WAABERI ACADEMY

MACRO- ECONOMICS

CHAPTER: ONE
INTRODUCTION TO MACRO-ECONOMICS

INTRODUCTION TO MACROECONOMICS
 Microeconomics
 The branch of economies that studies decision making by a single individual, household,
firm, industry or level of government

 Macroeconomics
• The branch of economies that studies decision making for the economy as a whole.
 Objectives:
1: conventional perspective
2: Islamic perspective
Macroeconomic Objectives from the Conventional Perspective

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Conventional perspective
1) To Achieve Full Employment
 The potential benefits of full employment in an economy are that it can optimize the
available resources efficiently.
2) To Achieve Price Stability
 Maintaining price stability is beneficial because it means
uncertainty and disruptions in the economy are avoided. It
means consumers and businesses can safely pursue long-term
consumption and production plans.
3) To Achieve Economic Growth
 Economic growth can be described as expansion in national output over a given period of
time.
 As long as a nation achieves economic growth it tells us that the economic performance
is positive.
However, an economy will not always encounter an upward trend over time as economies tend to
experience short-term ups and downs in their performance. This is called a business cycle.

4) To Achieve an Equitable Distribution of Income

 It is necessary to ensure that the economic growth of a nation is shared equally among the
population
5) To Achieve Equilibrium in the Foreign Sector
 Foreign sector means economic transactions or activities that take place beyond the
political boundaries.
 If a country faces balance of payment (BOP) deficit, it means that the country will have
to borrow from overseas and leads to high debt problems whereas a prolonged BOP
surplus will lead to inflation.
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Macroeconomic Objectives from an Islamic Perspective

(1) Social Justice

 There is no difference between the rich and the poor, between the high and the low, or
between the white and the black.
 There is to be no discrimination due to race or colour or position. .
(2) Equitable Distribution of Income
 Islam insists on a powerful built-in income-redistribution mechanism; nevertheless some
income inequality is allowed since it promotes individual initiative.
3) Universal Education
 Acquisition of knowledge is obligatory in Islam.
 Thus, every child, irrespective of his birth, must receive an equal opportunity to
education.
(4) Optimal Rate of Economic Growth
 Growth in an Islamic economy is comprehensive and includes moral, spiritual and
material aspects of man's life.
 Man is the central to all economic activities. This consideration should influence the
composition of investment because the expenditure on education is considered an
investment.
5) Maximization of Employment Generation
 An Islamic economy must ensure that economic growth results in a maximum
contribution to the creation of new employment opportunities.

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 CHAPTER: TWO
MEASURING THE NATIONAL INCOME AND OUTPUT

COMPONENTS OF MACROECONOMICS
1. House hold
2. Firm
3. Government
4. Foreign sector

CIRCULAR FLOW OF INCOME

Circular flow of income is an economic model depicting how money flows through the economy.
It describes the movement of factors of production and factors of payment.

The flow of factors of production from households to firm and the flow of goods and services
from firms to household are matched by equivalent flows of money—firms paying income to
households (Y) and households paying the firms for consuming the goods and services (C).

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The government collects taxes from households and firms. The government also makes
payments. It buys goods and services from firms, pays wages and interest to households, and
makes transfer payments to households

CONCEPTS OF NATIONAL INCOME

GDP: is the total market value of all final goods and services produced within a given period of
time by factors of production located within a country
GNP: is the value of final output produced by factors of production by resident of the country
during given period of time
Market Price
Market price refers to the current price in the market through the forces of demand and supply.
Market prices are the actual price paid by the consumers
Factor Cost
Factor cost is the price of output that is valued based on the cost of factors of production.
Therefore, factor cost is known as actual price earned by producers or sellers

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Personal Income (PI)
Personal income is the real income earned by households before they pay personal income taxes.
Disposable Personal Income (DPI)
Disposable personal income is the income available for personal consumption expenditure and
personal saving (after minus tax
PI = National income + Transfer payments – Corporate income taxes – Retained
earnings – Employee’s Provident Fund (EPF) – Social security contributions
(SOCSO) – Insurance premium

