Macroeconomics

Real work issue #1

Why does economic activity vary over time and why does this matter?

Conceptual understanding:
● Change in the conditions of the demand and supply sides of the economy
cause economic activity to vary over time.
● Fluctuations in economic activity impact the economic well-being of
individuals and societies.
● Different schools of macroeconomic thought identify different causes and
offer different solutions for macroeconomic problems.
Circular flow of income - Closed economy no government intervention
Circular flow of income - with leakages and injections
Macroeconomic objectives
Low inflation
Low unemployment
Economic growth
Sustainable level of government debt
Sustainable balance of payment
Decrease in poverty and inequality
Environmental sustainability
Measuring economic activity
National Income accounting - economy’s national income or value of output

National income/aggregate output - total output produced in and economy

(measured by GDP)

Why do we use these statistics:

- Measure performance over time (what is happening to income and output?)

- Income and output comparisons between countries
- Policy making to achieve macroeconomic objectives
Learning engagement
In groups, choose three Organisation for Economic Co-operation and Development (OECD)
countries. Using the OECD online databank, research data for the countries, over a 5–10 year
period.

● Gross national income (per capita, US dollars/capita)

● Real gross domestic product (GDP) forecast
● Unemployment rate (total % of labour force)
● Inflation (Consumer Price Index) (total/food/energy, annual growth rate %)
● Income inequality (Gini coefficient)
● Central government debt % GDP (HL only)
● Central government deficit % GDP (HL only)
Learning engagement questions
● Which countries have been most successful in achieving their macroeconomic objectives?
● Which individual macroeconomic objective has been achieved most successfully?
● Which individual macroeconomic objective has been achieved least successfully?
● What might explain this?
● What patterns can be observed between the different macroeconomic objectives?
● What might explain these patterns?

Review the OECD Better Life Index and the happy planet index for the selected countries.

Following your research, your group needs to discusses the following questions, based on their findings, and presents to
the class.

● What appears to be the relationship between economic growth and environmental sustainability?

● What appears to be the relationship between economic growth and equity?

● Suggest possible reasons for these relationships.

● In which of the four countries is economic well-being highest? Justify your choice.
How to measure national income/aggregate output
Expenditure method

Income method

Output method
Real work example
The longest economics expansion in US history - Up till 2020, until the global Covid-19 pandemic

began, the US economy was growing and had been growing for more than a decade: for the first time

ever, the economy started and ended a decade (the 2010s) without experiencing a recession. While this

was not the strongest economic expansion, it was the longest and was driven by many factors, including

government spending, tax cuts, and increased consumer spending as well as rising confidence.

Watch THIS video and answer the following questions:

● What factors in the economy contributed to such a long expansion?

● Which components of GDP contributed most to this rise?
● What role did the government play, if any, in this expansion?
Distinction between GDP and GNI
GDP

GNI
Distinction between Nominal and Real values
Nominal values

Real values
GDP/GNI per capita at purchasing power parity (PPP)
Influenced by price levels - lower price levels create greater purchasing power

PPP = Special exchange rates between countries that makes the buying power
of each currency equal to the buying power of $1 and eliminates the
influence of price differences between countries
Calculating nominal GDP and GNI

Calculate the GDP for year 1

Calculate the GNI for year 1

Calculate the GDP for year 2

Calculate the GNI for year 2

GDP deflator
Price deflator - A price index used to convert nominal values into real values e.g.
nominal GDP into real GDP

GDP deflator = nominal GDP

X 100
real GDP

Real GDP = nominal GDP

price deflator X 100
Calculate the real GDP for 2011, 2012 and 2013
Calculate the GDP deflator for 2001,2002,2003
Distinction between total and per capita values
● Different population sizes between countries impacts comparisons in GDP per
capita

● Population growth influences GDP per capita and the standard of living
Activity
Using GDP to measure living standards

Start by watching the following video which explains a little more about how national income is calculated and then complete the
accompanying questions:

Questions

(a) How do economists avoid the difficulties associated

with double counting when measuring the size of an
economy?

(b) What is the difference between GDP and GNP?

(c) To what extent does GDP represent living standards

within a nation?
Learning engagement
The largest economy in the world? The US economy has been the largest economy in the world for more than a century since

the productivity of the country shot up during the Second Industrial Revolution. However, China’s economy is catching up. Its

nominal and real GDP have begun to close the gap between itself and the US over the past three decades. As of 2019, China’s

nominal GDP is roughly two-thirds that of the US. However, as you have just learned, nominal GDP is a relative figure and

sometimes other measures such as PPP can provide us with a better idea of the true extent of an economy’s strength.

In what ways do you think this will change the outlook of the US and Chinese economies? What will this mean for future

development?

For more information, have a look at this blog post published by the World Bank.
Learning engagement continues
To get a better idea of what the future of the largest economies may look like by

GDP PPP, have a look at THIS video and consider the following questions:

● What is driving economies like Indonesia and Egypt to make such large leaps in
the relative GDP PPP rankings?
● How is the measure of GDP PPP more meaningful than nominal GDP when
comparing different countries’ economies?
Business cycle
Watch THIS introductory video from Kognity
Shows short term fluctuations in real GDP consisting of alternative fluctuations of
expansions and contractions.
(Phases should be discussed i.t.o employment of resources and inflation)
Peak
Contraction (Recession)
Trough
Expansion
Long term growth trend and potential output
Long term growth trend - the line that runs through the business cycle,
representing average growth rates over a longer period of time. It shows how
output grows over time when fluctuations are ironed out

Potential
output/Potential GDP =
the level of real GDP
when there is ‘full
employment’ meaning
unemployment = natural
rate of unemployment
Unemployment - actual and potential growth
Contraction - unemployment increases

Expansion - unemployment decreases

Meaning of full employment

Natural rate of unemployment - occurs when a country is producing at its potential

or full employment and is equal to the sum of structural + frictional + seasonal
unemployment

Full employment when unemployment = natural rate of unemployment

Full employment and the natural rate of unemployment
Why do we study the business cycle

To reduce intensity of the fluctuations

Why national income statistics do not accurately measure the true
value of output
GDP and GNI do not include:

● Non- marketed output

● Output sold in underground/parallel markets
● Quality improvements in goods and services
● Negative externalities
● Depletion of natural resources
● Differing domestic price levels
Why national income statistics do not accurately measure the true value of
economic well-being.

