3.3 Macroeconomics objectives

Define Economic growth

Sustained increase in a country's real GDP over time. Occurs when their is an increase in the quality or quantity of an economy’s FOP

Short-term growth vs Long-term growth on a diagram

Short-term: actual growth in the economy can be seen in a shift in AD to the right or movement of a point on a PPC model

Long-term: Potential growth in the economy (in the long-run)

shift in LRAS or shift in curve of PPC

How is Economic growth measured?

By comparing GDP or GNI values from different times:

Comparing real GDP from last year with this years real GDP: growth in percent = [(new GDP - old GDP) / old GDP] x 100

Consequences of economic growth:

1. Impact on living standards:

economic growth leads to improvements in living standards → decreases in poverty levels, increases spending (on both merit and demerit goods) + increase in investments

- of economic growth for living standards: Increases cost of living, Risks higher inflation rates

2. Impact on environment:

Create negative externalities on the environment = market failure my result (climate change, overfishing etc.)

Current consumption of raw materials is nor sustainable in the long-run

3. Impact on income distribution

Creates higher gaps between wealthy and poor (income and wealth)

Governments earn more tax revenue → can be spent on helping poor people but income/wealth gaps can increase with economic growth

Inflation:

A sustained increase in the general price level in an economy over a period of time

Goods and services get more expensive = the value of money decreases

Measuring inflation using CPI:

Consumer price index

- A base year = the price index of goods and services = 100

-> index number = value in year X / value in base year x 100

- Changes in this price index can be measured by comparing to the base yeareg.

if CPI is 110 next year, there has been a 10% inflation that year

Done by collecting information of prices of a typical household's expenditures (gas, food, transport)

inflation calculation

Percentage change = new-old/old x 100

Limitations of inflation calculation

Not all households have the same expenditures, and CPI only accounts for an average household.

Inflation can vary within regions of a country, and CPI only accounts for the general price level.

CPI does not measure changes in product quality.

Something might become more expensive, but also have better features (Nokia phones -> Smartphones)

Consumption patterns change over time, so the "basket" that CPI uses will have to change.

Types of inflation:

1.Demand-pull inflation:

2. Cost-push inflation

Demand-pull inflation: (graph and real life example)

Inflationary gap

An increase in AD which sees the AD curve shift right causes an increase in prices

Increase in C+I+G(x-m)

eg. May 12 2022: Why is inflation so high

The surge in demand for goods has pushed off inflation (pushes up prices) → seen an extraordinary surge in the supply of goods. Once lockdown ends = surge in demand for goods and services because consumers want to spend.

Cost-push inflation (graph)

An increase in the costs of production which causes a shift in the SRAS to the left = increasing the price level

Caused by an increase in the cost of production → eg. increase in wages, energy costs

Cost-push inflation = stagflation

Consequences of high inflation:

1. Uncertainty - Lower confidence in the economy, leading to less consumption and investment

2. Redistributive effects and effects on savings:

- Worse for poor people who were already struggling.

- Savers will lose out as their savings are worth less, borrowers will gain as the money they have to pay back to lenders is now worth less (and easier to obtain), and lenders will lose as the money they get from borrowers is now worth less.

Damage to export competitiveness:

- Exporting goods and services becomes more expensive and imports become cheaper, net exports decreases

3. Impact on economic growth:

- Workers are likely to want raises, raising costs of production, decreasing AS

Inefficient resource allocation:

- Having to update prices and look for cheaper alternatives of goods and services takes time, leading to inefficiencies.

Deflation:

Decrease in the general price level in an economy over a period of time

Bad deflation: (graph, def and real life example)

Bad deflation: A decrease in AD and a shift to the left.

- AD decreases = cut and increasing unemployment ⇒ more pressure on spending and lower AD

This leads to a deflationary spiral:

- With an increase in cyclical unemployment

Deflation discourages spending as consumers wait for prices to fall further

It discourages borrowing as the real value of debt increases during deflation

If a country gets into a deflationary spiral = AD keeps decreasing

eg. Japan in the last 20 years. Wages are not rising so consumer spending is not increasing. Japan is struggling to meet inflation targets of 2%, even now with inflation increasing around the world. Businesses are reducing prices to increase sales which also negatively impacts price levels

Why does it not happen often

1. Wages are sticky: People do not want to accept lower wages so wages do not fall easily

2. Fear of price wars: If one firm decreases, the price when other firms will have to follow. This leads to a price war where all producers in the market lose.

