Macroeconomic objectives

Low unemployment
• Definition: Unemployment – people of working age who are without work,
available for work and actively seeking employment. (ILO)
• Unemployment rate formula: (Number of unemployed people / Labour force) *
100

Difficulties in measuring unemployment:

• Hidden unemployment (working people who are excluded from the measure of
unemployment because of the definition of unemployment)
• Underemployment (people want full-time jobs, yet are only able to get part-time
jobs)
• Regional, gender, age and ethnic disparities are not taken into account as it is an
average
• Many inaccuracies when gathering data and inconsistency in the definition
across different countries when measuring unemployment.
 Distribution of unemployment
• Geographic disparities: most countries have
some regions more prosperous than others,
inner city unemployment may be higher than
suburban or rural unemployment.
• Age disparities: young people are more likely to
be unemployed.
• Ethnic and Gender disparities: ethnic minorities
and women tend to be more unemployed.
Consequences of unemployment:
• Loss of GDP, less income for the unemployed
• Loss of government revenue (tax)
• Cost to the government in the form of
unemployment benefits
• Greater disparities in income distribution
• Various social problems (growing
unemployment-related crime rates; higher
stress levels; homelessness)
Factors affecting the level of unemployment

• At any given time people are becoming

unemployed while others are gaining
employment and the level of unemployment
depends on the relationship between these two.
If more people are becoming unemployed than
gaining jobs, then the level of unemployment
will rise. If more jobs are being created so that
more people are gaining jobs than losing jobs,
then the level of unemployment will fall.
 Causes of unemployment
• The labor market and National Minimum Wage
that cause real-wage unemployment (graph)
• Demand-deficient unemployment or cyclical
unemployment (AD shifts to left graph)
• Equilibrium unemployment or natural
unemployment (NRU)
Natural rate of unemployment= Structural
unemployment+ frictional unemployment +
seasonal unemployment
 Types of unemployment:
• Frictional – people are switching jobs
• Structural – people are out of job because their skills are no
longer required (e.g. technology improved and machinery
replaced humans or consumer preferences changed and a
service/good is no longer produced)
• Seasonal – people are out of job because their workplace
only operates seasonally (e.g. skiing resorts)
• Cyclical (also known as Demand Deficient) – because of
weak demand for various goods and services, firms decrease
their output and fire workers
• (Real-wage unemployment)
Equilibrium unemployment: frictional,
structural, seasonal.
What causes unemployment
 two main types of disequilibrium
unemployment.
1. Real-wage (classical) unemployment occurs when trade
unions push wages above the market-clearing level, or when
the government introduces a minimum wage that is above the
market-clearing level. This is ab in the diagram.

2. Demand-deficient (cyclical/Keynesian) unemployment

is where unemployment occurs because AD in the economy
has fallen (recession), and so the demand for labour has also
fallen. The unemployment is longer if wages are ‘sticky
downwards’ and so do not adjust. This is ab in the
diagram.
Cyclical unemployment can be seen here:

• As aggregate demand falls from AD1 to AD2,

unemployment increases by the amount Y1-
Y2. That is demand deficient unemployment.
 Solutions to unemployment
Cures for frictional and seasonal unemployment:
• Cutting unemployment benefits – becomes less beneficial to stay unemployed
• Improving information – making it easier to find jobs
Cures for structural unemployment:
• Training schemes and education – help people re-specialise and gain skills
which are demanded improving the occupational mobility
• Relocation – providing incentives to move to places where person’s skills are
required
• Subsidies to firms for adult retraining programs, support of apprenticeship
programs, job centers.
Cures for cyclical unemployment:
• Expansionary fiscal and/or monetary policies aimed at increasing aggregate
demand
 Solutions to unemployment
EQUILIBRIUM UNEMPLOYMENT – can only be cured by supply-side policies
shifting the LRAS to the right.

DISEQUILIBRIUM UNEMPLOYMENT
1. Real-wage (classical) unemployment – If trade unions are preventing the
labour market from clearing, then the government should pass laws to reduce
the power of the trade unions (market based policy). If the government is
preventing the labour market from clearing, then the minimum wage should
be reduced or removed (market-based policy).
This may also be cured by an expansionary demand-side policy,
but this does not really cure the actual cause of the ‘problem’.
2. Demand-deficient (cyclical) unemployment – The government can intervene
to bring about an increase in AD through the use of an expansionary fiscal or
monetary policy.
 Which are the most effective policies?
Remember that it depends upon the type of unemployment involved. However, the
types of equilibrium unemployment (frictional, structural and seasonal) may ONLY
be cured by supply side policies.
• Real-wage unemployment may be cured by supply-side or expansionary demand-
side policies, but the demand-side policies do not cure the actual cause of the
unemployment.
• Demand-deficient unemployment may be cured by expansionary demand-side
policies.