How is the following link to the concept of economic well-being:

● GDP/GNI make no distinction about the composition output (what does a

country produce)
● Does not reflect achievements in level of education, health and life
expectancy
● No information on the distribution of income and output
● Does not take into account increased leisure
● Does not take into account quality of life
Comparison over time and between countries
Over time - Use real GDP but statistics can over/underestimate the true value
because of the factors not included in the calculation of output and economic
well-being

Between countries - The exclusion of many factors limits the validity of

international comparison e.g not showing distribution of income etc
Learning engagement
Real-world issue: Why does economic activity vary over time and why does this matter?

Inquiry statement: How the government of a chosen country has responded to business cycle fluctuations

Key concepts: Change and economic well-being

Consider these inquire questions when watching the videos on the next slides:
● Do economies go through changes? Explain
● What changes has Venezuela gone through recently?
● What has caused these changes in Venezuela?

TOK question - impact of political ideologies, have a brief discussion about Venezuela’s political ideology.
Video for learning engagement on previous slide

Venezuela Crisis Explained

Why Is Venezuela In Crisis?

Alternative measures of well-being: OECD Better life index
Alternative measures of well-being: OECD Better life index
2 group of factors that determine well-being in the present:

OECD framework for

measuring well-being and
progress
Alternative measures of well-being: OECD Better life index
Both quality of life and material conditions depends on 4 types of capital:

Natural capital - environmental resources

Human capital - education, skills and health

Economic capital - money and wealth

Social capital - network of people with shared values and understanding

Happiest countries
Alternative measures of well-being: OECD Better life index
Criticism:
Needs to include equity in the index
Difficulties in measuring the some of the dimensions which makes it difficult to
compare countries

Look at this
http://www.oecdbetterlifeindex.org/responses/
Happiness Index

Based on 6 dimensions:
● Real GDP per capita
● Social support
● Healthy life expectancy
● Freedom to make life choices
● Generosity
● Perception of corruption
Check this out
https://countryeconomy.com/demography/world-happiness-index
Happy Planet Index
Happy Planet Index
Measures sustainable well-being

Happy Planet Index = Life expectancy x well-being x inequality of outcomes

Ecological footprint

Life expectancy - average number of years a pearson is expected to live based on UN data
Well-being - populations satisfaction measured by the Gallup World Poll
Inequality of outcomes - inequalities between people’s life expectancy and well-being. Life
expectancy and well-being are adjusted downwards to take inequalities into consideration
Ecological footprint - impact on the environment of each individual in society on average. What land
is required and what land needs to absorb CO2 emissions. The higher the ecological footprint the
lower the HPI
Green GDP
Green GDP = GDP minus environmental costs of production
Aggregate demand (Home learning)
Why Aggregate demand is downward sloping
1. Spending power. Example - At a lower price level, consumers are likely to have higher
disposable income and therefore spend more. (Note this assumes that wages are
constant and not falling with prices)
2. International competitiveness. Example - If there is a lower price level in the UK, UK
goods will become relatively more competitive, leading to higher exports. Exports are a
component of AD, and therefore AD will be higher.
3. Interest rates. Example - At a lower price level, interest rates usually fall, and this
causes higher aggregate demand as people will borrow less so their is less demand for
borrowed money
Determinants of AD components
On a sticky note which of the following determinantes impacts Consumption, Investment, Government spending, Net
exports (X-M)

wealth business political and

confidence economic
priorities

income of trading technology trade policies consumer

partners confidence

level of corporate interest rates level of income taxes

indebtedness household
●
indebtedness,

expectations of exchange rates business taxes

future price level

●
Aggregate demand (Learning engagement)
Make a copy of THIS document and add it to your Macroeconomic folder
Aggregate supply
Short run Aggregate Supply - relationship between price and quantity of real output
produced by firms when resource prices do not change

SR in macroeconomics = when prices of resources are constant or inflexible (especially wages)

LR in macroeconomic = when prices of all resources are flexible (even wages)

Why wages? Wages are a large parts of a firm's cost of production and do not easily change over the sort
run as:

- People have fixed working contracts

- Decrease in wages influences workers morale
- Labour unions exists and put pressure on firms
- Governments implement NMW
SRAS slope and changes
Direct/positive relationship between prices and real output
When prices increase output prices increase if (input prices i.e resource prices) remain constant
the profit rises.

Changes in the SRAS

Changes in the cost of production as well as supply shocks

Home learning - complete p280 9.3

LRAS monetarist/ new classical view
Classical perspectives is based on the following principles:

- The importance of the price mechanism

- The concept of competitive market equilibrium
- The view that the economy is a harmonious system that automatically moves
to full employment
LRAS monetarist/ classical view
Reasons for the LRAS being vertical

As SR prices increase firms increase output (resource costs remain constant) and
so more profits are being made - then over the LR when wage prices/ resource
prices changes are matched by the SR price increases, there is no incentive for a
firm to change productions as they are in the same place
LRAS monetarist/ classical view
I.t.o. SR curve

Deflationary gap (recessionary gap)

Inflationary gap

Full employment
Shifts in AD and SRAS caused by the business cycle
Shifts in AD causing inflationary and deflationary (recessonary) gap

Shifts in SRAS causing higher levels of GDP(output) and stagflation (when there is
a recession with high levels of inflation - SRAS shifting to the left)
Automatic adjustments - why can inflationary and
deflationary gaps not persist in the long run?
Deflationary gap causes PL to fall - when PL falls it is matched by a fall in wage prices and a fall in
resource prices causing SRAS to shift to the right and back to full employment. Think about the
demand and supply of labour having downward pressure on wages - ADL<ASL (unemployment >
natural rate of unemployment)

Inflationary gap causes PL to increase - when PL increases it is matched by an increase in wage

prices and a increase in resource prices causing SRAS to shift to the left and back to full
employment. Think about the demand and supply of labour having upwards pressure on wages
ADL >ASL (unemployment < natural rate of unemployment)
Inquiry questions
Page 294 on the Economics resource:
Keynesian LRAS
3 sections

1. Spare capacity - resources are unemployed, increase output without the risk
of increase prices
2. GDP increases with increase in price levels - output increases with increase
employment in resources a bottleneck in recourse supplies begins as there is
no longer spare capacity in the economy. Costs of production begin to
increase - unemployment = natural rate of unemployment
3. AS becomes vertical where real GDP cannot increase anymore and prices
start to increase rapidly
Keynesian LRAS - Getting stuck
Price and wages are downward inflexible:

Keynes - With increase AD there is an inflationary gap and wages start to increase

When AD decreases and there is a recessionary gap wages do not fall even over
a long period of time because of labour contracts, trade unions, minimum wages
and workers morale.

Other product prices will also not fall as firm will not lower prices and reduce their
profits. Oligopolists will not lower prices as fear of price war.

