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

Measuring econ activity and illustrating variations

National Y accounting

GDP

  • income, output and expenditure methods
  • calculations from national Y data, using expenditure approach

GNI

  • calculations from data
  • real vs nominal & calculation using GDP deflator
  • pc & calculation
  • ppp

Business cycle

Circular flow of income

  • leakages & injections

Appropriateness of GDP and GNI

  • comparison
  • over time
  • country comparisons

Alternative Measures:

  • OECD Better Life Index
  • Happiness Index
  • Happy Planet Index

Variations in Econ Activity

AD

components: C,I,G,X,M

determinants:

  • C: consumer confidence, interest rates, wealth, income taxes, level of household indebtedness, expectations of future price level
  • I: interest rates, business confidence, tech, business taxes, level of corporate indebtedness
  • G: political and economic priorities
  • X-M: income of trading partners, exchange rates, trade policies

SRAS

determinants:

  • costs of FoP
  • indirect taxes

Alternative views of AS:

  • Monetarist/ New Classical vs Keynesian
  • recessionary gaps

LRAS

Keynesian vs New Classical

determinants:

  • changes in Q&Q of FoP
  • improvements in tech
  • increases in efficiency
  • institutional changes

SR Equilibrium

New Classical

  • LR equilibrium at full employment level of output
  • automatic adjustment
  • unemployment at LR equilibrium = full employment

Keynesian

  • persistance of recession

Assumptions of Keynesianism vs New Classical

Economic Objectives

Economic Growth

Short-term growth

  • actual growth on PPC
  • role of AD

Long-term growth

  • shifts of PPC
  • role of LRAS

Measuring econ growth & calculating from a set of data

Consequences of econ growth including:

  • living standards
  • environment
  • income distribution

Low Unemployment

Measurement of unemployment and the unemployment rate
& calculating from a set of data

Difficulties of measuring unemployment

Causes of unemployment—cyclical (demand deficient), structural, seasonal, frictional

Natural rate of unemployment—sum of the structural, seasonal, frictional unemployment

Costs of unemployment—personal, social & economic costs

Low & Stable inflation

Measuring the inflation rate, using consumer price index (CPI) data & calculation

The limitations of the CPI in measuring inflation

Causes of inflation—demand-pull and cost-push

Costs of a high inflation rate—uncertainty, redistributive effects, effects on saving, damage to export competitiveness, impact on economic growth, inefficient resource allocation

Causes of deflation—changes in AD or SRAS

Disinflation and deflation

Costs of deflation—uncertainty, redistributive effects, deferred consumption, association with high levels of cyclical unemployment and bankruptcies, increase in the real value of debt, inefficient resource allocation, policy ineffectiveness

How do Govts manage their economies and how effective are their policies?

Demand-Side Policies

Fiscal

Monetary
Control of money supply and interest rates by the central bank

Goals of monetary policy

  • low and stable inflation
  • inflation targeting
  • low unemployment
  • reduce business cycle fluctuations
  • promote a stable economics environment for long-term growth
  • external balance

The process of money creation by commercial banks

MM Diagram

Tools of monetary policy

  • open market operations
  • minimum reserve requirements
  • changes in teh CB min lending rate (discount rate)
  • QE

Real vs nominal int rates

  • calculation of real interest rates from data

Expansionary and contractionary policies

Effectiveness of MP

  • constraints including: limited scope when close to zero, low consumer & bus confidence
  • strengths including: incremental, flexible and easily reversible; short time lags
  • strengths and limitations in promoting growth, low unemployment, and stable inflation

Sources of revenue:

  • direct & indirect tax
  • sale of g&s from state-owned enterprises
  • sale fo govt assets & expenditure

Goals of FP:

  • low and stable inflation
  • low unemployment
  • promote a stable economic environment for long-term growth
  • reduce business cycle fluctuations
  • equitable distribution of income
  • external balance

Expansionary & contractionary policies

Keynesian Multiplier

Effectiveness of FP

  • constraints including:political pressure; time lags; sustainable debt; crowding out (HL)
  • strengths including: targeting specific sectors; govt spending effective in deep recession
  • automatic stabilisers: preogressive taxes & unemployment benefits
  • strengths & limitations in promoting growth, low unemployment and low and stable inflation

Supply-Side policies

Goals of SS Policies

  • long-term growth by increasing the economy’s productive capacity
  • improving competition and efficiency
  • reducing labour costs and unemployment through labour market flexibility
  • reducing inflation to improve international competitiveness
  • increasing firms’ incentives to invest in innovation by reducing costs

MB policies

Encourage competition

  • deregulation
  • privatisation
  • trade liberalisation
  • anti-monopoly legislation

Labour market policies

  • reduce power of trade unions
  • reduce unemployment benefits
  • abolish min wages (diagram)

incentive related policies

  • personal income tax cuts
  • corporate and CGT tax cuts

Interventionist-based policies

  • education, training
  • improving, Q, Q and access to healthcare
  • R&D
  • provision of infrastructure
  • industrial policies

Demand-side effects of SS policies
&
SS effects of fiscal policy

Effectiveness of SS policies

Constraints on SS policies:

  • market based: equity issues, time lags, vested interests, environmental impact
  • interventionist—costs, time lags 


Strengths of SS policies

  • market based: improved resource allocation, no burden on government budget
  • interventionist—direct support of sectors important for growth

Strengths and limitations in promoting growth, low unemployment, and low and stable rate of inflation

MACROECONOMICS

Calculation of CPI using a weighted price index

Relative costs of inflation vs unemployment

Sustainable level of govt (national) debt

Measurement of national debt as a % of GDP

Relationship between budget deficit and government debt

Costs of high govt debt:

  • debt servicing costs
  • credit ratings
    impacts on future taxation and govt spending

Trade-off between inflation and unemployment: SR & LR Phillips Curve

Inequality & Poverty

Inequality

Meaning of economic inequality

  • unequal distribution of income
  • unequal distribution of wealth

Measuring inequality (Lorenz Curve and Gini coefficient)

Constructing a Lorenz Curve from income quintile data

Poverty

Meaning of Poverty

  • absolute poverty
  • relative poverty

Measuring Poverty

  • single indicators including international poverty lines, minimum income standards
  • composite indicators including the MPI

Relationship between equality & equity

Difficulties in measuring poverty

Causes of inequality & poverty:

  • inequality of opportunity
  • different levels of resource ownership
  • different levels of human capital
  • discrimination (gender, race and others)
  • unequal status and power
  • govt tax and benefits policies
  • globalisation and tech change
  • market-based SS policies

Impact of inequality and poverty on:

  • econ growth
  • standards of living
  • social stability

Policies to reduce poverty, wealth and income inequality

Taxation

  • progressive, regressive and proportional tax rates
  • direct taxes (personal, corporate and wealth taxes)
  • indirect taxes

Calculation of indirect tax paid from a given tax rate and level of expenditure

Calculation of total tax and avg tax rates from set of data

Average and marginal tax rates

Further policies

  • policies to reduce inequalities of opportunities / investment in human capital
  • transfer payments
  • targeted spending on g&s
  • universal basic income
  • policies to reduce discrimination
  • min wages

Expenditures:

  • current expenditures
  • capital expenditures
  • transfer payments