2 3 MACROECONOMIC OBJECTIVES LOW UNEMPLOYMENT LOW AND

2. 3 MACROECONOMIC OBJECTIVES: LOW UNEMPLOYMENT LOW AND STABLE RATE OF INFLATION EQUITY IN THE DISTRIBUTION OF INCOME THE ROLE OF TAXATION IN PROMOTING EQUITY

2. 3 Macroeconomic Objectives: Low unemployment

1. Define the term unemployment. Unemployment (or joblessness) occurs when people are without work and actively seeking work. 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

2. Explain how the unemployment rate is calculated. The unemployment rate is the number of people looking for work divided by the total number of people in the labor force. Calculating the Unemployment Rate: (Number of unemployed)/(Labor force) X 100 = unemployment rate

3. Calculate the unemployment rate from a set of data. HOW TO: The unemployment rate is the proportion of the labor force that is unemployed. This means they are actively seeking work but unable to find it. You may be given a table showing the number of people in different groups, like college students, retirees, people looking for jobs, people who have given up looking for jobs, part time workers, full time workers, etc… You will have to calculate the unemployment rate from this information. NOTE: People who are working part time but want to work full time ARE EMPLOYED. People who have given up looking for jobs are DISCOURAGED WORKERS and are no longer considered unemployed, rather, they have dropped out of the labor force. Discouraged workers are not accounted for in unemployment data.

3. Calculate the unemployment rate from a set of data. The country of Altinima has a population of 150, 000. According to the latest data, there are 20, 000 people under the age of 16, and 30, 000 people who are over the age of 16, but not looking for work. Currently, there are 5, 000 people who are 16 or older and actively looking for work. The president of Altimina has asked you what the size of the labor force is, what the number of unemployed is and what the unemployment rate for Altimina is. The labor force in Altimina is ? The number of unemployed is ? The unemployment rate is ?

4. Explain the difficulties in measuring unemployment, including the existence of hidden unemployment, the existence of underemployment, and the fact that it is an average and therefore ignores regional, ethnic, age and gender disparities. Unemployment data may be based on people who are registered as unemployed. Alternatively, it may be calculated as the number of people who are claiming unemployment benefits. There may be problems measuring the true numbers of people unemployed. For example, the incentive to register as unemployed is likely to depend on the availability of unemployment benefits. A person who is not entitled to any benefits is not likely to register as unemployed.

4. Explain the difficulties in measuring unemployment, including the existence of hidden unemployment, the existence of underemployment, and the fact that it is an average and therefore ignores regional, ethnic, age and gender disparities. hidden unemployment: The unemployment or underemployment of workers that is not reflected in official unemployment statistics because of the way they are compiled. Only those who have no work but are actively looking for work are counted as unemployed. Those who have given up looking, those who are working less than they would like, and those who work at jobs in which their skills are underutilized are not officially counted among the unemployed, though in a sense they are. These groups constitute hidden unemployment. Note: Because of hidden unemployment, official statistics underestimate unemployment.

4. Explain the difficulties in measuring unemployment, including the existence of hidden unemployment, the existence of underemployment, and the fact that it is an average and therefore ignores regional, ethnic, age and gender disparities. Underemployment Labor that falls under the underemployment classification includes those workers that are highly skilled but working in low paying jobs, workers that are highly skilled but work in low skill jobs and part-time workers that would prefer to be full-time. This is different from unemployment in that the individual is working but isn't working at their full capability. BREAKING DOWN 'Underemployment' For example, an individual with an engineering degree working as a pizza delivery man as his main source of income is considered to be underemployed and underutilized by the economy as he in theory can provide a greater benefit to the overall economy if he were working as an engineer. Also, an individual that is working part-time at an office job instead of full-time is considered underemployed because they are willing to provide more employment, which can increase the overall output.

4. Explain the difficulties in measuring unemployment, including the existence of hidden unemployment, the existence of underemployment, and the fact that it is an average and therefore ignores regional, ethnic, age and gender disparities. There is also discouraged workers. These people are long-term unemployed who have given up the search for work and are no longer eligible for benefits. As soon as they give up the search, they are no longer part of the unemployed. Distribution of unemployment: A national unemployment rate establishes an average for a whole country, and this is very likely to mask inequalities among different groups within an economy. Typical disparities: Geographical disparities Age disparities Ethnic differences Gender disparities

4. Explain the difficulties in measuring unemployment, including the existence of hidden unemployment, the existence of underemployment, and the fact that it is an average and therefore ignores regional, ethnic, age and gender disparities. http: //big. assets. huffingtonpost. com/unemploymen t. gif

5. Discuss possible economic consequences of unemployment, including a loss of GDP, loss of tax revenue, increased cost of unemployment benefits, loss of income for individuals, and greater disparities in the distribution of income. Economic consequences of unemployment: � Lower level of Aggregate Demand � Under-utilization of the nation’s resources � Brain-drain � A turn toward protectionism and isolationist policies � Increased budget deficits diminished tax base increased transfer payments � increased difficulty for labor market entrants employers have more choices, they favor experienced workers � unemployed workers lose their skills