Thus - Prices are unlikely to fall even during a recession

Inability of the economy to move into the long run
Keynesian model
Recessionary gap (deflationary gap)

Inflationary gap

Full employment

Keynes model conclusion:

- An economy can remain stuck in a deflationary gap

- Increase in AD may not always increase price levels
Shifts in aggregate supply
Increase in potential output shows economic growth over the long run
A decrease in potential growth shows negative growth or a fall in real output
Factors that change AS over the long run:
● Increase in quantities in the f.o.p
● Increase in the quality of the f.o.p
● Improvements in technology
● Increase in efficiency
● Institutional changes e.g. privatization
● Reduction in the natural rate of unemployment
Keynes and monetarist/new classical models
Automatic self correction vs persistent deflationary gap
Monetarists/ New classical - automatically corrects deflationary and inflationary
gaps

Keynes - deflationary gap can remain for long periods of time with an equilibrium
less than full employment due to low levels of aggregate demand
Aggregate demand need not cause increases in price levels

Monetarist/new classical - increase in AD will always lead to higher price levels

Keynes - If on the horizontal part of the LRAS increase in AD does not mean
increase in price levels.
Assumptions and implications of the models (Kognity)
Learning engagement
Read the Theory of knowledge section on p 294 and choose one of the Thinking
points to discuss

Looking at one of the countries you have already investigated:

- When did the country experience a recession?

- What caused the recession?
John Maynard Keynes
Unemployment
Look at the unemployment data of two of the countries you have already
investigated. The data you should explore should be the following:
● unemployment rate
● unemployment by age
● unemployment by gender
● unemployment by educational attainment
● long-term unemployment.

What do you See, Think, Wonder?

Your inquiry question:
Now develop your own inquiry question that you will address throughout your
learning of the topic ‘unemployment’

All inquiry questions should now be added to a single piece of butcher paper
Low unemployment
Unemployment - people of working age who are actively looking for a job but who
are not employed

Underemployment - people of working age who have part-time jobs but would
rather want full-time jobs, jobs that don’t use peoples full skill set.

(Resources are being wasted)

Calculating unemployment
Labour force - people who are of working age who are employed plus people of
working age who are unemployed (seeking work)

Unemployment as a number - all people of working age who are actively seeking
work but who are unemployed
Percentage of unemployed people is the unemployment rate
Unemployment rate = number of unemployed
Labour force X 100
Watch the video then answer the questions on the next slide
Learning engagement
After watching the video on the previous slide answer the following questions:
(a) Explain which of the following people would be included in the nation's unemployment rate:
● a housewife who wishes to work but not currently employed
● a part time worker seeking full time employment
● a student at college looking for a part-time job to supplement their studies
● a worker of 55 - 60 who voluntary retires.

(b) Why does the above make it difficult for nations to accurately calculate unemployment and
why is it also sometimes difficult to compare unemployment rates between different nations?
Watch the video then answer the following question:

Why is the official rate of unemployment lower than the number of people
unemployed?
Difficulties in measuring unemployment
Statistics of then underestimate because of hidden unemployment:
● Excludes - discouraged workers who stop seeking work as they cannot find a
job
● No distinction made between part-time and full-time jobs. It is all seen as
full-time - so people may be underemployed.
● No distinction on the type of work - highly trained people doing low skilled
jobs.
● Excludes - people on retraining jobs who previously lost their jobs and people
who retire early although they would rather work
● Does not include people working in the underground economy
Difficulties in measuring unemployment (continue)
Disadvantage of national unemployment rate calculated for the whole nation, does
not take into account unemployment that is caused within different population
groups:
Religion
Gender
Ethnic groups
Age
Occupation and educational attainment
Costs of unemployment
Economic costs:
- Decrease output
- Tax revenue
- Government spending - benefit and social costs
- Unequal distribution of income
- Large budget deficit or smaller surplus

Personal and social costs

- Personal problems
- Social problems
Types/causes of unemployment
Structural unemployment - changes in demand for a particular type of skills due to:
- Technology
- Changes in the structure of an economy - increased manufacturing sector
when workers have low skills. (Manufacturing sector becomes bigger than the
agriculture sector)
Changes in geographical locations - when firms move from one place to another
and workers are unable to move
(Structural unemployment is a mismatch between labour demand and labour
supply)
Diagram showing structural unemployment - mismatch
between labour demand and supply

Decrease in demand for labour because of

- Decrease in demand for a particular skill (technology)

- Changes in geographical location

Over short run there would be excess supply of labour as wages wouldn’t decrease
Diagram showing structural unemployment - labour market
rigidities
Factors that prevent the forces of Demand and supply working:

E.g.

- minimum wages
- Labour unions negotiating higher wages
- Employment protection laws
- Generous unemployment benefits

Shifts wage rate above the equilibrium and increases the cost of production
Frictional unemployment
When workers are between jobs
Seasonal unemployment
When demand for labour changes on a seasonal basis depending on the needs of
firms.

THUS

Full employment:

Unemployment = natural rate of unemployment (sum of structural, seasonal and

frictional unemployment)
Cyclical unemployment/demand deficient unemployment
= decrease in AD due to downturns in the business cycle

Draw this in a graph

Showing 4 types of unemployment on Monetarists graph
Recessionary gap - unemployment > NRU, cyclical unemployment exists as well as structural,
frictional and seasonal unemployment.

Full employment - potential output - Unemployment = sum of structural, seasonal and frictional
unemployment. Zero cyclical unemployment

Inflationary gap - unemployment < NRU as structural, seasonal and frictional unemployed will
find temporary unemployment
Now let's go back to your inquiry question
Discussion on the inquiry question
Creative questions starts
1. Brainstorm at least 5 questions about the topic INFLATION

2. Review your list, identify the most interesting question and write it on the
board/butcher paper
Inflation
Inflation is a sustained increase in the general or average level of prices.
Deflation is a sustained decrease in the average level of prices (general price level) in an
economy.
Disinflation - when the rate of inflation falls, this is not the same as deflation as prices are
still rising but at a slower rate than before.
Demand pull inflation - the result of when rises in AD are greater than the countries ability
to produce those goods and services.
Cost push inflation - the result of a rise in production costs.
Measuring inflation
Measuring inflation
Consumer Price index (CPI) - measures the cost of living/ cost of goods and services purchased
by a typical household in an economy and compares the value of the basket of goods and
services in one year with the value of the same basket in the base year.

Inflation is measured as a percentage change in the value of the basket from one year to
another. A positive percentage change indicates inflation a negative percentage change indicated
deflation.

