IB Economics/Macroeconomics

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[edit] Macroeconomics

[edit] Measuring National Income

Circular flow of income
Methods of measurement - income, expenditure and output
Distinction between

gross and net
national and domestic
nominal and real
total and per captia

GDP: Gross Domestic product is the total amount of goods and services produced by means of production which are domestically located in one years time. GNP: Gross national product is the total amount of goods and services produced by means of production which are domestically owned in one years time.

[edit] Circular flow of income

Household provide factor services and consumer spending to firms. Firms provide income and goods and services. Household income (Y) is spent on domestic firms’ output (O), country imports (M), taxes (T) to the government, and a portion is placed in the form of savings (S) in financial institutions, i.e. banks. T, S, and Ms are all termed leakages (L). These Ls are countered by injections (J) which is comprised of: government spending (G), investment expenditure (I), and export expenditure (X). Since L must always ultimately equal J it is a circular flow. Stock appreciation and discrepancies are taken into account too.

Methods of measurement- income, expenditure, output. There are three main ways of measuring a country's GDP:

Income: Income takes into account wages and salaries, rent, interest, self-employed income and adds up to make total domestic income.

Expenditure: Takes into account all spending in an economy. C+I+G+[X-M]

Output: Takes into account everything which is produced in an economy.

Problems with Measuring National Income

Transfer payments, payments made to students and pensioners even though they don't really help produce anything in the economy.
Non-market economy: If you build an extra wall in your house yourself the NY statistically stays the same but if you had paid a builder it would have risen, even though the work you have done has contributed to the total output of final goods and services in the economy.
Price changes
Parallel Economy: Many people work and is unrecorded by the authorities. This includes both black markets (selling illegal goods) and informal markets (selling legal goods illegally to circumvent price restrictions).
Self Sufficiency: In many poor countries food does not enter the market place. Food is grown for yourself in a subsistence manner thus the national income is lower than it should be.

Distinction between

Gross and Net: Net domestic product = GDP- depreciation
Domestic and national: GNP= GDP + net factor income. Many US Homes and Firms receive factor income from abroad.
Nominal and real: Nominal measures at the current value. Real takes into account inflation.
Total and per capita: Per capita is divided by a country's population.

Problems with using NY figures for a comparison between countries

Composition of Output : Does not show what this income is spent on for example Soviet Russia spent significant amounts on armaments in the cold war, however this does not improve the standard of living.
Composition of Expenditure: National income figures do not take into account what the incomes are spent on. For example heating in cooler countries adds nothing to standards of living; however, does contribute to national incomes.
Exchange Rate Distortions: Exchange rate conversions may not create an accurate representation of a populations relative purchasing power. Purchasing power parity may take this into account.
Unaccounted for Activity : Parallel markets, such as subsistence living and black market activity are not taken in GDP.
Distribution of Income: Doesn't take into account how this income is distributed.
Intangible additions to welfare: Doesn't take into account the ability to enjoy fresh air and have leisure time.
Externalities and environmental damage: Damage to the environment and pollution are not taken into account.

[edit] Introduction to development

Definitions of economic growth and economic development
Differences in the definitions of the two concepts
Gross Domestic Product (GDP) versus Gross National Product (GNP) as measures of growth:

Limitations of using GDP as a measure to compare welfare between countries: It is very difficult to use GDP as a measure of welfare for various reasons.

Allowance for differences in purchasing power when comparing welfare between countries: A better measure than GDP pc is GDP at PPP or purchasing power parity. It is a measure which takes into account how much you can purchase a basket of goods in one country in comparison with another. For example, in Austria it costs 20 euros for a haircut, however- with 20 euros one can purchase 5-6 haircuts in Brazil.

Alternative methods of measurement
Problems of measuring development

[edit] Economic growth

Economic Growth is defined as an increase in output in an economy measured by an increase in real GDP over a period of time. An increase in a society's potential output by a change in a country's quantity and quality of resources.

Benefits

Increased living standard
Improved lifestyle
Lower poverty rates
Higher life expectancy

Limitations

More inequality
Pollution increases
Breakdown of family values
Social problems (overcrowding, suicide, divorce, traffic...)

Reasons for Economic Growth

increase in investment (more tools, machines, factories)
Innovation (new tools, new robots, new techniques)
Improvements of quality of workforce (instead of quantity)
Infrastructure (telephones, roads...)
Social and legal institutions (ownership of land)
Available resources (oil..)