6. Discuss possible personal and social consequences of unemployment, including increased crime rates, increased stress levels, increased indebtedness, homelessness and family breakdown. Individual consequences of unemployment: � Decreased household income and purchasing power � Increased levels of psychological and physical illness, including stress and depression � lower quality of life � lower self-esteem Social consequences of unemployment: � Downward pressure on wages for the employed � Increased poverty and crime � Transformation of traditional societies Psychological Effects of Unemployment and Underemployment

7. Describe, using examples, the meaning of frictional, structural, seasonal and cyclical (demand-deficient) unemployment. Classical Unemployment: (Real-Wage ) 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: This is the desirable process of finding work, employers looking for the right worker. In order to help accelerate this process, governments assist people looking for jobs with programs and qualification surveys. Seasonal: Unemployment caused by changes in season’s. e. g Santa Clause 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

8. Distinguish between the causes of frictional, structural, seasonal and cyclical (demand-deficient) unemployment. Different Causes of Unemployment 1. Frictional Unemployment: This is unemployment caused by the time people take to move between jobs, e. g. graduates or people changing jobs. There will always be some frictional unemployment in an economy because information isn’t perfect and it takes time to find work. However, if there is imperfect information and people don't get to hear of jobs available that may suit them then frictional unemployment will be higher. The better the economy is doing, the lower this type of unemployment is likely to be. This is because people will usually be able to find jobs that suit them more quickly when the economy is doing well.

8. Distinguish between the causes of frictional, structural, seasonal and cyclical (demand-deficient) unemployment. Frictional unemployment 2. Structural Unemployment This occurs due to a mismatch of skills in the labor market it can be caused by: Occupational immobility's. This refers to the difficulties in learning new skills applicable to a new industry, and technological change, e. g. an unemployed farmer may struggle to find work in high tech industries. Geographical immobility's. This refers to the difficulty in moving regions to get a job, e. g. there may be jobs in London, but it could be difficult to find suitable accommodation or schooling for their children. Technological change. If there is the development of labor saving technology in some industries, then there will be a fall in demand

8. Distinguish between the causes of frictional, structural, seasonal and cyclical (demand-deficient) unemployment. Demand-deficient or cyclical unemployment Demand-deficient unemployment occurs when there is not enough demand to employ all those who want to work. It is a type that Keynesian economists focus on particularly, as they believe it happens when there is a disequilibrium in the economy. It is also often known as cyclical unemployment because it will vary with the business cycle. When the economy is booming, there will be lots of demand so firms will be employing large numbers of workers. Demand-deficient unemployment will at this stage of the cycle be fairly low. If the economy slows down, then demand will begin to fall. When this happens firms will begin to lay workers off as they do not need to produce so much. The behavior of demand-deficient unemployment will exactly mirror the business cycle. Classical economists emphasis supply side factors as the main cause of unemployment. They argue that demand deficient unemployment tends to be only short term. However other Keynesian economists emphasize the

8. Distinguish between the causes of frictional, structural, seasonal and cyclical (demand-deficient) unemployment. Seasonal unemployment exists because certain industries only produce or distribute their products at certain times of the year. Industries where seasonal unemployment is common include, § Hotel and catering § Tourism § Farming § Holiday § Construction The effects of seasonal unemployment are often highly regionalized.

9. Explain, using a diagram, that cyclical unemployment is caused by a fall in aggregate demand. Cyclical/Demand-deficient: Unemployment resulting from business recessions that occur when total demand is insufficient to create full employment.

10. Explain, using a diagram, that structural unemployment is caused by changes in the demand for particular labor skills, changes in the geographical location of industries, and labor market rigidities. Structural unemployment is a more permanent level of unemployment that's caused by forces other than the business cycle. It can be the result of an underlying shift in the economy that makes it difficult for certain segments of the population to find jobs. It's typically when there is a mis -match between the jobs available and the skill levels of the unemployed.

Equilibrium Unemployment If the labor market is in equilibrium and there is still unemployment, then there must be a gap between the actual supply of labor and the potential supply of labor as this diagram shows.

Equilibrium Unemployment The labor supply curve shows the number of people who are willing and able to supply their labor at each given wage rate. If there is equilibrium in the labor market then that implies that everybody who is willing to work at the equilibrium wage rate is working, so any remaining unemployment must be people who could work (potential supply - Spot) but are not willing to work at the equilibrium wage. This is called equilibrium

11. Evaluate government policies to deal with the different types of unemployment. Policies to deal with different types of unemployment: Classical Unemployment: (Real-Wage ) � Reduce Union labor power and/or reduce or eliminate national minimum wages laws. (Supply Side policies) Structural: � Enhance occupational mobility of people, so that they are more able to take available jobs. � Re-trains programs, subsidies to firms that train workers, tax breaks to move to where the jobs are, support more apprenticeships programs. (Supply

