Econ revision

Absolute Poverty

the situation where a population are unable to meet its bare subsistence needs (food, clothing and shelter) to maintain a minimum level of living.

Who’s considered to be in absolute poverty?

Those who live below the International Poverty Line ($2.50 a day)

What is the problem with measuring poverty using the IPL

• normative decisions have to be made about what are ‘necessities of life’

  • This can occur even in just one country as what is inhumane to live without today could’ve been a luxury back in the day

• The extent of poverty over/under the line isn’t captured

Relative Poverty

a condition where a household's income or disposable income is significantly lower than the typical or median income in its own country. Generally, people are considered to be relatively poor if they earn below 50% or 60% of the national median.

Neither absolute nor relative poverty…

… reflects WHERE the poverty is. For example:

• between regions (north/south)

• genders

• rural/urban areas

Poverty Cycles

k

minimum wage

the minimum amount of remuneration that an employer can legally pay a worker

Arguments against raising minimum wage

• raising minimum wage causes firms to reduce their demand for labour (to cut costs)

• employers MAY replace workers with machines

• rising wages = rising CoP = rising prices

• Businesses that can’t afford it will go out of business

arguments for raising the minimum wage (1)

• there is no definite link between minimum wage and unemployment

• some things can’t be done by machines

• rising wages motivates people to work more/harder which offsets rising CoP

Other arguments for raising the minimum wage

• rising wages can convince some people to join the workforce

• rising wages leads to rising consumption so AD and employment rise

• allows people to escape the poverty trap

• reduces inequality

How has globalisation and tech progression caused poverty

• it has caused the D for manufacturing workers in developed nations to fall

• wages for them have fallen and they’re technologically unemployed

• D_L for high skilled workers has risen as have their wages

• income inequality has risen and the middle class is ‘hollowed out’

How have market based SSP caused poverty

• Reaganomics and Thatcherism de-regulated the financial sector allowing for the rich to earn more on their investment

• Union power was limited so wages have fallen without much protesting (they can’t)

• the reforms also allowed for more ‘non-standard’ work (not full time)

How have tax and benefits policies caused Poverty

• the top band of tax systems are falling

• corporate profits, dividends, savings and capital gains are taxed at a lower rate than income

• austerity

How has unequal status and power caused poverty

• rich, powerful people have a disproportionate say in politics

• campaigners are financed by the rich so gear their policies towards appealing to their donors

• poorer people are less likely to ever be politicians and are underrepresented in politics.

How has inequality of opportunity caused poverty

• the opportunities that people face are simply unequal from where we’re born to who we’re born to and so on.

how has discrimination caused poverty

• for any reason (gender, age, race)

• prevalent in the opportunities we receive and the outcomes of them. Poorer kids are discriminated against as they don’t have the same educational opportunities so don’t land the highest paying jobs

  • wage discrimination - same job but different wages for reasons unrelated to performance or skills

How has differences in human capital caused Poverty

• in the last decade, skilled worker wages have risen too fast in comparison to unskilled thereby increasing inequality

How has the unequal ownership of resources caused poverty

• owning physical capital - profit

• owning financial capital (shares) - dividends

• the higher your income, the more likely you are to own those things and their value rises a lot faster than wages

Poverty is measured…

,,, in each country by a national poverty line which is a % of median income (usually 50-60)

Poverty Indices

• Human Suffering Index - Ranks the levels of suffering experienced by poor people of calorie intake, supply of clean water and more

• Multi dimensional poverty index - uses 10 indicators to show deprivation in education, health and living standards

  • a person is multi-dimensionally poor if they’re depraved in 1/3 of the indicators

challenges in measuring poverty

• difficult to define (Absolute, Relative, Multi-dimensional) so hard to measure

• some elements are impossible to measure like the anxiety of not knowing when the next meal is

• a Govt can edit the poverty line and the definition to make it look like poverty has lessened

• The results are often from household surveys. results may be worse in a country with less resource

The Lorenz Curve…

…can be used to:

• compare income distribution in 2 or more countries

• compare income distribution in a country over time

How to calculate a Gini index value from a Lorenz curve

• Area A / (Area A + Area B)