DPI = Personal income – Personal income

tax

METHODS OF MEASURING INCOME

 The accurate meaning of national income is commonly referred to as the concepts of
gross domestic product (GDP).
 GDP is the total market value of all final goods and services produced within a given
period of time by factors of production located within a country.
 The GDP can be computed in three ways:
(i) Income approach
(ii) Expenditure approach
(iii) Product or Output approach
(iv) Since the income approach, expenditure approach and product approach are the three
methods of measuring the same thing, they must thus be identical.
(v) This can be expressed as accounting identity:

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Income Approach
 The income approach measures national income by looking at the GDP from the
perspectives of sum of incomes received from the production of the output.

Components in Income Approach

Compensation Proprietors’ Corporate

Rental income Net interest
of employees income profits

National Income (NI) = NDPFC + Net Factor Income Abroad

Personal Income (PI) = National income + Transfer Payments Corporate Income Taxes –
Retained/Undistributed Earnings –Employee’s Provident Fund (EPF) – Social Security
Contributions (SOCSO) – Insurance Premium
Disposable Personal Income (DPI) = Personal Income – Personal Income Tax

Expenditure Approach
 Expenditure approach measures national income by looking at the GDP from the
perspectives of total spending on the final goods and services.

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 Components in Expenditure Approach

Personal
Gross Private Net Export
Consumption Government
Domestic
Expenditure (C) Expenditure (G) (X – M)
Investment (I)

NPmp = GDPmp + Net Factor Income Abroad

GNPfc = GNPmp + Subsidies – Indirect Taxes
National Income (NI) = GNPfc – Depreciation
Personal Income (PI) = National income + Transfer Payments – Corporate Income
Taxes – Retained/Undistributed Earnings –Employee’s Provident Fund (EPF) – Social Security
Contributions (SOCSO) – Insurance Premium
Disposable Personal Income (DPI) = Personal Income – Personal Income T

Output Approach
 Under Output or Product or Value Added Approach, national income is measured by
adding up the net value of all the goods and services produced in the country, sector by
sector during a year.

Three Sector in Output Approach

Primary Secondary Tertiary

Sector Sector Sector

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GNPfc = GDPfc + Net Factor Income Abroad
National Income (NI) = GNPfc – Depreciation
Personal Income (PI) = National income + Transfer Payments – Corporate Income
Taxes – Retained/Undistributed Earnings –Employee’s Provident Fund (EPF) – Social Security
Contributions (SOCSO) – Insurance Premium
Disposable Personal Income (DPI) = Personal Income – Personal Income Tax

NOMINAL INCOME VS REAL INCOME

Nominal income is the national income that is measured in the current price level.
Any change in nominal income reflects the combined effects of change in quantity and change in
price level.
Real Income Real income refers to the national income that is measured at a constant price or in
a base year.
By comparing the value of production in the two years at the same prices, the changes in real
income reflects only the changes in real output.

Per Capita Income

GDP per capita is often used as an indicator of living standards.
Per capita income refers to average income per head of population

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Growth Rate
Growth rate is the percentage change in quantity of goods and services produced from one to
another

USES OF NATIONAL INCOME

(1) Standard of living indicators
(2) Government planning and policies
(3) Sectoral contributions
(4) International comparisons

PROBLEMS OF MEASURING NATIONAL INCOME

(1) Problems of non-monetized sector
(2) Underground economy
(3) Non-market transactions
(4) Problems of expertise and modern machinery.
(5) Problems of double counting

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 Ch.03
DETERMINATION OF NATIONAL INCOME EQUILIBRIUM

• APPROACHES IN DETERMINING NATIONAL INCOME EQUILIBRIUM

Aggregate Supply = Aggregate Demand Approach
Leakages = Injections Approach
• Injection is an income that can be raised within the circular flow. Injections include
investments, government expenditures and exports
• A leakage is an income received by all sectors in the economy which is not distributed
within the circular flow. Leakages include savings, taxes and imports. A leakage will
reduce our national income.
AUTONOMOUS AND INDUCED CONSUMPTION
 Consumption: can be defined as spending by all households in the economy on goods
and services produced within the economy.
 Consumption is the main component of aggregate expenditure.
 The most important factors which influences consumption is disposable income.
Yd = Y + Transfer payment - Taxes
Yd = Y – T
CONCEPT OF CONSUMPTION
APC: measures the proportion of income which is used by h. hold by different level of
disposable income

