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Chapter 13 – Level of overall economic activity

Measure of national income
- Measured in GDP – 3 different methods:
o Output method – value of goods/services produced – summing all of value
added by firms (cost of input deducted) 0 data grouped based on sectors of
production (primary, secondary, tertiary)
o Income method – value of all incomes earned
o Expenditure method – value of all spending on goods/services – C+I+G+(X-
M) – spending by households, firms, governments, foreigners
- GDP – total value of all the final goods & services produced in an economy in a year
- Normally measured by expenditure method, however it would be equal to other
methods with some inaccuracies
- National output = national income = national expenditure
Difference between GDP/GNI
- GDP could be defined – total of all economic activity in a country regardless of who
owns the productive assets
o E.g., Indian MNC in Canada’s profits will be included in Canadian GDP
- GNI – total income earned by a country’s factors of production regardless of where
assets are located
o E.g., Indian MNC profits won’t be included in Canada’s GNI because Canada
does not own it
- Net property income from abroad – difference between earned assets – income paid to
foreign assets operating domestically
GNI = GDP + net property income from abroad
Difference between nominal/real GDP, nominal/real GNI
Nominal GDP – value of products at current prices
Real GDP - Nominal GDP adjusted for inflation – done using a GDP deflator
- This is done in order to compare the real value of prices and not the ones that are
received as a result of inflation which could suggest an increase in GDP without an
actual increase in economic activity
- The same is done for GNI
How is GDP/GNI per capita measured
- GDP/Size of the population – done in order to compare the living standards between
countries
o E.g., China GDP - $13,457 billion BUT $9,633 per capita, Canada GDP -
$1,733 billion BUT $46,733 per capita
- Same is done for GNI
Why are national income statistics gathered
Data gathered can be used in various ways:
- Judge whether government has been successful in achieving economic growth
- Helps develop policies
- Helps develop models and forecast about future
- Businesses use them to make forecasts about demand
- Analysis of economy’s performance
- Used as a basis to evaluate quality of life
- Used to compare with different countries
Limitations of statistics
- Inaccuracies – data comes from variety of sources and has to be revised – statisticians
need to make effort to make sure that the data used is reliable
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- Unrecorded/under-recorded economic activities – people who do work themselves are

not calculated in GDP but produce the same amount of output were they to hire a firm
to do that – GDP is estimated. Another problem is the hidden economy – where
people work illegally and are thus excluded from the GDP – tax evasion, unrecorded
work – GDP is also estimated
o E.g., farmers that grow food in developing countries
o E.g., high taxes on cigarettes – incentive to get cigarettes illegally; hiring
workers unofficially
o E.g., Mexico – 30.0% of GDP is in hidden economy USA – 8.6%
- External costs – Environmental costs are not included in the GDP therefore even if
output increases, quality of life, due to external costs, does not increase
- Other quality of life concerns – GDP does not include extra-hours work or
volunteering that leads to better standards of living – those could even be discouraged
in pursuit of economic growth
- Composition of output – Some goods do not benefit consumers – defense/capital
goods – GDP will not raise living standards
Business cycle
- Pattern of periods of growth, slow/falling – fluctuations
in economic activities measured by changes in the real
GDP
- Recovery: economic expansion – increase in AD where
consumers spend more and suppliers hire workers
- Boom: increase in AD, increases prices – inflationary
pressure will build up
- Recession: negative GDP growth – reduction in spending
and employment – leads to deflation
- Trough: people are still working and saving, governments
are spending, low interest rates are present – AD will
increase
- Output gap: difference between actual and potential
outputs – below A – unemployment, above B - inflation
Other measures
OECD Better Life Index
- Promotes policies to improve economic/social well-being – 11 topics that are essential
in terms of material living conditions and quality of life
o Housing, income, jobs, community, education, environment, governance,
health, life satisfaction, safety work-life balance
o Countries include – Brazil, China, Russia, South Africa
Happiness Index
- Composite index composed by UN that ranks based on GDP/capita, social support,
life expectancy, freedom of choice, generosity and corruption perception
o E.g., 1st rank – Finland – 7.632 score, 156th rank Burundi – 2.905
Happy planet index
- Sustainable well-being – achieving long and happy lives + sustainability
- Wellbeing * life expectancy * inequality of outcomes / ecological footprint
- Wellbeing: satisfaction of life overall (1-10)
- Life expectancy: average # of years a person is expected to live
- Inequality of outcomes: inequalities between people in terms how long they live how
happy they feel, life expectancy (%)
- Impact that a resident has on the environment (gha/per person)
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Chapter 14 – Aggregate demand

What is aggregate demand

- AD: total spending on goods and services in a period of time
at a given price level 0 where the whole economy and its
sectors are taken into consideration
- Shows the relationship between average price level and real
output – inverse relationship – at low prices more is
demanded
Components of AD
Consumption
- Total spending by consumers on domestic goods/services – looks at durable – cars,
computers (can be used for > 1 year) and non-durable – rice, toilet paper (used up
immediately) goods
Investment
- Addition of capital stock to the economy – goods that are used to produce goods
o Replacement investment: firms spend on capital to maintain productivity of
their capital
o Induced investment: spend on capital to increase their output in response to
higher demand
Government spending
- Spending on variety of goods – depends on policies and objectives of the government
Net exports
- Exports: domestic goods bought by foreigners – inflow of export revenues into the
country
- Imports: goods/services bought from foreign producers – outflow of import
expenditure
- Net component = Revenue – Expenditure (X-M) – can be positive or negative