[edit] Economic Development

Economic Development: is defined as a qualitative measure of a country's standard of living. This takes into account things such as health, education, and GDP at PPP.

Note: Sustainable economic growth is an increase in real output but at the same time not using up all the available resources . Leaving some or replacing those used up so that future generations can still grow economically.

[edit] Measuring Growth (GDP vs GNP)

It is quite difficult to measure an increase in economic growth because of GNP. If Ford's sales increase, then that doesn't mean that employees in the US benefits, if they have in fact been outsourced to say China. The government does take in a bit of revenue, but to say that the rest of the country has benefited is an overstatement.

[edit] Comparing welfare (GDP)

[edit] Purchasing Power

[edit] Alternative Measurements of Development

[edit] Problems of measuring Development

[edit] Macroeconomic models

Aggregate demand- components: Aggregate demand is composed of five parts.

Consumption: How much households demand.
Investment: How much firms demand.
Government: How much Governments demand.
[Exports- Imports]: How many exports are demanded from a country minus the number of imports said country demands.

This all makes for a very elegant equation: Aggregate demand= C+I+G+[X-M]

Aggregate supply: Aggregate supply is national output which is equal to national income.
Short run: In the short run demand and supply are the same.
Long-run (Keynesian versus neo-classical approach): There are two different examples of long-run supply curves. Keynesians believe that the long-run supply curve is a flipped L shaped. That we are never reaching an economy's full capacity and working towards it. Neo-classicals believe that this is not the case, and the supply curve is in fact- perfectly inelastic.
Full employment level of national income:
Equilibrium level of national income :
Inflationary gap: the gap between actual output and full employment output (+) OR the excess of Agg demand at the full employment level of real GDP
Deflationary gap: the gap between full employment output and actual output (-) OR the shortfall in Agg demand at the full employment level of real GDP
Diagram illustrating trade/business cycle:

A business cycle is composed of four parts.

Boom
Recession
Slump
Expansion

[edit] Demand-side policies

Shifts in the aggregate demand curve/demand-side policies

Fiscal policy
Interest rates as a tool of monetary policies

Shifts in the aggregate supply curve/supply-side policies
Strengths and weaknesses of these policies

Higher level extension topic

Multiplier effect:

calculation of multiplier

Accelerator
“Crowding out

[edit] Shifts in the aggregate supply curve/supply-side policies

Fiscal Policy Government policies relating to government expenditure and taxation levels.

EXPANSIONARY: increasing level of gov’t spending and reducing taxes

Lower Unemployment
Higher Inflation
More Imports than Exports

(Higher Economic Growth

CONTRACTIONARY: reducing level of gov’t spending and increasing taxes

Higher Unemployment
Lower Inflation
More Exports than Imports
Lower Economic Growth

International Factors

foreign exchange rate
state of world economy

Interest rates as a tool of monetary policies

Monetary Policy

This is when the central bank* tries to control the economy by changing interest rates and the money supply *(e.g. Federal Reserve, Bank of England. UK split from govt. in 1997)

The interest rate is the cost of borrowing money
The money supply is how much money/credit there is available for people to borrow
Changes in the interest rate will either encourage or discourage people to borrow money hence influencing aggregate demand
Changes in money supply will make it easier or harder for people to borrow money hence influencing aggregate demand
If interest rate goes down, consumption will go up and investment will go up (firms will borrow money to invest) and so aggregate demand will go up.
If money supply goes up, it is easier to borrow money, credit is available therefore aggregate demand will increase

Expectations

Expectations of higher income: if you think your salary will rise you will tend to spend more.
If there is an expectation of higher prices in the future you will tend to buy more goods in the present, and hence, increase spending.
Expectation of higher profit: you will invest more money into machines/tools now.

Keynesian policy that consists of injections of demand into the circular flow of income stimulate further rounds of spending

[edit] Unemployment and Inflation

Unemployment

Full employment and Underemployment: A society is almost never fully employed, but one of the goals is to reach full employment. Full employment has two conditions: Everyone who wants to work is working, and the rate of inflation is stable. When the economy is at full employment, there is no cyclical unemployment but still frictional and structural unemployment. This is defined as natural unemployment.

You are only classified as unemployed if you go and register with the government as available for work.
The labor force is defined as those of 16 years of age or older who are employed plus all those who are unemployed seeking work.

Unemployment rate : the number of people with no work expressed as % of the labour force

Cost of unemployment: There are numerous costs of unemployment. For one thing, demand-side unemployment may be a slippery slope. For another thing, there are social costs such as high crime rates. There is a loss in potential output. There is political unrest brought by high levels of unemployment.

