Professional Documents
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IB
Economics
SL
Unit
2:
Macroeconomics
Mr.
R.S.
Pyszczek,
Jr.
City
Honors
School
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
The
Circular
Flow
of
Income
Model
Pgs
234-236
l
Describe,
using
a
diagram,
the
circular
ow
of
income
between
households
and
rms
in
a
closed
economy
with
no
government.
IdenQfy
the
four
factors
of
producQon
and
their
respecQve
payments
(rent,
wages,
interest
and
prot)
and
explain
that
these
consQtute
the
income
ow
in
the
model.
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
The
Circular
Flow
of
Income
Model
l
Explain
how
the
size
of
the
circular
ow
will
change
depending
on
the
relaQve
size
of
injecQons
and
leakages.
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
The
Circular
Flow
of
Income
Model
l Outline
that
the
income
ow
is
numerically
equivalent
to
the
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
The
Circular
Flow
of
Income
Model
The
diagram
below
displays
the
Circular
Flow
of
resources,
goods
and
services
in
a
naQon
with
a
closed
economy
and
no
government
sector.
To
fully
understand
how
producQve
resources,
goods
and
services
and
money
ow
from
households
to
rms
and
from
rms
to
households
through
voluntary
exchanges
in
a
naQons
product
and
resource
markets
lets
examine
our
role(s)
in
this
diagram.
Unit 2: Macroeconomics
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
The
Circular
Flow
of
Income
Model*
One
of
the
main
basic
economic
models
is
the
circular-ow
model,
which
describes
the
ow
of
money
and
products
throughout
the
economy
in
a
very
simplied
way.
The
model
represents
all
of
the
players
in
an
economy
as
either
households
or
rms
(companies),
and
it
divides
markets
into
two
categories:
l
h\p://economics.about.com/od/economics-basics/ss/The-Circular-Flow-Model_3.htm#step-heading
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
The
Circular
Flow
of
Income
Model
In
the
Product
(goods
and
services)
Markets,
households
buy
nished
products
from
rms
that
are
looking
to
sell
what
they
make.
In
this
transacQon,
money
ows
from
households
to
rms,
and
this
is
represented
by
the
direcQon
of
the
arrows
on
the
lines
labeled
$$$$
that
are
connected
to
the
Product
Market
box
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
The
Circular
Flow
of
Income
Model
The
term
factors
of
producQon
refers
to
anything
that
is
used
by
a
rm
in
order
to
make
a
nal
product.
Some
examples
of
factors
of
producQon
are
labor
(the
work
done
by
people),
capital
(the
machines
used
to
makes
products),
land,
and
so
on.
Labor
markets
are
the
most
commonly
discussed
form
of
a
Factor
Market,
but
its
important
to
remember
that
factors
of
producQon
can
take
many
forms.
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
The
Circular
Flow
of
Income
Model
When
households
provide
labor
to
rms,
they
can
be
thought
of
as
the
sellers
of
their
Qme
or
work
product.
(Technically,
employees
can
more
accurately
be
thought
of
as
being
rented
rather
than
being
sold,
but
this
is
usually
an
unnecessary
disQncQon.)
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
The
Circular
Flow
of
Income
Model
Therefore,
the
funcQons
of
households
and
rms
are
reversed
in
factor
markets
as
compared
to
in
goods
and
services
markets.
Households
provide
labor,
capital,
and
other
factors
of
producQon
to
rms,
and
this
is
represented
by
the
direcQon
of
the
arrows
on
the
Labor,
capital,
land,
etc.
lines
on
the
diagram
above.
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
The
Circular
Flow
of
Income
Model
In
the
other
side
of
the
exchange,
rms
provide
money
to
households
as
compensaQon
for
the
use
of
factors
of
producQon,
and
this
is
represented
by
the
direcQon
of
the
arrows
on
the
$$
lines
that
connect
to
the
Factor
Markets
box.
Unit 2: Macroeconomics
Unit
2:
Macroeconomics
2.1
Unit
2:
Macroeconomics
2.1
Examples
of
Leakages*
l
Savings:
Households
saving
a
porQon
of
their
income
which
than
allows
the
bank
to
give
businesses/rms
a
loan.
Taxes:
The
government
is
deducQng
a
porQon
of
the
households
income
which
then
goes
directly
back
to
the
household
where
eligible.
This
transacQon
is
called
transfer
payments,
such
as
subsidies,
AISH,
Employment
Insurance
and
CPP.
Import
spending:
Is
money
leaving
a
country
to
pay
for
imported
goods
made
by
other
countries.
It
is
simply
goods
coming
into
a
country
and
money
leaving
that
country.
Resources:Dr.Power's
Class
Discussion,
Principles
of
Macreconomics.Sayre
Morris-
Page
92-94,
Google
Books
Unit
2:
Macroeconomics
2.1
Unit
2:
Macroeconomics
2.1
Examples
of
Injec6ons*
l
Investment
Spending:
Is
when
businesses
buy
capital
goods
funded
by
loans
from
the
bank.
Government
Spending:
Is
when
the
Government
buys
goods
and
services
from
other
businesses
using
net
taxes.
Export
Spending:
Goods
leaving
the
country
and
money
coming
in
from
the
selling
of
the
goods.
Resources: Dr.Power's Class Discussion, Principles of Macreconomics.Sayre Morris- Page 92-94, Google Books
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP),
and
Gross
NaQonal
Product
(GNP)
or
Gross
NaQonal
Income
(GNI)
l DisQnguish
between
GDP
and
GNP/GNI
as
measures
of
economic
acQvity.
l DisQnguish between the nominal value of GDP and GNP/GNI and the
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP),
and
Gross
NaQonal
Product
(GNP)
or
Gross
NaQonal
Income
(GNI)
l DisQnguish
between
total
GDP
and
GNP/GNI
and
per
capita
GDP
and
GNP/GNI.
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP),
and
Gross
NaQonal
Product
(GNP)
or
Gross
NaQonal
Income
(GNI)
l
Evaluate
the
use
of
naQonal
income
staQsQcs,
including
their
use
for
making
comparisons
over
Qme,
their
use
for
making
comparisons
between
countries
and
their
use
for
making
conclusions
about
standards
of
living.
Explain
the
meaning
and
signicance
of
green
GDP,
a
measure
of
GDP
that
accounts
for
environmental
destrucQon.
