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UNEMPLOYEMENT, FISCAL POLICY, GLOBALISATION, INTERNATIONAL TRADE, MONETARY…
UNEMPLOYEMENT
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Effect of Unemployment
Loss of job skills
▪ If unemployment persists for a long period, individuals will lose their job skills, causing a loss in human capital. It will also lead them to radical social and political activities by increasing crime rates.
Permanent loss of output of goods and services ▪ An economy with high unemployment is not using all of their resources, especially labour available to it.
- The economy is operating below its production possibility frontier, reducing the economy’s efficiency and production.
Loss in government revenue
▪ High unemployment means that the government will receive less taxation revenue but will have to pay more on unemployment benefits.
Social problems ▪ Unemployment results in lower morale and human suffering. The family unit will be affected if the sole bread-winner were to lose his job.
- Social problems arise if the unemployed turn to drugs or crime.
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Unemployment Insurance
- a government program that partially protects the incomes of workers who become unemployed
FISCAL POLICY
Public Finance
Field of economics that studies the government actions and the various ways of financing government expenditure.
Government Revenue
Money collected by a government from various sources. Government earned by received from taxes levied on income and wealth accumulation of individuals Non-tax revenues from fees & penalties and non-revenues receipts
Tax revenue
A compulsory contribution imposed by the government on private individuals and organizations to raise revenue to finance the expenditure on public goods and services. It is the most important source of government revenue.
Non-tax revenue
Non-tax revenues are revenues which arise from other sources besides tax. It includes receipts from licences, regulation fees and permits, services fees, sales of goods, interest and returns on investment and fines.
Non-revenue receipts
Refunds of expenditure, interdepartmental credit, refunds of overpayment, erroneous payment, reimbursement and contribution from government departments, statutory bodies and government-owned enterprise.
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ROLES
- Fiscal policy is implemented to counter the effects of booms and slumps, and to maintain economic stability.
- It is used to prevent an economy from experiencing a prolonged recession, such as during the financial crisis in 1997 and 1998 and the debt crisis in 2008.
- Fiscal policy can raise the general level of real income and aggregate demand. In addition, the fiscal policy is also used to curb inflation, such as during the oil crisis in the 1970s.
- Fiscal policy is implemented to smoothen the fluctuations in the economy associated with the business cycle. This involves reducing government expenditure or raising taxes when the economy is on the verge of overheating.
- Conversely, at the onset of recession, as problems of unemployment and declining output worsen, the government shall cut taxes or raise government expenditure to boost its economic activities.
TYPES
Contractionary Policies
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- Contractionary fiscal policy is a policy that is used as a macroeconomic instrument by the country’s central bank or finance ministry to slow down the economy.
- Contractionary policies are authorized by a government to decrease the money supply and eventually, the spending in a country.
- Contractionary fiscal policy is the use of government spending, taxation and transfer payments to shrink the economic output.
- When an economy is in a situation where its growth is at a rate that rampantly causes inflation, contractionary fiscal policy may be used to bring it to a more sustainable level.
Decreasing Government Spending :
- Government spends less/buys fewer goods & services, chain of events lead slower GDP growth
Raising Taxes :
- Government increases taxes, consumers and businesses have fewer dollars to spend/save, also lead slows growth of GDP.
Expansionary Policies
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- When an economy in recession or depression, the expansionary fiscal policy used to stimulate economic activities. This type of fiscal policy results is increase government spending and lower taxes.
- A recessionary or deflationary gap occurs when the actual GDP below its long-run level. It shows that aggregate demand at which the GDP is lower than it would be in a full employment situation.
- A government will usually increase their spending, which will directly increase the aggregate demand in order to close this gap, since government spending creates demand for goods and services.
- The national income will increase through the multiplier effect.
Increasing Government Spending :
- Triggers a chain of events that raise output and creates jobs
Cutting Taxes :
- Consumers and businesses have more money to spend or invest so increases demand and output.
FINANCIAL INSTITUTIONS
Financial System
- Group of institutions in the economy (help match one person’s saving with another person’s investment)
- Moves the economy’s scarce resources from savers to borrowers.