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 APC: C
Yd
MPC: measures the rate of change in consumption expenditure when disposable income change

MPC: ΔC
Δ Yd
Consumption Function
 Consumption function shows the amount of households spending on goods and services at
different levels of disposable income.
 According to Keynes, there are two types of consumption, namely autonomous
consumption and induced consumption.
 Induced consumption: is consumption incurred by income
 Autonomous consumption: is a consumption not incurred by income
The general form of the consumption function equation is
C=a + b Yd
 C= total consumption
 a = autonomous consumption which is independent of the Yd
 b = marginal propensity to consume (MPC) or slope of consumption function
 Yd = disposable income
Factors Influencing Consumption
 Income level
 Expectation
 Wealth
 The price level
 Interest rate
 Stock of durable goods
Saving Theory
 Autonomous saving or dissaving is the part of savings not related to income it occurs when there is
autonomous consumption.
 Autonomous consumption is the expenditure incurred by the consumer if there is no income.
 Saving is considered as part of income received by households that is not used consumption or
expenditure.

 APS: measures the proportion of income which by h. hold save

APS: S
Yd
 MPC: shows the relationship btw a change income and total disposable income

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 MPS: ΔS
Δ Yd
Saving Function

 S = -a + (1 - b)Yd

 -a = autonomous saving

 b = marginal propensity to consume (MPC)

 Thus, (1 - b) = 1 - MPC = MPS

Break-even Income

 Break-even point refers to the point at which consumption is equal to national income.

At this point, saving is equal to zero

Autonomous Investment
 Autonomous investment is an investment which is fixed and does not depend on national income.
This type of investment depends on other factors, such as interest rate, government spending and
the level of technology.

Induced Investment
 Induced investment is the investment which depends on national income. It has direct relationship
between investment and national income.

Factors Influencing Investment

 Price and productivity of capital goods
 Expectations of the future
 Innovations
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  Profits
 The rate of interest
 Rate of return
 Government policies

DEFINITION AND CALCULATIONS OF THE EXPENDITURE MULTIPLIER

 The expenditure multiplier can be defined as the ratio of the change in income to the change in
aggregate demand. This aggregate demand can be referred to investments, government spending,
taxes and balance budget and import.

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  The size of the expenditure multiplier which depends on household marginal decisions to spend,
is called the marginal propensity to consume (MPC) or marginal propensity to save (MPS).

 The multiplier shows that an initial change in aggregate demand can have a much greater impact
on the equilibrium level of national income. The expenditure multiplier denoted by K can be
measured by:

 Since the size of K depends on MPC and MPS, therefore K can be measured using the following
formula:
 The investment multiplier is the ratio of an increment in national income to an initial increase in
investment. It shows that any increase in public or private investment spending has a more than
proportionate positive influence on aggregate income and the overall economy.
 The government spending multiplier is a ratio of an increment in national income to an initial
increase in government spending. It shows that any increase in government spending has a more
than proportionate positive influence on aggregate income and the overall economy.
 The tax multiplier is a ratio of a decrease in national income to an initial increase in tax. It
shows that any increase in tax will have a negative influence on aggregate income and the overall
economy.
 The balanced budget multiplier occurs when there is an equal change in government spending
(G) and taxes (T).
 An equal increase in autonomous government expenditure and autonomous taxes will lead to an
increase in the equilibrium level of national income, while an equal decrease in autonomous
government expenditure and autonomous taxes will lead to a decrease in the equilibrium level of
national income.
Inflationary Gap
 An inflationary gap can be defined as a situation where national income exceeds the full
employment level.
 The increase is only the increase in the nominal income, but no real increase in goods and
services.