11. Evaluate government policies to deal with the different types of unemployment. Policies to deal with different types of unemployment: Frictional: � The government should lower unemployment benefits to encourage unemployed workers to take the jobs that are available rather than allow them to wait for a better one to come along. � Also, by improving the flow of information from potential employers to people looking for jobs. (Supply Side policies) Seasonal: � Reduce unemployment benefits and a greater flow of information of jobs available in the off season. (Supply

11. Evaluate government policies to deal with the different types of unemployment. Policies to deal with different types of unemployment: Cyclical/Demand-deficient: � Increase in aggregate demand through the use of fiscal or monetary policies Regional Unemployment: � Reduce unemployment benefits and a greater flow of information of jobs available in the off season. (Supply Side policies) Voluntary Unemployment: � Reduce unemployment benefits and a greater flow of information of jobs available in the off season. (Supply Side policies)

11. Evaluate government policies to deal with the different types of unemployment. Policies for Reducing Unemployment: There are two main strategies for reducing unemployment Demand side policies to reduce demanddeficient unemployment (unemployment caused by recession) Supply side policies to reduce structural unemployment / (the natural rate of unemployment)

12. Explain that the natural rate of unemployment is the rate of unemployment that exists when the economy is producing at the full employment level of output. NATURAL UNEMPLOYMENT: The combination of frictional and structural unemployment that persists in an efficient, expanding economy when labor and resource markets are in equilibrium. Natural unemployment exists when the economy is at full employment, which for practical purposes is defined as the condition in which the quantity of resources demanded is equal to the quantity of resources supplied. Most important for policy purposes, natural employment exists with stable prices, that is, no inflation. NAIRU is an acronym for Non-Accelerating Inflation Rate of Unemployment, and refers to a level of unemployment below which inflation rises. It is widely used in mainstream economics. It was also introduced as NIRU (Non-Inflationary Rate of Unemployment).

12. Explain that the natural rate of unemployment is the rate of unemployment that exists when the economy is producing at the full employment level of output. Friedman and Phelps concluded that expected inflation is what changed the short-term relationship between unemployment and inflation into the long-term natural rate of unemployment. Expected inflation causes people to demand greater wages so that their incomes will keep pace with inflation. By increasing the cost of labor, the short-term increase in employment is reversed back to the natural rate of unemployment. This relationship is summarized in the natural rate hypothesis, which states that unemployment eventually returns to its normal, or natural, rate, regardless of the inflation rate. The short-term unemployment rate can be approximated by the following equation, where p equals a modifying parameter: Unemployment Rate = Natural Rate of Unemployment - p × (Actual Inflation - Expected Inflation)

12. Explain that the natural rate of unemployment is the rate of unemployment that exists when the economy is producing at the full employment level of output.

12. Explain that the natural rate of unemployment is the rate of unemployment that exists when the economy is producing at the full employment level of output.

2. 3 Macroeconomic Objectives: Low and stable rate of inflation

13. Distinguish between inflation, disinflation and deflation. (Stagflation& Hyperinflation) 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.

13. Distinguish between inflation, disinflation and deflation. (Stagflation& Hyperinflation) Good Deflation and Bad Deflation Good Deflation is very much a real condition of the economy, characterized by substantial growth and development in some sectors of a country, despite the fact that the prices of products in these sectors has been reducing since a long span of time. In fact, Good Deflation results from technological progresses, which initiates excess supply of goods.

13. Distinguish between inflation, disinflation and deflation. (Stagflation& Hyperinflation) Bad Deflation is born out of trifling demands. It is an economic situation characterized by reduction in the prices not due to developments in the productivities, but because of a lack of demand induced by crashing down of the stock market or other market factors. In fact, Deflation becomes bad when the consumers save their money for future uncertainties, or in the expectation that prices may

13. Distinguish between inflation, disinflation and deflation. (Stagflation& Hyperinflation) Disinflation is a decrease in the rate of inflation – a slowdown in the rate of increase of the general price level of goods and services in a nation's gross domestic product over time. For example if the annual inflation rate one month is 5% and it is 4% the following month, prices disinflated by 1% but are still increasing at a 4% annual rate.

13. Distinguish between inflation, disinflation and deflation. (Stagflation& Hyperinflation) Stagflation In economics, the term stagflation refers to the situation when both the inflation rate and the unemployment rate are high. It is a difficult economic condition for a country, as both inflation and economic stagnation occur simultaneously and no macroeconomic policy can address both of these problems at the same time.

13. Distinguish between inflation, disinflation and deflation. (Stagflation & Hyperinflation) In economics, hyperinflation occurs when a country experiences very high and usually accelerating rates of inflation, rapidly eroding the real value of the local currency, and causing the population to minimize their holdings of the local money.

14. Explain that inflation and deflation are typically measured by calculating a consumer price index (CPI), which measures the change in prices of a basket of goods and services consumed by the average household. The Consumer price index (CPI) / retail price index (RPI) measures changes in the average prices of goods and services that the average consumer sees. The GDP deflator is measured as the ratio of the value of total domestic output at current prices divided by the same quantity of output valued at the constant prices of a selected base year The tax and price index (TPI) attempts to measure the changes in income before tax that the average consumer would need to maintain their purchasing power The producer price index (PPI) measures changes in the average prices of goods sold in primary markets by producers of commodities in all stages of processing All price indices suffer from certain inaccuracies. For example, they have a hard time taking into account quality changes, and the “basket” may not always be entirely representative of the purchases actually made.