Shape of AD

Changes in AD
- Movement along: changes in price
- Shift: changes to components of AD
Changes in consumption
Income taxes
- With increased taxes people have less disposable income – that remains for spending
and saving – consumption thus decreases and AD falls – and vice versa
Interest rates
- Consumption falls with increased interest rate to borrow money thus AD falls and
saving becomes more attractive – vice versa
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o E.g., borrowing to buy a house may become expensive and people will have
less income to be used
Wealth
- Income: money people earn
- Wealth: assets people own – physical and monetary – houses and shares. Change to
wealth may happen because of:
o Change in house prices: Increase in prices makes consumers confident to
increase consumption
o Change in value of stocks/shares: Increase in value makes people feel
wealthier, encouraging consumption
Consumer confidence
- If prices are going to rise – reduce consumption in the future and consume now
- If prices are going to fall – consumption is put off until prices fall – durable goods
- If economic future is optimistic – confident to take loans
o E.g., getting a promotion in the future due to a “boom”
- If economic future worsens – people save now
Indebtedness
- With high interest rates consumers will have less disposable income to consumer,
which will lead to falling AD
o E.g., 2019 1,515 Canadians poll revealed that 62% Canadians with debt are
anticipating to take more debt in the upcoming year
Changes in investment
Interest rates
- High interest rates discourage money borrowing rates and
firms are likely to save – there is an inverse relationship
between interest rates and investment
Business taxes
- High corporate taxes will cause the firms to have less money
to invest and so AD will fall – and vice versa
Technological change
- Firms need to invest into new technology to remain
competitive – increases AD
Business confidence
- If demand is likely to fall – decrease in investments
- If demand is likely to increase – increase in investment to increase output and
productivity
o E.g., Brexit – reduced UK business investment
Corporate indebtedness
- Easy to borrow money – business investment increases – and vice versa
- Short-run with high taxes – debt might be taken on but businesses will have less
money to spend – AD falls
Changes in government spending
- Political + economic priorities of the government – depends on commitment and
obligations – increase in spending increases AD
o E.g., spending on schools and hospitals, or giving support to a certain industry
Changes in net exports
- Positive net = trade surplus – AD increases
- Negative net = trade deficit – AD decreases
Level of exports
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- Increase in foreign income increases the amount that the country will export from
your country
- Changes in value of currency – if stronger then the country’s exports are more
expansive – AD falls – and vice versa
- Changes in trade policies – liberalized trade reduces tariffs and allows more exports –
increase AD – and vice versa
- Inflation in trading partners – high inflation in country A than in country B reduces
competitiveness and reduces export revenues – vice versa
Level of imports
- Increase in national income – increases consumption and investment on goods and
components
- Change in exchange rate - increase in exchange rate – makes imported goods less
expensive
- Increased protectionism – decreases import expenditure – vice versa
- Inflation rates – similar as to before

Overall: changes in national income, exchange rates, trade polices and relative inflation rates
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Chapter 15 – Aggregate Supply

What is aggregate supply
- Aggregate supply – total amount of all the goods and
services produced in the economy at a given price level
Short-run AS curve
- Similar to normal supply, and has a positive relationship
between price level and output
- Short-run: Period of time when prices of factors of
production do not change – price of labour is fixed
- In short-run to increase output AC will also increase
Shifters of SRAS
- Movement along: Changes in price levels
- Shift of SRAS: changes in other factors that result in supply-side shocks – factors that
cause changes in costs of production:
o Change in wage rates: increase in wages – increase in costs – AS falls
E.g., increase in minimum wage, labour unions negotiating higher
wages
o Change in raw material costs: increase in widely used raw materials – OIL –
used in production processes – AS falls
Note: increase in price of a rubber (e.g.,) will not increase overall AS
as it is too insignificant
o Import prices: import prices for raw materials increase – AS falls
E.g., euro falls then raw materials become more expensive
o Change in government taxes/subsidies – increase in taxes results in AS fall –
vice versa – similar with subsidies as well
Subsidies will have a lesser impact on SRAS
because it focuses on single product unless it
is essential and widely used – fuel
AD and SRAS
- Meet at an equilibrium where AD = AS
LRAS
New classical LRAS
- Believe in efficiency of market forces and minimum
government intervention should be imposed
- LRAS – inelastic/vertical – full level of employment – potential
output that could be produced if economy was operating at full
capacity
- Potential output – based on quantity and quality of factors of
production – not price level
Keynesian AS
- 3 main phases:
o Phase 1: AS perfectly elastic – low levels of economic
activity – output can be raised without average cost
increase – existence of spare capacity
o Phase 2: Economy approaches potential output – spare
capacity is used up – bidding for resources occurs –
increases cost for producers and higher price level will
compensate
o Phase 3: Economy reaches full capacity – impossible to
increase output further – factors of production are
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employed – AS inelastic – output cannot be increased without improvement of

quantity and quality of factors of production
Shifters of AS and LRAS curves
- Outward shift – productive potential has increased – and is linked to PPC shift – shifts
to the right
- Shifts if there is an improvement in quality (increase in productivity) or quantity of
factors of production – affected by advances in technology
o Land: new resources, land reclamation, more resources AND/OR tech.
advancements, fertilizers and irrigation
o Labour + entrepren.: increase in birth rate, immigration, decrease in
unemployment AND/OR education, training, apprenticeship
o Capital: investment AND/OR technology, R&D
Can come through market forces: e.g., motivation to study for higher
wages, businesses want to earn more profits and want to engage in
R&D
- Government policies are also used to improve quantity/quality of factors of
production – interventionist and market-based
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Chapter 16 – Macroeconomic equilibrium

Equilibrium occurs at a point where AD is equal to AS however there are differences
between short and long-term runs
Level of output in short-run equilibrium
- AD = SRAS – output produced in the economy is equal to
the total demand in the economy and there are no upward or
downward pressure on price levels
Level of output in long-run equilibrium
- AD = LRAS – different for different schools of thought
New classical perspective
- Economy will always move towards long-run equilibrium –
where AD meets LRAS
- Any changes in AD – will be on price level
- Automatic movement towards equilibrium – means without
any government intervention
- Inflationary gap: occurs where economy is in equilibrium of
level of output is greater than the full employment level of
output (AD rises)
- Believe that it will return to equilibrium in the long-run
because there are no unemployed resources – for example a rise
in price levels indicates that factors of production also cost more
– therefore SRAS will fall and return to equilibrium
- Deflationary gap: occurs when economy is in equilibrium at a
level of output that is less than the full-employment level of
output (AD falls)
- Will not persist because prices for factors of production will also
fall, meaning that SRAS will shift and increase, returning to
long-run equilibrium
- Overall: no need for government intervention – AD will be purely inflationary in the
long run and they recommend that the government leaves economy to market forces

