IB ECONOMICS SL MACROECONOMIC OBJECTIVES LOW UNEMPLOYMENT, LOW AND STABLE RATE OF INFLATION 10.1 LOW UNEMPLOYMENT • Unemployment - people of working age who are actively looking for a job but are not employed • Underemployment - people of working age with part-time jobs when they would rather work full time • The economy is wasting resources by not using them fully. MEASURING UNEMPLOYMENT • Labor force - number of employed people + number of unemployed people of working age • Excludes: children, retired, people who can’t work, and people who don’t want to work • unemployment rate = (number of unemployed)/(labor force) x 100 • An accurate rate is hard to get because of hidden unemployment. • Unemployment figures: • include unemployed people actively looking for work. It excludes discouraged workers (unemployed workers who have given up job-searching). • don’t distinguish between full-time and part-time employment and counts part-time workers as full-time • doesn’t distinguish on type of work • don’t include people on retraining programs or those who retire early • don’t include people working in the underground/informal economy • The national unemployment does not account for differences that arise due to population groups • region, gender, ethnic groups, age, occupation/skill CONSEQUENCES OF UNEMPLOYMENT • Loss of real output - output produced is less than what the economy is capable of producing • Loss of income for unemployed workers workers worse off financially • Loss of tax revenue - unemployed people have no income, so they don’t pay income taxes • Costs to the gov’t - less tax revenue for other goods/services and social problems will cost tax revenue.
• Unequal distribution of income unemployed become poorer and employed maintain income • Difficulties finding work - unemployed may lose skills and jobs require new skills (hysteresis) • Personal problems - unemployed will be stressed and will result in problems • Greater social problem - high rates of unemployments can cause serious social problems
TYPES OF UNEMPLOYMENT • Structural unemployment - demand changes, location changes, and labor market rigidities • Changes cause demand for new skills; leads to mismatch between supplied/demanded skills • Firms relocate to foreign countries, because the production costs may be cheaper there. • Labor market rigidities - factors preventing supply and demand forces from working in labor market: minimum wage, labor union/wage bargaining, employment protection laws, unemployment benefits • Frictional unemployment - workers between jobs; fired, quit, or wanting a better job • certain amount of frictional unemployment inevitable, due to incomplete information • Seasonal unemployment - demand for labor changes due to seasonal changes • The 3 types of unemployment above are considered inevitable & make up natural unemployment macroeconomic objectives page 1
Cyclical Unemployment • Cyclical unemployment (demand-deficient) • unemployment that arises when the economy produces less than its potential output • occurs during downturns of business cycle (recessionary gap); decrease in AD • AD decrease causes real GDP decrease, and firms lay off workers • Keynesian concept representable in both models • usually involve government policies to increase AD to eliminate recessionary gap. • Potential output (Yp): unemployment = natural rate. Cyclical unemployment = 0. • Recessionary gap (less than Yp): unemployment > natural rate. Cyclical unemployment present. • Inflationary gap (more than Yp): unemployment < natural rate. Cyclical unemployment = 0. • Different parts of unemployment requires different types of government policies.
10.2 Low and stable rate of inflation • Inflation - sustained increase in general price level • Deflation - sustained decrease in general price level • Disinflation - a decrease in the rate of inflation MEASURING INFLATION AND DEFLATION • Price indices are used to measure inflation or deflation. It’s the measure of average price in a base period. • Consumer Price Index (CPI) - measure of cost of living of typical household. A hypothetical basket with lots of goods is created and the value is cost. The same basket has its value calculated for later years. The percentage change shows whether there is inflation/deflation. PROBLEMS WITH CPI • Different inflation rates for different income • Comparability over time (less over longer earners based on consumption patterns periods of time) • Different inflation rates depending on • Some goods have highly volatile prices cultural/regional factors because of wide supply/demand swings. This can cause problems if they are included in • Consumption changes when prices change (substitutes) the CPI. • Consumption changes due to discount stores • Economists measure a core rate of inflation, Consumption changes due to new products. which is usually a CPI without volatile food/ • energy items. • Product quality change International comparisons • PRODUCER PRICE INDEX (PPI) • PPI is several price indices of prices received by producers at different stages. • Measure price level changes from producer point of view. • Can be seen as a predictor for CPI change • % change in real income (purchasing power) = % change in nominal income - rate of inflation If the price level increases, your nominal income increases, but your real (purchasing power) income remains the same. macroeconomic objectives page 2
CONSEQUENCES OF INFLATION • Redistribution effects - inflation redistributes income; some people become better and others worse off • People with have fixed or slow increasing incomes/wages become worse off because of the price level changes • Cash holders are worse off because the purchasing power decreases • Savers of money become worse off because they need to have an interest rate equal to inflation rate • Lenders may be worse off • Borrowers gain because the money borrowed is probably worse off • Payers of fixed or slow increasing incomes have to pay less • Uncertainty - People can’t really predict the future and have to be more cautious • Menu costs - firms have to adjust prices and reprint menus and advertisements and they cost
• Money illusion - people feel better off when their nominal income increase even though they don’t really have extra real income. • International competitiveness - Exports become more expensive if the price level of that country increases and thus there will be more imports than exports.