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP),
and
Gross
NaQonal
Product
(GNP)
or
Gross
NaQonal
Income
(GNI)
l
Evaluate
the
use
of
naQonal
income
staQsQcs,
including
their
use
for
making
comparisons
over
Qme,
their
use
for
making
comparisons
between
countries
and
their
use
for
making
conclusions
about
standards
of
living.
Explain
the
meaning
and
signicance
of
green
GDP,
a
measure
of
GDP
that
accounts
for
environmental
destrucQon.
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP)*Pgs.
237-250
GDP
is
the
monetary
value
of
all
the
nished
goods
and
services
produced
within
a
country's
borders
in
a
specic
Qme
period,
though
GDP
is
usually
calculated
on
an
annual
basis.
It
includes
all
of
private
and
public
consumpQon,
government
outlays,
investments
and
exports
less
imports
that
occur
within
a
dened
territory.
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP)
GDP
is
commonly
used
as
an
indicator
of
the
economic
health
of
a
country,
as
well
as
to
gauge
a
country's
standard
of
living.
CriQcs
of
using
GDP
as
an
economic
measure
say
the
staQsQc
does
not
take
into
account
the
underground
economy
-
transacQons
that,
for
whatever
reason,
are
not
reported
to
the
government.
Others
say
that
GDP
is
not
intended
to
gauge
material
well-being,
but
serves
as
a
measure
of
a
naQon's
producQvity,
which
is
unrelated.
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP)
Real
GDP
takes
inaQon
into
account,
allowing
for
comparisons
against
other
historical
Qme
periods.
The
Bureau
of
Economic
Analysis
issues
its
own
analysis
document
with
each
GDP
release,
which
is
a
great
investor
tool
for
analyzing
gures
and
trends,
and
reading
highlights
of
the
very
lengthy
full
release
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP)
Weaknesses
of
using
GDP:*
l
Revisions
can
change
historical
gures
measurably
(the
dierence
between
3%
and
3.5%
GDP
growth
is
a
big
one
in
terms
of
monetary
policy
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP)*
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP)
How
do
we
calculate
it?
GDP
=
C
+
G
+
I
+
NX
"C"
is
equal
to
all
private
consumpQon,
or
consumer
spending,
in
a
naQon's
economy.
ConsumpQon/Consumer
Spending
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP)
How
do
we
calculate
it?
GDP
=
C
+
G
+
I
+
NX
"G"
is
the
sum
of
Government
Spending.
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP)
How
do
we
calculate
it?
GDP
=
C
+
G
+
I
+
NX
"I"
is
the
sum
of
all
the
country's
businesses
spending
on
capital.
Investment
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP)
How
do
we
calculate
it?
GDP
=
C
+
G
+
I
+
NX
"NX"
is
the
naQon's
total
net
exports,
calculated
as
total
exports
minus
total
imports.
(NX
=
Exports
-
Imports)
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
NaQonal
Product
(GNP)*
GNP
is
an
economic
staQsQc
that
includes
GDP,
plus
any
income
earned
by
residents
from
overseas
investments,
minus
income
earned
within
the
domesQc
economy
by
overseas
residents.
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
NaQonal
Product
(GNP)*
GNP
is
a
measure
of
a
country's
economic
performance,
or
what
its
ciQzens
produced
(i.e.
goods
and
services)
and
whether
they
produced
these
items
within
its
borders.
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
NaQonal
Income
(GNI)*
The
sum
of
a
naQons
gross
domesQc
product
(GDP)
plus
net
income
received
from
overseas.
Gross
naQonal
income
(GNI)
is
dened
as
the
sum
of
value
added
by
all
producers
who
are
residents
in
a
naQon,
plus
any
product
taxes
(minus
subsidies)
not
included
in
output,
plus
income
received
from
abroad
such
as
employee
compensaQon
and
property
income.
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
NaQonal
Income
(GNI)
GNI
measures
income
received
by
a
country
both
domesQcally
and
from
overseas.
In
this
respect,
GNI
is
quite
similar
to
Gross
NaQonal
Product
(GNP),
which
measures
output
from
the
ciQzens
and
companies
of
a
parQcular
naQon,
regardless
of
whether
they
are
located
within
its
boundaries
or
overseas.
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP),
and
Gross
NaQonal
Product
(GNP)
or
Gross
NaQonal
Income
(GNI)
To
convert
a
naQons
GDP
to
GNI,
three
terms
need
to
be
added
to
the
former:
1)
net
compensaQon
receipts,
2)
net
property
income
receivable
and
3)
net
taxes
(minus
subsidies)
receivable
on
producQon
and
imports.
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP),
and
Gross
NaQonal
Product
(GNP)
or
Gross
NaQonal
Income
(GNI)
Lets
use
Canadas
2010
GDP
and
GNI
numbers
to
understand
the
reconciliaQon
between
these
two
measures
of
economic
output.
l
Unit
2:
Macroeconomics
2.1
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP),
and
Gross
NaQonal
Product
(GNP)
or
Gross
NaQonal
Income
(GNI)
Lets
use
Canadas
2010
GDP
and
GNI
numbers
to
understand
the
reconciliaQon
between
these
two
measures
of
economic
output.
l
Net property income receivable = -$28.2 million (note the negaQve sign)
Net taxes = 0
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Economic
Ac6vity
Measures
of
Economic
AcQvity:
Gross
DomesQc
Product
(GDP),
and
Gross
NaQonal
Product
(GNP)
or
Gross
NaQonal
Income
(GNI)
Lets
use
Canadas
2010
GDP
and
GNI
numbers
to
understand
the
reconciliaQon
between
these
two
measures
of
economic
output.
l
Unit
2:
Macroeconomics
2.1
Explain
the
long-term
growth
trend
in
the
business
cycle
diagram
as
the
potenQal
output
of
the
economy.
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
The
Business
Cycle
Economies
go
through
a
regular
pa\ern
of
ups
and
downs
in
the
value
of
GDP.
This
is
known
as
the
business
cycle
(someQmes
you
also
see
it
referred
to
as
the
economic
cycle).
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
The
Business
Cycle*
The
business
cycle
is
characterized
by
four
main
phases:
l Boom:
high
levels
of
consumer
spending,
business
condence,
prots
and
investment.
Prices
and
costs
also
tend
to
rise
faster.