Inflationary Deflationary

Keynesian perspective
- Equilibrium occurs at AD=LRAS but at different levels – at a
level of output below the full employment level of a national
income – where spare capacity is present
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- Deflationary/output gap – level of AD is not sufficient to buy the

potential output – can also be seen on a PPC
- AD can increase output without increasing price – due to spare
capacity, however if AD continues increasing it can result in an
inflationary pressure
- After reaching full employment the outcome of AD increases will be
purely inflationary and no change in output is seen – increase in
prices occurs due to the allocation of resources along the AD
components
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Chapter 17 – Demand management and demand side policies

Fiscal policy
- Public spending is broken into three categories:
o Capital expenditure: adds on to the capital stock of the economy
E.g., national highway upgrades, building schools
o Current expenditure: spending on purchases of day-to-day goods
E.g., textbooks in schools, wages
o Transfer payments: benefits paid to people for which no goods and services
are produced in return
E.g., unemployment benefits, child support
- Government receive revenues from taxes, tariffs and governmental businesses
- Fiscal policy: governmental policies relation to its expenditure and taxation rates –
use expansionary and contractionary/deflationary fiscal policies to
increase/decrease AD
Aims of fiscal policy
- Maintain low, stable inflation rate
- Low unemployment rate
- Stable economic environment long-term
- Reduce business cycle fluctuations
- Promote equitable income distribution
- Achieve external balance between export revenue and import expenditure
Expansionary fiscal policy
- Form of Keynesian demand management that has a variety of
measures to achieve their aims:
o Encourage consumption – taxes should be lowered to
increase AD
o Encourage investment – corporate taxes should be
lowered to increase AD
o Government projects – increase spending to
improve/increase services to increase AD
Effectivity of fiscal policies
- Effective in the long run when dealing with deep recession
o E.g., Great Depression in the 30s where the governments who used fiscal
policies were more successful than those who weren’t
- Government can help target certain sectors and lift taxes or increase government
investment
o E.g., American recovery and reinvestment act (2009) – Obama made a
stimulus to American families and small businesses to boost demand and
instill confidence
- Nonetheless some constrains include:
o Time lags: takes time to approve of taxes and then implement them and it will
also take time for AD to shift – people need time to react. Taxes can also be
inflationary if the market has fixed itself
o Political pressure: government spending might be affected by political parties
who (e.g.,) do not want an increase in taxes in fear of losing votes
o Sustainable debt: sometimes budget deficits occur because of funding and the
country will then end up in unsustainable national debt in the long run
o Effect on net exports: increase in government borrowing may lead to an
increase in interest and thus exchange rates – exports are less attractive which
will lead to a fall in net exports
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o Crowding-out: to increase spending through increased borrowing the

government prevents the firms to have access to investments – decreasing its
rate
o Inability to achieve specific targets: difficult to predict final outcomes because
of the different areas of economy that are impacted by the fiscal policy
Sustainable level of government debt – a macroeconomic objective
Government (national debt)
- Accumulation of all budget deficits over the years – total amount of money the
government owes to its creditors
- Expressed as a percentage of GDP
o E.g., Japan’s debt as a % of GDP = 253 (2017) with a -4.5% budget deficit;
Singapore – 110.6% with a 0.4 budget surplus (2017)
Costs of high level of government debt
- Good in short-term (deficit spending) as it allows for economic growth
- Long-term debt servicing (amount of money needed to repay interest on loans) costs
increase and has a number of bad effects:
o Crowding out of private investments – increased spending through increased
borrowing prevents firms to have access to investments
o Increase in interest payments leads to the need to cut benefits and services that
the government provides
o To maintain those benefits the government will tax higher – will lead to
decrease in output and income
o Decrease the ability to respond to emergencies – if the debt is too big money
cannot be borrowed
Multiplier effect (HL)
- Multiplier effect: Increase in AD is greater than the amount of spending
- Government spending + investment – injections that are multiplied as people receive
shares of income and then spend it
- Generally people will spend money on taxes, saving and foreign goods and sevices
and the remainder on domestic goods and services – known as marginal property to
consume (MPC)
o E.g., government spends $100 million on construction and their workers - $20
mil. Goes to taxes, $10 on imports and $10 on savings and the rest, 60% is
spent on food, clothing etc… = is re-spent
- Formula:

- All changes depend on withdrawals – if taxes increase multiplier decreases, if imports

fall then multiplier increases
- To fill a deflationary gap the government must estimate the gap between equilibrium
output and full employment output and estimate value of multiplier to judge the
increase in AD – difficult to estimate = limitation to fiscal policy
Monetary policy
- Policies concerning supply of money and level of interest rates
- Base rate – set by central bank – government’s bank – independent body that is
responsible for maintaining a low and stable rate of inflation
Aims of monetary policy
- Inflation targeting – setting a medium-term inflation rate as a goal – 2%
- Low unemployment rate
- Stable economic environment for long-term growth
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- Reduce business cycle fluctuations