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National Income Accounts
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Identity
- An equation that must be true because of the way the variables in the equation are defined
- Clarify how different variables are related to one another
Accounting Identities
GDP :
- Total income
- Total expenditure
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Closed economy :
- Doesn’t interact with other economies
- NX = 0
Open economy :
- Interact with other economies
- NX ≠ 0
Assume closed economy : NX = 0
National saving (saving), S
- Total income in the economy that remains after paying for consumption and government purchases
- Y –C –G = I
- S = Y –C –G
- S = I
T = taxes minus transfer payments
- S = Y –C –G
S = (Y –T –C) + (T –G)
Private saving, Y –T –C
- Income that households have left after paying for taxes and consumption
Public saving, T –G
- Tax revenue that the government has left after paying for its spending
Budget surplus: T –G > 0
- Excess of tax revenue over government spending
Budget deficit: T –G < 0
- Shortfall of tax revenue from government spending
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Saving = Investment
- For the economy as a whole
- One person’s savings can finance another person’s investment
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GLOBALISATION
Advantages
- Increase productivity when countries produce goods and services
- Promote global competition
- Cheaper import keeps prices low and inflation at bay.
- An open economy encourages technological development and innovation
- Jobs in export industries pay more than those in import-competing industries
- Free movement of capital gives domestic scene access to foreign investment and keeps interest rates low
Consequences
- Economic governance and regulation
- International trade & trade liberalisation
- International finance: FDI, capital mobility and the foreign portfolio investments
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- Malaysia implemented multi-faceted strategies to face the challenges of globalization:
- Sound macroeconomic management
- Banking reforms
- Strengthening human resource base and training reforms
- Development of SMIs, Science and Technology (S&T) and R&D
- Enhancing quality of life
- Strengthening moral and ethical values
Disadvantages
- Millions of jobs lost to imports or production abroad; those displaced find lower-paying jobs.
- Millions of domestic workers fear getting laid off.
- Workers face pressure for wage concessions under threat of having the jobs move abroad.
- Service and white-collar jobs are joining blue-collar ones and they are vulnerable to moving overseas
- Local workers may lose their competitiveness when firms build state-of-the-art factories in low-wage countries
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Meaning
the process of international interaction and integration among people, companies and governments of different nations through open trade, investments, financial flows, and mutual exchange of ideas, information, technology and knowledge
characterised by an increase in flow of trade, capital, and information as well as mobility of individuals to cross borders.
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INTERNATIONAL TRADE
- Closed economy
- Economy that does not interact with other economies in the world
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- Open economy
- Economy that interacts freely with other economies around the world
Open economy
Interacts with other economies in two ways:
- It buys and sells goods and services in world product markets
- It buys and sells capital assets such as stocks and bonds in world financial markets
- Beside participation in world market, residents of an open economy also participate in world financial markets.
The Flow Of Goods
Exports (X)
- Goods & services - produced domestically and sold abroad
Imports (M)
- Goods & services - produced abroad and sold domestically
Net exports (X-M) - Trade balance
- Value of a nation’s exports minus the value of its imports
Trade balance (Net exports)
Net exports(NX) :
- measure the imbalance between a country’s exports and its imports
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Trade surplus (Positive net exports)
- Exports are greater than imports (X > M)
- indicate country sells more goods & services abroad than it buys from other countries
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X > M
NX > 0
Y > C + I + G
S > I
NCO > 0
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• Income, Y (C+I+G+NX) > Domestic spending (C+I+G)
• If Y > spending, then saving, S (Y-C-G) must be > I (investment)
• Because saving is more than investment, country must be sending some saving abroad, hence NCO must be positive (> 0)
Trade deficit (Negative net exports)
- Imports are greater than exports (X < M)
- indicate country sells fewer goods & services abroad than it buys from other countries
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X < M
NX < 0
Y < C + I + G
S < I
NCO < 0
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• Income, Y < Domestic spending (C+I+G)
• If income, Y < spending, then saving, S < investment, I
• Because the country is investing more than it is saving, it must be financing some domestic investment by selling assets abroad, hence NCO must be negative (< 0)
Balanced trade
- Exports equal imports (X = M)
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X = M
NX = 0
Y = C + I + G
S = I
NCO = 0
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• Income, Y = Domestic spending (C+I+G) • Saving, S = Investment, I
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Factors influence a country’s exports, imports, and net exports:
- Tastes of consumers for domestic and foreign goods.