Unemployment
tends
to
be
low
as
growth
in
the
economy
creates
new
jobs
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
The
Business
Cycle*
The
business
cycle
is
characterized
by
four
main
phases:
l Recession:
falling
levels
of
consumer
spending
and
condence
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
The
Business
Cycle*
The
business
cycle
is
characterized
by
four
main
phases:
l Slump
/Depression:
a
prolonged
period
of
declining
GDP
-
very
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
The
Business
Cycle*
The
business
cycle
is
characterized
by
four
main
phases:
l Recovery:
things
start
to
get
be\er;
consumers
begin
to
increase
Unit
2:
Macroeconomics
2.1
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
The
Business
Cycle*
There
are,
however,
some
drawbacks
for
an
economy
that
is
growing
rapidly:
l
The risk of demand pull inaQon if actual growth exceeds potenQal growth
Unit
2:
Macroeconomics
2.1
Unit
2:
Macroeconomics
2.1
The
Level
of
Overall
Economic
Ac6vity
Theory
of
Knowledge:
Poten6al
Connec6ons
What
is
the
empirical
evidence
for
the
existence
of
the
business
cycle?
How
do
we
decide
whether
this
evidence
is
sucient?
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Aggregate
Demand
and
Aggregate
Supply
Aggregate
Demand
(AD)
The
AD
Curve*
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Explain
how
the
AD
curve
can
be
shixed
by
changes
in
investment
due
to
factors
including
interest
rates,
business
condence,
technology,
business
taxes
and
the
level
of
corporate
indebtedness.
Unit
2:
Macroeconomics
2.2
Explain
how
the
AD
curve
can
be
shixed
by
changes
in
government
spending
due
to
factors
including
poliQcal
and
economic
prioriQes.
Explain
how
the
AD
curve
can
be
shixed
by
changes
in
net
exports
due
to
factors
including
the
income
of
trading
partners,
exchange
rates
and
changes
in
the
level
of
protecQonism.
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Aggregate
Demand
and
Aggregate
Supply
Aggregate
Demand
(AD)
An
increase
in
consump<on
shi=s
the
AD
curve
to
the
right.
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
2)
Investment*
l
Unit
2:
Macroeconomics
2.2
Interest
Rates
Firms
borrow
from
banks
to
make
large
capital
intensive
purchases,
and
if
the
interest
rate
decreases,
it
becomes
cheaper
for
rms
to
invest
and
provides
incenQve
for
rms
to
take
risk.
Unit
2:
Macroeconomics
2.2
Business
Condence
If
rms
are
condent
about
the
economy
and
its
future
growth,
they
are
more
likely
to
invest.
Investment
Policy
If
governments
provide
incenQves
such
as
tax
breaks,
subsidies,
loans
at
lower
interest
rates
then
investment
can
increase.
However,
corrupQon
and
bureaucracy
deters
investment.
Na6onal
Income
As
rms
increase
output,
they
would
need
to
invest
in
new
machines.
This
relaQonship
is
known
as
The
Accelerator.
Unit
2:
Macroeconomics
2.2
Government
spending
forms
a
large
total
of
aggregate
demand,
and
an
increase
in
government
spending
shi=s
aggregate
demand
to
the
right.
Government
spending
is
categorized
into
transfer
payments
and
capital
spending.
Transfer
payments
include
pensions
and
unemployment
benets
and
capital
spending
is
on
things
like
roads,
schools
and
hospitals.
Governments
spend
to
increase
the
consumpQon
of
health
services,
educaQon
and
to
re-
distribute
income.
They
may
also
spend
to
increase
aggregate
demand.
Unit
2:
Macroeconomics
2.2
Imports
are
foreign
goods
bought
by
consumers
domesQcally,
and
exports
are
domesQc
goods
bought
abroad.
Net
exports
is
the
dierence
between
exports
and
imports,
and
this
factor
can
be
net
imports
too,
if
imports
are
greater
than
exports.
An
increase
in
net
exports
shi=s
aggregate
demand
to
the
right.
The
exchange
rate
and
trade
policy
aects
net
exports.
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Explain,
using
a
diagram,
why
the
short-run
aggregate
supply
curve
(SRAS
curve)
is
upward
sloping.
Explain,
using
a
diagram,
how
the
AS
curve
in
the
short
run
(SRAS)
can
shix
due
to
factors
including
changes
in
resource
prices,
changes
in
business
taxes
and
subsidies
and
supply
shocks.
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
changes in size & quality of the labor force available for producQon
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Explain,
using
a
diagram,
that
the
monetarist/new
classical
model
of
the
long-
run
aggregate
supply
curve
(LRAS)
is
verQcal
at
the
level
of
potenQal
output
(full
employment
output)
because
aggregate
supply
in
the
long
run
is
independent
of
the
price
level.
Explain,
using
a
diagram,
that
the
Keynesian
model
of
the
aggregate
supply
curve
has
three
secQons
because
of
wage/price
downward
inexibility
and
dierent
levels
of
spare
capacity
in
the
economy.
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Aggregate
Demand
and
Aggregate
Supply
Aggregate
Supply
(AS)
Improvements
in
producQvity
and
eciency
cause
the
long-run
aggregate
supply
curve
to
shix
out
over
the
years.
Unit
2:
Macroeconomics
2.2
Explain,
using
the
two
models
above,
how
factors
leading
to
changes
in
the
quanQty
and/or
quality
of
factors
of
producQon
(including
improvements
in
eciency,
new
technology,
reducQons
in
unemployment,
and
insQtuQonal
changes)
can
shix
the
aggregate
supply
curve
over
the
long
term.
Unit
2:
Macroeconomics
2.2
Unit
2:
Macroeconomics
2.2
Equilibrium
Short-Run
Equilibrium
l Explain,
using
a
diagram,
the
determinaQon
of
short-run
equilibrium.
Unit
2:
Macroeconomics
2.2
Equilibrium
Equilibrium
in
the
Monetarist/New
Classical
Model
l
Unit
2:
Macroeconomics
2.2
Equilibrium
Equilibrium
in
the
Keynesian
Model
l
Explain,
using
the
Keynesian
AD/AS
diagram,
that
the
economy
may
be
in
equilibrium
at
any
level
of
real
output
where
AD
intersects
AS.
Unit
2:
Macroeconomics
2.2
Equilibrium
Equilibrium
in
the
Keynesian
Model
l
Discuss
why,
in
contrast
to
the
monetarist/new
classical
model,
the
economy
can
remain
stuck
in
a
deaQonary
(recessionary)
gap
in
the
Keynesian
model.
Explain,
using
a
diagram,
that
if
AD
increases
in
the
verQcal
secQon
of
the
AS
curve,
then
there
is
an
inaQonary
gap.