- Achieve balance between exports and imports
Expansionary monetary policy
- To increase AD, interest might be lowered – reduces cost
of borrowing OR supply of money could be increased
- Causes an increase in national income, economic growth
and decrease in unemployment = trade-off between low
unemployment and inflation
Effectivity of monetary policies
- Strengths include:
o Quick to put in place – central banks can set interest rates quickly
o No political intervention – adjusted by central banks only = opposite of fiscal
Can implement policies that may be politically unpopular – however
this is theoretical, as some governments may influence their banks
o No crowding out – interest rates are lowered
o Ability to make small changes – allows to have precise targets such as the 2%
goal
- Limitations include:
o Time lags – time is needed to have an effect
o Ineffectiveness when interest rates are low – when the interest is close to zero
it cannot be cut
o Low consumer and business confidence – in deep recession consumption
might not increase even when interest rates are high
Commercial banks creating money (HL)
- Credit creation – creating money – occurs when commercial banks lend money to
customers = making loans based upon the deposits
- Banks give out more than they get – money/banking credit multiplier – related to
minimum reserve requirement (how much money banks must have)
o E.g., depositing $100,000 with the 20% reserve requirement allows for the
bank to give out 4 $100,000 loans with $20,000 backing up
- Size of money multiplier formula:

Tools to control money supply (HL)

- Minimum reserve requirements: the larger the requirement, the smaller the money
multiplier – to reduce money supply the reserve requirement should be increased –
AD falls and vice versa
- Open market operations: buying and selling of government securities – bonds. To
reduce money supply the central bank will sell more
bonds, reducing the amount of money that could be lent,
increasing interest rates – AD falls and vice versa
- Changes in central bank minimum lending rate: rate at
which the bank charges loans – central bank controls it. To
reduce AD the minimum lending rate will be raised,
increasing interest rates and vice versa
- Quantitative easing: introducing new money into the money supply by a central bank
– new money is injected by purchasing assets from commercial banks with newly
created electronic cash; effects include:
o Increases reserves and liquidity of commercial banks – AD increases
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o Lower interest rates – reduces debt of people who borrowed money –

increases confidence
o Low interest rate – exchange rates fall – AD increases
Determinants of equilibrium nominal interest rate (HL)
- Nominal rate of interest – interest rate available that does not allow inflation – if it is
adjusted for inflation, it is real
- Interest rates – opportunity cost of holding money – if nominal
rate is high then there is an opportunity to have large returns
on savings HOWEVER if the nominal rate is high then
opportunity cost of holding money isn’t significant
- Supply of money – constant, thus inelastic – controlled by
central bank
- Money market – demand for money = supply of money
Difference between nominal and real interest rates
- Real rate of interest = nominal rate – inflation rate
o E,g., interest 5% and inflation rate 3% = 2% of real rate of interest – this
shows that those who save money only gain 2%, whereas those who borrow
pay back at 2% rate
When negative, savers lose money at 2%, borrowers pay back 2% less
than borrowed
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Chapter 18 – Supply-side policies

What are supply-side policies and their goals
- Increase long-run AS – increase quantity/quality of factors of
production.
- Goals include
o Long-term economic growth by increasing productive
capacity
o Improve competition and efficiency
o Reduce labour costs and unemployment – increased
labour market flexibility
o Reduce inflation to improve competitiveness
o Increase firms incentive to invest in innovation

What are market-based, supply-side policies

- Focus on allowing markets to operate freely with minimal
government intervention – designed to incentivize hard work
and productivity.
- Policies include:
o Reduction in household income taxes: if taxes are
reduced people are incentivized to be more productive
and work harder
o Reduction in corporate taxes: if taxes are reduced then the businesses are able
to invest into factors of production and research and development, thus
generating positive supply-side benefits
o Labour market reforms:
Reduction in trade union power: reducing union power will reduce the
ability to negotiate higher costs of labour – more workers may be hired
Reduction/elimination of minimum wages: cost of labour will be
reduced
Reduction in unemployment benefits: incentive to look for jobs – if of
course they are available
o Deregulation: with many regulations costs of production may be high, thus
reducing the amount of laws will increase AS
o Privatization: sale of government-owned firms to private sector – makes the
firms more efficient and increase potential output
o Policies to increase competition: increases efficiency and productive potential
o Trade liberalization: free trade – result of removing subsidies, tariffs and
quotas – leads to efficiency to compete with foreign firms
Limitations of market-based supply-side policies
- Reduction in household taxes – might not incentivize people to work – choose to
work less with more income to be disposed. This may also benefit higher wage
earners more than lower wages – increase in income inequality
- Reducing corporate taxes – increases net profits and wealthy shareholders profit from
it – income inequality
- Labour-market reforms – reduction in living standards – income inequality
- Deregulation:
o Negative environmental effects – negative externalities of production
o Reduction in worker safety
o Worsening in working conditions – working hours changed
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- Privatized firms may be sold to those who have connections to the government, thus
having a monopolized firm that does not reduce costs and prices or offers choice
- Time lags to see the effect of policies
Interventionist supply-side policies
- Investment in human capital: providing training and education – could be done
through subsidies and taxation and programs as well as investment in health care
- Research and development: government could finance it themselves, provide tax
credits – firms must spend their profits on research, guarantee IP rights
- Provision and maintenance of infrastructure: necessary for economic activity – the
government will invest into those
o E.g., Nigeria plans to invest $20 billion in infrastructure over the next 5-19
years
- Direct support for businesses/industrial policies: agencies that can improve the
competition in industries, provide subsidies, support companies
Limitations of interventions supply-side policies
- Monetary costs: opportunity cost – spending more money on one than the other
AND/OR spending may increase government indebtedness
- Time lags: to see the potential outcome
- Government: depending on the ideological aims different policies will be
implemented
- Controversies: funding certain education system more than the other, implementing a
certain type of examination rather than the other
Connection between supply-side policies and demand-side policies
Demand-side effects of supply-side policies
- Market based policies, such as tax reduction will increase AD in the short-run
- Interventionist policies all have demand-side effects because of government spending
– increase in spending increases AD
Supply-side effects of demand-side policies
- Expansionary fiscal policy of tax reduction – incentivizes workers to work and allows
for firms to invest – increases AS
- Expansionary fiscal policy of an increase in government spending – increases AS
depending what the government invests in
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Chapter 19 – Macroeconomic Objectives: Low unemployment

What is unemployment and how is it measured
- People of working age without work, available for work and actively seeking
employment
- Unemployment rate:

- Labour force – economically active population that excludes those who are not of age
to work
o E.g., students, parents who look after children, retired = not labour force
Difficulties of measuring
Institutional differences when measuring unemployment
- Depends on who collects it and how – registration of unemployment (Switzerland,
Austria), number of people claiming the benefits (Britain, Belgium), can also
include surveys, records, social security info
o Some may not register as unemployed if benefits are low
Hidden unemployment
- Unemployed for long time that have given up the search – discouraged workers;
- Part-time workers/temporary contracts – want to work full-time
- Over-qualified – working low-jobs and wanting to find jobs that suit their skills
Distribution of unemployment limits national unemployment rates reliability
- The percentage is an average of a whole country and it thus masks the inequalities
that might occur:
o Geographical disparities: different regions might have more problems than
others
o Age disparities: <25 have higher rates than national average
o Ethnic differences: minorities suffer from higher rates than national average –
education or prejudice of employers
o Gender disparities: women have higher rates than men – education,
discrimination by employers
Costs of unemployment
- Costs are associated with long-term unemployment
- Unemployment costs to unemployed: less income than if they worked = low living
standards, long-term unemployment creates stress, anxiety, depression, relationship
break-down and suicide
- Unemployment costs to society: homelessness, high crime and vandalism rates, gang
activities
- Unemployment costs to society: less output produced than potential output – economy
is operation within PPC. Additionally low-income taxes from unemployed reduces
the amount of money the government receives – causing it to spend more money on
other areas
Main factors affecting level of unemployment
- Represented by the pool of unemployment – affected by job creation/reduction – the
main problem are those who remain in the pool and cannot get out
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Labour market
- Represented by AD and AS, where, as wages decrease the demand
for workers increases. AS shows that as average wage rates
increase more people are willing to work
- Equilibrium – AS=AD
Cyclical unemployment
- Refers to the business cycle where during recession demand falls
and factors of production are cut, demanding less workers
- Demand for labour decreases, however wages do not fall because
they are sticky – lower wages are demotivating + union ensure that
wages are kept
Curing cyclical unemployment
- Increase government spending, lower taxes, decrease interest rates,
increase monetary supply
Structural unemployment
Exists in two forms:
1. Permanent fall in demand for a type of labour – as new jobs are created other disappear
- Those who have skills in one area do not have skills for new jobs – lack
occupational mobility
- New jobs are created in one part, but not the other – geographic
mobility
- Causes:
o Technological change – increase in mechanization cuts jobs
o Globalization – setting firms in less expensive countries creates
unemployment in developed countries
E.g., China has low-cost labour and exports more
o Consumer taste changes – alternatives to fuel that decreases demand for coal
- Note: cyclical unemployment may lead to structural if the skills of redundant workers
are no longer needed
2. Change in institutional framework – laws governing labour market and trade unions
- Laws governing labour market:
o Firing requires documentation and proof – this might cause fear to employ
more workers
o Minimum wage implementation – quantity of labour demanded falls
- Laws governing trade unions
o Unions might not allow for firms to employ non-union members, contributing
to unemployment
Curing structural unemployment
- Interventionist – enhance occupational mobility
o Training and education – to learn skills
o Upskilling/retraining programs
o Subsidies to provide training
o Apprenticeship programs (Germany, Austria)
o Job centers – info about jobs and training
- Problems include opportunity cost and effectivity in long-term
- Market based:
o Decrease unemployment benefits – to shift AS of labour to the right
o Deregulation in legislation that businesses follow to hire and fire
- Problems include lower living standards – increase inequity and worse working
conditions
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Frictional unemployment
- Short-term – people are between jobs/education and are looking to move on to a job
Reducing frictional unemployment
- Lower unemployment benefits
- Improving flow of information – internet job sites, job centers and counsellors
Seasonal unemployment
- Demand for workers falls based on time of the year – skiing, water sports instructors,
construction workers
Reducing seasonal unemployment
- Encourage to take different jobs in off-season – try training
- Decrease unemployment benefits
- Increase flow of information
Natural rate of unemployment
Natural rate of unemployment – unemployment that is greater than the equilibrium level –
comprised of structural, frictional and seasonal unemployment
- Structurally unemployed – may not be suited for the job, may not have skills or may
not be aware
- Frictionally unemployed – voluntarily left and are looking for better ones
- Seasonally unemployed – do not have expertise or are not willing to take a different
job
What is more effective in reducing unemployment – demand or supply
- If unemployment is linked to economic activity – demand policies will be used
- All concerns are linked with consumer confidence and how much the government
spends as well as time lags
- Also, even at full employment there will be some unemployment – natural
unemployment – supply-side will be used – no need to increase AD
- Reality: hard to determine the type of unemployment therefore a mix of policies will
be used – interest rates and supply-side policies
Crowding out (HL)
- Running budget deficits – selling bonds to banks that then sell it to
people who want to save money – crowding out
- Because the government borrows, interest rates increase and the
businesses will not borrow more
- AD might not increase as much as the government wanted it to –
however it depends whether the increase in spending outweighs the
fall in investment
- Keynesians argue that crowding out does not occur if the economy
produces less than full employment, whereas new classicists
believe that it is always a problem when government spends
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Chapter 20 – Macroeconomic objectives: low and stable inflation rate