15. Construct a weighted price index, using a set of data provided. To establish a weighed price index, we first determine the weighted price of a basket of goods by adding together the average price (P) of each category multiplied by the category weight expressed in hundredths. Assuming a price index has three categories, A, B and C, the weighted price of the basket of good is: (Pa x weighted in hundredths) + (Pb x weighted in hundredths) + (Pc x weighted in hundredths) Calculate the inflation rate from a set of data.

16. Calculate the inflation rate from a set of data. HOW TO: The inflation rate = (CPI year 2 – CPI year 1)/CPI year 1 x 100 It is the rate of change in the CPI between two years. You do NOT always simply take the CPI and calculate the rate of change since it was 100. This would tell you how much inflation there was since the base year, but inflation is usually measured between two years. IR = CPI 2 – CPI 1/CPI 1 x 100

17. Explain that different income earners may experience a different rate of inflation when their pattern of consumption is not accurately reflected by the CPI. Not all of a nation’s household are typical in that the income of a nation is not evenly distributed across all households. Some consumers will typically purchase a very different basket of goods than is measured to determine the CPI and inflation. If a large percentage of a consumer’s income goes towards a small selection of the goods measured by the CPI, then the CPI as a whole may over or understate inflation depending on how the prices of those particular goods have changed relative to the rest of the goods measured.

18. Explain that inflation figures may not accurately reflect changes in consumption patterns and the quality of the products purchased. The CPI only looks at one characteristic of the consumer goods it records: the price. What is not accounted for is the quality or the technology behind the products. What is not captured by this measure, however, is the improvement in consumer happiness resulting from improved quality and technology of newer and better products that increase in both price and quantity.

M 10/3/ECONO/HP 2/ENG/TZ 2/XX/M+ Explain how inflation can be measured and explain three problems associated with the measurement of inflation. Candidates may include: a definition of inflation measures of inflation such as a price index, retail price index, deflator, price deflator discussion of basket of goods (regimen), weighting, base year, regional issues (country and city). Problems associated with the measurement of inflation: price index based on purchasing preferences of “typical” household errors in the collection of data changes in consumption habits over time quality and types of goods and services change over time changes in producer prices are excluded one-off events such as seasonal variations, oil price shocks international comparisons.

19. Explain that economists measure a core/underlying rate of inflation to eliminate the effect of sudden swings in the prices of food and oil, for example. In many countries, what is reported most often to households by the government is what’s known as the core CPI. This price index does not include changes in the price of food and fuel, which economists ignore because of the frequent dramatic swings in price from one period to the next. However, for many households food and fuel make up a significant proportion of their expenditures. A CPI that does not account for these goods may not accurately reflect the effect that inflation is having on the typical household. Core CPI

20. Explain that a producer price index measuring changes in the prices of factors of production may be useful in predicting future inflation. The Producer Price Index is a family of indexes that measures the average change over time in the selling prices received by domestic producers of goods and services. Producer Price Index PPIs measure price change from the perspective of the seller. This contrasts with other measures, such as the Consumer Price Index (CPI), that measure price change from the purchaser's perspective.

21. Discuss the possible consequences of a high inflation rate, including greater uncertainty, redistributive effects, less saving, and the damage to export competitiveness. Costs of Inflation Include: International competitiveness: A relatively higher inflation rate will make British goods less competitive, leading to a fall in exports. However this may be offset by a decline in the exchange rate. But, if a country is in the Euro (e. g. Greece, Ireland Spain) they can’t devalue. Therefore, high inflation can be very damaging as it leads to a decline in competitiveness. Confusion and Uncertainty: When inflation is high people are uncertain what to spend their money on. Also, when inflation is high firms may be less willing to invest because they are uncertain about future profits and costs. This uncertainty and confusion can lead to lower rates of economic growth over the long term. Menu Costs. This is the cost of changing price lists. When inflation is high, prices need changing frequently which incurs a cost. However, modern technology has helped to reduce this cost. Shoe leather costs. To save on losing interest in a bank people will hold less cash and make more trips to

21. Discuss the possible consequences of a high inflation rate, including greater uncertainty, redistributive effects, less saving, and the damage to export competitiveness. Income redistribution. Inflation will typically make borrowers better off and lenders worse off. Inflation reduces the value of savings, especially if the saving is not index linked. However it does depends on the real rate of interest. e. g. if a saver gets a higher rate of interest than the inflation rate he will not lose out. Boom and Bust Economic Cycles. High inflationary growth is unsustainable and is usually followed by a recession. By keeping inflation low it enables a long period of economic growth. E. g. in the UK, low inflation helped economic growth to be more stable in the period 1992 -2007. Sustainable, low inflationary, economic growth is highly desirable. Cost of Reducing Inflation: High inflation is deemed unacceptable therefore governments feel it is best to reduce it. This will involve higher interest rates to reduce spending and investment. This reduction in Aggregate Demand will lead to a decline in economic growth and unemployment. Fiscal Drag. The amount of tax we pay will increase if there is inflation. This is because with rising wages more people will slip into the top income tax brackets. See: Fiscal Drag low inflation is often seen as harmless or even beneficial because it allows prices to adjust more easily