The use of demand-side policies may have bad effects elsewhere in the economy. For
example, if interest rates are lowered, this may lead to inflation and a fall in the
external value of the currency (the exchange rate). Furthermore, there is no
guarantee that expansionary monetary policy will be effective in raising AD. If
consumer and business expectations about the future are pessimistic, then lower
interest rates may not necessarily lead to increased AD.
 NRU
• There is also Natural Rate of Unemployment –
it is also known as the equilibrium rate. Mainly
used by Monetarists and is referred to as the
rate which exists at the full employment level
of income where the AS is vertical.
• Cure: Supply-Side Policies which would shift
the LRAS (Monetarist view) and the vertical AS
part (Keynesian view) to the right.
 HL: Crowding out (page 289)
• “Crowding out” – governments borrow to
increase their expenditure and offer a high
interest rate on their bonds. Private sector, in
order to compete with the government,
increases its interest rate, thus discouraging
private investment. This is how government
spending “crowds out” private investment.
• AD eventually may fall due to higher interest
rate, thus creating unemployment.
 Low and stable Inflation
Definitions:
• Inflation is persistent increase in the price level of an economy over a period of time.
• Disinflation is fall in the rate of inflation.
• Deflation – decrease in the price level of an economy over a period of time.
• Core or underlying rate of inflation – this measurement eliminates the effect of volatile
swings in the prices of e.g. food or oil.
Inflation is mostly measured using the CPI – Consumer Price Index. It measures the changes
in prices of a “repesentative” basket of goods and services consumed by an average
household.
Weaknesses of the CPI:
• There is no such thing as an “average” household – different consumption patterns lead to
different CPIs
• Quality of goods/services provided is not taken into account
• PPI or the Producer Price Index measures the changes in prices of goods as they leave the
factories and before distributors, wholesalers, or retailers (stores) add their profit margin.
 Issues involved in measuring inflation
• When using the CPI, the basket used in any country represents the purchasing
habits of a ‘typical’ household, but this will not be applicable to all people and
there may be variations in regional rates of inflation within a country.
• Errors in the collection of data that limit the accuracy of final results.
• Items are removed or added in the basket and this limits the ability to make
comparisons from one time period to another.
• Countries measure inflation in different ways and include different components.
• Prices may change for a variety of reasons that are not sustained like season
variations in food prices or volatile oil prices may lead to unusual movements of
inflation that can be misleading.
• Economists also measure changes in the factors of production through the
commodity price index, which tracks changes in raw material prices. Upward
movement in commodity prices signals cost-push pressures and may be an
indicator of inflation.
 Consequences of inflation:
• Greater uncertainty that could lead to falling investment and
consumption, so less economic growth.
• Redistributive effect – high inflation rate for savers means that
the real interest rate they are getting on their money placed in
a bank is smaller; high inflation rate for borrowers means the
real interest rate they are paying because of their loan is
smaller. People who save/hold cash may become worse off.
• Export competitiveness falls (provided other exporting
countries do not experience same or higher rate of inflation)
• Loss of purchasing power, labour unrest, uncertainty.
• Shoe-leather costs (cost of searching for the best price)
• Menu costs (cost of constantly changing your goods’/services’
prices)
 Consequences of deflation:
• High levels of cyclical unemployment and bankruptcies – when people see
falling prices, they believe they will keep falling and therefore, deter their
spending. As a result, consumption falls and aggregate demand decreases,
increasing demand deficient unemployment and eventually causing firms to go
out of business.
• Unemployment increase, loss of business and consumer confidence.
• It benefits lenders and harms borrowers.
• It may well improve the balance of payments, depending upon the price
elasticity of demand for exports and imports.
• Interest rates tend to be very low so deflation makes the use of monetary
policy ineffective.
• It redistributes wealth from those with assets to those who are earning high
incomes or who have high cash balances.
• Less profit for firms which means reduced investment.
 Causes of deflation
There are two types (causes) of deflation.
1. ‘Good‘ deflation is productivity-driven and
comes about as costs and prices are pushed
lower by improvements in productivity.
2. ‘Bad‘ deflation reflects a sharp slump in
demand, excess capacity and a shrinking
money supply (as in the USA in the 1930s).
two types of inflation: cost-push and demand-pull.