• Governments prefer a low and stable rate of inflation, not zero rate, because a zero rate is really close to deflation. Ideal rate ~2-3% TYPES/CAUSES OF INFLATION • Demand-pull inflation - inflation caused by increases in AD, which is called by changes in the AD determinants. Involves excess of AD over AS at full employment - and there would be an increase in AD. • Cost-push inflation - inflation caused by production cost increases or supply-side shocks. • Only analyzed in monetarist model and not in the Keynesian model. • Not a recessionary gap because the SRAS curve, not the AD curve moves. • SRAS decrease can cause stagflation. • Deflation is not as common in the world: • Wages don’t fall easily • Price wars may occur • Firms want to avoid menu costs arising from price changes. CONSEQUENCES OF DEFLATION • Redistribution effects with effects opposite of inflation • Uncertainty, menu costs • Risk of deflationary spiral - deflationary spiral is a series of events that make the deflation worse and consumers spend less because they expect the price to fall. • Risk of bankruptcies and crisis - real value of debt increases during a deflation and thus makes it harder for firms or consumers to pay back the debt macroeconomic objectives page 3
CAUSES OF DEFLATION • Usually a decrease in AD leads to a “bad” deflation and an increase in AS leads to a “good” deflation. • Bad because associated with recession. • Good deflation associated with expansion (LRAS shift to right). • Deflation still isn’t good because it discourages spending, and is sometimes a greater threat than inflation.
ECONOMIC GROWTH, EQUITY IN THE DISTRIBUTION OF INCOME 11.1 ECONOMIC GROWTH • Economic growth - increase in real GDP, expressed in % change (per capita) over period of time. • Growth rates can impact a country’s performance. • Reductions in unemployment and increases in productive efficiency can cause growth of actual output (diagram A) • A shift of the PPC means that an economy can produce more of the two goods (diagram B), but does not mean that output increases - only the possibilities. The factors that cause these PPC shifts are: • quantity increase of resources • quality increase of resources • PPCs can also shift inwards. • Capital - resources that can produce future benefits • Physical capital - capital from investments, spending for machines. • Human capital - skills, ability, knowledge, and health of workers. • Natural capital - “land” or “natural resources”; everything under the land, everything on land, and the ecosystem of the country • Land - given by nature and doesn’t change • Natural capital - can be destroyed or improved
Diagram A
Diagram B
• Investment can apply to the three factors of production, and can be done by the private sector or the public sector. Investment is needed to build capital. • Increase in quantity of physical capital - increase in number of machines, tools, etc. in an economy. • Increase in quality of physical capital - technological advances. • A technological advanced incorporated into capital good is embodied into new capital. • Increase in quantity of labor is not always growth. The quality of labor is more important because it increases the productivity of the workers. • Natural capital has two types: commodities and ecological resources • Marketable commodities can contribute to growth but are not essential. Some countries, like Taiwan, have high rates of growth even while producing only a little marketable commodities. • Ecological goods and common access resources are important to long-term growth. Environmental destruction will cause future generations to have an unsustainable economy. • Productivity - quantity of output produced for each hour of work of working population (real GDP/total hours worked). Improvement in productivity increases produced output => growth • In the AD-AS model, rightward LRAS shifts cause economic growth macroeconomic objectives page 4
• In the PPC, outward shifts cause growth relating to increasing possibilities, and the movement of production points is the results of increasing efficiency.
11.2 EQUITY IN THE DISTRIBUTION OF INCOME • Equity - condition of being fair or just • Equality - equal with respect to something • Some think that it is fair to have income equality, but others think that it is more equitable for those who work more to get more income. • Ownership of factors of production is unequal, and the prices vary enormously. Some people in the labor market earn more than others because of special skills. • Results in the distribution of income being unequal because some people have more factors of production than others. THE LORENZ CURVE • A quintile is a 20% portion of a country’s population. Income is distributed by quintiles, and if income were equally distributed, every quintile will receive 20% of the income. • To be more realistic, the poorest quintile receives less than 20% of income, and the richest 20% receives more than 20% of income. • Can also be split into deciles (10%), or quartiles (25%). A • Lorenz curve shows degree of income equality in an economy. • The percentages are cumulative: 40 shows the lower 40%. • The closer the Lorenz curve is to the income equality line, the greater the equality of income distribution. The Gini coefficient is (area between diagonal and Lorenz • curve)/(entire area under 45° line). • It has a value between 0 and 1. Zero means perfect income inequality. The closer the coeff. is to 1, the greater the inequality. POVERTY • Poverty is the inability to satisfy minimal consumption needs. • Absolute poverty is measured with a poverty line (minimum income level needed for a family to sustain sufficiently). • World Bank defined lines: less than $1.25/day (extreme poverty), less than $2/day (moderate poverty). • Taking % of population whose income falls below the poverty line. • Many developing countries also have national poverty line, and those with a higher income will have higher national poverty lines, so a higher percentage of people there will be considered poor. • Relative poverty compares incomes of individuals with the median incomes. Related to equality of income. • Even though people can buy basic necessities, they can’t afford goods/services that are typical in a society. Usually the percentage is 50% of median income.