What is inflation
- Persistent increase in average price level in the economy – measures through CPI
Costs of high inflation
- Loss of purchasing power: 2% inflation rate means that prices have risen by 2% - if
your income does not cover costs then you will not be able to buy goods – there is a
fall in real income and fall in purchasing power
o Some workers may have inflation linked incomes and will not lose out
however those who don’t because of self-employment, weak bargaining power
or temporary contracts don’t
o Some problems may also be caused if expected inflation is lower than what
actually happens
- Effect on saving: if inflation rate is higher than the saving interest rate than you lose
money saving rather than spending
- Effect on economic growth: if people save rather than consume (by buying fixed
assets) then there are fewer saving available – negative implications for economic
growth
- Effect on interest rates: with high inflation, nominal interest rates are high, to keep
real rates positive – borrowers will pay back less – savers lose money
- Effect on international competitiveness: if a country’s inflation is higher than its
partner’s then imports are more attractive – this worsens trade balance
- Uncertainty: reduction in investment – negative effect on economic growth
- Labour unrest: wages are not keeping up with inflation – leads to disputes
Measuring inflation
- Consumer price index (CPI) (or RPI retail price index) – measured by using a basket
of consumer goods/services and measure the price change over time
- Include typical goods and weights are given to each specific category – components
are determined by surveys and prices are determined from shopping outlets
Issues in measuring inflation
- Typical household does not include all people – some might live alone, some might
have a large family – CPI is not an accurate reflection of a particular area – is harmful
if a group has a higher cost of living than what the national average states
- Sampling might be inaccurate – some outlets in some cities are selected – but not all
and not a large amount
- Some products may be removed from the basket – comparisons of price changes
cannot be made
- Quality of the products are not included – a price of a better product might increase
but it is no longer the same product
- Different countries measure inflation differently – hard to compare internationally
- Prices may change due to unprecedented events – seasonal variation – usually a core
rate of inflation is thus identified
- CPI measures changes in consumer prices and in order to get the full picture a
commodity price index is used – to measure changes in the factors of production
prices
o Producer price index – tracks prices of goods as they leave factories and
before retailers add profit margins
Causes of inflation
Demand-pull inflation
- Shift in AD – AD components such as:
o High consumer confidence
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o High level of demand of exports

o Increase in government spending
o Monetarists believe that it occurs due to excessive
growth of the money supply by the central bank
Cost-push inflation
- Increase in costs of production – AS decreases, reasons
include:
o Increase in labour costs
o Costs of raw materials
o Increases in costs of imports of materials
o Fall in exchange rate
Demand-pull and cost-push together
- E.g., AD increases due to an increased wealth – prices rise,
more wages are demanded, AS decreases, but because of high
prices AD increases again because consumer think they can
still earn more – inflationary spiral
Government reducing inflation
- Demand-side policies are used for both types of inflation –
contractionary fiscal and monetary – supply-side have a large
time lag
- Fiscal policy: unpopular because of a decrease in government spending and thus there
is less support for the government + there is a legislative time lag
- Monetary policy: high interest rates = harder to repay and investment is decreased
- Cost-push inflation – higher prices and falls in GDP – contractionary policies will
make GDP fall even further, however they are necessary
o Central banks can set target rates explicitly or implicitly – e.g., national bank
of Poland – 2.5% ±1% inflation rate, whereas US has an informal rate
- Trust in central banks allows for consumers to expect inflation to fall and are less
likely to demand higher wages – the more independent the more stable the prices
- Monetary policy – most effective – fiscal policies are too hard to implement –
however it is still hard to tightly control the money supply in the economy
- Problem of trade-off – battle inflation by decreasing AD = unemployment occurs =
fight unemployment by increasing AD – inflation occurs
Deflation
- Persistent fall in the average level of prices in the economy
Good deflation
- Comes from improvements in supply – shift LRAS to the
right – improvements to quality/quantity of factors of
production. Results in a decrease of average price level and
increase in deflation and output – leading to employment
and growth
Bad deflation
- AD falls – prices decrease, output decreases –
unemployment increases as fewer workers are needed
- Not to mix with disinflation – falling rate of inflation
Costs of bad deflation
- Unemployment: AD low – workers are laid off – may lead to a deflationary spiral
- Deferred consumption: consumers wait until prices drop to buy durables – leads to a
deflationary spiral and AD falls
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- Falling consumer confidence: pessimism about the future leads to a fall in AD and a
deflationary spiral
- Effect on investment: less investments because of losses and reduced confidence –
reduces economic growth
- Costs to debtors: debt rises and it is harder to repay – causing bankruptcies – worsens
business confidence
- Policy ineffectiveness: monetary policies are not likely to help increase AD
Weighted price index to calculate inflation (HL)
- To calculate inflation rate:
𝑌2 − 𝑌1
× 100
𝑌1
- Inaccurate because it gives all products an equal weighting – thus weights are used
- Thus, indexes are calculated as follows: weight * index per category and the results
are then added for each year. The previous equation is then used
- Average index = sum of all categories/number of categories
Trade-off between inflation and unemployment (HL)
Phillips curve
- Suggests an inverse relationship between unemployment and inflation
– depending on what the government focuses on, the other variable
will increase
- After 1970s this model was disproved because of stagflation –
combination of high inflation and high unemployment levels
Long-run Phillips curve
- Monetarists explain that natural unemployment will always exist at
an inflation rate – if a demand-management policy is used to
reduce unemployment AD will increase and the inflation rate will
also increase
- Workers would think that there is an increase in wages – however
it is a money illusion – they will then leave those jobs –
unemployment is at the natural rate but at 6%
- As a result higher wages will be demanded and the economy will
be at point C
- LRPC are inelastic and can be shifted through supply-side policies – shifting natural
rate of unemployment
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Chapter 21 – Economic growth

Diagrams to illustrate growth
- Using AD/AS and PPC – where at point a, the economy is
underemploying its factors of production – and increase in AD
increases the output and moves the point a to point b – economy is
moved to full employment of resources
- Economic growth can be achieved by increasing full employment level
– increasing GDP and shifting LRAS and PPC curves – result of an
increase of quality/quantity of factors of production and technology –
through market forces or government policies
Sum up
- Deflationary gaps – fall in economic growth – can be solved by
demand management policies
- Growth in the business cycle is a result of supply-side policies that
generate long-term economic growth
Measuring economic growth