Discuss
why,
in
contrast
to
the
monetarist/new
classical
model,
increases
in
aggregate
demand
in
the
Keynesian
AD/AS
model
need
not
be
inaQonary,
unless
the
economy
is
operaQng
close
to,
or
at,
the
level
of
full
employment.
Unit
2:
Macroeconomics
2.2
Equilibrium
Theory
of
Knowledge:
Poten6al
Connec6ons
Business
condence
is
a
contribu<ng
factor
to
the
level
of
AD.
What
knowledge
issues
arise
in
aDemp<ng
to
measure
business
condence?
The
Keynesian
and
Monetarist
posi<ons
dier
on
the
shape
of
the
AS
curve.
What
is
needed
to
seDle
this
ques<on:
empirical
evidence
(if
so,
what
should
be
measured?),
strength
of
theore<cal
argument,
or
factors
external
to
economics
such
as
poli<cal
convic<on?
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
The
Meaning
of
Unemployment
Pgs.
285-299
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
The
Meaning
of
Unemployment*
Be
out
of
work
and
willing
to
accept
suitable
job
(labor)
or
start
an
enterprise
(prospecQve
entrepreneur)
if
the
opportunity
arises,
and
acQvely
looking
for
ways
to
obtain
a
job
or
start
and
enterprise.
~InternaQonal
Labor
OrganizaQon
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
The
Meaning
of
Unemployment*
Full
employment
and
Underemployment:
A
society
is
almost
never
fully
employed,
but
one
of
the
goals
is
to
reach
full
employment.
Full
employment
has
two
condiQons:
Everyone
who
wants
to
work
is
working,
and
the
rate
of
inaQon
is
stable.
When
the
economy
is
at
full
employment,
there
is
no
cyclical
unemployment
but
sQll
fricQonal
and
structural
unemployment.
This
is
dened
as
natural
unemployment.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
The
Meaning
of
Unemployment*
l
You
are
only
classied
as
unemployed
if
you
go
and
register
with
the
government
as
available
for
work.
The
labor
force
is
dened
as
those
of
16
years
of
age
or
older
who
are
employed
plus
all
those
who
are
unemployed
seeking
work.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
The
Meaning
of
Unemployment*
UR
=
Unemployment
Rate
UR
=
Labor Force
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
The
Meaning
of
Underemployment*
As
unemployment
Americans
nd
part
Qme,
temporary,
and
seasonal
work,
the
ocial
unemployment
rate
could
decline.
However,
this
does
not
necessarily
mean
more
Americans
are
working
in
their
desired
capacity.
It
will
conQnue
to
be
important
to
track
underemployment-
to
shed
light
on
the
true
state
of
the
U.S.
workforce,
and
the
millions
of
Americans
who
are
searching
for
full-Qme
employment.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Consequences
of
Unemployment
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Consequences
of
Unemployment
Individual
Consequences
of
Unemployment*
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Consequences
of
Unemployment
Social
Consequences
of
Unemployment*
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Consequences
of
Unemployment
Economic
Consequences
of
Unemployment*
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Consequences
of
Unemployment
Economic
Consequences
of
Unemployment*
l
loss of output
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Consequences
of
Unemployment
Economic
Consequences
of
Unemployment*
l
Increased
diculty
for
labor
market
entrants
-
employers
have
more
choices,
they
favor
experienced
workers
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Consequences
of
Unemployment
The
individual,
social
and
economic
consequences
of
unemployment
are
not
limited
to
those
outlined
previously,
but
it
should
be
clear
that
the
costs
of
unemployment
are
wide
ranging,
thus
making
low
unemployment
a
worthy
and
important
goal
for
macroeconomic
policy
makers.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Types
and
Causes
of
Unemployment
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Explain,
Using
a
Diagram,
that
Cyclical
Unemployment
is
Caused
by
a
Fall
in
Aggregate
Demand.
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
FricQonal
Unemployment*
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
FricQonal
Unemployment
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Structural
Unemployment*
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Structural
Unemployment
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
The
Natural
Rate
of
Unemployment
(NRU)*
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
The
Natural
Rate
of
Unemployment
(NRU)*
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Low
Unemployment
Cyclical
Unemployment*
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Explain
that
inaQon
and
deaQon
are
typically
measured
by
calculaQng
a
consumer
price
index
(CPI),
which
measures
the
change
in
prices
of
a
basket
of
goods
and
services
consumed
by
the
average
household.
Explain
that
dierent
income
earners
may
experience
a
dierent
rate
of
inaQon
when
their
pa\ern
of
consumpQon
is
not
accurately
reected
by
the
CPI.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
The
value
of
a
dollar
does
not
stay
constant
when
there
is
inaQon.
The
value
of
a
dollar
is
observed
in
terms
of
purchasing
power,
which
is
the
real,
tangible
goods
that
money
can
buy.
When
inaQon
goes
up,
there
is
a
decline
in
the
purchasing
power
of
money.
For
example,
if
the
inaQon
rate
is
2%
annually,
then
theoreQcally
a
$1
pack
of
gum
will
cost
$1.02
in
a
year.
Axer
inaQon,
your
dollar
can't
buy
the
same
goods
it
could
beforehand.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
The
U.S.
Bureau
of
Labor
StaQsQcs
measures
two
kinds
of
CPI
staQsQcs:
CPI
for
urban
wage
earners
and
clerical
workers
(CPI-W),
and
the
chained
CPI
for
all
urban
consumers
(C-CPI-U).
Of
the
two
types
of
CPI,
the
C-CPI-U
is
a
be\er
representaQon
of
the
general
public,
because
it
accounts
for
about
87%
of
the
populaQon.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
CPI
is
one
of
the
most
frequently
used
staQsQcs
for
idenQfying
periods
of
inaQon
or
deaQon.
This
is
because
large
rises
in
CPI
during
a
short
period
of
Qme
typically
denote
periods
of
inaQon
and
large
drops
in
CPI
during
a
short
period
of
Qme
usually
mark
periods
of
deaQon.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Explain
that
inaQon
gures
may
not
accurately
reect
changes
in
consumpQon
pa\erns
and
the
quality
of
the
products
purchased.
Explain
that
a
producer
price
index
measuring
changes
in
the
prices
of
factors
of
producQon
may
be
useful
in
predicQng
future
inaQon.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
The
Producer
Price
Index
(PPI)
is
a
weighted
index
of
prices
measured
at
the
wholesale,
or
producer
level.