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• Many factors can cause poverty: • Low incomes - poverty is defined by income falling below a certain level. • Unemployment - even though unemployment benefits are given, they are still lower than work received income. • Low levels of human capital - there’s usually a positive relationship between skill and income levels • Low levels of capital/land ownership some have no resources to rely on, such as a home or stocks that would give them an income advantage. • Poverty comes with several consequences • Low living standards - low income causes low living standards • Lack of access to health care & education - this lowers productivity and income even more • Higher mortality rate - limited health care and poor nutrition can cause many deaths • There are several ways that can promote equity • Transfer payments - payments made by gov’t to individuals just to redistribute income. Vulnerable groups receive the transfer payments and include pensions, benefits, grants, etc. Made possible by gov’t tax collection. • Provision of merit goods - Merit goods would be underconsumed if the market controlled income distribution. Education
• Discrimination - social groups can be discriminated against and receive less pay • Geography - people living in isolated places have limited choices • Age - older people may have pension, but they are usually low. • Limited social services - those with low income rely on social services, but if they are reduced, the people may have to purchase these services. • Poverty - poverty can cause even more poverty • Social problems - crime rates, drugs, homelessness • Inability to realize full potential - people can’t realize their full potential and talent is then wasted. May result in lower economic growth.
and health care are considered fundamental rights. Subsidized to make sure they are affordable. Tax revenue used to ensure provision of good. • Government intervention - minimum wage legislation, food price ceilings, and farmer price floors. • Taxation - allows redistribution to take place by lowering income inequality
TAXES • Direct taxes - taxes paid directly to the government by taxpayer, and the revenue is used to fund many gov’t spending • Personal income taxes - most important source of tax revenue; paid by households on all forms of income • Corporate income taxes - corporations are businesses that have formed a legal body that is separate from its owners. corporate income taxes are taxes on corporation profits • Wealth taxes - property taxes and inheritance taxes • Social insurance contributions (payroll tax) - taxes paid by workers and their employers that are paid into specific funds, like insurance and health care. They are earmarked, because they are spent on a specific purpose. • Indirect taxes - taxes that are paid indirectly through suppliers
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• • • • •
• General expenditure (sales) tax - tax on good/service spending and are a fixed % of retail price. The EU and other countries uses a value added tax and is a tax paid on value added by each producer. • Excise tax - tax paid on specific goods and services • Customs duties (tariffs) - tax applied on imports Proportional taxation - constant tax rate; as income increases, fraction income paid is constant Progressive taxation - increasing tax rate; as income increases, fraction of income paid increases • The more progressive a tax system, the more equal the distribution of income becomes Regressive taxation - decreasing tax rate; as income increases, fraction paid decreases • Makes income distribution less equal Corporate income taxes and social insurance contributions are usually proportional. Indirect taxes are regressive.
EVALUATING EQUITY IN INCOME DISTRIBUTION VS. EFFICIENCY • Taxes affect allocation of resources. • Intended to move economy to more efficient allocation. • Most taxes are not made with the intention of correcting market failure, though. • Can even cause some inefficiency because they change the relative price of goods - and since prices without market failure make the best resource allocation, taxes can cause inefficiency. • A very progressive tax system can cause a higher degree of income distribution, but this will also be as a disincentive work or save. • Sales taxes are usually set on all goods and services, so there is no relative price change and thus no impact. But they are regressive and lead to unequal distribution. • Some necessities excluded from some taxes to make them more affordable, increasing equity, but then relative price has changed. • Some argue that taxes affecting allocation is mainly theoretical, and that in the real world, they aren’t significant enough to reduce growth. • Progressive taxes can make business cycle fluctuations not as serious. • Greater equality can cause more efficient use of resources. • Some argue that transfer payments may have undesirable consequences because they are disincentives for some to accept work. Others argue that it prevents these vulnerable groups that may face poverty. • Transfer payments also lower effects of fluctuations. • There are opportunity costs when the gov’t subsidizes or provides merit goods. • Government intervention conflicts with resource allocation and leads to loss of social surplus and inefficiency.
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