Macroeconomic Aims and Conflicts
Economic Growth
Definition: An increase in the output of an economy and, in the long run, an increase in the economy's productive potential.
Actual Economic Growth: An increase in the output of an economy.
Potential Economic Growth: An increase in an economy's productive capacity, achieved through a rise in the quantity and/or quality of factors of production.
Actual vs. Potential Economic Growth
Production Possibility Curve: A movement from point A to point B on the curve represents actual economic growth (more capital and consumer goods). A shift outwards of the PPC from YY to ZZ represents potential economic growth (the economy is capable of producing more).
Aggregate Demand (AD)
Definition: The total demand for a country's products at a given price level.
Components:
C (Consumption): Spending by households on goods and services.
I (Investment): Spending by the private and public sectors on capital goods.
G (Government Spending): Spending on state-provided goods and services.
X-M (Net Exports): The value of exports minus imports.
Impact of Price Level: A fall in the country's price level causes an extension in aggregate demand due to increased purchasing power and international competitiveness.
Causes of Increase in AD (Rightward Shift of AD Curve): Increase in population, cut in interest rates, lower exchange rate, and greater confidence.
Aggregate Supply (AS)
Definition: The total amount of goods and services that domestic firms are willing and able to sell at a given price level.
Elasticity:
Perfectly elastic when the economy has a significant number of unemployed resources.
More inelastic as the economy approaches full employment, due to competition for resources.
Perfectly inelastic at full employment, as further increase in output is not possible.
Increase in AS (Rightward Shift of AS Curve): Costs of production fall, or the quantity/quality of resources increases.
A rise in AD results in a rise in the country's output and a small rise in the price level.
Changes in AD and AS affect the macroeconomy.
Increase in productive potential that occurs when an economy is operating close to full employment, it can cause a rise in the country's output and a fall in the price level.
Reasons for Governments Aiming for Economic Growth
Improved Living Standards: Producing more goods and services can raise people's living standards through better nutrition, housing, and healthcare.
Achievement of Other Economic Aims:
Increased employment.
Avoidance of upward pressure on the price level.
Improved trade position.
Job creation for the poor and increased tax revenue.
Criteria for Economic Growth
Determinants: Level of output relative to maximum possible output and growth in productive capacity.
Possible Economic Growth Rate: If an economy is growing at 2% below its maximum output and its productive capacity is expected to increase by 3%, its possible growth rate is 5%.
Most governments would like their economies to be working at full capacity.
Low Unemployment
Full Employment: The lowest level of unemployment possible, where those willing and able to work at the going wage rate can find employment.
Economically Inactive: People not in the labor force (e.g., children, retired, homemakers, disabled).
Economically Active: People in work or unemployed but actively seeking work; comprise the labor force.
Unemployment Rate Calculation
Formula:
Example: If 5 million people are unemployed out of a labor force of 40 million, the unemployment rate is:
Reasons for Governments Aiming for Low Unemployment
Avoidance of Waste of Resources:
Those unemployed can suffer disadvantages, including low income.
Government tax revenue may have to be spent supporting the unemployed.
Criteria for Unemployment
Achieving 0% Unemployment: Generally considered impossible due to workers changing jobs and being unemployed for short periods.
Target Rate: Governments aim for a low rate of unemployment, varying by country and economic circumstances; often difficult to get below 3%.
Price Stability
Definition: The price level in the economy is not changing significantly over time.
Reasons for Governments Aiming for Price Stability
Economic Certainty: Ensures greater economic certainty, helping firms, households, and workers plan with confidence.
International Competitiveness: Prevents the country's products from losing international competitiveness.
Criteria for Inflation
Target Inflation Rate: Most governments do not aim for a 0% change in price; some set a target inflation rate (e.g., 2%).
Reasons for Not Aiming for 0% Inflation:
Overstatement of Price Rises: Measures of inflation tend to overstate rises in prices.
Price Improvements: Price rises can hide improvements in products.
Benefits of Slight Price Rise:
Can encourage producers to increase output.
Enables firms to cut wage costs by not raising wages in line with inflation.
Avoiding Fall in Price Level (Deflation): Governments try to avoid a fall in the price level caused by a fall in aggregate demand, as it could result in a decline in output and a rise in unemployment.
Balance of Payments Stability
Definition: A country's record of economic transactions with other countries (revenue from exports and expenditure on imports).
Reasons for Governments Aiming for Balance of Payments Stability
Long-Term Goal: Value of exports should equal the value of imports.
If expenditure on imports exceeds revenue from exports for a long period, the country will be living beyond its means and will get into debt.
If export revenue is greater than import expenditure, the inhabitants of the country will not be enjoying as many products as possible.
Criteria for Balance of Payments Stability
Small Surpluses or Deficits: Governments may not be concerned if there is a small surplus or deficit, especially if short-term.
Import of Raw Materials and Capital Goods: Deficit caused by increased import of raw materials and capital goods may not be a cause for concern, as these products may increase the economy's ability to produce more goods and services.
Fluctuations in Income: Short-term deficits and surpluses may arise from fluctuations in income at home and abroad.
Redistribution of Income
Definition: Governments may seek to redistribute income from the rich to the poor.
Reasons for Governments Seeking to Redistribute Income
Inequality: The more money someone has, the less they tend to appreciate each unit. A rich person with an income of $10000 a week is unlikely to miss $10, but that sum would make a huge difference to someone currently struggling on $20 a week.
Poverty Reduction: Governments try to reduce poverty because of the hardships it causes.
Social Justice: A significant gap between the rich and the poor can cause social unrest.
Methods of Income Redistribution
Taxation:
The rich are taxed more than the poor.
Government Spending:
Money raised is spent directly on the poor through benefits (e.g., housing, unemployment).
Expenditure on education and health particularly benefits the poor.
Criteria for Income Redistribution
Avoiding Disincentives: Governments are unlikely to aim for a perfectly equal distribution of income, as taxing the rich too heavily and providing too generous benefits may act as a disincentive to effort and enterprise.
Possible Conflicts Between Macroeconomic Aims
Full Employment vs. Stable Prices: Low unemployment may conflict with stable prices. Higher aggregate demand may lead to higher prices. Low unemployment is likely to push up wages, resulting in inflation.
Full Employment and Economic Growth vs. Balance of Payments Stability: Higher output may result in higher exports and increase in incomes. Firms may also import more imported raw materials and capital goods.
Priority Policy
Government Decisions: If aims conflict, governments must decide between issues like reducing inflation and reducing unemployment.
Influencing Factors: The relative scale of the problem, its consequences, and citizens' concerns influence the choice.