A
monthly
release
from
the
Bureau
of
Labor
StaQsQcs
(BLS),
the
PPI
shows
trends
within
the
wholesale
markets
(the
PPI
was
once
called
the
Wholesale
Price
Index),
manufacturing
industries
and
commodiQes
markets.
All
of
the
physical
goods-producing
industries
that
make
up
the
U.S.
economy
are
included,
but
imports
are
not.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
The
PPI
release
has
three
headline
index
gures,
one
each
for
crude,
intermediate
and
nished
goods
on
the
naQonal
level:
1)
PPI
Commodity
Index
(crude):
This
shows
the
average
price
change
from
the
previous
month
for
commodiQes
such
as
energy,
coal,
crude
oil
and
the
steel
scrap.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
The
PPI
release
has
three
headline
index
gures,
one
each
for
crude,
intermediate
and
nished
goods
on
the
naQonal
level:
2)
PPI
Stage
of
Processing
(SOP)
Index
(intermediate):
Goods
here
have
been
manufactured
at
some
level
but
will
be
sold
to
further
manufacturers
to
create
the
nished
good.
Some
examples
of
SOP
products
are
lumber,
steel,
co\on
and
diesel
fuel.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
The
PPI
release
has
three
headline
index
gures,
one
each
for
crude,
intermediate
and
nished
goods
on
the
naQonal
level:
3)
PPI
Industry
Index
(nished):
Final
stage
manufacturing,
and
the
source
of
the
core
PPI.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
The
core
PPI
gure
is
the
main
a\racQon,
which
is
the
nished
goods
index
minus
the
food
and
energy
components,
which
are
removed
because
of
their
volaQlity.
The
PPI
percentage
change
from
the
prior
period
and
annual
projected
rate
will
be
the
most
printed
gure
of
the
release.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
The
PPI
looks
to
capture
only
the
prices
that
are
being
paid
during
the
survey
month
itself.
Many
companies
that
do
regular
business
with
large
customers
have
long-term
contract
rates,
which
may
be
known
now
but
not
paid
unQl
a
future
date.
The
PPI
excludes
future
values
or
contract
rates.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
VolaQle elements, such as energy and food, can skew the data.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Consequences
of
DeaQon
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Be\er Infrastructure
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Demand
Pull
InaQon
is
when
too
many
consumers
are
chasing
too
few
goods
(scarcity),
so
the
average
price
of
goods
and
services
in
a
naQon
rises
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
The
Meaning
of
Economic
Growth
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
The
Meaning
of
Economic
Growth*
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Causes
of
Economic
Growth
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Causes
of
Economic
Growth:
ProducQon
PossibiliQes
Curve
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Causes
of
Economic
Growth:
ProducQon
PossibiliQes
Curve
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Causes
of
Economic
Growth:
ProducQon
PossibiliQes
Curve
l
Among
others,
factors
such
as
labor,
capital
and
technology
will
aect
where
the
producQon
possibility
fronQer
lies.
The
PPF
is
also
known
as
the
producQon
possibility
or
transformaQon
curve.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Causes
of
Economic
Growth
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Causes
of
Economic
Growth:
Long
Run
Aggregate
Supply
(LRAS)
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Causes
of
Economic
Growth:
Long
Run
Aggregate
Supply
(LRAS)
l
Unit
2:
Macroeconomics
2.3
Macroeconomic
objec6ves
Economic
Growth
Causes
of
Economic
Growth:
Long
Run
Aggregate
Supply
(LRAS)
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Causes
of
Economic
Growth
Sources
of
ProducQvity
Growth:
Physical
Capital*
l
Economies
with
greater
quanQQes
of
capital
per
worker
experience
a
greater
level
of
output
per
hour
of
labor
and,
therefore,
a
higher
level
of
economic
growth.
Increases
in
capital
stock
result
from
high
levels
of
private
investment,
as
rms
replace
old
capital
and
expand
exisQng
factories
to
meet
AD
over
Qme.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Causes
of
Economic
Growth:
Physical
Capital
Developing
human
capital
alone
is
not
enough
to
create
economic
growth.
Economies
must
also
invest
in
developing
physical
capital.
Physical
capital
is
the
tools,
factories,
and
equipment
that
are
used
in
the
producQon
process.
As
the
stock
of
physical
capital
increases,
the
naQon
experiences
capital
deepening.
Capital
deepening
refers
to
the
amount
of
capital
available
to
each
worker.
Capital
deepening
provides
for
a
more
producQve
labor
force.
The
average
American
worker
is
backed
by
$130,000
worth
of
physical
capital.
This
is
one
of
the
reasons
for
America's
producQvity
edge.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Causes
of
Economic
Growth
l
The be\er educated or trained a worker is, the more producQve they are?
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Consequences
of
Economic
Growth
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Consequences
of
Economic
Growth:
Economic
Consequence*
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Consequences
of
Economic
Growth:
Non-Economic
Consequence*
l
InaQon
Resource DepleQon
Structural Unemployment
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Economic
Growth
Consequences
of
Economic
Growth:
Non-Economic
Consequence*
l
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
The
dierence
between
the
straight
line
and
the
curved
line
is
the
amount
of
inequality
of
wealth
distribuQon,
a
gure
described
by
the
Gini
coecient.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
The
eects
of
poverty
are
most
oxen
interrelated
so
that
one
problem
hardly
ever
occurs
alone.
For
instance,
bad
sanitaQon
makes
it
easier
to
spread
around
old
and
new
diseases,
and
hunger
and
lack
of
water
make
people
more
vulnerable
to
them.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Indirect
taxes
can
also
be
dened
as
fees
that
are
levied
equally
upon
taxpayers,
no
ma\er
their
income.
This
is
a
primary
reason
why
they
are
thought
of
as
taxes
that
are
passed
on,
as
the
price
of
the
tax
is
compensated
for
by
simply
increasing
the
overall
price
of
the
good
or
service.
Some
economists
argue
that
indirect
taxes
lead
to
an
inecient
marketplace
and
alter
market
prices
that
don't
match
their
equilibrium
price.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
A
tax
that
increases
the
price
of
a
good
so
that
consumers
are
actually
paying
the
tax
by
paying
more
for
the
products.
An
indirect
tax
is
most
oxen
thought
of
as
a
tax
that
is
shixed
from
one
taxpayer
to
another,
by
way
of
an
increase
in
the
price
of
the
good.