22. Discuss the possible consequences of deflation, including high levels of cyclical unemployment and bankruptcies. Deflation is a period when the general price level falls i. e. the cost of a basket of goods and services is becoming less expensive It is normally associated with falling AD causing a negative output gap (actual GDP < potential GDP) Deflation can be caused by an increase in productive potential, which leads to an excess of aggregate supply over demand Benign Deflation If falling prices are caused by higher productivity, as happened in the late 19 th century, then it can go hand in hand with robust growth. On the other hand, if deflation reflects a slump in demand persistent excess capacity, it can be dangerous, as it was in the 1930 s, triggering a downward spiral of demand prices. If the falling prices are simply the result of improving technology or better managerial practices, that is fine. Malign Deflation Malign deflation occurs when prices fall because of a structural lack of demand which creates huge excess capacity in an economic system. If there is a slump in demand, companies go out of business and sack people, and hence demand falls again – the negative multiplier effect starts to have its effect. Problems of Deflation

22. Discuss the possible consequences of deflation, including high levels of cyclical unemployment and bankruptcies. Possible Economic Costs of Deflation: Holding back on spending: Consumers may opt to postpone demand if they expect prices to fall further in the future. If they do, they might find prices are 5 or 10% cheaper in 6 months. Debts increase: The real value of debt rises when the general price level is falling and a higher real debt mountain can be a drag on consumer confidence and people’s willingness to spend. The real cost of borrowing increases: Real interest rates will rise if nominal rates of interest do not fall in line with prices. For example UK policy interest rates were slashed to 0. 5% in 2009 but realistically they cannot go any lower. If inflation is negative, the real cost of borrowing increases. Lower profit margins: Lower prices can mean reduced revenues and profits for businesses - this can lead to higher unemployment as firms seek to reduce their costs by shedding labor. Confidence and saving: Falling asset prices such as price deflation in the housing market hit personal sector wealth and confidence – leading to further declines in aggregate demand.

N 05/3/ECONO/SP 1/ENG/TZ 0/XX/M Explain the costs of inflation and the costs of deflation. [10 marks] • Definitions of both inflation and deflation Costs of inflation include: • effects on those who rely on fixed-income or are in a weak bargaining position • implications of higher export prices • inflation harms lenders and benefits borrowers • uncertainty • inflation may lead to high nominal interest rates • menu costs • “shoe-leather” costs Costs of deflation include: • falling prices may cause consumers to defer spending leading to greater deflationary pressure • investment spending is discouraged • benefits lenders and harms borrowers.

M 11/3/ECONO/HP 2/ENG/TZ 1/XX/M 4. A country suffers an inflation rate of 10 %. Explain the costs associated with this for the country’s economy? Candidates may include: a definition of inflation a definition of rate of inflation � an explanation of the effect of higher inflation on real income � families suffer a loss of purchasing power if incomes do not keep up with the rate of inflation � fixed income earners suffer lower real income � savers and lenders suffer lower real returns unless interest rates keep up with the rate of inflation � the demand for real assets (such as real estate) increases at the expense of productive investment � business decision-making may be hampered by uncertainty � menu costs � the signaling power of relative price change is undermined � increased unemployment if inflation is cost-push � the country loses international competitiveness if trade partners experience a lower rate of inflation with negative consequences for the balance of payments � inflation may lead to a depreciation/devaluation of the currency that would reduce the country’s purchasing power abroad and increase its external debt burden.

23. Explain, using a diagram, that demand-pull inflation is caused by changes in the determinants of AD, resulting in an increase in AD. Demand-Pull Inflation: results from an increase in aggregate demand when the economy is at or near full-employment. Demand-pull inflation - is inflation demanding?

23. Explain, using a diagram, that demand-pull inflation is caused by changes in the determinants of AD, resulting in an increase in AD. Demand-pull inflation becomes a threat when an economy has experienced a boom with GDP rising faster than the long-run trend growth of potential GDP Demand-pull inflation is likely when there is full employment of resources and SRAS is inelastic Main Causes of Demand-Pull Inflation 1. A depreciation of the exchange rate increases the price of imports and reduces the foreign price of a country's exports. If consumers buy fewer imports, while exports grow, AD in will rise – and there may be a multiplier effect on the level of demand output 2. Higher demand from a fiscal stimulus e. g. lower direct or indirect taxes or higher government spending. If direct taxes are reduced, consumers have more disposable income causing demand to rise. Higher government spending and increased borrowing creates extra demand in the circular flow 3. Monetary stimulus to the economy: A fall in interest rates may stimulate too much demand – for example in raising demand for loans or in leading to house price inflation. Monetarist economists believe that inflation is caused by “too much money chasing too few goods" and that governments can lose control of inflation if they allow the financial system to expand the money supply too quickly. 4. Fast growth in other countries – providing a boost to UK exports overseas. Export sales provide an extra flow of income and spending into the UK circular flow – so what is happening to the economic cycles of other countries definitely affects the UK

24. Explain, using a diagram, that cost-push inflation is caused by an increase in the costs of factors of production, resulting in a decrease in SRAS. Cost-Push Inflation: results from an increase in the cost of production. (energy or labor mostly) Seen by an inward shift of the aggregate supply. Cost-push inflation is inflation pushy?