Consequences of Poverty and Inequality for Economic Growth

• it can be a motivator for the poorest to improve skills and gain an education to ascend the classes

• A more equal society has no drive and no pools of money needed to invest

• higher levels of poverty and inequality means fewer opportunities for poor people which traps them in a vicious cycle. Kids finish school with a basic education so productivity and EG fall

Consequences of Poverty and Inequality for living standards & social stability

• wide income disparity means anyone below the average is poor

• poor people have to decide what to/what not to buy

• in unequal societies, neighbourhoods and regions may be known rich/poor and may be self perpetuating

• concentrated council housing leads to an area with poorer infrastructure and education

• poorer areas have high hostility which leads to rising tension and crime

Policies to redistribute income/wealth & lower poverty

• Broader access to education in marginalised communities

• improve provision of housing, electricity etc

• improve access to essential healthcare services

• introduce/increase state pension

• taxes (Inheritance, progressive)

• minimum wages

• means tested benefits

What is the Marginal rate of tax

the % of tax paid on the NEXT pound you earn

What is the average rate of tax

the total tax a person paid / their income x 100

what is a regressive tax

A regressive tax is a tax that takes a larger percentage of income from low-income earners than from high-income earners

What is Monetary Policy

the set of official policies governing the supply of money and level of interest rates in a country

Who uses MP

a central bank (the bank for banks and the G)

two types of MP

Expansionary MP - raises AD and lowers IR

Contractionary MP - lowers AD and raises IR

how has monetary policy evolved over time in the UK?

1980s - German mark was shadowed to control inflation + strong belief in monetarist theories

‘90 - UK entered EU ERM

‘92 - ‘97 - UK leaves EU ERM (Black Wednesday) and moves back to floating xchange rates set by the G

‘97 - now - The BofE set up to be independent to the G and MPC set up to set IR

How did the European Union Exchange Rate Mechanism (EU ERM) work

Worked by setting an agreed upon central xchange rate for partaking currencies against the ECU and allowing fluctuations (+ or - 6%) in the UK’s case

What happened on Black Wednesday?

• 16th Sept 1992

• the £ fell by >6% against the ECU

• The govt tried to perk up the GBP by buying it up with foreign currency reserves and raising IR upto 12% in a day

• to no avail as the UK left the EU ERM

Strengths of MP

• easily implemented (IR can be altered quickly by BofE)

• The BofE is independent - politics don’t impede its function

• There’s no crowding out (only IR is affected)

• Precise changes can be made - IR can be altered by as little as +- 0.25% (fine tuning)

Weaknesses of MP

• time lags - AD takes time to reply to changes in IR

• If IR is already low its ineffective at raising AD

• if confidence is already low (esp in a recession) lowering IR does nothing

What is credit creation

credit creation occurs when banks lend money to customers, they’ll receive a deposit and loan out more as a multiple of the deposit

what is the minimum reserve requirement (MRR)

the % of a deposit that banks are legally required to hold in reserve incase the depositor needs it (the uk doesn’t have one)

how does credit creation work

• someone deposits 100k into my bank (MRR is 20%)

• i divide it into 5 packets of 20k (the mrr)

• i keep one for the depositor

• the remaining 4 i use as the MRR and grant 4 ×100k loans

(I just created 400k)

money multiplier formula

1/mrr

How is the MRR used to control the money supply

if the BofE raises the MRR the multiplier decreases (inv. proportional) this will lower credit creation which lowers money supply which raises IR - (this is contractionary MP)

how do open market operations to control money supply

• this involves buying&selling of govt securities (bonds) by the BofE (low risk and redeemable after a few years)

• If the BofE wants contractionary MonetaryPolicy they’ll sell the securities - decreases funds and lowers money supply (IR rises and C+I fall)

(expansionary MP is the opposite)

what does the open market operations diagram look like

did you get it?

what are 3 ways of saying the base rate

• minimum lending rate

• refinancing rate

• discount rate

How does the BofE alter the base rate to control money supply

• this is the IR for banks and it influences our own IR

• If the BofE wants CMP they’ll raise base rate which raises commercial IR which decreases borrowing snd raises savings so c+i fall as does AD