Causes of demand-pull inflation: (AD shift to right)

• Lower tax rates
• Growing government spending
• Lower interest rates
• Growing consumer confidence
• Economic growth in other countries (leading to
growing exports, hence increasing AD)
• Depreciation of a country’s currency (leading to
growing exports, hence increasing AD)
Causes of cost-push inflation: (SRAS shifts to
left)
• Rising costs of production (capital, raw
material and labour costs)
• Increased indirect taxation (e.g. VAT)
• Currency depreciation (leading to rising costs
of production)
Demand pull and cost push inflation together

• Graph on page 299

 Curing inflation
• To cure inflation, governments
can use contractionary fiscal (cutting
government expenditure and/or increasing direct
taxes) and/or contractionary monetary policies
(raising the interest rates) to decrease aggregate
demand. Also, supply-side policies could be
used. However, those mostly affect the economy
in the (very) long-run. Therefore, there would be
little-to-none instant effect on the price level.
 Higher Level
• Pages 306-311
 HL- Phillips Curve
• A shortage of labour might set off an increase
in wages, meaning there is a trade off
between unemployment and increases in
inflation. (Phillips Curve)

• Graph of Phillips Curve and Long-run Phillips

curve
Original and long-run Phillips curve
 Economic Growth
Definitions:
• Economic growth is the realised increase in potential GDP of an economy over
a period of time. – it is important to know that there are a number of
definition of what economic growth is. Therefore, if exam question asks you to
talk about economic growth, be very careful how you define it.
• This definition connects both of those below.
• Actual growth which takes place when an economy is below full employment
level of income and moves towards its potential level of GDP (by employing
more of its resources).
• Potential growth occurs in the long-run and it is associated with the increase
in quantity and/or quality of factors of production (this shifts the vertical part
of the Keynesian AS curve; the vertical LRAS curve in a Monetarist diagram).
• Also, see the diagram as you are required to know how to demonstrate
economic growth using a PPC (Production Possibilities Curve).
• Actual growth is from point A to point B. (deflationary gap)
• Potential growth is the shift of the PPC curve PPC1 to PPC2.
• The definition of economic growth given above would be from point C to
point D (“…realised increase in potential…”)
 Graphs to illustrate economic growth

• Shifting of the AD curve to right

• Shifting of LRAS curve to right

Short term vs Long term growth
How to measure economic growth
• Growth rate= {(real GDP in year 2- real GDP in
year 1)/ real GDP in year 1} x100
 Consequences of economic growth
Positive:
• Higher living standards
• Government budget improvements (higher tax revenues, less government
spending due to less unemployment)
• Falling unemployment
• Growing income and consumption
• Higher productivity, improvement in competitiveness of a country’s exports
Negative:
• Possible inflation
• Negative externalities (overall damage to the environment, higher emissions
of greenhouse gases)
• Possible increase in current account deficit
• Rising Gini coefficient ( i.e. higher income inequality, less equity)
 Economics of Inequality and Poverty
• Throughout the world there’s evidence of great inequalities
in income and wealth
• Poor people throughout the world are working hard, but lack
the opportunities to improve their well-being
• Inequalities are caused by many factors and can harm
everyone, but it’s often women who are hardest hit
• It’s not right that governments claim to be concerned about
inequality; but then implement policies that actually
increase it
• There are number of things that government can do to
reduce inequality
 Equality and equity
• Equality is where economic outcomes are the
same for different people or different social
groups and equity is about fairness- it means that
despite the differences, everyone should be given
the same opportunities to succeed, no mater
their socio-economic background, gender or race.
• Inequalities in income and wealth are considered
to be ‘inequalities in outcome’ where equity is
referred to as ‘inequality of opportunity’.
 Equity in the distribution of income
Due to unequal distribution of factors of production it is hardly possible for
the market system to result in equitable distribution of income. Even
though inequality does provide incentives for businesses to research and
improve, the popular opinion is that income/wealth should be
redistributed from the rich to the poor. There are different ways this can
be done each having its pros and cons. That is the main discussion topic
between policy makers – ways and the amount of redistribution.