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  When aggregate demand exceeds full employment level, inflation will occur. An inflationary gap
may be due to an increase in aggregate expenditure.
 To reduce the inflationary gap, a contractionary policy can be implemented.
 The government can practise contractionary fiscal policy by reducing government expenditure
and raising taxes
Deflationary Gap
 A deflationary gap occurs when national income is not at full employment.
 The deflationary gap is a situation where the national income is below the full employment level.
This shows that resources are not fully utilized.
 To reduce the deflationary gap, expansionary policies can be implemented. The government can
reduce taxes and increase the government spending

CH.04
Money
Money is defined as anything that acts as a medium of exchange; any commodity that is generally
acceptable as a payment for goods and services
Types of Money

 Commodity money: Items such as cowrie shells, cattle, tea, sheep, tobacco are used as money.
 Metallic money: Metals used as money were iron, tin, copper, silver and gold
 Paper money: Legal tender approved by the government to circulate as a mean of payment, such
as dollar bills
 Token money: Money which has a lower metallic value than its face value, such as 50 cent coin.
 Fiat money. Any item issued by the central bank and declared by government as money. It
consists of paper money and coins.
 Bank money: Money deposited in a current account or demand deposits.
 Plastic money: Credit cards or debit cards which are not money.

Characteristics of Money
 Acceptability: must be widely accepted as a medium of exchange.
 Durability: able to keep for a long period of time and withstand the wear and tear of many
people using it.
 Divisibility: must be easily divided into small units.
 Portability or transportability: easily carried around.
 Scarcity, but not too scarce or non-convertibility: relatively scarce and hard for people to obtain.
Uniformity or homogeneity: in the same weight and design

Functions of Money
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 (1) A medium of exchange
(2) A store of value
(3) A unit of account
(4) A standard for deferred payment

DEMAND FOR MONEY

1. Transaction Motives
People use money as a medium of exchange for conducting everyday transactions, e.g.
paying for food and transport
2. Precautionary Motives
Money is held as a precaution against some unforeseen events, e.g. paying for the repair of
the car, an emergency or medical bills.
3. Speculative Motives
According to Keynes, people also hold money to buy financial assets, e.g. bond and shares
SUPPLY OF MONEY
 The supply of money is controlled by the central bank.
The central bank issues the currency and decides the banking policy on credit creation
M1: Narrow money
The most narrowest definition of the supply of money and it comprises of the most liquid assets
M2: M1 + Near Money
 M2 is a broader and less liquid definition of the money supply.
M3: Broad Money
 M3 is the broadest definition of the supply of money with the lowest liquidity.

 The intersection of the demand for money, MD, and the supply of money, MS, determines the
equilibrium interest rate.
 At the equilibrium interest rate of i0, the quantity of money demanded is equal to the quantity of
money supplied at M0.

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Central bank
Owned and controlled by the government.
Central bank conducts monetary policy, regulates banks and issues currency to ensure the financial
stability of a country
Commercial banks
Owend by the private sector.
They are profit-making institutions with a charter from the government to engage in the business of
banking to accept deposits and provide loans
Finance Companies
Provides loans for the purchase of vehicles and properties.
Finance companies provide the same services as banking institutions except that they do not issue
cheques.
Islamic Banks
Islamic banking is conducted based on Shari’ah principles.
It does not allow the paying and receiving of interest since Islam prohibits riba and promotes profit
sharing.
Merchant Banks
Do not accept deposits from the public as they only provide support services and advice to commercial
banks, in terms of financial management and portfolio management.
Discount Houses
Provide short-term loans in the financial market.
Discount houses:
receive loans with lower rates of interest from financial institutions and supply loans to the public at a
higher rate of interest, and
obtain profits.
Non-bank Financial Intermediaries
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Development financial institutions
 Set up by the government to promote investments in the industrial and agricultural sectors.
 Its main function is to provide loans and financial assistance to firms and farmers.