(EMP the opposite of what i just said)

What is Quantitative Easing (QE)

• the introduction of new money into an economy

• Expansionary MP

• a common form of EMP since ‘08 when IR was low and demand wasn’t rising

steps to QE

• Central bank buys securities off of financial institutions

• this gives them more reserves - more liquidity (encourages more lending as IR is low too)

• C+I rises as does AD

• low IR = low xchange rates which raises (x - m)

Interest rates are

The price (opportunity cost) of having money OR the reward for saving

Real IR =

Nominal IR - inflation rate

money market diagram

did you get it?

What is fiscal policy (FP)

When tax revenue and government expenditure are used to influence an economy

the 3 types of public spending

• Capital spending (investing in Capital stock)

• Current spending (ongoing payments)

• Transfers (benefits and other things which the G doesn’t expect back)

Aims of FP

• maintain a low and stable rate of inflation

• a low unemployment rate

• stable environment for long term growth

• promote an equitable distribution of income

What is Expansionary FP

• The G can lower income tax which raises disposable income which raises consumption

• The G can lower corporate taxes which increases profit and increases investment

• the government can raise their own spending which increases AD

(EFP is a trade off between lower unemployment and inflation

expansionary FP diagram

did you get it

aims of contractionary FP

• control economic growth

• curb inflation

• lower a budget deficit

Strengths of FP

• Great at dealing with recessions (Great Depressions and 2008 World Depression)

• Govt expenditure can be used to target certain sectors

• Tax cuts can also be targeted

Constraints of Fiscal policy

• Time lags (Tax cuts have to be changed democratically and once changed it takes a while to see effects)

• Political pressure (the govt won’t raise taxes if they wanted to keep power)

• Too much EFP leads to unsustainable debt

• crowding out - a rise in The G borrowing leads to them monopolising the available funds so the rise in G spending is negated by the fall in investment

What is Government (national) debt

the accumulation of all the budget deficits over the years & [as a % of GDP] , the amount owed to creditors

what are Debt Servicing costs

the amount of money needed to make payments on the principal & interest of a loan in a given time period

what are the costs of running high government debt

• crowding out

• rising debt servicing means the G will cut back in other sectors

• and if they don’t cut back they’ll raises taxes which leads to falling income and output

• Govts with large debts have fewer options when it comes to responding to crises

What is the multiplier effect

an injection of g. spending leads to a larger final increase in national income and GDP. one person's spending becomes another person's income, triggering multiple rounds of subsequent consumption.

how does the multiplier effect work

• G. spending and Business investments are injections into the circular flow

• these injections are then multiplied through the economy

• people receive a share and then spend a part of what they receive

what is the Marginal propensity to consume

the proportion of an extra unit of income that will be spent as opposed to saved

what are the two keynsian multiplier formulae

multiplier = 1/1-mpc or 1/mpw (

what is the MPW

MRT + MPM + MPS

What is a market failure

A situation where the free market equilibrium does not lead to the socially optimal allocation of resources

What is an externality

indirect costs/benefits imposed on uninvolved third parties resulting from an economic transaction or activity

MSC (Marginal social cost)

• The additional cost to society from producing one more unit of a good

• MSC = MPC - MEC

MSB (Marginal social benefit)

• The additional benefit society gains from the consumption of an extra unit of a good

• MSB = MPB - MEB

When MSC = MSB

• there are no externalities

• we have reached maximum community (or society) surplus and so therefore we have reached allocative efficiency

• socially optimal point

When externalities exist in a market

• MSC doesn’t = MSB

• inefficient allocation of resources

• we get a maket failure

What are the 4 types of externality

• Positive Consumption Externalities

• Negative Consumption Externalities

• Positive Production Externalities

• Negative Production Externalities

What are positive externalities of consumption

• Any good/service that, when consumed, benefits both the consumer and also third parties not involved in the transaction

• (For example getting vaccinated benefits you as you won’t get sick but society benefits too as you can’t infect anyone else)