Indicators of income equality/inequality

Definitions:
• Lorenz curve – shows proportion of a population’s income that is earned
by a given percentage of the population.
• Gini coefficient – numerical measure of income inequality.
• Lorenz curve above – the more the curve is bent the more unequal distribution of
income. The 45 degree curve shows complete equality – 1% of population receives
1% of population’s income; 10% receives 10% and so on.
• Gini coefficient’s formula: A / (A+B)
• Gini coefficient values are between 0 and 1 (as can be seen from the formula
above). The lower the value of the coeffcieint the lower the inequality. The higher
the value of Gini’s coefficient the higher the inequality.
 Higher level
• Page 325-326
 Poverty
• High level of income inequality means that a significant
portion of the population is living in some form of
poverty.
• Two types of poverty: absolute poverty – when a
household’s income is below the poverty line (official
World Bank’s poverty line – 1.90$ a day). and relative
poverty – standard defined by the average income
(required for a lifestyle in a typical society) in a certain
country, meaning that a person is poor relative to the
others in the country, earning less than 50% of the
median income.
 How poverty is measured
• Apart from World Bank’s international poverty line of $1.90 PPP,
economists set their own ‘national poverty lines’ which reflect relative
poverty. An alternative approach in a country may be to set the poverty
line at the minimum amount of income that households need to meet
their basic needs for goods and services, for example Canada uses a
‘market-based measure’ which measures the cost of a basket of goods
and services needed to live a ‘modest, basic standard of living.’
• Multidimensional Poverty Index (MPI) is a composite indicator because it
attempts to measure the many specific dimensions of poverty, rather
than simply looking at income as a single indicator; some dimensions
include health (nutrition, child mortality), education (years of schooling,
school attendance), and standards of living (cooking fuel, sanitation,
drinking water, electricity, housing, assets like TV or computer)
 Difficulties in measuring poverty
• Different types of poverty like absolute poverty, relative
poverty, extreme poverty, income poverty, etc.
• Elements of poverty which are difficult to measure like
uncertainty, fear, vulnerability
• Household surveys require enormous amount of resources
and these surveys may be of poor quality in third world
countries.
• It’s in the interest of government to adjust their national
poverty lines to reduce the extent of official poverty in the
country, thus affecting the poverty statistics in order for the
government to ‘look better’
 Causes of inequality and poverty
• Inequality of opportunities: a child being born into a middle- or high-
income family is likely to have more educational or health opportunities
than a child being born into a poor household. There is no social mobility
and children with a disadvantaged background face too many challenges and
have too few opportunities to move up the socio-economic ladder. This
situation is even harsher in developing countries.
• Discrimination: gender, race, ethnicity, age, religion, sexual orientation and
wage discrimination may occur.
• Differences in human capital: low supply of highly-skilled computer
engineers and high supply for unskilled manual work leading to increasing
inequality.
• Different levels of ownership of resources/ capital: the higher the person’s
income, the more physical and financial capital they will own like companies
that earn profit and dividents.
 Causes of inequality and poverty
• Globalization and technological progress: less demand for manufactured workers
in developed countries increases structural unemployment while more demand
for higher education in sectors such as the financial, technology, and electronic
industries.
• Market-oriented, supply-side policies: deregulation in financial markets increases
the opportunity for wealthy people to earn more income from their investments
or less trade union power meaning less power for collective bargaining usually
means lower wages.
• Government tax and benefit policies: ‘progressive’ taxation has fallen in many
countries and ‘austerity’ policies like cutting welfare benefits have worsen the
incomes and standards of living among lower-income people.
• Unequal status and power: donation from powerful private individuals and
wealthy citizens and companies to reduce minimum wage or the business
regulation. As a result, the ‘voice’ of low-income people may not be represented
in governing policy.
Consequences of inequality and poverty
• For economic growth: on the one hand, large gaps between high and
low-income groups provide the incentives for entrepreneurship and
innovation and when there is more equality, and the gap is smaller, there
are fewer incentives. But on the other hand, inequality may harm
economic growth due to high levels of poverty, and fewer opportunities
for lower income families. Children from poorer backgrounds are likely to
leave school without the appropriate skills or training.
• For living standards and social stability: very limited income to buy food,
fuel, school supplies, and transportation, low income areas are less likely
to have good schools and attract good teachers with poor infrastructure
and facilities, there may be social instability due to crime and gang-
related activities, and unstable political climate and social tensions may
be harmful to the political system and democratic process.
 Role of taxation in reducing poverty, income