Employees Provident Fund (EPF)

 Provides retirement benefits to employees.
 Each month, employees and employers have to contribute a certain percentage of income to the
EPF for their retirement.
The Central Bank and Its Functions
 Issue currency and to ensure currency stability
 Banker and financial adviser to the government
 Overseeing monetary policy
 Holder of the country’s stock of gold and foreign currency reserves
 Banker to the banks
 Lender of last resort to commercial banks and the government
THE CENTRAL BANK AND ITS MONETARY POLICY
Policy used by the central bank to control the supply of money as an instrument for achieving the ultimate
objectives of the economic policy of price stability or low unemployment
Types of Monetary Policy
(i) Contractionary or tight monetary policy: aims to decrease money supply and control
inflation.
(ii) Expansionary monetary policy: aims to increase money supply and control unemployment
during recession.
Tools of monetary policy

1. Quantitative Instruments

Open Market Operation

Legal Reserve Requirement
Bank Rate Policy or Discount Rate
2.Qualitative Measures
Fixing Margin Requirements
Direct Credit Controls on Bank Lending
Commercial Bank
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  A commercial bank is a financial institution which performs the functions of accepting deposits
from the general public and giving loans for investment with the aim of earning profit.
Banks make their profits by taking small, short-term,
Commercial Banks and Their Functions
(1) Accepting deposits from customers
(2) Providing loans and advances
(3) Direct loans, overdraft, discounting of bills
The Credit Creation Process
Credit creation is the process where a small given deposit will lead to a greater increase in the money
supply of the economy.
Assumptions:
(i) Cash ratio is fixed by the central bank e.g. at 10%.
(ii) There are many banks in the banking system and each customer deposits money in different
banks.
(iii) Banks only have two types of assets: Cash and loans.
(iv) Commercial banks do not keep excess cash reserves; all excess reserves are ‘loaned out’ (e.g.
90%).

Limitations of Credit Creation Process

(1) Amount of cash
(2) Cash reserve ratio / legal reserve requirement.
(3) Banking habits of the people
(4) Supply of collateral securities
(5) Availability of borrowers
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 (6) Excess reserves
(7) Currency drain

CH.05
public finance

 Public finance is the field of economics that studies the government actions and the various ways
of financing government expenditure.

Major Functions of Public Finance

(1) Allocation function

 It is the responsibility of the government to provide for public goods. Public goods, such as
national defence, government administration, judiciary law enforcement, public healthcare and
public infrastructures such as roads, and so on are different from private goods.
(2) Distribution function
 Through its tax and expenditure policy, the government affects distribution of personal income of
households in a manner which is just and fair. As such, it taxes the rich and spends on schemes
which will greatly benefit the poor.
(3) Stabilization function

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 The economy of a country is affected by economic fluctuations, such as conditions of boom and
depression. Such changes will benefit some and harm others
CONVENTIONAL GOVERNMENT REVENUES
Tax revenue
 A compulsory contribution imposed by the government on private individuals and organizations
to raise revenue to finance the expenditure on public goods and services. It is the most important
source of government revenue.

Non-tax revenue
 Non-tax revenues are revenues which arise from other sources besides tax. It includes receipts
from licences, regulation fees and permits, services fees, sales of goods, interest and returns on
investment and fines
Non-revenue receipts
 Refunds of expenditure, interdepartmental credit, refunds of overpayment, erroneous payment,
reimbursement and contribution from government departments, statutory bodies and government-
owned enterprise.


1) Progressive Tax
Tax is imposed, so that the effective tax rate increases as the amount to which the rate is applied
increases. This is where the rate of tax increases as income increases

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Proportion Tax

 The rate of tax remains constant as income

Regressive Tax

 In this tax structure, the lower income group will bear a higher proportion of tax than the higher
income group. This is where the rate of tax decreases as the income increases.
 changes. An example is the corporation tax.