- Prices of goods at home and abroad.
- Exchange rates at which people can use domestic currency to buy foreign currencies.
- Incomes of consumers at home and abroad.
- Cost of transporting goods from country to country.
- Government policies toward international trade.
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- Y = C + I + G + NX,
- S = I + NX
- National saving : S = Y – C – G
(income of the nation after paying for current consumption and government purchases)
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Rearranging the equation,
Y – C – G = I + NX,
where, S = I + NX
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Because NX = NCO, re-write the equation as:
S = I + NCO
- which is Saving = Domestic investment + Net capital outflow
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Purchasing-Power Parity
Theory of exchange rates
- a unit of any given currency should be able to buy the same quantity of goods in all countries
- principle called the law of one price: a good must sell for the same price in all locations
Arbitrage
- the process of taking advantage of price differences for the same item in different markets
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Implications of PPP
If purchasing power of the dollar is always the same at home and abroad
- Then the real exchange rate cannot change
Theory of purchasing-power parity
- Nominal exchange rate between the currencies of two countries
- Must reflect the price levels in those countries
Limitations of PPP
Theory of purchasing-power parity
does not always hold in practice
- Many goods are not easily traded
- Even tradable goods are not always perfect substitutes
- When they are produced in different countries
- No opportunity for profitable arbitrage
Purchasing-power parity
- Not a perfect theory of exchange-rate determination
- Real exchange rates fluctuate over time
Large and persistent movements in nominal exchange rates
- Typically reflect changes in price levels at home and abroad
MONETARY POLICY
Meaning of money
- set of assets in an economy that people regularly use to buy goods and services from other people
-Without money, trade would require barter
- Every transaction would require a double coincidence of wants—the unlikely occurrence that two people each have a good the other wants
functions of money
medium of exchange
- item buyers give to sellers when they want to purchase good & services.
unit of account
- the yardstick people use to post prices and record debts.
store of value
- item people can use to transfer purchasing power from the present to the future
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Type of money
Commodity money
- with intrinsic value (have value even not used as money)
- Examples: sheep, gold coins
Fiat money
- without intrinsic value
- Example: Paper money and coins
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Characteristics
- Acceptability
- Durability
- Divisibility
- Portability/transportability
- Scarcity
- Uniformity or homogeneity
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Money Supply
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Assets
- Currency: the paper bills and coins in the hands of the public (non-bank).
- Demand deposits: balances in bank accounts that depositors can access on demand by writing a check
Measures
M2: a broader and less liquid definition, everything in M1 plus savings deposits, small time deposits, money market mutual funds, and a few minor categories.
M3: the broadest definition of the supply of money with the lowest liquidity, includes M2 plus savings, fixed deposits in other financial institutions, merchant banks and discount houses
M1: The most narrowest definition and it comprises of the most liquid assets ; include currency, demand deposits, traveler’s checks, and other checkable deposits.
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INFLATION
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Effects of Inflation
- Unequal income distribution and wealth
- Reduce investment and production
- The amount of saving will decrease
- Deficit in the balance of trade
- Breakdown in functions of money
- Defined as a persistent and sustained increase in the general price level.
- increase in the cost of living, causes lower purchasing power.
- inverse relationship between inflation and the value of money.
- Inflation is measured by using the Consumer Price Index (CPI)
BUSINESS CYCLE
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What are Business Cycle?
A periodic (collect in longer year) but irregular fluctuations (up-and-down movement) of total production and other measures of economic activity.
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- Bank Reserves - banks keep only a fraction of deposits as reserves and use the rest to make loans
The reserve ratio (R) = fraction of deposits that banks hold as reserves /
=total reserves as a percentage of total deposits
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