3. Changing prices costs money: Dont want to incur costs of changing prices in the short-term (menu costs) = it takes time and money for firms to change = they will resist price changes in the short-term so they don't incur those costs

Good deflation (graph, example and def)

- A shift in LRAS with AD remaining constant

- Improvements in technology increase productivity and lower the costs of production (LRAS shifts due to quality → SRAS shifts due to cost change)

- This is associated with economic expansion, lower unemployment, rising incomes

- occurs when aggregate supply of goods (say from technological advances, improved productivity, and the like) increases faster than aggregate demand, resulting in falling prices

eg. occurred in Britain in the 19th century (industrial revolution)

Consequences of deflation

1. Uncertainty: Prices are not stable, and there is uncertainty over whether to buy (consumers) or invest (businesses). AD will decrease due to a lack of C and I.

2. Fixed income gain: As the income is fixed, the value of income increases because the price level falls, and those on fixed income gain because the value of their income does not change.

3. Lenders gain: The value of the debt increases due to the deflation.

4. Borrowers lose: The value of the debt increases due to the deflation. Less likely for consumers and businesses to take out loans

Inflation vs Deflation: (Is deflation more serious than inflation for a country?)

Agree with the statement;

- Inflation is naturally occurring in the business cycle

- Inflation is easier to correct as it's done through demand-side policies (fiscal and monetary)

Disagree:

- It depends on what is causing the deflation to how bad it can be. A decrease in AD is bad deflation but an increase in SRAS is good deflation

- Cost-push inflation is extremely problematic (inflation caused by a decrease in SRAS)

Low Unemployment

Unemployment: The total number of people actively seeking work but are not employed

- eg. If you are a student and do not want to work, you are not unemployed because you are not looking for work

Unemployment rate calculation

number of unemployed/labour force x 100

Labour force calculation

Labour force = number of employed + number of unemployed

Difficulties with measuring unemployment:

- Hidden unemployment: people who become discouraged and stop looking for a job are no longer counted as unemployed

- Underemployment: people working below their skill level (fully qualified doctor working as a substitute teacher). Part-time workers are counted as employed and no longer unemployed

- People retraining aren't included: students are not counted as unemployed

- Disparities in a country aren't recognized: Age, level of education and skill level, geographic region, gender. None of these things are accounted for in a nationwide figure Not specific enough eg. male unemployment and female unemployment

The natural rate of unemployment:

LRAS: Full employment level of output = zero cyclical unemployment (natural rate of unemployment)

- The natural rate of unemployment: Unemployment that occurs at full employment level of output Structural + frictional + seasonal

- The natural rate of unemployment (of which structural unemployment is most serious) has potential solutions in the aggregate supply side of the macroeconomy (supply-side policies)

Type of unemployment:

Cyclical unemployment

Frictional Unemployment

Seasonal unemployment

Structural Unemployment

Cyclical unemployment (Graph)

(Demand deficient unemployment)

Caused by a fall in AD (fall in output due to less C, I, G, XM) which is why it is also known as demand-deficient unemployment → firms would lay off people

This coincides with the points in the business cycle that are below the long-term growth trend

Actions that can be taken (cylicial unemployment)

- Methods to minimize the troughs in the business cycle such as transfer payments (unemployment benefits, family allowance.) This give lower-income earners more money in their pockets to spend in the economy.

- Government policy to increase AD such as expansionary fiscal policy (government-related) and or monetary policy (interest rates) = demand-side policies (fixed demand)

Frictional Unemployment

Unemployemnt associated with people who are out of work between jobs as they look for a job.

- If people leave a job to look for a new one, they are part of frictional unemployment

Actions that can be taken: Frictional Unemployment

Try to reduce the time it takes to find a new job.

- Set up job centres to make it easier to find and spend less time unemployed.