Consequences of economic growth

Positive consequences
- If there are supply-side policies to shift LRAS then there will be a non-
inflationary growth, as AD increases steadily due to increasing
population and increasing prices
- Increase in GDP per capita – improves living standards
- Advancement in technology – improves living standards and makes life easier
- Increase in tax revenue which increases investments and reduces inequality
- High productivity may result in competitiveness of exports – however also
encourages imports – overall increases trade in a country
- Rises in levels of education and human capital – greater demand for freedom and
democracy
Negative consequences
- Higher income may decrease living standards – people might give up their leisure and
relationship times + people are never fully satisfied and always demand more goods
the more they earn
- Economic growth results in structural changes in economy which can results in
structural unemployment – an increase in technology may lead to firms relocating
elsewhere and demand for labour in this country falls – non-equitable growth
o SDG 8 – inclusive and sustainable growth
- Growth may result in higher greenhouse gases emissions and high level of waste and
depletion of non-renewable sources – growth conflicts sustainable development
o SDG 12 – sustainable development
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Chapter 22 – Poverty and inequality

Equality and equity
- Equity: giving same opportunities to succeed – be treated fairly and given resources to
reach full healthy potential
- Equality: economic outcomes are the same for different people
o Some say that inequality gives incentive to work and encourages
entrepreneurship and educating to improve overall productivity
o Inequality rates have been increasing but differently – are a result of unfair
and not inclusive growth catered by national policies and institutions
o Inequality of outcome – what a person earns based on their efforts
o Inequality of opportunity – people do not have access to better job or
education because of their background
Measuring income inequality
- Measured using Lorenz curve, gathering data through national surveys
- Line of absolute equality – perfectly equal distribution – the farther away a curve is
from the line, the more unequal the distribution
- Used to compare countries in terms of income distribution or compare changes in a
country over time
- Gini index: derived from Lorenz curve – area under the line of absolute equality – the
higher the index, the more unequal the country is
- Gini index and HDI are not correlated – some countries may have a high HDI but low
Gini
o E.g., Mauritania – HDI 159th rank, Gini – 32.6 (2018). Finland Gini – 27.1
(2017); South Africa Gini – 63.4 (2017)
Lorenz Curve construction (HL)
- Populations are broken down into 5 quintiles – each representing a percentage of a
population – to construct the curve a cumulative share of incomes must be calculated
(adding all the share of income values)

Inequality of wealth
- Income: all the money that people earn – salaries, bonds, dividends from shares,
assets selling – all the information is submitted to the government for taxation
purposes
- Wealth: net worth – value of total assets (property, money in savings, investments)
minus liabilities (debts)
- Wealth – more concentrated, where top 1% owns almost half of all wealth
Inequality and poverty links
- High inequality results in some sort of poverty
Meaning of poverty
- Absolute poverty: income of a person/household – not enough to meet basic needs
and where people earn less than $1.90 a day – given at PPP exchange rates
o When $1.90 is transferred to countries it will buy approximately the same
amount of goods/services in any country
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SDG 1 – eliminating all extreme poverty by 2030

E.g., Nigeria – 87 million people living in extreme poverty (2018),
Uganda – 14.2 million people living in extreme poverty (2018)
Difference between relative and absolute poverties
- Absolute poverty – stays the same and is based according to costs of basic needs
- Relative poverty – comparative based on living standards in a country – poor relative
to others – people who earn less than 50% 0f median income
o SDG 1.2 – reducing at least half of the proportion of people living in all
dimensions of poverty
Measuring poverty
- Using the international poverty line - $US1.90 – but countries set national poverty
lines to measure relative poverty
o E.g., Australia – 50% of median income – 13.2% of population was in relative
poverty; Korea – 17.4% of total population lives in poverty – 43.8% are those
above 65 years
- Alternatively – setting a minimum amount of income that a household needs to meet
basic needs and enjoy the basic standard of living – controversial method
- Example: market-based measure – using a basket of goods – how much a family
spends per month and multiplying that value by 12 to set a national value
o E.g., Using this method Canada estimated 12.1% of population living in
poverty (2015)
Multidimensional Poverty Index (MPI)
- Poverty exists in different forms (people face many deprivations) – MPI is a
composite indicator that includes those forms
- 3 Key dimensions: health, education, standards of living – MPI has specific ways to
measure those (indicators)
o Health: nutrition, child mortality
o Education: years of schooling, school attendance
o Living standards: cooking fuel, sanitation, drinking water, electricity, housing,
assets
Poor if a person is deprived of a 1/3 of these indicators
- Understanding natures of poverty allows for implementation of specific strategies to
reduce poverty – e.g., focusing on providing nutrition vs. proving sanitation
Difficulties in measuring poverty
- Many types of poverty exist and it is difficult to define and differentiate each one of
them
- Elements of poverty – fears, worries – difficult to measure and thus cannot be
included in measurements
- Surveys to gather data might be of poor quality in countries where resources are
scarce (to improve those techniques)
- Governments may change their national poverty line to show that they are reducing
poverty, however in reality people are in no better place to meet basic needs
Causes of inequality and poverty
- Inequality of opportunities: based on the family and class that a child is born in
determines their future significantly – rich get more opportunities than the poor
o Poverty traps and social mobility – moving from one income level to a higher
one – those who are born in poverty are less likely to move up the social
ladder (intragenerational) or the ability of a person to move to a higher level of
income than their parents (intergenerational)
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o Those born with a disadvantaged background are less socially mobile – those
in LDCs have virtually no opportunities
- Discrimination: occurs based on race, age, ethnicity, religion, sexual orientation –
manifests in opportunities that people face
o Low-incomers do not receive the same education as high-incomers kids
o Wage discrimination: those in the same/similar position receive different
wages because of their characteristics that are not related to their skills
- Differences in human capital: those who are higher-skilled have much higher wages
than low-skilled ones – increasing inequality
o Reduction in trade-union power leads to loss of job and wage falls security
- Different levels of ownership of resources: those with higher incomes are able to earn
more profits and shares – those have risen at a higher rate than salaries – only source
of income for low-incomers – wealth is thus concentrated among the rich
- Globalization and technological progress affect different labour types differently:
technology began suppressing workers and only high-skilled workers are employed to
look after technology and assist overall – middle class is thus hollowed out and low-
income workers lose their jobs – structural unemployment
- Market-oriented, supply-side policies: deregulation created opportunities for wealthy
people to earn more from investments – deepening inequalities – financial system
takes more risks with no supervision. Labour market – creates non-standard contract
employment – no job and wage security, health and safety concerns, decrease in
income
- Government tax and benefits policies: corporate taxes and savings taxes are much
lower than income taxes, which benefits the wealth. Austerity policies reduce
spending to reduce debts – reduces investments into redistribution of income
o E.g., unemployment insurance, child benefits
- Unequal status and power: wealthy people are more likely to affect political decisions
if their candidate has been chosen – low-income people have no say because they lack
the background to run political activities
Consequences of inequality and poverty
For economic growth
- Gaps between classes will motivate low-income workers to train and learn to get
better paying jobs – investment is needed for economy to grow
- Inequality harms growth – low-income workers are most likely to be stuck in the
poverty cycle. Social and political instability are also results of poverty and are
damaging to growth
For living standards and social stability
- Poverty causes people to stress and worry and choose what products to get with
limited incomes
- Areas that have a greater concentration of low incomes are less likely to have good
schools and teachers, as well as infrastructure
- Inequality may also lead to hostility and increase in social tension and criminal
behaviour – and the political system is unlikely to be supported
Role of taxation in reducing poverty, income and wealth inequality
- Progressive taxes: as income rises, people pay higher percentage of their income –
pay a larger percentage
o Comes in a tax on wealth form – charge people based on the value of their
assets (few countries impose this) – but this could help reduce income taxes in
middle and low incomers
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o Can also be included in corporate taxes however in reality MNCs and firms
evade large taxes by hiring tax experts that minimize their tax commitments
Calculating progressive taxes (HL)
- Normally you would be given a table with different brackets and you would be given the
value a person earns
- Then you calculate the difference of taxable income and multiply it with the tax rate – you
continue doing so and adding up the values until the bracket with the given income is reached

