1) Economic growth – in the short run, an increase in real GDP, and in the long run, an increase in productive capacity, that is, in the maximum output that economy can produce.
2) Unemployment – a situation where people are out of work but are willing and able to work. All people, who are able to work (employed or unemployed) are called labour force. They are economically active. People of working age who are neither employed nor unemployed are called economically inactive.
3) Inflation – rising in general price level.
4) Deflation – a sustained fall in general price level.
5) Balance of payments – a record money flows coming in and going out of a country.
Objectives of government economic policy.
1) Economic growth.
Economic growth is very important for government, who also are trying to achieve economic growth. If the government do it well, there is sustainable economic growth. It means economic growth that can continue over time and does not endanger future generations’ ability to expand productive capacity. The first type of sustainable economic growth is when increasing in aggregate supply match increases in aggregate demand. How can government achieve growth? By matching trend growth. It means expected increase in potential output over time. It is measure of how fast the economy can grow without generating inflation. A good example of a possible source of sustainable economic growth can be wind firms.
2) Employment and unemployment.
The government also seek to high employment and low unemployment. Some governments state that their objective is full employment, that means a situation where those wanting and able to work can find employment at the going wage rate. But don’t be confused with full employment, because it doesn’t mean that unemployment equals zero, because there is always unemployment near 3 percentages in economy (because some people are loosing their jobs and looking for another everyday).
3) Inflation.
As we know from last chapter, inflation is rising in price level. The government doesn’t want to make inflation zero, the government seeks to low inflation, because low inflation can bring advantages. For example, it may enable firms to reduce their prices by not increasing wages in line with inflation rather that by making some workers redundant.
4) Balance of payments.
The government seeks to avoid current account deficit, when more money is leaving the country that entering, as result of sales of its exports, income and current transfers from abroad being less that imports and income and current transfers going abroad.
5) Economic stability.
6) Income redistribution.
The government can do this by transferring some income from the rich to the poor (by providing special taxes, for instance).
GDP and real GDP.
Economists always measure economy by nominal GDP ( output measured in current prices and so not adjusted for inflation.)
Measuring economic growth.
Economic growth is usually measured by the annual percentage change in real GDP.
Production and productivity.
Labour productivity – output per worker hour. If productivity rises by more than wages, then labour costs will fall and the country can become more price competitive.
Difficulties in interpreting changes in Real GDP.
One problem of interpretation is that the rise in output may be exceed by a rise in population.
Another problem is informal economy (economic activity that is not recorded or registered with the authorities in order to avoid paying tax or complying with regulations, or because the activity is illegal.
Measuring unemployment.
This can be measured by unemployment rate.
Formula: the unemployed x 100% / labour force
In the
Claimant count – a measure of unemployment that includes those receiving unemployment-related benefits.
Measuring inflation.
Inflation can be measured by Consumer Price Index (CPI) – a measure of changes in the price of representative basket of consumer goods and services. Differs from the retail price index (RPI) in methodology and coverage.
And also by Retail Price Index (RPI) – measure of inflation that us used for adjusting pensions and other benefits to take account of changes in inflation and frequently used in wage negotiations. Differs from the consumer price index (CPI) in methodology and coverage.
The structure of the current account of the balance of payments.
Current account includes trade in goods, trade in services, income and transfers. Trade in goods records the earnings from exports and the expenditure on imports. Trade in services, for instance, includes travel, insurance, financial and computer and information services. This part of current account sometimes called invisible balance (because we can’t see services). The income part includes investment income. Transfers cover the transfer of money made and received by government and individuals.
The causes of economic growth.
One of the causes is increase in AD (aggregate demand). Economic growth can also be caused by a cut in income tax or a rise in consumer confidence. All this changes can occur in the short run. We can show AD increasing on the diagram below.
Economic growth for long term can be caused by increases in quantity and quality of resources. The main causes of this is advanced technologies or improvements in education and training. Diagram below shows economic growth with increase in AS (aggregate supply)
The causes of unemployment.
We can look at cause from two different sides (changes in demand and changes in supply).
Cyclical unemployment – unemployment arising from a lack of aggregate demand.
Structural unemployment – unemployment caused by the decline of certain industries and occupations due to changes in demand and supply.
Frictional unemployment – short term unemployment occurring when workers are in-between jobs. Actually, these people have just dropped their jobs and looking for other jobs.