We use a ‘basket’ if goods and services this contains thousands of goods and services
consumed by a typical household

Price index = is a measure of average price in one period relative to average prices in a
referenced period called the base year.
Constructing a weighted price index (HL)
A weighted price index is an index that ‘weights’ the various goods and services
according to their relative importance in consumer spending.
How to calculate the weighted price index
Step 1

Calculate the cost of buying the basket of the quantity of each good purchased by its goods in each year. This is done by multiplying
price and then adding up the totals:

Step 2

Calculate the weighted price index by dividing the cost of the basket of goods for each year by the cost of the basket in the base year
and multiplying by 100.
Calculating inflation from the weighted price index (SL&HL)

The inflation rate is the percentage change in the average price level from one
year to the next.

In equation form, it is:

Home learning
Home learning
Calculating real income
We can use the GDP deflator as well as the CPI to calculate real income

Real income = Nominal income

X 100
CPI
Important:

You cannot compare price levels across years by using price indices with a
different base year even if the basket of goods and services are the same
Problems with the consumer price index
● Different rates of inflation for different income earners - people have different
‘baskets’ depending on their income levels. Spending patterns will be different
● Different rates of inflation depending on regional and cultural factors -
purchase different goods depending on tastes due to cultural and regional
factors
● Changes in consumer patterns due to consumer substitution when prices
change - consumer may change spending depending on increases in prices
and now purchasing substitutes. The result is changing weights but because
weights in the basket are fixed the changes cannot be accounted for in the
CPI
Problems with the consumer price index
● Changes in consumer patterns due to discount stores and sales - buying
goods and services at lower price than those in the CPI calculations
● Changes in consumer patterns due to introduction of new products
● Changes in product quality
● International comparison - the calculation differs from each country as the
basket includes different goods and services. EU has the HICP to be
consistent across the EU.
● Comparability over time - countries change base year roughly every 10 years
however some baskets can change every year
Core rate of inflation
Food and energy prices fluctuate significantly and thus would give a misleading
impression of the CPI this is why we use the core rate of inflation as we
eliminate the volatile price of food and energy.
Causes of inflation
Causes of inflation
Demand - pull inflation - excess AD over AS at the full employment level of output.
This is caused by an increase in AD

Cost - push inflation - Fall in SRAS resulting from an increase in wages or other
costs of production.

Draw the diagrams

Cost of a high rate of inflation (real, nominal, purchasing power)

Purchasing power is the quantity of goods and services that can be bought with a
given amount of money

When prices increase purchasing power and real income decreases

When prices decrease purchasing power and real income increases

%change in real income (purchasing power) = % change in nominal income minus

% change in price levels (or inflation)
Cost of inflation
1. Redistribution effects:
- People on fixed incomes
- Wages that increase less rapidly than inflation
- Holders of cash
- Savers
- Lenders
2. Uncertainty
3. Impact on savers
4. Impact on international competitiveness
5. Effects on economic growth - low I, high M, AD shifts to the left
6. Impact on resource allocation
7. Social and personal costs are unequally distributed - assets lose value, necessities become
expensive
Costs of inflation
Hyperinflation and Deflation
Learning engagement:

https://docs.google.com/document/d/1o0hIxNP4HyS0vomv44zZz6lgL38V0VQO1V
PgMNIsH2E/edit?usp=sharing
Watch the following short video, which describes the
hyperinflation of the Robert Mugabe era
The following short video features an extract from a news service on the difficulties of life for the middle
classes in an inflation hit nation.
Consequences of hyperinflation

Hyperinflation - when there is a very high rate of inflation. When price levels
increase by more than 50% per month
The cause is because of an increase in the supply of money, like printing money
Thus:
● Money loses its value rapidly
● Consumers increase spending as they want to benefit from lower prices
before they get too high, this causes prices to increase even more
● Workers demand higher wages - causing cost-push inflation
(This all will cause an inflationary spiral)
Consequences of hyperinflation
Business stop investing in productive activities and invest in assets that have a
higher value
Firms withhold goods so they can sell them later t a higher price
Money loses its value
People resort to bartering
Appropriate rate of inflation - low and stable. Many governments say an inflation
rate between 2%-3%. Below 2% too low (deflation) higher than 3% too high
Use the following video to explain why deflation may be as significant a threat to
an economy?
Deflation
Prices of goods rarely fall

- Wages rarely fall

- Large oligopolies may fear a price war

Causes of deflation:

Decrease in AD over a long time period (bad deflation) e.g. recession, depression

Increase in SRAS (good deflation) as connected to economic expansion

Cost of deflation
1. Redistribution effects - fixed incomes gain but borrowers and payes of fixed
incomes lose
2. Increase in real value of debt
3. Uncertainty
4. Deferred consumption - consumers postpone consumption as they expect
prices to fall further. It discourages spending and AD falls further
5. Risk of bankruptcies and a financial crises
6. Inefficient resource allocation
7. Policy ineffectiveness - expansionary policies may be ineffective due to a lack
of response by consumers and firms
Positive of deflation
Increased international competitiveness
Creative questions starts
3. Reflect: What new ideas do you have about the topic, concept, artwork, or
object that you didn’t have before?
Relationship between unemployment and Inflation
Arthur Okun - ‘misery index’ is the sum of unemployment and inflation rate of a
country - the higher the index the greater the misery of the population

The index does not distinguish between the separate effects of each of these on
the well-being of society.

Other studies found that unemployment and inflation separately cause

unhappiness. However unemployment causes much more unhappiness than
inflation. Not only causing unhappiness to the person unemployed but also the
people around them
Conflict between unemployment and inflation
Using the Keynesian LRAS:

When there is an deflationary gap there is cyclical unemployment. As AD

increases and unemployment decreases so price levels start to increase.

More resources are employed creating a bottleneck that results in higher wages
and other resource prices.
Phillips curve
Breakdown in the theory
Phillips curve theory heavily influenced by Keynes.