- Average tax rate = total tax paid/total income * 100

- Important to note that those tables are too simplified and normally some amount would be
deducted – for example when moving, or when donating to a recognized charity
- Check p.343 for more practice questions!
Regressive taxes
- Indirect, take a larger share of income from lower income people than higher income
people
- Can be used to discourage consumption of goods – however worsen income
inequality
Pros and cons of progressive taxes as a means of achieving an equitable income distribution
Pros:
- Progressive taxes lower the gap between high- and low-income people and allow to
achieve greater equity
- Also allows the government to collect funds to finance expenditures and redistribution
– social services and welfare programs
Cons:
- People might feel that hard work is going to result in having to pay more – less
incentive to work
- High taxes discourage entrepreneurial activity – some might even leave the country
- Taxes on interest could depress saving and stock/share purchases – deprives financial
markets of funds
Those however do not have notable effect on the richest people in populations
Further policies to reduce poverty and inequalities in income and wealth
Transfer payments
- Tax revenues are used to redistribute income and provide assistance to improve living
standards – income is transferred from some group to support others
o Child support, maternity/paternity benefits, pensions, housing allowances
o Can be universal: given to everyone, or means tested: given to those who meet
requirements or whose income is below a certain level
Policies to promote equal opportunities through human capital investments
- Quality of spending is what ensures equity – governments need to plan policies –
subsidies, transfers, programs that allow people to get opportunities. Those include:
o Health insurance – access to health care
o Programs to provide pre- and post-natal care to low income families
o Access to good quality child care and preschool programs – subsidies to make
affordable education
o Conditional cash transfers – money given to parents on conditions –
immunization/school attendance – elevate poverty and increase human capital
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o School food policies – food to poor children

o Health education – improve diet and nutrition
o Recruitment of quality teachers and resources in disadvantaged areas
o After-school programs to teach skills and provide safe environments
o Support for low-performing students
o Apprenticeships to prepare for work
o Financial support, tutoring to prepare students for higher education
o Training and experiences to help those who lost jobs
o Community programs to provide parenting support
o Resources towards elder care – helps senior citizens with low pensions
Policies to reduce gender and other discrimination
- Diversity policies that ensure that everyone gets to be treated equally. Those include:
o Laws to ensure equal pay
o Action to encourage work places to have greater diversities and provide
opportunities for those who have been discriminated against
o Legislation – illegal to discriminate against others
o Diversity quotas – those who have been discriminated must take a % off all
working people in a business
o Mandating a certain percentage of boards of directors be women
o Requirements for accessibility – disabled will not be excluded
What do increased minimum wages achieve
- Minimum amount of remuneration that an employer can legally pay a worker –
protects workers against unduly low pay – element of policies to overcome poverty
- Minimum wages should be raised if workers are not able to get out of poverty and are
stull struggling
- Arguments for raising minimum wage:
o Some work cannot be done by machines
o Higher wages motivate and increase productibity
o Higher wages encourage to stay in jobs longer
o Higher wages encourage to join labour market
o Higher wages result in increased consumption
o Helps escape poverty traps
o Can help narrow the wage gap between men and women
o Helps reduce inequality
- Arguments against:
o Machines may replace workers
o Higher wages mean higher costs of production and thus prices
o Businesses that cannot afford higher wages will go out of business -
unemployment
Universal Basic Income
- All citizens receive a guaranteed amount with no conditions or requirements – would
be enough to keep people above the poverty line – would be the same for everyone
- Is used because many times the unemployment benefits are better than job payments
and it disincentivizes people to look for jobs
- Arguments against:
o Giving money for free disincentivizes people to look for jobs
o Expensive
o Giving it to rich people?
- Arguments for:
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o Money allows for people to escape poverty and start a business, look for a job,
return to school
o Money could be collected from taxing the rich, removing welfare payments,
redistributing income
o Giving it to rich people makes it universal and ensures that it is not yet another
form of welfare payment