and wealth inequality
• Progressive taxation: income taxes are paid by households, property taxes
are as a form of wealth tax, and a small percentage tax on the super-rich
could generate significant funds in an economy, and firms pay taxes on
their profits however very large companies can advantage of different tax
systems around the world and there is tax avoidance.
• Regressive taxation: larger share of income from lower income people pay
more than from higher income people like VAT, and inequality worsens.
• Arguments for and against progressive taxation: progressive tax structure
gives the government the funds to finance necessary expenditures like
transfer payments, child allowances, maternity and paternity benefits,
unemployment insurance and pensions as a means of promoting equity.
Arguments against higher progressive tax structures include disincentives
to work harder, to start a business, or to have dividends or capital gains.
 Promoting equity
The most popular way of redistributing income is taxation (and
transfer payments). There are 2 types of taxes:
• Direct taxes are those placed on people’s incomes and wealth
• Indirect taxes are those placed on producers (goods/services) who
then attempt to pass it onto consumers in the form of a higher price
(e.g. VAT)
Taxes are:
• Progressive – the average rate of tax rises as the person’s income
rises (e.g. most income taxes, because of tax-brackets)
• Regressive – the average rate of tax decreases as the person’s
income rises (e.g. tax on fuel)
• Proportionate – the average rate of tax is constant
 About taxes..
• Taxes are the first step in the redistribution of income. The
second step is for governments to pass on the collected taxes to
the poor. That is done using transfer payments which are
transfers of incomes from one person to another with no
production taking place. Examples of transfer payments include
unemployment benefits, old age pensions, child allowances,
etc.
• Governments can also use the collected taxes to provide
socially desirable goods such as free healthcare or free
education, infrastructure including sanitation and clean water.
That makes those goods/services accessible to low income
people which is also promotion of equity.
 Arguments against higher taxes
• A key feature of the market system is incentives. Higher taxes may create a
disincentive effect because if people know that higher income means that
they have to pay higher marginal rates of taxes, then they may not be
motivated to work harder and get better-paying jobs.
• There is likely to be less entrepreneurial activity without the incentive of
higher incomes. Since entrepreneurship is one of the factors of production,
then this will have negative supply side effects on the economy.
• If businesses earn higher profits and this puts them into a higher tax
bracket, then they have less incentive to invest to increase capacity.
• There might be a brain drain as high-skilled people leave the economy to
go to work in places where they don’t pay such high taxes.
• It may be difficult for the country to attract foreign direct investment, since
multinationals will prefer to work in countries where taxes are lower.
Further policies to reduce poverty, inequality
in income and wealth
• Transfer payments like child support, maternity and paternity benefits, old
age pensions, housing allowances, fuel allowances. Some transfers are
universal like child support and others are ‘means tested’ given to people
with low income.
• Investment in human capital; examples include public health insurance, pre-
natal and post-natal care, child care and preschool programs, immunization,
school food, health education in schools, recruitment of quality teachers,
after-school programs, apprenticeships, financial support to students,
training and work experience, community programs, elder care.
• Policies to reduce gender and other discrimination such as law for equal
pay for work of equal value, affirmative action for greater diversity in
workplace, legislation to make it illegal to discriminate in education or
employment positions, gender equality, requirements for accessibility for
disabled people,.
Further policies to reduce poverty, inequality
in income and wealth
• Increased minimum wage? Higher wages encourage people to
join the labour market, increase consumption thus AD increases,
escape the poverty trap and provide better opportunities for low-
skilled workers’ children, narrow wage gap between men and
women, and reduction in inequality.
• Universal Basic Income (UBI): ‘free money for everyone’ as
technology and automation will continue to eliminate certain
forms of work and increase inequalities. In a UBI scheme, all
citizens would receive a guaranteed amount, each week or each
month, with no conditions or eligibility requirements, an amount
that would be enough to keep people above poverty line and
would be the same for everyone regardless of their income.
 Poverty
• Absolute poverty – when a household’s income is below the poverty line (official
World Bank’s poverty line – 1.90$ a day).
• Relative poverty – standard defined by the average income (required for a
lifestyle in a typical society) in a certain country.
Causes of poverty:
• Low incomes
• Lack of human capital (no education and training)
• Unemployment
Consequences of poverty:
• Low living standards (leading to higher levels of diseases, child mortality rates,
etc.)
• Lack of access to healthcare
• Lack of access to education
• Poverty-related social problems
 Higher level
• Page 341- 344 and page 353
 Reading
• Economics 2020 Edition, Oxford, Jocelyn Blink
& Ian Dorton chapters 19, 20, 21, 22