Seasonal unemployment

Unemployment associated with seasonal industries

- Things like tourist-related employment such as skiing or summer resorts as well as fruit picking

- Geographical areas that have seasonal unemployment = make it hard it be employed

Actions that can be taken: Seasonal unemployment

Diversify the economy so different jobs are available that are less seasonal (not AD related) → Investments need to be made

Structural Unemployment

Mismatch of skills/geographical location : There are different kinds of strucutral unemployment

1. Changes in demand for particular skills or industries: Coal mines close and the miners do not have skills for other kinds of work

2. Changes in the geographical locations for jobs: A factory moves to a different location because it is cheaper to produce and the workers in the first location are out of work

Mismatch of skillls/geographical location (graph, def and example)

- Demand for labour is derived from the demand for the product, if the industry becomes less important = employ fewer workers

- Demand for labour in that industry will decrease and create structural unemployment

Eg. As demand for labour is derived from demand for the industry, a fall in demand for housing in the UK has led to a decrease in demand for construction workers in the UK. The number of available positions in construction fell by 8.24%

Labour market rigidites (graph/explain,example)

Minimum wage legislation that stops firms from paying low wages

Stops the labour market from bending and moving to different situations

- The minimum wage means people are willing and able to work for less money but can't because of the minimum wage, this causes unemployment shown by a surplus of labour

eg.

Minimum wage increase in New York: In most areas of the state, including upstate New York, the wage will increase to $15 an hour, according to the state labour department

Increase of 5.6% over the current minimum wage of $14.20 an hour in Upstate New York. The hike will translate into an extra $32 a week for a full-time worker in a minimum-wage job

The minimum wage in New York has increased substantially in the last 10 years. A decade ago it was $7.25 an hour. Once the latest set of increases are in place, the wage will have increased over 120% from that level in Upstate New York.

Action to Prevent Structural Unemployment:

Labour market rigidities:

Decreased demand for an industry or relocation

Labour market rigidities (graph)

Classical economists would argue that removing labour market rigidities would increase employment. There will be more people able to work at the lower wage because there will be more labour demanded

- However, lower living standards for those on minimum wage. There will be lower wages and potentially worse working environments for those working

Decreased demand for an industry or relocation

Retrain workers so they have different skill sets and are able to get different kinds of jobs

- Encourage firms to relocate to regions that need jobs

4 types of unemployment in relation to LRAS:

Ye

Explain the relationship with unemployment

Low unemployment = higher consumer spending and short-term economic growth = business investment which in the short term increases AD but in the long-term economic growth due to an increase in quality or quantity of FOP SRAS, LRAS and AD shifts to the right

- Higher tax: More people are working which means people are paying income tax and also more products being purchased and more indirect tax all leading to increased tax revenue

- More spending on unemployment benefits and increases in government expenditure

- Prevents brain drain: Low unemployment provides opportunities for skilled workers to remain in the country so the government doesn't experience brain drain

Sustainable level of government Debt HL

Governments may run deficits (spending > income) to achieve other macro objectivies

- However, repeated budget deficits will lead to debt = which is the total amount of money owed by the government to lenders

- A debt to GDP ratio is used to emasure the amount of debt in relation to the economy's size (US has more debt than Japan, but not when compared to their economies)

Cost of High government debt

Debt servicing costs: the money the government has to pay back (initial amount + interest rate).

This will be higher when there is more debt

Credit ratings: A rating of a borrower's ability to repay a loan → rating tends to be lower for countries with more debt = harder to get better loans

Impact on future taxation and spending: The money will have to be paid back at some point = future scrifices are made when taking on debt now

Conflict between objectivies HL:

1. low unemployment = households will have more money to spend, increasing aggregate demand

- When everyone is employed = leads to wage inflation: workers realize their labour is scarce and use this power to lobby for higher wages which will increase cost of production

- May decrease AS = causing demand-pull inflation

2. Trade-off between inflation and unemployment

- The phillips curve (illustrates the trade off between unemployment and inflation)

3. High economic growth and low inflation:

- As an economy grows = the amount of spare capacity diminishes + the cost of production will increase = increase the general PL = inflation

.4. High economic growth and environmental sustainability:

- Increased levels of production and consumption may cause negative externalities.

5. High economic growth and equity in income distribution:

- Economic growth often creates a larger gap between the rich and the poor (everyone is better off than before, but some more than others).

The phillips curve (draw + explain)

Short-run phillips curve (SPRC)

Long-run phillips curve (LPRC)

- NRU = natural rate of unemployment → because there will always be some people unemployed (structural, frictional, seasonal)

- SPRC = below x-axis because if the unemployment rate is beyond this point = deflation will start to occur as the unemployment will decrease spending & PL

- LPRC is a vertical line because in the long run, everything will revert to the natural rate of unemployment

High unemployment effects on inflation

Because many become unemployed, consumption in the economy will decrease → shifting AD to the left, decreasing General price level of the economy

This is why the SRPC goes beyond the x-axis: At a high enough unemployment rate, AD will have a leftwards shift.