Unit 3 Macroeconomics

• National income accounting measures economic activity • Income, output, and expenditure approaches are equivalent in the circular flow model • Diagram: circular flow of income showing decision-makers, leakages, and injections

• Nominal GDP measures national output within a country • Nominal GNI adjusts GDP for net income flows with the rest of the world • Calculation: nominal GDP using the expenditure approach • Calculation: nominal GNI from data

• Real GDP and real GNI adjust for price changes • Per capita measures divide real GDP or real GNI by population • Purchasing power parity (PPP) adjusted measures improve international comparisons • Calculation: real GDP and real GNI using a price deflator • Calculation: real GDP per capita and real GNI per capita

• The business cycle shows short-term fluctuations around a long-term growth trend or potential output • Diagram: business cycle with short-term fluctuations and long-term growth trend

• GDP and GNI statistics have limits when measuring economic well-being • National income data can be used for comparisons over time and between countries • Alternative well-being measures include the OECD Better Life Index, Happiness Index, and Happy Planet Index

• Aggregate demand equals consumption, investment, government spending, and net exports • AD = C + I + G + (X - M) • Diagram: AD curve

• Consumption depends on consumer confidence, interest rates, wealth, income taxes, household debt, and expected future prices • Investment depends on interest rates, business confidence, technology, business taxes, and corporate debt • Government spending depends on political and economic priorities • Net exports depend on trading partner income, exchange rates, and trade policies • Diagram: shifts of the AD curve

• SRAS depends on costs of factors of production and indirect taxes • Diagram: SRAS curve • Diagram: shifts of the SRAS curve

• Monetarist and new classical models use a long-run aggregate supply curve • Keynesian models use a Keynesian aggregate supply curve • Models show inflationary and deflationary or recessionary gaps • Diagram: alternative views of the AS curve

• LRAS or Keynesian AS can shift with quantity or quality of factors, technology, efficiency, and institutions • Diagram: shifts of LRAS or Keynesian AS

• Short-run equilibrium occurs where AD intersects AS • Monetarist and new classical models determine long-run full employment equilibrium at potential output • In the monetarist or new classical model, automatic adjustment returns the economy to full employment and unemployment equals the natural rate of unemployment • In the Keynesian model, deflationary or recessionary gaps can persist • Diagram: macroeconomic equilibrium in short run and long run

• Monetarist, new classical, and Keynesian models rely on different assumptions • Their implications differ for policy, adjustment, unemployment, and output gaps

3.3.1Economic growth

• Short-term growth includes actual growth in the PPC model and AD-driven increases in real output • Long-term growth includes outward PPC shifts and LRAS-driven increases in full employment output • Economic growth is measured using growth rates • Diagram: PPC showing actual growth and growth in production possibilities • Diagram: AD increase showing higher real output • Diagram: LRAS increase showing higher full employment output • Calculation: economic growth rate from data

3.3.2Consequences of economic growth

• Growth can affect living standards, the environment, and income distribution • Evaluation requires weighing benefits against costs and sustainability concerns

3.3.3Low unemployment

• Unemployment rate measures unemployment relative to the labour force • Measuring unemployment can be difficult • Causes include cyclical, structural, seasonal, and frictional unemployment • Natural unemployment is the sum of structural, seasonal, and frictional unemployment • Costs include personal, social, and economic costs • Calculation: unemployment rate from data • Diagram: minimum wage causing unemployment • Diagram: fall in demand for labour in a market or region • Diagram: deflationary gap showing cyclical unemployment

3.3.4Low and stable inflation

• Inflation is measured using CPI data • CPI has limitations as an inflation measure • Inflation can be demand-pull or cost-push • High inflation creates uncertainty, redistributive effects, saving effects, export competitiveness damage, lower growth, and inefficient allocation • Calculation: inflation rate from weighted CPI data • Diagram: demand-pull inflation • Diagram: cost-push inflation

3.3.6Deflation and disinflation

• Deflation can be caused by changes in AD or SRAS • Disinflation is a fall in the inflation rate; deflation is a fall in the price level • Deflation costs include uncertainty, redistributive effects, deferred consumption, cyclical unemployment, bankruptcies, higher real debt, inefficient allocation, and policy ineffectiveness • Diagram: deflation