24. Explain, using a diagram, that cost-push inflation is caused by an increase in the costs of factors of production, resulting in a decrease in SRAS. Causes of Cost Push Inflation Higher Price of Commodities. A rise in the price of oil would lead to higher petrol prices and higher transport costs. All firms would see some rise in costs. As the most important commodity, higher oil prices often lead to cost push inflation (e. g. 1970 s, 2008, 2010 -11) Imported Inflation. A devaluation will increase the domestic price of imports. Therefore, after a devaluation we often get an increase in inflation due to rising cost of imports. Higher Wages are one of the main costs facing firms. Rising wages will push up prices as firms have to pay higher costs (higher wages may also cause rising demand) Higher Taxes. Higher VAT and Excise duties will increase the prices of goods. This price increase will be a temporary increase. Higher Food Prices. In western economies food is a smaller % of overall spending, but in developing countries, it plays a bigger role. (food inflation) Cost push inflation could be caused by a rise in oil prices or other raw materials.

excess monetary growth Inflation due to excess monetary growth: With more money in the system there is more demand spending which increases aggregate demand. Monetary inflation is a sustained increase in the money supply of a country. It usually results in price inflation, which is a rise in the general level of prices of goods and services. Originally the term "inflation" was used to refer only to monetary inflation, whereas in present usage it usually refers to price inflation.

25. Evaluate government policies to deal with the different types of inflation. For Demand-pull inflation, the approach would be to either: � reduce aggregate demand with either deflationary fiscal policy and/ or deflationary monetary policy. � Policies to increase aggregate supply would also be used to increase real output and lower price levels. Cost-Push Inflation: � By addressing Input prices, productivity & governmental involvement in the business sector cost push inflation can be addressed Excess Monetary Growth: � By addressing monetary policy that inflates the money supply above money demand.

2. 3 Macroeconomic Objectives: Equity in the distribution of income A Richer World – BBC

26. Explain the difference between equity in the distribution of income and equality in the distribution of income. Equity is a normative concept and concerns the fairness with which scarce resources are allocated among competing ends. Inevitably there are huge disagreements between people as to what an equitable distribution of resources should be. Some people argue for much great equality in the post-tax distribution of income and wealth achieved by making the tax and benefit system much more progressive. They believe that a lack of equity leads to market failure because each one dollar of income equates to an economic vote. And since resources tend to flow to those markets where economics votes are highest, a high level of inequality can lead to what is perceived as being an

26. Explain the difference between equity in the distribution of income and equality in the distribution of income. The opposite of equity is inequality, and this can arise in two main ways: Inequality of outcome � Inequality of outcome from economic transactions occurs when some individuals gain much more than others from an economic transaction. For example, individuals who sell their labor to a single buyer, a monopsony's, may receive a much lower wage than those who sell their labor to a firm in a very competitive market. Differences in income are an important type of inequality of outcome. Inequality of opportunity � Inequality of opportunity occurs when individuals are denied access to institutions or employment, which limits their ability to benefit from living in a market economy. For example, children from poor homes may be denied access to high quality education, which limits their ability to achieve high levels of income in the future. .

27. Explain that due to unequal ownership of factors of production, the market system may not result in an equitable distribution of income. Given the unequal distribution of income that exists in most capitalist economies, is unlikely to be one in which all have an equal say _ clearly economic voting power is directly related to income so that the rich would have many more votes, and thus a much greater pull on resources, than the poor. Consequently, the resulting pattern of resource allocation may overlook the pressing, often life and death needs of the poor, and reflect instead the more trivial wants of the rich. In the economics of the market place, human wants are those that are supported by effective demand i. e.

27. Explain that due to unequal ownership of factors of production, the market system may not result in an equitable distribution of income. Human needs, however, if unaccompanied by the wherewithal to pay, are simply ignored. This is the overriding reason for the existence of malnutrition and starvation in the world today: it is not that there is an overall shortage of food - there is more than enough in total terms to feed everyone; the problem, quite simply, is that those who need the food lack the money to pay for it. Hence the 'free' market, given the degree of inequality which typically exists, is likely to be one in which many people are severely disadvantaged in terms of their market power.