The causes of inflation.
As we know inflation is price growing. Therefore inflation is caused by changes in prices. Price can be changed, because of changes in aggregate demand and changes in cost of production. So we have two types of inflation:
- Demand-pull inflation – increases in price level caused by increases in aggregate demand.
- Cost-push inflation – increases in price level caused by increases in cost of production.
Deficit in the current account of the balance of payments.
When expenditure abroad is greater that income from abroad.
There are two main causes of deficit:
- because the country’s inhabitants have spent more on goods and services from abroad than residents have spent in the country’s products or services.
- because there has been a net outflow of investment income
Another causes: changes in income at home and abroad, changes in exchange rate and structural problems.
Surplus in the current account of the balance of payments.
When the country’s revenue form abroad is greater than expenditure abroad.
It can be when the quantity of country’s product is high and the cost of production is low (so expenditure will rise), also when there is a recession in the country ( import will decrease because people won’t be willing to but some products during a recession)
The consequences of unemployment.
- lost output. Having people who are ready to work is a waste of resources (labour). On the diagram below we can that real output is below potential output because of non-full using resources (labour).
- lost tax revenue. It is when real value of taxes is lower than potential. When people are working, the government receive more taxes, because people are earning more and spending more.
- government spending on unemployment benefits. The problem is that the government has to spend more on unemployment benefits with rising un. rate. Instead of spending on another areas, such as health, communication, education, etc. (opportunity cost!)
- hysteresis. This means unemployment can causing unemployment. And it also can caused long- term unemployment (for mare than one year).
The benefits of unemployment.
- for some people it may give more time to search a new job.
- it also makes easier for firms to find workers.(exactly they need)
- reducing inflation. (people will buy less with less income)
The consequences of inflation.
- Fall in value of money. With rising in price people will spend less, so the value of pounds will decrease.
- Menu cost – the costs of changing prices due to inflation.
- Shoeleather costs – costs in terms of the extra time and effort involved in reducing money.
- Administrative costs.
- Inflationary noise – the distortion of price signals caused by inflation.
- Random redistribution of income. Some people will lose their money and some people will earn. So there will be a big gap between rich and poor people.(like in
- Fiscal drag – people’s income being dragged into higher tax bands as a result of tax brackets not being adjusted in line with inflation.
- Uncertainty. When firms are not certain about their costs in the future and also people are not certain about prices in the future.
- Inflation causing inflation.
- Loss of international competitiveness.
The benefits of inflation.
If the salaries are rising too during inflation, workers will be satisfied, even prices are growing. Also firms will increase their output, because aggregate demand will increase ( if it is demand-pull inflation). It will probably involve more places for unemployment, because firms will have to extend their production to increase their output.
Deflation – decreasing in price level.
The consequences of a deficit and a surplus on the current account of the balance of payments.
Deficit – raise unemployment; reduce economy’s output; fall in the exchange rate; less pressure on price level.
Surplus – increase in bank lending; growth in exchange rate; increasing in aggregate demand.
The costs of economic growth.
The graph below shows the opportunity cost of economic growth (capital goods instead of consumer goods)
The benefits of economic growth.
1) A rise in people’s material standard of living.
2) Economic growth enables poverty within a country to be reduced without having to redistribute existing income.
3) A rise in the level of a country’s real output.
International Monetary Fund (IMF) – an international organization that helps co-ordinate the international monetary system.
World Trade Organization (WTO) – an international organization that promotes free international trade and rules on international trade disputes.
Exchange rate
Exchange rate – the price of one currency in terms of another currency or currencies.
Monetary Policy Committee (MPC) – a committee of the Bank of England with responsibility for setting the interest rate in order to meet the government’s inflation target.
Factors affected the exchange rate:
1) An increase in demand for pounds.
2) An increase in supply for pounds.
3) Changes in income abroad.
4) Changes in income in the country.
5) Speculation – buying and selling currency ( very common in
The relationships between the exchange rate and the interest rate.
Exchange rate is rising – interest rate is falling.
A reduction in interest rate – reduction in exchange rate.
The effect of a change in the exchange rate on export and import prices.
SPICED – strong pound import cheap export dear (expensive)!!!!!!!!!
Changes in the exchange rate and the macroeconomy.
The possible effect of a lower exchange rate on the economy is showed on the diagram below.
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