• UNDERconsumed

What are positive externalities of Production

• Any good/service that, when produced, benefits third parties not involved in the transaction

• By going to school and seeking further education, you are becoming a more skilled worker and will greatly benefit future employers

• UNDERproduced

When drawing production externality diagrams

• For -ve PE

  • MSC > MPC

• For +ve PE

  • MSC < MPC

MSB = MPB FOR BOTH (as we assume there are no consumption externalities)

What are negative externalities of Consumption

• Any good or service that, when consumed, negatively affects third parties

• When you choose to smoke, the public is subject to second hand smoking

• OVERconsumed

What are negative externalities of Production

• These occur when the production of a good or service creates external costs that are damaging to third parties. (Usually environmentally damaging)

• Any type of factory has these

• OVERproduced

When drawing Consumption Externality diagrams

• For -ve CE

  • MPB > MSB

• For +ve CE

  • MPB < MSB

MSC = MPC FOR BOTH (as we assume there are no production externalities)

What are demerit goods

• Goods that are harmful to consumers, but people who consume them are either unaware of the possible harm, or ignore the risks

• Consumers have imperfect information about the risks to themselves and to others (demand is higher than it should be)

• all demerit goods create negative externalities

What are merit goods

• Goods that are beneficial to consumers, but are under consumed as people underestimate the potential benefits , or choose to ignore the potential benefits

• Consumers have imperfect information about the benefits to themselves and to others (demand is lower than it should be)

• all merit goods create positive externalities

How do you draw an Externalities diagram

1. Is it Production or Consumption

   1. Consumption diagrams have 2 benefits curves and Production diagrams have 2 cost curves

2. Is it positive or negative

   1. this determines which cost/benefit curve goes above the other one

3. Free Market Equilibrium (MPC = MPB)

4. Allocatively efficient point (MSB = MSC)

5. Welfare gain

   1. The triangle with the tip at the Allocatively efficient point

6. Over/Under Production/Consumption

In the free market

Externalities aren’t considered at all and this is reflected in the prices of goods and services

Marginal Private Cost

• is the same as supply in an externalities diagram

• the additional costs affecting a firm when they seek to produce an extra unit of good or service

Marginal Private Benefit

• is the same as demand in an externalities diagram

• the additional benefits affecting the individual when they seek to consume an extra unit of good or service

External Benefit

The benefit provided to 3rd parties outside the market trade

External Cost

The cost provided to 3rd parties outside the market trade

The price at the socially optimal point

is the value the good has to us after we consider the effect on third parties

Market Equlibrium

when supply meets demand

efficient resource allocation

All that is bought is sold. ALLOCATIVE EFFICIENCY is achieved

Surplus and Shortage

Surplus - Demand < Supply [excess supply]

Shortage - Demand > Supply [excess demand]

How does excess demand [a shortage] self correct

• currently more is being demanded than supplied

• the price of the good rises (firms do this)

• demand contracts and supply extends until they meet and the market clears

How does excess supply [a surplus] self correct

• currently more is being supplied than demanded

• the price of the good falls

• demand extends and supply contracts until they meet and the market clears

what effect do the following shifts have on price and quantity:

• Rightward shift in Demand

• Rightward shift in supply

• leftward shift in supply

• leftward shift in demand

• Price and Quantity rise

• Price falls, quantity rises

• price rises, quantity falls

• price and quantity fall

General chain of reasoning

1. A shift in either supply or demand (for whatever reason)

2. Excess supply or demand

3. price either rises or falls to clear excess

4. new equilibrium is established (it is always in the middle)

What’s another name for the price mechanism

Supply and demand

signalling function of price (there are three total functions)

• the actions of consumers and producers set the price in a market

• the prices reflect changing circumstances

• the prices then tell producers/consumers how to act

Rationing function of price

• resources are scarce

• the price of any good is so that only those willing AND able will have the good rationed out amongst them

(If demand rose and supply decreased only those who were most willing and able could get the good)

incentive function of price

• lower prices incentivise consumers to buy more (utility to price ratio is large)

• high prices incentivise producers to make more (they’ll maximise profit)

(assuming they’re all rational)