28. Analyze data on relative income shares of given percentages of the population, including deciles and quintiles. A quintile is a 20% portion of a country’s population; we can divide a population into five quintiles, ranging from the lowest quintile (the poorest 20% of the population) to the highest quintile (the richest 20%). If income were completely equally distributed, everyone would receive exactly the same income, in which case every quintile would receive 20% of income. However, in the real world this is a virtual impossibility. Income shares can also be shown by deciles, which are 10% portions of the population (there are ten deciles) as well as quartiles, or 25% portions of the populations (there are four quartiles).

29. Draw a Lorenz curve and explain its significance. The two main methods for measuring inequality are the Lorenz curve and the Gini index. The Lorenz curve: �A Lorenz curve shows the % of income earned by a given % of the population. A ‘perfect’ income distribution would be one where each % received the same % of income. Perfect equality would be, for example, where 60% of the population gain 60% of national income. In the above Lorenz curve, 60% of the population gain only 20% of the income, hence the curve diverges from the line of perfect equality of income. � The further the Lorenz curve is from the 45 degree line, the less equal is the distribution of income. ‘

29. Draw a Lorenz curve and explain its significance.

30. Explain how the Gini coefficient is derived and interpreted. The Gini co-efficient or index is a mathematical device used to compare income distributions over time and between economies. The Gini coefficient can be used in conjunction with the Lorenz curve. It is calculated by comparing the area under the Lorenz curve and the area from the 450 line to the right hand 'x' axis. In terms of the Gini index, the closer the number is to 100 the greater the degree of inequality.

31. Distinguish between absolute poverty and relative poverty. Absolute Poverty The state of people who live on less than $1. 25 per day (purchasing power parity), as defined by the World Bank. Generally, such individual are unable to afford the basic necessities of life: food, shelter, education, health, etc. Relative Poverty The state of earning an income that puts one in the lowest income level within his or her own country. Unlike absolute poverty, it exists everywhere, since within even the richest nations a proportion of the population earns relatively less than the top income earners.

31. Distinguish between absolute poverty and relative poverty line an absolute level of income set by the federal government for each family size below which a family is deemed to be in poverty rate the percentage of the population whose family income falls below an absolute level called the poverty line

32. Explain possible causes of poverty, including low incomes, unemployment and lack of human capital. Poverty has many causes, some of them very basic. Some experts suggest, for instance, that the world has too many people, too few jobs, and not enough food. But such basic causes are quite intractable and not easily eradicated. In most cases, the causes and effects of poverty interact, so that what makes people poor also creates conditions that keep them poor. Primary factors that may lead to poverty include overpopulation, the unequal distribution of resources in the world economy, inability to meet high standards of living and costs of living, inadequate education and employment opportunities, environmental degradation, certain economic and demographic trends, and welfare incentives.

32. Explain possible causes of poverty, including low incomes, unemployment and lack of human capital. Causes of poverty Unemployment or having a poor quality (i. e. low paid or precarious) job as this limits access to a decent income and cuts people off from social networks; Low levels of education and skills because this limits people’s ability to access decent jobs to develop themselves and participate fully in society; The size and type of family i. e. large families and lone parent families tend to be at greater risk of poverty because they have higher costs, lower incomes and more difficulty in gaining well paid employment; Gender - women are generally at higher risk of poverty than men as they are less likely to be in paid employment, tend to have lower pensions, are more involved in unpaid caring responsibilities and when they are in work, are frequently paid less ; Disability or ill-health because this limits ability to access employment and also leads to increased day to day costs; Being a member of minority ethnic groups and immigrants/undocumented migrants as they suffer particularly from discrimination and racism and thus have less chance to access employment, often are forced to live in worse physical environments and have poorer access to essential services; Living in a remote or very disadvantaged community where access to

33. Explain possible consequences of poverty, including low living standards, and lack of access to health care and education. Direct costs: � � � Health care for the uninsured and the underinsured Shelters for the homeless Public housing and support for private housing Food for the hungry Direct costs to victims of higher crime rates High debt levels Indirect costs: � � Increased costs for police, the judicial system, correction facilities and security systems Reduced income taxes and other taxes “Loss of the multiplier effect of having people employed at living wages” Contributions to society lost because of an uneducated public

33. Explain possible consequences of poverty, including low living standards, and lack of access to health care and education. Consequences of Poverty has far reaching consequences on the society. People suffering from poverty will generally have a low standard of living. They are not able to afford education and lack access to health care and education. This will lead to a low quality of human capital and thus compromise economic growth. Poverty takes a toll on poor children’s development. For example, poverty causes malnutrition which would affect the development of a child’s mental thinking and healthy body. Poverty may also lead to political instability and lead to increased risk of war, mass emigration of population and terrorism.