Fuel,
liquor
and
cigare\e
taxes
are
all
considered
examples
of
indirect
taxes,
as
many
argue
that
the
tax
is
actually
paid
by
the
end
consumer,
by
way
of
a
higher
retail
price.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Explain
the
term
transfer
payments,
and
provide
examples,
including
old
age
pensions,
unemployment
benets
and
child
allowances.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Transfer
payments
are
not
a
part
of
the
naQonal
income
so
they
are
cut
from
naQonal
income
to
get
n.n.p
in
order
to
arrive
naQonal
income
such
payments
are
bad
debts
incurred
by
banks,
payments
of
pensions,
charity,
scholarships
etc.
In
the
UK
they
have
several
transfer
payments
such
as
EMA
and
a
job
seeker's
allowance.
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.3
Macroeconomic objec6ves
Unit
2:
Macroeconomics
2.4
Fiscal policy
Explain
that
the
government
earns
revenue
primarily
from
taxes
(direct
and
indirect),
as
well
as
from
the
sale
of
goods
and
services
and
the
sale
of
state-
owned
(government-
owned)
enterprises.
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Explain
the
relaQonship
between
budget
decits/
surpluses
and
the
public
(government)
debt.
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
The
opposite
of
a
budget
decit
is
a
budget
surplus,
and
when
inows
equal
oulows,
the
budget
is
said
to
be
balanced.
Unit
2:
Macroeconomics
2.4
Fiscal policy
In
the
early
20th
century,
few
industrialized
countries
had
large
scal
decits.
This
changed
during
the
First
World
War,
a
Qme
in
which
governments
borrowed
heavily
and
depleted
nancial
reserves.
Industrialized
countries
reduced
these
decits
unQl
the
1960s
and
1970s
despite
years
of
steady
economic
growth.
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
When
spending
exceeds
income,
the
result
is
a
budget
decit,
which
must
be
nanced
by
borrowing
money
and
paying
interest
on
the
borrowed
funds,
much
like
an
individual
spending
more
than
he
can
aord
and
carrying
a
balance
on
a
credit
card.
A
balanced
budget
occurs
when
spending
equals
income.
The
U.S.
government
has
only
had
a
budget
surplus
in
a
few
years
since
1950.
The
Clinton
administraQon
(1993-2001)
famously
cured
a
large
budget
decit
and
created
a
surplus
in
the
late
1990s.
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Explain
how
changes
in
the
level
of
government
expenditure
and/or
taxes
can
inuence
the
level
of
aggregate
demand
in
an
economy.
Describe
the
mechanism
through
which
expansionary
scal
policy
can
help
an
economy
close
a
deaQonary
(recessionary)
gap.
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Fiscal
policy
is
largely
based
on
the
ideas
of
BriQsh
economist
John
Maynard
Keynes
(18831946),
who
believed
governments
could
change
economic
performance
by
adjusQng
tax
rates
and
government
spending.
Unit
2:
Macroeconomics
2.4
Fiscal policy
To
illustrate
how
the
government
could
try
to
use
scal
policy
to
aect
the
economy,
consider
an
economy
thats
experiencing
a
recession.
The
government
might
lower
tax
rates
to
try
to
fuel
economic
growth.
If
people
are
paying
less
in
taxes,
they
have
more
money
to
spend
or
invest.
Increased
consumer
spending
or
investment
could
improve
economic
growth.
Regulators
dont
want
to
see
too
great
of
a
spending
increase
though,
as
this
could
increase
inaQon.
Unit
2:
Macroeconomics
2.4
Fiscal policy
Another
possibility
is
that
the
government
might
decide
to
increase
its
own
spending
say,
by
building
more
highways.
The
idea
is
that
the
addiQonal
government
spending
creates
jobs
and
lowers
the
unemployment
rate.
Some
economists,
however,
dispute
the
noQon
that
governments
can
create
jobs,
because
government
obtains
all
of
its
money
from
taxaQon
in
other
words,
from
the
producQve
acQviQes
of
the
private
sector.
Unit
2:
Macroeconomics
2.4
Fiscal policy
One
of
the
many
problems
with
scal
policy
is
that
it
tends
to
aect
parQcular
groups
disproporQonately.
A
tax
decrease
might
not
be
applied
to
taxpayers
at
all
income
levels,
or
some
groups
might
see
larger
decreases
than
others.
Likewise,
an
increase
in
government
spending
will
have
the
biggest
inuence
on
the
group
that
is
receiving
that
spending,
which
in
the
case
of
highway
spending
would
be
construcQon
workers..
Unit
2:
Macroeconomics
2.4
Fiscal policy
Fiscal
policy
and
monetary
policy
are
two
major
drivers
of
a
naQons
economic
performance.
Through
monetary
policy,
a
countrys
central
bank
inuences
the
money
supply.
Regulators
use
both
policies
to
try
to
boost
a
agging
economy,
maintain
a
strong
economy
or
cool
o
an
overheated
economy.
Unit
2:
Macroeconomics
2.4
Fiscal policy
Construct
a
diagram
to
show
the
potenQal
eects
of
expansionary
scal
policy,
outlining
the
importance
of
the
shape
of
the
aggregate
supply
curve.
Describe
the
mechanism
through
which
contracQonary
scal
policy
can
help
an
economy
close
an
inaQonary
gap.
Construct
a
diagram
to
show
the
potenQal
eects
of
contracQonary
scal
policy,
outlining
the
importance
of
the
shape
of
the
aggregate
supply
curve.
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
AutomaQc
stabilizers
act
in
a
manner
that
is
against
the
prevailing
economic
trend.
For
example,
in
a
progressive
taxaQon
structure,
the
share
of
taxes
in
naQonal
income
falls
when
the
economy
is
booming
and
rises
when
the
economy
is
in
a
slump.
This
has
the
eect
of
cushioning
the
economy
from
changes
in
the
business
cycle.
Similarly,
total
net
transfer
payments
such
as
unemployment
insurance
decline
when
the
economy
is
in
an
expansionary
phase,
and
rise
when
the
economy
is
mired
in
recession.
Unit
2:
Macroeconomics
2.4
Fiscal policy
Explain
that
scal
policy
can
be
used
to
promote
long-term
economic
growth
(increases
in
potenQal
output)
indirectly
by
creaQng
an
economic
environment
that
is
favorable
to
private
investment,
and
directly
through
government
spending
on
physical
capital
goods
and
human
capital
formaQon,
as
well
as
provision
of
incenQves
for
rms
to
invest.
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.4
Fiscal policy
Unit
2:
Macroeconomics
2.5
Monetary policy
Interest
Rates
Interest
Rate
DeterminaQon
and
the
Role
of
a
Central
Bank
l
Describe
the
role
of
central
banks
as
regulators
of
commercial
banks
and
bankers
to
governments.
