unemployment vs inflation

conflicts between macroeconomic objectives