In the 1970s and 1980s, there was a period of stagflation as OPCEC reduces
supply of oil which caused SRAS to decrease.
SR and LR Phillips curve
Long run Phillips curve
Milton Friedman challenged the relationship between inflation and unemployment -
he states that there is a trade off but only in the short run. In the LR there is not a
negative relationship but the LRPC then is vertical at the level of full employment
(NRU=unemployment)

See graphs on the next slide - Read p325-327

Long run Phillips curve
Today
Phillips curve broke down during financial crisis of 2008

Other reasons for the breakdown:

- Global competition makes it difficult for firms to raise prices as unemployment

falls
- Wages have not been rising in MEDC
Economic growth
https://drive.google.com/file/d/1uEgWl7Agd-I3o3E-cGZ4RWQw3x15s5P4/view?us
p=share_link
Economic growth
= increase in real GDP

Real GDP = the total output produced in an economy

Real GDP per capita = total output per person

Economic growth and case studies

Calculating economic growth
Real GDP and Real GDP per capita
If real GDP is growing at a faster rate than the population then real GDP will also
increase

If the population is growing faster than the real GDP then real GDP per capita will
be decreasing
Growth of real GDP

2016 GDP Annual Growth Rate 2021 GDP

$1000 9.40% $1567

$1000 0.15% $1008

$1000 -4.81% $782

Short term vs Long term Economics growth
SR economic growth = Actual growth
Show this on a Keynesian and Monetarist/New classical diagram (Increase AD)
Short term growth can also happen with increase in SRAS (Monetarist/New
classical diagram only)

Short term growth more frequently happens with a shift in AD rather than a shift in
SRAS
Short term vs Long term Economics growth
Long term growth = potential growth (corresponds to the long term growth trend in
the business cycle)

Show this on a Keynesian and Monetarist/New classical diagram (increase in

LRAS)

Long run growth

Short term vs Long term Economics growth using PPF/PPC
You can show actual and potential economic growth on the PPC/PPF diagram. (note in
the real world a country cannot produce on the their PPF - as it’s unlikely that ALL
resources are fully employed)

Note that a country can get stuck on a point inside the PPF while the PPF still shifts to
the right:
Examples
- labour force increases but workers remain unemployed
- discovery of natural resources but these resources remain unexploited or their
exploration is undertaken inefficiently
Short term vs Long term Economics growth
Why does economic growth occur?
(Make sure you know what the following are: Physical Capital, Human Capital and
Natural Capital)

Physical capital, technology and growth - quantity of physical capital =

increase in number of tools/machinery/equipment. Quality of physical capital
depends on technological advancements in the capital good. Use of capital goods
embodying new technologies leads to a larger quantity of output
Why does economic growth occur?
Human resources, human capital and economic growth - quantity of labour
e.g immigration/influx of foreign workers can be a source of growth unless high
levels of unemployment already exist in the country, in this case it will not
contribute to economic growth.

Quality of labour = education, vocational training, building schools. Spending on

providing medical services.

This will lead to long run economic growth

Why does economic growth occur?
Natural resources, natural capital and economic growth

2 kinds of natural capital: 1. Marketable commodities 2. Ecological resources

1. Marketable commodities - commodities that are bought and sold e.g. oil, gas,
metals, minerals

Can contribute to growth but are not essential some countries do not have
marketable commodities but have succeeded to attain high levels of GDP per
capita
Why does economic growth occur?
2. The role of common pool resources are necessary for long term growth and
depends on country ability to maintain and improve environmental quality thus natural
capital.
Environmental destruction can have negative impacts on output and growth as workers
lose jobs, get sick etc.

It is important for present investment into natural capital and environmental preservation
to ensure economic growth in the future
Productivity and economic growth
Definition of productivity
Increase in quantity and quality of the f.o.p increase productivity
Productivity = Real GDP
Total number of hours worked
Factors increasing productivity:
Increase in quantity and quality of physical capital, technology and growth
Improvements in quantity and quality through investment in human capital
Improvements in quantity and quality of ecological resources
Consequences of economic growth
1. Impact on the standard of living. Factors that allow economic growth to have a positive
impact on standard of living.
a) Distribution of income
b) Household spending
c) Share of income controlled by woman
d) Government spending on education
e) Contributions by NGO’s
Consequences of economic growth
2. Impact of economic growth on the environment
Leads to unsustainable use of resources (environmental losses) due to increased
consumer incomes and spending
Some economists believe that resources allocation for environmental protection
leads to a smaller increase in output and lower economic growth however some
environmental damage is irreversible and we will not be able to correct this in the
future
Government needs to implement policies aiming to limit environmental
externalities
Unsustainability will limit economic growth in the future
Impact of economic growth on the environment (continues)

Growth and sustainability can be achieved together under the following conditions:

Implement market-based policies to internalize negative externalities

More environmental regulations

Increase human capital in production instead of physical capital

Emphasis on green investment and R&D into green technologies

Changes in the structure of an economy towards more service and more protection for natural resources

However:

Modern theories show that there is a maximum rate of growth that is consistent with environmental sustainability - if
an economy exceeds the rate then resource use will become unsustainable - e.g. spending on regulations has an
opportunity cost
Recap on what a circular economy is
Watch THIS video and answer the questions below:
Based on what is said in this video, reflect and answer the following questions.

1. According to the video, in what sense does nature have a circular cycle?
2. Why can’t the linear approach work in the long term?
3. Explain two ways mentioned in the video by which we could reduce the amount of
waste and create capital.
4. How can this ‘re-thinking’ you mentioned in question 3 help the economy to resemble
the biological cycle?
Impact of Economic growth on income distribution.
● No relationship between GDP per capita and income distribution
● Latin America has highly unequal income distribution
● Inequalities have widen over the past three decades
● Income inequalities due market-based supply-side policies - lack of government protection of
the vulnerable. in developing countries
● Inequalities have increased due to economic and trade liberalization.
● People become worse off because of less educated and skilled workers geographical location
thus cannot export loss or jobs because of privatization or reduction in size of government
sector.
● Inequalities in developing countries because of inappropriate government policies such as: -
- capital-intensive production in agriculture
- low levels of investment and government in human capital affects the poor more than the rich
- investment in infrastructure in urban areas instead of rural areas
- Investments in formal high paid jobs sectors instead of urban slums
Economic growth + inquiry case studies
Conflicts between macroeconomics objectives
Macroeconomic objectives:

Low/Stable inflation

Low unemployment

Economic growth

Balance of payment

Equity in income distribution

Environmental sustainability
Economics of inequality and poverty
Equity = fairness

Equality = people are given the same resources and opportunity

Both used to explain the distribution of income and wealth

Income = money received

Wealth = stock of assets

Equity is interpreted as great equality (or less inequality)

Case study South Africa

Economic inequality
Economic inequality = the degree that people in a population differ in their ability to satisfy their economic
needs

Sources of economic inequality

● income and wealth
● education
● health
● nutrition
● gender
Focuses is mainly on differences in income and wealth

Unequal distribution of income = Income inequality arises from differences and how evenly income is
distributed. income includes wages salaries interest from savings dividends rent tension.