[edit] Problems with Unemployment

the average unemployed person costs the British government 8000 pounds a year
loss of output
diminished tax base
increased transfer payments
opportunity cost
increased taxes, increased burden
increased difficulty for labor market entrants - employers have more choices, they favor experienced workers
unemployed workers lose their skills
social costs - social stigma, increased unemployment is said to be proportional to the increase in domestic violence, crime, use of drugs, suicide, depression etc. - economically sub-optimal.

Advantages: spare labour-- could be attractive for investors, wages wont be high - they can pay people less as they know others are available.

[edit] Types of unemployment

Classical Unemployment: your wage is too high, the price of the good goes up and no one buys it so the firm moves to a cheaper country
Structural: Unemployment caused by the demand for your product falling e.g. coalmining, we use oil now. Some skills are no longer needed e.g. you are a trained draughtsman but we use computers now
Frictional: People leaving their jobs looking for another one. Unemployment associated with frictions in the system that may occur because of the imperfect job market information that exists.
Seasonal: Unemployment caused by changes in seasons.e.g a Father Christmas only works a few weeks a year
Cyclical/Demand-deficient: Unemployment resulting from business recessions that occur when total demand is insufficient to create full employment.
Regional Unemployment: if there is a coalmining area which closes down there will be large unemployment in that area
Voluntary Unemployment: you are unemployed by choice, you get money from the government anyway
real wage

[edit] Solutions to unemployment

boost aggregate demand e.g. increase gov. spending, build statues (creating jobs), reduce taxes
interest rates reduced: more investment, more money borrowed, more money spend, more jobs
Supply side economics: train the workers make them more skilful. Also reduce taxes to increase working incentives
Lower the retirement ages/ raise school leaving age: it reduces unemployment however these days is unlikely
Conscription: the army counts as employment

[edit] Inflation

Definition of inflation and deflation

Inflation is defined as a sustained rise in the average price level and a fall in the value of money.
Deflation is defined as a sustained fall in the average price level and a rise in the value of money.

Costs of inflation and deflation

Inflation may harm some individuals and benefit others. Individuals with liquid assets which are not collecting interest may be harmed. Individuals with fixed assets such as paintings, housing, etc. will benefit.

Causes of Inflation

cost push: Inflation that occurs when there is an increase in the cost of production.
demand pull: Inflation that occurs when a sector of the economy increases the demand for goods and services.
excess monetary growth: The money supply increases, and prices increase.

(HL)

Methods of measuring inflation
Problems of the methods of measuring inflation
Phillips Curve
Short-run
Long-run
Natural rate of unemployment
Non-Accelerating Rate of Unemployment (NAIRU) - excluded from IB syllabus in 2003.

[edit] Distribution of Income

direct taxation: income tax
Indirect taxation: tax on goods or services
Progressive taxation: the bigger your income, the larger % you pay of tax
Regressive taxation:the bigger your income, the smaller % you pay of tax
Proportional taxation: everyone pays the same tax % e.g. 10%

Purpose of taxes

to raise gov. revenue
to narrow the gap between rich and poor e.g progressive tax
to safe guard health e.g. tax in cigarettes, alcohol
influence consumer spending e.g. lead free petrol
to control the economy (fiscal policy)
to control externalities
to stop/ reduce imports (tariffs)

Type of Taxes

direct taxation: income tax
indirect taxation: tax that is included in expenses, levied on good/service and not on individual or organization
progressive taxation: tax increases as income increases
proportional taxation: tax percent remains constant regardless of income
regressive taxation: tax increases as income decreases
Profit Tax: a tax on the firms profits. Usually there are different rates for smaller and larger firms
Wealth Tax: A tax on your wealth on an annual basis
Inheritance tax/ Death Duties/ Estate Duties: when you die you leave behind an estate, the gov. taxes these estates
Gift Tax/ Capital Transfer Tax: a tax on large gifts
Capital Gains tax: a tax on the gain you make between buying and selling something. Usually refers to shares

Transfer payments: payment by government as gift or aid and not for good or service.

Higher level topics

Laffer curve: a graph showing the relationship between tax rate and government revenue
Lorenz curve: a graph showing the distribution of wealth in the economy.
Gini coefficient: a number between 0 and 1 quantifying the distribution of wealth in the economy. 1 is perfectly inequal distribution.