Explain
that
central
banks
are
usually
made
responsible
for
interest
rates
and
exchange
rates
in
order
to
achieve
macroeconomic
objecQves.
Explain,
using
a
demand
and
supply
of
money
diagram,
how
equilibrium
interest
rates
are
determined,
outlining
the
role
of
the
central
bank
in
inuencing
the
supply
of
money.
Unit
2:
Macroeconomics
2.5
Monetary policy
Interest
Rates
Interest
Rate
DeterminaQon
and
the
Role
of
a
Central
Bank*
l
Unit
2:
Macroeconomics
2.5
Monetary policy
Interest
Rates
Interest
Rate
DeterminaQon
and
the
Role
of
a
Central
Bank
l
Unit
2:
Macroeconomics
2.5
Monetary policy
Interest
Rates
Interest
Rate
DeterminaQon
and
the
Role
of
a
Central
Bank*
l
Unit
2:
Macroeconomics
2.5
Monetary policy
Interest
Rates
Interest
Rate
DeterminaQon
and
the
Role
of
a
Central
Bank
l
The
ECB
has
adopted
a
specic
strategy
to
ensure
the
successful
conduct
of
monetary
policy.
The
ECB
has
dened
price
stability
as
a
year-on-year
increase
in
the
Harmonized
Index
of
Consumer
Prices
(HICP)
for
the
euro
area
of
below
2%.
In
the
pursuit
of
price
stability,
the
ECB
aims
at
maintaining
inaQon
rates
below,
but
close
to,
2%
over
the
medium
term.
The
strategy
also
includes
an
analyQcal
framework
for
the
assessment
of
all
relevant
informaQon
and
analysis
needed
to
take
monetary
policy
decisions.
This
framework
is
based
on
two
pillars:
economic
analysis
and
monetary
analysis
Unit
2:
Macroeconomics
2.5
Monetary policy
Interest
Rates
Interest
Rate
DeterminaQon
and
the
Role
of
a
Central
Bank
l
The
primary
objecQve
of
the
ECBs
monetary
policy
is
to
maintain
price
stability.
This
is
the
best
contribuQon
monetary
policy
can
make
to
economic
growth
and
job
creaQon.
Monetary
policy
decisions
are
taken
by
the
ECB's
Governing
Council.
The
Council
meets
every
month
to
analyse
and
assess
economic
and
monetary
developments
and
the
risks
to
price
stability
and
to
decide
on
the
appropriate
level
of
the
key
interest
rates,
based
on
the
ECB's
strategy.
Unit
2:
Macroeconomics
2.5
Monetary policy
Explain
how
changes
in
interest
rates
can
inuence
the
level
of
aggregate
demand
in
an
economy.
Unit
2:
Macroeconomics
2.5
Monetary policy
Unit
2:
Macroeconomics
2.5
Monetary policy
Interest
rates
are
the
annual
charge
for
borrowing
funds,
usually
specied
as
a
percent
of
the
amount
borrowed.
Changes
in
interest
rates
aect
the
overall
expense
of
borrowing
and
thus
expenditures
undertaken
with
the
borrowed
funds.
Higher
interest
rates
tend
to
decrease
expenditures
and
lower
interest
rates
lead
to
an
increase
in
expenditures.
Unit
2:
Macroeconomics
2.5
Monetary policy
Unit
2:
Macroeconomics
2.5
Monetary policy
Unit
2:
Macroeconomics
2.5
Monetary policy
Unit
2:
Macroeconomics
2.5
Monetary policy
Construct
a
diagram
to
show
the
potenQal
eects
of
easy
(expansionary)
monetary
policy,
outlining
the
importance
of
the
shape
of
the
aggregate
supply
curve.
Describe
the
mechanism
through
which
Qght
(contracQonary)
monetary
policy
can
help
an
economy
close
an
inaQonary
gap.
Unit
2:
Macroeconomics
2.5
Monetary policy
Unit
2:
Macroeconomics
2.5
Monetary policy
Unit
2:
Macroeconomics
2.5
Monetary policy
But
risks:
l
l
InaQon
Lower
exchange
rate=
expensive
imports
Unit
2:
Macroeconomics
2.5
Monetary policy
Unit
2:
Macroeconomics
2.5
Monetary policy
Unit
2:
Macroeconomics
2.5
Monetary policy
But
risks:
l
l
Unit
2:
Macroeconomics
2.5
Monetary policy
Explain
that
central
banks
of
certain
countries,
rather
than
focusing
on
the
maintenance
of
both
full
employment
and
a
low
rate
of
inaQon,
are
guided
in
their
monetary
policy
by
the
objecQve
to
achieve
an
explicit
or
implicit
inaQon
rate
target.
Unit
2:
Macroeconomics
2.5
Monetary policy
The
central
bank
responsible
for
the
monetary
system
of
the
European
Union
(EU)
and
the
euro
currency.
The
bank
was
formed
in
Germany
in
June
1998
and
works
with
the
other
naQonal
banks
of
each
of
the
EU
members
to
formulate
monetary
policy
that
helps
maintain
price
stability
in
the
European
Union.
Unit
2:
Macroeconomics
2.5
Monetary policy
The
European
Central
Bank
has
been
responsible
for
the
monetary
policy
of
the
European
Union
since
January
1,
1999,
when
the
euro
currency
was
adopted
by
the
EU
members.
The
responsibiliQes
of
the
ECB
are
to
formulate
monetary
policy,
conduct
foreign
exchange,
hold
currency
reserves
and
authorize
the
issuance
of
bank
notes,
among
many
other
things.
Unit
2:
Macroeconomics
2.5
Monetary policy
Unit
2:
Macroeconomics
2.5
Monetary policy
Unit
2:
Macroeconomics
2.5
Monetary policy
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Explain
that
supply-side
policies
aim
at
posiQvely
aecQng
the
producQon
side
of
an
economy
by
improving
the
insQtuQonal
framework
and
the
capacity
to
produce
(that
is,
by
changing
the
quanQty
and/or
quality
of
factors
of
producQon).
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
However,
the
single
idea
behind
all
three
pillars
is
that
producQon
(i.e.
the
"supply"
of
goods
and
services)
is
most
important
in
determining
economic
growth.