Unequal distribution of wealth = wealth inequality arises from differences and the amount of wealth
people own For example houses land.
Measurement of Economic inequality
Measured in quintiles

Quintile = 20% proportion of a country’s population

Population can be divided in five quintiles where lowest 20% poorest and the upper 20% the rich

The poorest quintile of the population receives less than 20% of income the richest quintile more
than 20% of the income

If income were distributed evenly each quintile would receive 20% of income

Income stats can also be in deciles (10%) or quartiles (25%)

Lorenz Curve
= shows income inequality in an economy. Plots the actual relationship between
percentage of the population and the shares of income they receive.
To draw the Lorenz curve
- Draw a box
- Vertical axis = Cumulative percentage of income (total amount of income in
an economy in cumulative percentages, 0%-100%)
- Horizontal axis = Cumulative percentage of population (total population an
economy in cumulative percentages, 0%-100%)
- Line of perfect equality means that 20% of population receives 20% of income
etc.
- The further the curve is away from the line of equality the more unequal the
distribution is
Constructing the Lorenz curve from data (HL)
Add income quintile data;

Poorest 20% what do they get?

The 40% of population add first and second quintile

The 60% of populations add first, second and third quintile

Gini Coefficient (HL)
Gini coefficient = area between diagonal and lorenz curve
Entire are under the diagonal line
Gini coefficient = A/A+B
Will have a value between 0 and 1
0 = perfect income inequality
Values can be expressed as either decimals (0 to 1) or percentages (0 to 100)
Gini coefficient = a summary measure of income inequality
A lorenz curve closer to the diagonal line will have a gini coefficient closer to 0
Wealth inequality
3 methods can also be used to measure wealth inequality:

- Quintiles

- Lorenz curve

- Gini coefficient

Distribution of wealth is far more unequal than income distribution

Reasons for greater wealth inequality:

- limited growth in wages making it difficult to save (low and middle income group)

- HIgh income earners have the ability to save thus acquire wealth

- HIgher income leads to higher wealth and higher health leads to greater income & wealth & income
etc.
Economic inequality and poverty
Complete this task

https://docs.google.com/document/d/1hIOJhjwwjpKk4-cfKOoEvP5oJ4ighkSGu2scI
C0aLLM/edit
Policies to reduce income and wealth inequalities and
poverty
Taxation is part of the fiscal policy of the government, together with government spending,
and is a way to redistribute income in society in a more equal way.

Tax is government revenue which is spent on public goods, transfer payments, subsidies,
merit goods etc

Direct Tax = taxes paid to the government tax authorities by the taxpayer(Personal,tax,
corporate tax and wealth tax {property taxes & inheritance taxes} also social security
contributions/payroll taxes

Indirect taxes = tax on goods and services (sales tax, excise tax, custom duties/tariff)
Taxes:
Tax rates = fraction of income paid as tax in percentage terms

Taxes can be:

Proportional - as income increases tax rates remain constant
Progressive - as income increases the tax rate increases
Regressive - as income increases the tax rate decreases
Progressive tax achieves more equal income distribution by shrinking the difference
between high income and low income income distribution
All these types of taxes apply to direct and indirect tax
Indirect tax and regressive
Explain using an example:
Evaluating tax as a policy
Disincentive to work

Reduces savings thus affects investments

Corporate tax - lowers investment - lowers production

Impact of lower taxes

Case study taxes - Sweden
Case study taxes - How Sweden balances high taxes and growth
Other policies to reduce income and wealth inequalities
Investment in human capital - difference between high income and low income education
- does influence health are as well
Transfer payments - grants etc, people need to qualify
Targeted government spending - merit goods - including infrastructure
Universal basic income - money resident of a country would receive regardless of the
amount on income they already receive - example technology as lack of this would lead
to joblessness - e.g. students, young couples starting a family (even the rich would get it)
Policies to reduce discrimination
Minimum wage and price controls
Case-study - Obamacare
How government spending on healthcare can reduce the level of poverty in the US
Calculating direct and indirect tax (HL)
Calculate the total tax paid

Calculate the average tax rate on income

Calculate indirect tax and amount spent on indirect tax

The role of spending and taxation on inequality (Videos)
The impact of taxation on income inequality in the USA
The role of spending and taxation on inequality (Videos)
Laffer curve
The role of spending and taxation on inequality (Videos)
So is progressive taxation fairer?
Sustainable levels of government debt (HL only)
Government debt = national debt = public debt is money that government owes to lenders outside of the government.

What does governments spend their money on????

when expenditure is greater than revenue = budget deficit.

when revenue is greater than expenditure = budget surplus
when revenue is equals to expenditure = balanced budget.

Deficits minus Surplus = government debt (when there is a budget deficit debt will become larger with a surplus debt will become
smaller)

Sustainable debt = a level of debt with government has enough revenue to meet its debt obligations (this includes interest on borrowed
money)

Governments borrowing = bonds, attractive due to interest. Can borrow from within or the country, or outside (internal and external
sources
Measurement of debt as share of GDP
Debt is a share of GDP = debt-to-GDP ratio

Think back of the financial crisis in 2008

Macroeconomic policy
1. Demand-side policies/demand management policies

Definition

Aim to eliminate short term fluctuations in the business cycle

2 policies - also known as stabilization policies:

Monetary and Fiscal policy (aim is to reduce short run fluctuations)

2. Supply side policies

Definition (quality and quantity of the fop as well as institutional changes to improve the

productive capacity

2 categories of supply side policies

Market - based supply side policies - working of demand and supply

Intervention supply side policies - government intervention

Monetary policy
https://drive.google.com/file/d/1ykAqURpv-8mbYooG6l6HlEANsis8TZoL/view?usp
=sharing (study notes)
Purpose of central banks
(a) The maintenance of which key macroeconomic
objective does the video include in its list of roles?

(b) Why might governments give central banks the task

of maintaining inflation, rather than other
macroeconomic objectives e.g. low unemployment.
Role of central banks
https://www.investopedia.com/articles/03/050703.asp

= an financial institution regulating a country’s financial system

Carries out monetary policy - control of supply of money and interest rates

Banker to the government

Banker to commercial banks (holds deposits and lends money)

Regulator of commercial banks

Are independent central banks under threat
Goals of monetary policy (do not discuss these points using
interest rates or money supply as it is talking about the goals)

Low and stable inflation

Low unemployment - cyclical unemployment

Reduce fluctuations in the business cycle

Promote stable economic environment for long term growth

External balances (influences ER to maintain a good levels of X and M)