3.3.7Inflation versus unemployment

• Policymakers compare the relative costs of unemployment and inflation • Trade-offs may appear between low unemployment and low inflation

3.3.10Conflicts between macroeconomic objectives

• High economic growth may conflict with low inflation • High growth may conflict with environmental sustainability • High growth may conflict with equity in income distribution

• Equality and equity are related but distinct concepts • Equity involves fairness and may require normative judgment

• Economic inequality includes unequal distribution of income • Economic inequality also includes unequal distribution of wealth

• Lorenz curve and Gini coefficient measure income distribution • Diagram: Lorenz curve showing income distribution and changes in distribution

• Absolute poverty differs from relative poverty • Poverty can be measured using international poverty lines and minimum income standards • Composite measures include the Multidimensional Poverty Index • Measuring poverty has practical and conceptual difficulties

• Causes include unequal opportunity, resource ownership, human capital, discrimination, status, and power • Government tax and benefit policies can affect inequality and poverty • Globalisation, technological change, and market-based supply-side policies can affect inequality and poverty

• Income and wealth inequality affect economic growth • Inequality affects standards of living and social stability

• Progressive, regressive, and proportional taxes affect distribution differently • Average and marginal tax rates are used to analyse tax burdens • Direct taxes include personal income, corporate income, and wealth taxes • Indirect taxes affect expenditure and can be regressive

• Policies include investment in human capital and reducing inequality of opportunity • Transfer payments, targeted spending, universal basic income, anti-discrimination policies, and minimum wages can reduce poverty or inequality

• Monetary policy is central bank control of money supply and interest rates • Goals include low stable inflation, low unemployment, reduced business cycle fluctuations, long-term growth conditions, and external balance

• Nominal interest rates are not adjusted for inflation • Real interest rates adjust nominal rates for inflation • Calculation: real interest rate from data

• Expansionary monetary policy can close deflationary or recessionary gaps • Contractionary monetary policy can close inflationary gaps • Diagram: AD/AS showing expansionary and contractionary monetary policy

• Constraints include near-zero interest rates and low consumer or business confidence • Strengths include incremental adjustment, flexibility, reversibility, and short time lags • Evaluation considers effects on growth, unemployment, and price stability

• Fiscal policy uses government revenue and expenditure • Revenue sources include direct taxes, indirect taxes, state-owned enterprise sales, and sale of government assets • Expenditure includes current spending, capital spending, and transfer payments

• Goals include low stable inflation, low unemployment, long-term growth conditions, reduced business cycle fluctuations, equity in income distribution, and external balance

• Expansionary fiscal policy can close deflationary or recessionary gaps • Contractionary fiscal policy can close inflationary gaps • Diagram: AD/AS showing expansionary and contractionary fiscal policy in Keynesian and monetarist/new classical models

• Constraints include political pressure, time lags, and sustainable debt • Strengths include targeting specific sectors and effective government spending in deep recessions • Evaluation considers effects on growth, unemployment, and price stability

• Supply-side policies aim to increase productive capacity and long-term growth • Goals include competition, efficiency, labour market flexibility, lower inflation, international competitiveness, and incentives for innovation

• Competition policies include deregulation, privatization, trade liberalization, and anti-monopoly regulation • Labour market policies include reducing union power, reducing unemployment benefits, and abolishing minimum wages • Incentive policies include personal income tax cuts, business tax cuts, and capital gains tax cuts • Diagram: AD/AS and LRAS showing effects of supply-side policies • Diagram: minimum wage

• Interventionist policies include education, training, health care, research and development, infrastructure, and industrial policies • These policies target quality and quantity of factors of production

• Supply-side policies can have demand-side effects • Fiscal policies can have supply-side effects

• Market-based constraints include equity issues, time lags, vested interests, and environmental impact • Interventionist constraints include costs and time lags • Market-based strengths include improved resource allocation and no direct burden on the government budget • Interventionist strengths include direct support for sectors important for growth • Evaluation considers growth, unemployment, and price stability