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 TYPES OF GOVERNMENT BUDGETS
Budget deficit
 Budget deficit is where the government expenditure exceeds its revenue, (G > T).
 A deficit budget is where the government plans to spend more than it receives. It can be done by
raising government expenditure or reducing tax.
 The government will use this budget when the economy is in recession. A decrease in tax enables
individuals to have more money in their hands and to spend more.
Budget surplus
 Budget surplus is where tax revenues exceed government expenditure, (G < T).
 The surplus budget will be adopted by the government to overcome inflation. It can be done by
raising the tax or reducing the government expenditure.
(3) Balanced budget
 A balanced budget policy is where the government expenditure is equal to its revenue, (G = T).
Fiscal policy
1: expansionary fiscal policy
2: contractionary fiscal policy

Contractionary Fiscal Policy

 Contractionary fiscal policy is a policy that is used as a macroeconomic instrument by the
country’s central bank or finance ministry to slow down the economy.
 Contractionary policies are authorized by a government to decrease the money supply and
eventually, the spending in a country.
 Contractionary fiscal policy is the use of government spending, taxation and transfer payments to
shrink the economic output.
 When an economy is in a situation where its growth is at a rate that rampantly causes inflation,
contractionary fiscal policy may be used to bring it to a more sustainable level
Expansionary Fiscal Policy
 When an economy is in recession or depression, the expansionary fiscal policy will be used to
stimulate economic activities. Naturally, this type of fiscal policy results in an increase in
government spending and lower taxes.

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  A recessionary or deflationary gap occurs when the actual GDP is below its long-run level. It
shows that aggregate demand at which the GDP is lower than it would be in a full employment
situation.
 A government will usually increase their spending, which will directly increase the aggregate
demand in order to close this gap, since government spending creates demand for goods and
services.
 The national income will increase through the multiplier effect.
Roles of Fiscal Policy
 Fiscal policy is implemented to counter the effects of booms and slumps, and to maintain
economic stability.
 It is used to prevent an economy from experiencing a prolonged recession, such as during the
financial crisis in 1997 and 1998 and the debt crisis in 2008.
 Fiscal policy can raise the general level of real income and aggregate demand. In addition, the
fiscal policy is also used to curb inflation, such as during the oil crisis in the 1970s.
 Fiscal policy is implemented to smoothen the fluctuations in the economy associated with the
business cycle. This involves reducing government expenditure or raising taxes when the
economy is on the verge of overheating.
 Conversely, at the onset of recession, as problems of unemployment and declining output worsen,
the government shall cut taxes or raise government expenditure to boost its economic activities.
Sources of revenue for an Islamic government includes:
 Zakat
 Al-Fai
 Jizyah
 Kharaj
 Taxation
 Ushur
 Sadaqah
 Waqaf
ISLAMIC GOVERNMENT EXPENDITURES
 Expenditures on tasks ordained by Shari’ah.
 Expenditures necessitated by tasks assigned to the state by the people.
Expenditures necessary in the light of the Shari’ah

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 CH. O6
MACROECONOMIC PROBLEMS

INFLATION
 Defined as a persistent and sustained increase in the general price level.
 Implies that there is an increase in the cost of living that causes lower purchasing power.
 There is an inverse relationship between inflation and the value of money. A rise in the general
price means a drop in the value of money.
 Measures of inflation:
– Inflation is measured by using the Consumer Price Index (CPI).
– Basket of goods and services includes foods, shelter, clothing, medical, furniture and
transportation.
– An increase in the CPI reflects inflation in the economy
Types and Causes of Inflation
(i) Demand-pull inflation (shift in demand side)
 This type of inflation is caused by excess demand in fully employed economy.
 Demand-pull inflation occurs when aggregate demand (AD) exceeds the aggregate supply (AS).
As AD = C + I + G + (X - M), any increase of these variables will cause aggregate demand to rise

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Cost Push Inflation (shift in supply side)
 Caused by a decrease in aggregate supply due to an increase in cost of production for each unit of
output produced.
 For instance, when price of raw materials or wages increase, the cost of production will also
increase causing aggregate supply to decrease and the price of goods and services to increase.
 The shift in the aggregate supply curve may result from various factors:

• Due to wage increases which will lead to increase in the cost of production and the output price.
Monetary Inflation
 Monetary inflation is a sustained increase in the money supply of a country, resulting in price
inflation.
 Money supply increases through an expansionary fiscal policy or expansionary monetary policy.
 Quantity Theory of Money shows a direct relationship between the growth of the money supply
and inflation, MV = PT, where:
– M is Money supply
– V is Velocity of circulation
– P is Price level
– T is Transactions or output
Effects of Inflation
(i) Unequal income distribution and wealth
(ii) Reduce investment and production Cost Push Inflation