Inflation targeting - Monetary policy
Usually 2% but say between 1.5%-2.5%
It is set i.t.o. This consumer price index and based on predictions of future inflation based on CPI.
Advantages
Low rate of inflation
Ability to plan economic activity
Government can plan its spending and taxes if it has knowledge of the inflation target
DIsadvantages
Reduces ability of central bank to pursue other macroeconomic objectives. (Think about the phillips
curve)
Reduces ability of central bank to respond to supply shocks (stagflation)
If inflation too high has significant impact on purchasing power. If inflation too low may lead to higher
unemployment
When expansionary monetary policy goes wrong
Warren Buffett's view of the 2008 financial crisis
Case Study - Australia
https://www.theguardian.com/australia-news/2022/may/05/laden-with-world-beatin
g-debt-australian-households-are-at-increased-risk-as-rates-rise-expert-says
Determination of the rate of interest (HL)
= cost of borrowing
Factors determining different interest rates
- risk of the loan
- amount of time the loan must be paid back (maturity) - the longer the loans the higher the interest rate as
there is more risk and visa versa
- size of the loan - the larger the loan the lower the interest rate
- degree of market power of the lender
Definition of money market - anything that is acceptable for the payment of goods and services
Interest rate determined by demand and supply of money
Demand and supply of money Diagram (HL)
Supply of money - amount of money in circulation fixed by the central bank

Demand for money (by consumer, firms and governments) when interest rates fall
demand for money increases. Currency or checking account in the bank does not
earn interest. Put money in savings account to earn interest. High interest rate
less attractive to hold money
Important to note: (Target interest rate HL)
Central bank will increase and decrease money supply to achieve its target
interest rate

If the BOE is decreasing the interest rate from 1% to 0.5% then it means that 0.5%
is the target rate and they will increase the money supply until it is reached
How does the central bank change money supply (HL)
Deposits into your bank account are then lent to customers
Money that is kept in the vault = required reserves. This is a fraction of the total
deposits which is called minimum reserve requirements or required reserve ratio.
E.g
If minimum reserve requirement is 30% the bank will have to keep $300 if you
deposit $1000 they will then lend out $700 (excess reserves). If Fred borrows
$700 and buys a phone from Sara who then deposits the $700 in her bank
account. The bank has to keep 30% of the $700 so $700x0.3 = 210. Thus
$700-$210= $490. This will happen numerous times until the amount of initial
excess reserves of $700 are multiplied by the money multiplier.
How does the central bank change money supply (HL)
……… continue from slide 141

The money multiplier = 1/required reserve ratio

Thus: 1/0.3 = 3.33

Thus: $700 x 3.3 = $2310 - this is the amount of new loans created. Thus new
money created

If minimum reserve requirement drops to 20%

Then 1/0.2 = 5 thus $800 x 5 = $4000 (from the initial $1000 received)
Tools of monetary policy (HL)
This is how the central bank controls the amount of new money:
1.Open market operations - where central bank buys and sells bonds to
commercial banks to control money supply and interest rates. The holder of the
bond is the lender the issuer of the bond is the borrower.
To lower interest rates - Central bank will buy bonds increasing commercial banks
excess reserves which they can then lend thus increasing the money supply
To increase interest rates - Central banks will sell bonds to commercial banks the
banks will then pay the central bank reducing excess reserves thus money supply
decreases
Tools of monetary policy (HL)
2. Minimum reserve requirements - if reserve requirements decrease (banks keep a lower percentage
of the deposits) this increases excess reserves and increases money supply lowering interest rates

If reserve requirements increase (banks keep a higher percentage of the deposits) this decreases
excess reserves and decreases money supply increasing interest rates

3. Changes in central bank’s minimum lending rate (minimum lending rate = is the interest charges
by the central bank when it lends funds to commercial banks). Called basse rate in the UK, refinancing
rate in the EU and discount rate in the US). If banks want more money for lending they can borrow from
the central bank.

A lower base rate means that it costs less to borrow from the central bank increasing reserves and
increasing money supply

A higher base rate means that it costs more to borrow from the central bank decreasing reserves and
decreasing money supply
Tools of monetary policy (HL)
4. Quantitative easing - Used to increase money supply in the economy - here
Central banks buy bonds on a large scale - works like open market operations but
includes more financial assets. First happened in Japan in 2001 and then other
countries during the 2008 financial crisis.

Central bank buys huge quantities of assets that commercial banks own. To pay
for the assets the central bank creates reserves electronically for commercial
banks. Commercial banks sell their assets to the central bank and this increase
their reserves increasing the money supply. This will then increase their lending
ability increasing AD
Nominal vs Real interest rates
Nominal - with inflation (it is the market rate)
Real - without inflation
Use and example
Nominal interest rate is 6% and the inflation rate is 2% then the real interest rate =
6%-2% = 4%
If in your bank account you have $1000 and earn 6% interest then in nominal
terms you will have ($1000 x 1.06) = $1060
But in real terms your $1000 will only have the purchasing power of ($1000 x 1.04)
= $1040
Role of monetary policy (deflationary/recessionary gap and
inflationary gaps)

Changes in interest rates due to changes in the money supply

Expansionary policy (easing) when there is a recessionary gap - Increase money
supply - interest rates decrease
Contractionary policy (tightening) when there is an inflationary gap- Decreasing
money supply - interest rates increase. AD decreases but price levels won’t
(ratchet effect) this is what happens in the real world (show Keynes diagram with
no price drop)
Use monetarists/new classical model and the Keynesian model
Keynesian model with the ratchet effect
Remember Keynes said that wages are sticky downwards? It’s the same with
prices

Ratchet effect means

Prices increase when AD increases and stay there until there is further increases
in AD

When AD falls prices do not necessarily fall (firms are reluctant to drop price levels
in the real world)
Ratchet effect diagram
 Evaluating Monetary policy
Constraints on Monetary Policy Strengths of Monetary Policy

1. Ineffective during recession 1. Interest rates can be adjusted - so changes

- IR can go lower than 0% can be made to ‘fine tune’
- Low confidence 2. Interest rate changes can be reversible
- Banks fearful of lending 3. Monetary policy is flexible
2. Conflict between gov objectives - domestic 4. Relatively short time lags
impact as well as impact on the external 5. Central bank independence
balance 6. Limited political constraint
3. May be inflationary if the AD increases 7. Does not have a direct impact on the budget
beyond what in needs to during a deficit or gov debt
recessionary gap 8. No crowding out (HL)
4. Can’t use monetary policy when there is
stagflation or cost-push inflation
Fiscal policy
Definition

TYpes of taxes:
Direct Tax = taxes paid to the government tax authorities by the taxpayer(Personal,tax, corporate tax and wealth tax {property taxes
& inheritance taxes} also social security contributions/payroll taxes

Sources of revenue:

● All taxes
● Sale of goods and services - electricity, water etc
● Sale of state-owned property/asset = privatisation

Types of government expenditure:

● Current expenditure - day-to-day operations of government activity

● Capital expenditure - public investment e.g. roads, airports, hospitals
● Transfer payments - payment to vulnerable groups, unemployment benefits, child allowances
Goals if Fiscal Policy
Low and stable inflation
Low unemployment - cyclical unemployment
Reduce fluctuations in the business cycle
Promote stable economic environment for long term growth
External balances (influencing imports)
Equitable distribution of income - this goal is not shared with monetary policy. FP has a
big influence on distribution of income by implementing tax policies and government
spending to produce and provide goods such as merit goods
Case study - Japan
Rad this article to get a better
understanding of Japan’s national
debt
Impact of Fiscal Policy on AD
Fiscal Policy influences:

C - changes in income taxes impacting disposable income

I - changing taxes on business profits will impact level of investment by firms

G - level of government’s own spending

Expansionary and contractionary fiscal policy
May consists of changes in

- Government spending
- Personal income tax
- Business taxes (influences after tax business profits)

Or a combination of the above

Evaluating Fiscal Policy
Constraints
● Problems with time lags (recognising
the problem, deciding on the
appropriate fiscal policy, the tune it
takes affect)
● Political constraints
● Sustainable debt (need to be able to
meet current and future debt
obligations)
● Tax cuts ineffective during recession
an increase in G is more effective
● AD might cause inflationary pressure
if it moves beyond intended level
● Can’t deal with cost push inflation
● Crowding out (HL)
Strengths
● Pulling an economy out of recession
● Ability to target sectors in the
economy (e.g. education or focus on
healthcare or infrastructure)
Direct impact on AD
● Dealing with escalating inflation
● Ability to affect potential output
● Automatic stabilizers (HL) - these are
stabilizers that automatically reduce
short term fluctuations without
intentional action taken by the gov
(personal income tax and
unemployment benefits)
Crowding out effect (HL)
Part one

Part two
Keynesian multiplier (HL) Case study vids 1 and 2
The government expenditure multiplier is the ratio of change in government expenditure to a change in national income. A
multiplier effect occurs when a change in injections brings about a greater proportionate change in national income. The
multiplier can occur because of a change in any one of the injections into the circular flow of income: investment(I),
government expenditure (G) and exports (X).

The multiplier can be measured as the ratio of change in any one of these injections (J) to a change in national income (Y).

multiplier = change in national income / change in injections

The government expenditure multiplier involved with fiscal policy would be:

government expenditure multiplier = change in national income/change in government expenditure

Keynesian multiplier (HL) Case study vids 1 and 2

Marginal propensity to consume (MPC)

This is the proportionate change in consumption brought about by a change in income. It is calculated using the equation:
MPC = ∆C/∆Y
Marginal propensity to save (MPS)
This is the proportionate change in saving brought about by a changing income. It Is calculated using the equation:
MPS = ∆S/∆Y
Marginal propensity to tax (MPT)
This is the proportionate change in tax brought about by a changing income. It Is calculated using the equation:
MPT = ∆T/∆Y
Marginal propensity to imports (MPM)
This is the proportionate change in imports brought about by a changing income. It Is calculated using the equation:
MPM = ∆M/∆Y
Calculating the value of the multiplier

The value of the multiplier can be calculated by using the following equations:
Multiplier = 1/(1-MPC) or 1/(MPS+MPT+MPM)
Multiplier calculations
Multiplier = change in real GDP divided by the initial change in expenditure

Be able to calculate the change in real GDP

Formula for the multiplier:

1/1-MPC or 1/MPW

Example: A country has a real GDP of $120 bn. If MPC is 0.8 and there is a $2
million increase in exports. What is the multiplier and the final real GDP amount
Example
$8 million is injected (autonomous spending)

Multiplier = change in real GDP divided by the initial change in expenditure

Multiplier and AD - HL
Initial injection is called autonomous spending meaning it is not caused by a
change in income

Then when the multiplier takes effet we call this induced spending meaning
spending has been caused by changes in income

Total effects on AD is the SUM of autonomous spending + induced spending this

will be the same as Autonomous spending X multiplier.

Show autonomous and induced spending on and AD diagram

Multiplier and the price level - HL
Using a Keynesian LRAS graph
From AD1 to AD2 there is an increase in
real GDP from Y1 to Y2 - this is equal to
the increase in AD. Here is the full
multiplier effect

From AD2 to AD3 the increase in real GDP

is smaller because of an increase in price
levels

From AD3 to AD4 there is no increase in

real GDP as the increase in price levels
have absorbed the whole multiplier which
in this case is zero
Goals = Supply side policies
- Promote LR growth by increasing productive capacity
- Improving competition and efficiency
- Reduces cost of production and reduces unemployment through labour
market flexibility
- Incentives for firms to invest in innovation and lower cost of production
- Reduce inflation to improve international competitiveness
Market based Supply side
policies
1. Encouraging competition
- Privatization
- Deregulation
- Contracting out private sector
- Anti-monopoly regulation
- Trade liberalization
2. Labour market reforms:
- Abolishing NMW
- Trade union reforms
- Decrease unemployment benefits
- Reducing job security
3. Incentive related policies
- Lowering personal income tax
- Low capital gains tax and interest income
- Lowering business taxes
Interventionist Supply side
policies
1. Investment in Human Capital:
Education and health services
- Training and education (include grant
and subsidies on the job training -
structural unemployment geographical
mobility)
- Improved health care service and
access
2. Investment in new technology
- R&D (include positive ext)
3. Investment in infrastructure
4. Industrial policies
- Support for SME
- Support for infant industries
Overlap between demand and supply side policies
Interventionist policies - Government spending

Market - based approaches - lowering taxes on business profits encourage R&D,

new technology and other investments

Both shifts AD first and then LRAS as this increase AD first and then LRAS

Supply side effects - Fiscal policy government spending

Monetary policy - interest rates affect investment

Evaluating Supply- side policies - Constraints

Market- based policies

Interventionist policies:
- Time lags
- Time lags
- Unfavourable impact on unemployment
- Negative impact on government
(focusing on competition, deregulation)
budgets
- Negative effects on equity
- Negative impact on government budget
- Interference with vested interest
(opposing trade union reforms and
privatization)
- Possible negative effects on the
environments
Evaluating Supply- side policies - Strengths

Market based policies: Interventionist policies:

- Improved resource - Direct support for

allocation
- May not burden gov
budget
- Ability to create
employment (labour
market reforms)
- Low inflationary
pressure (increasing
LRAS)
important sector growth
- Ability to create
employment
- Reduce inflationary
pressures
- Positive effects on equity
Read page 421, 424-427
Implementation

Policies for low unemployment

Policies for low inflation
Policies for economic growth
HL CALCULATIONS