The
supply-side
theory
is
typically
held
in
stark
contrast
to
Keynesian
theory
which,
among
other
facets,
includes
the
idea
that
demand
can
falter,
so
if
lagging
consumer
demand
drags
the
economy
into
recession,
the
government
should
intervene
with
scal
and
monetary
sQmuli.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
This
is
the
single
big
disQncQon:
a
pure
Keynesian
believes
that
consumers
and
their
demand
for
goods
and
services
are
key
economic
drivers,
while
a
supply-sider
believes
that
producers
and
their
willingness
to
create
goods
and
services
set
the
pace
of
economic
growth
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
In
economics
we
review
the
supply
and
demand
curves.
The
lex-hand
chart
below
illustrates
a
simplied
macroeconomic
equilibrium:
aggregate
demand
and
aggregate
supply
intersect
to
determine
overall
output
and
price
levels.
(In
this
example,
output
may
be
gross
domesQc
product
and
the
price
level
may
be
the
Consumer
Price
Index.)
The
right-hand
chart
illustrates
the
supply-side
premise:
an
increase
in
supply
(i.e.
producQon
of
goods
and
services)
will
increase
output
and
lower
prices.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Explain
how
investment
in
educaQon
and
training
will
raise
the
levels
of
human
capital
and
have
a
short-term
impact
on
aggregate
demand,
but
more
importantly
will
increase
LRAS.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Economist
Theodore
Schultz
invented
the
term
in
the
1960s
to
reect
the
value
of
our
human
capaciQes.
He
believed
human
capital
was
like
any
other
type
of
capital;
it
could
be
invested
in
through
educaQon,
training
and
enhanced
benets
that
will
lead
to
an
improvement
in
the
quality
and
level
of
producQon.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Explain
how
policies
that
encourage
research
and
development
will
have
a
short-term
impact
on
aggregate
demand,
but
more
importantly
will
result
in
new
technologies
and
will
increase
LRAS.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Spending on capital goods such as new factories & other buildings machinery & vehicles
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Infrastructure
is
also
an
asset
class
that
tends
to
be
less
volaQle
than
equiQes
over
the
long
term
and
generally
provides
a
higher
yield.
As
a
result,
some
companies
and
individuals
like
to
invest
in
infrastructure
for
its
defensive
characterisQcs.
Individuals
and
insQtuQons
can
invest
in
infrastructure
through
infrastructure
funds
and
can
even
choose
specialized
funds,
such
as
those
that
invest
in
transportaQon
infrastructure
or
water
infrastructure.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Explain
that
targeQng
specic
industries
through
policies
including
tax
cuts,
tax
allowances
and
subsidized
lending
promotes
growth
in
key
areas
of
the
economy
and
will
have
a
short-term
impact
on
aggregate
demand
but,
more
importantly,
will
increase
LRAS.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
The
Industrial
Policy
plan
of
a
country,
someQmes
shortened
IP,
is
its
ocial
strategic
eort
to
encourage
the
development
and
growth
of
the
manufacturing
sector
of
the
economy.
The
government
takes
measures
"aimed
at
improving
the
compeQQveness
and
capabiliQes
of
domesQc
rms
and
promoQng
structural
transformaQon."
A
country's
infrastructure
(transportaQon,
telecommunicaQons
and
energy
industry)
is
a
major
part
of
the
manufacturing
sector
that
usually
has
a
key
role
in
IP.
It
is
also
the
case
that
industries
fail
dismally
to
add
to
such
a
growing
body
of
manufacturing
industries.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Successful
policies
have
the
eect
of
shixing
the
LRAS
curve
to
the
right
leading
to
a
rise
in
potenQal
output
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Supply-side
reform
on
its
own
is
not
enough
to
achieve
this
growth.
There
must
also
be
a
high
enough
level
of
AD
so
that
the
producQve
capacity
of
an
economy
is
actually
brought
into
play.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Explain
how
factors
including
reducing
the
power
of
labour
unions,
reducing
unemployment
benets
and
abolishing
minimum
wages
are
used
to
make
the
labour
market
more
exible
(more
responsive
to
supply
and
demand).
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Policies
to
boost
compeQQon
such
as
deregulaQon
and
tough
anQ-monopoly
and
anQ-
cartel
laws
PrivaQzaQon of state assets (selling o public sector businesses into the private sector)
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Many
of
the
tradiQonal
legal
protecQons
enjoyed
by
the
trade
unions
have
been
taken
away
including
restricQons
on
their
ability
to
take
industrial
acQon.
The
result
has
been
a
decrease
in
strike
acQon
in
virtually
every
industry
and
a
signicant
improvement
in
industrial
relaQons
in
the
UK
Improved
partnerships
between
trade
unions
and
employers
can
make
a
big
contribuQon
to
raising
producQvity
and
improving
the
exibility
of
workers
in
their
jobs
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Explain
how
factors
including
personal
income
tax
cuts
are
used
to
increase
the
incenQve
to
work,
and
how
cuts
in
business
tax
and
capital
gains
tax
are
used
to
increase
the
incenQve
to
invest.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Economists
who
support
supply-side
policies
believe
that
lower
rates
of
income
tax
provide
a
short-term
boost
to
demand,
and
they
improve
incenQves
for
people
to
work
longer
hours
or
take
a
new
job
because
they
get
to
keep
more
of
the
money
they
earn.
Cu}ng
tax
rates
for
lower
paid
workers
may
help
to
reduce
the
extent
of
the
unemployment
trap
where
people
calculate
that
they
may
be
no
be\er
o
from
working
than
if
they
stay
outside
the
labor
force.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Do
lower
taxes
always
help
to
increase
the
acQve
labour
supply
in
the
economy?
It
seems
obvious
that
lower
taxes
should
boost
the
incenQve
to
work
because
tax
cuts
increase
the
reward
from
a
job.
But
some
people
may
choose
to
work
the
same
number
of
hours
and
simply
take
a
rise
in
their
post-tax
income!
Millions
of
other
workers
have
li\le
choice
over
the
hours
that
they
work.
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
Recessions
are
oxen
the
result
of
negaQve
demand-side
shocks
that
hit
real
incomes
of
consumers
and
demand
and
prots
for
businesses
Unit
2:
Macroeconomics
2.6
Supply-Side Policies
There
is
a
danger
that
a
deep
recession
and
slow
recovery
will
have
harmful
eects
on
the
supply
side
leading
to
a
reducQon
in
the
growth
rate
of
potenQal
GDP
and
a
loss
of
producQve
capacity.
This
is
known
as
a
hysteresis
eect
Unit
2:
Macroeconomics
2.6
Supply-Side Policies