(iii) The amount of saving will decrease

(iv) Deficit
Wage in
Push the balance
ImportofPush
trade Exhaustion of
Fall in Tax-push Profit Push
natural
Inflation Inflation exchange rate inflation Inflation
(v) Breakdown in functions of money resources

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Measures to Control Inflation
(1) Contractionary Fiscal Policy (Budget Surplus: T > G)
(i) Increase in Taxes
 An increase in tax will reduce the disposable income of individuals income and their
consumption on goods and services. This is turn will lead to a fall in prices.
(ii) Decrease in Taxes
A reduction in government spending will directly affect aggregate demand. The government will cut the
salary of its civil servant and postpone development projects to reduce the purchasing power of the public
Measures to Control Inflation
(2) Contractionary Monetary Policy
(i) Open Market Operations
 The central bank may sell government securities, short-term bonds or treasury bills in the open
market to the public to reduce bank deposits and credit creation of commercial banks.
 Money supply will reduce, hence reducing aggregate demand and price level.
(ii) Raising Required Reserve Ratio
In the event of inflation, the central bank will increase the required reserve ratio of all commercial banks

UNEMPLOYMENT
 Unemployment occurs when people who are in the working age group, are able and willing to
work, but are unable to find a suitable job.
 Defined as a situation in the economy, where there are people between the age 16 and 65 who are
not working, but are actively seeking jobs.

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  We can categorize the population into three different age groups:
(i) Less than 16 years old
(ii) 16–65 years old
(iii) More than 65 years old
 The age between 16–65 years is considered as the total labour force.

Population

Below 16 66 years and

16–65 years
years above

Labour Outside
force labour force

Employed Unemployed

Labor Force
 All persons above the age of 16 and older who are employed or are actively seeking employment.
 The labor force consists of employed and unemployed persons.
 Is everyone above 16 years of age included in the labor force?
– No, because students, housewives, pensioners and discouraged workers are consider as
outside of labor force.
Discouraged Worker
– A discouraged worker is an individual who wants to work, but who has been unsuccessful
for a long period of time in finding a job and who has consequently given up on seeking
jobs.
– A discouraged worker would like to work if the job prospects are good.
– Since the labour force is defined as people who are above 16 years of age and who are
actively seeking employment, discouraged workers are excluded from the labour force.
–
Types of Unemployment
(1) Frictional Unemployment
 This is short term or temporary unemployment.

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  Occurs when people enter the labour market to look for jobs or people leave their jobs, either
voluntarily or from being sacked, and are unemployed for a period of time while they are looking
for a new job.
2) Seasonal Unemployment
 Seasonal unemployment occurs when certain products cannot be produced during a certain
season.
3) Structural Unemployment
 This unemployment results from structural decline of industries, unable to compete or adapt to
changing demand and new products, or changing method of production
4)Cyclical Unemployment
 This unemployment is caused by a decrease in aggregate demand, due to a downswing of the
business cycle.

Measures to Control Unemployment

(1) Monetary Policies (Increase Money Supply, Decrease Interest Rate)
(a) Open market operation
(b) Lowering the required reserve requirement
(c) Lowering the bank rate (interest on borrowing)
(d) Lowering interest rate (interest on saving)
2. Fiscal Policies
(a) Increase government expenditure (G)
(b) b) Decrease in taxes (T)
3) Direct Control Policies
A) This refers to all direct measures other than monetary and fiscal policy taken by the
government
B) b) Diversification and integration of economy in agricultural, manufacturing,
construction,
Effects of Unemployment
1. Loss of job skills
2. Permanent loss of output of goods and services
3. Loss in government revenue
4. Social problems
Relationship btw UN-employment and inflation
Short-run and Long-run Phillips Curve Trade Off
 Short run Phillips curve shows an inverse relationship between inflation and unemployment in the
short run.

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  In the long run, the rate of inflation does not affect the natural rate of unemployment. The long-
run Phillips curve is vertical at the natural rate of unemployment at 0U 1.

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