33. Explain possible consequences of poverty, including low living standards, and lack of access to health care and education. What Is Kuznets Curve? The Kuznets curve is a hypothetical curve that graphs economic inequality against income per capita over the course of economic development. This curve is meant to illustrate the behavior and relationship of these two variables as an economy develops from a primarily rural agricultural society to an industrialized urban economy. The graph shows income inequality following the curve, first increasing before decreasing after hitting a peak as per-capita income

2. 3 Macroeconomic objectives: The Role of Taxation in Promoting Equity

34. Distinguish between direct and indirect taxes, providing examples of each, and explain that direct taxes may be used as a mechanism to redistribute income. An indirect tax is a tax collected by an intermediary i. e. seller, from the person who bears the ultimate economic burden of the tax i. e. consumer. It is imposed on expenditure. In simple terms, it is a tax which is imposed on goods and services sold. It is usually added to the cost of the good or service and charged from the ultimate consumer. The seller will then file a return to the government on all the taxes he has collected from the consumer. Examples GST (Goods and service tax) VAT (Value added tax) Consumers are charged a percentage of tax while purchasing a good/service and then the seller pays the tax collected to the Government.

34. Distinguish between direct and indirect taxes, providing examples of each, and explain that direct taxes may be used as a mechanism to redistribute income. Direct Taxes It is a tax paid directly to the government by the persons on whom it is imposed. Examples Tax imposed on peoples’ income-Income tax Tax on wealth – wealth Tax on firm’s profits. - corporate tax

35. Distinguish between progressive, regressive and proportional taxation, providing examples of each. Progressive Tax A tax in which people with more income pay a larger percentage in taxes. Example: Income tax (Direct Tax) Regressive Tax A tax in which people with more income pay a smaller percentage in taxes. Example: Sales Tax (Indirect Tax) Proportional Tax A tax in which people pay the same percentage of income in taxes regardless of their incomes. Example: Flat Tax (Direct Tax)

Examples of the Three Tax Systems regressive income tax % of income $50, 000 $15, 000 30% proportional tax % of income progressive tax % of income $12, 500 25% $10, 000 20% 100, 000 25 25, 000 25 200, 000 40, 000 20 50, 000 25 60, 000 30

36. Calculate the marginal rate of tax and the average rate of tax from a set of data. An average tax rate is the ratio of the total amount of taxes paid to the total tax base (taxable income or spending), expressed as a percentage. Let T be the total tax liability. Let B be the total tax base. Average tax rate = T / B

36. Calculate the marginal rate of tax and the average rate of tax from a set of data. A marginal tax rate is sometimes defined as the tax rate that applies to the last (or next) unit of the tax base (taxable income or spending). In plain English, the marginal tax rate is the tax percentage on the highest dollar earned. For example, in the United States, the top marginal tax rate is 39. 6%, but that rate applies only to earnings over $400, 000 per year; earnings under $400, 000 have a lower tax rate of 33% or less. That formal definition only holds true to the equation following when the denominator equals one unit of the tax base. In practice most decisions require the denominator to be a larger amount. The marginal tax rate equals the change in taxes divided by the change in tax base, expressed as a percentage. Let T be the total tax liability. Let B be the total tax base. Marginal tax rate = T/ B

37. Explain that governments undertake expenditures to provide directly, or to subsidize, a variety of socially desirable goods and services (including health care services, education, and infrastructure that includes sanitation and clean water supplies), thereby making them available to those on low incomes. Higher government spending on merit goods should yield a positive social rate of return which leads to an improvement in total economic welfare. There is a case for some form of government intervention to encourage increased consumption of merit goods. This might take the form of an explicit government subsidy to reduce the private marginal costs of consumption and cause an expansion of demand. The government often provides merit goods "free at the point of use" and then finances them through general taxation. Examples of merit goods that are largely state provided include primary health care and public schooling.

37. Explain that governments undertake expenditures to provide directly, or to subsidize, a variety of socially desirable goods and services (including health care services, education, and infrastructure that includes sanitation and clean water supplies), thereby making them available to those on low incomes. The tax and benefits system Governments can intervene to promote equity, and reduce inequality and poverty, through the tax and benefits system. This means employing a progressive tax and benefits system which takes proportionately more tax from those on higher levels of income, and redistributes welfare benefits to those on lower incomes.

37. Explain that governments undertake expenditures to provide directly, or to subsidize, a variety of socially desirable goods and services (including health care services, education, and infrastructure that includes sanitation and clean water supplies), thereby making them available to those on low incomes. Stages of redistribution: Original income can be adjusted in a number of ways to either increase or decrease posttax income.

37. Explain that governments undertake expenditures to provide directly, or to subsidize, a variety of socially desirable goods and services (including health care services, education, and infrastructure that includes sanitation and clean water supplies), thereby making them available to those on low incomes. Cash benefits are designed to help those on low or zero original income, and include contributory and noncontributory benefits. Contributory benefits, such as pensions and job-seekers' allowance, are those where individuals or employers make a contribution into the Social Security Fund. Non-contributory benefits, such as housing benefit, income support, career's benefit and child support, do not require a previous contribution to have been made. Generally, there are tests to see if individuals actually need these benefits, called means tests, though child benefit is not means tested and is a universal benefit available to all families with children.

37. Explain that governments undertake expenditures to provide directly, or to subsidize, a variety of socially desirable goods and services (including health care services, education, and infrastructure that includes sanitation and clean water supplies), thereby making them available to those on low incomes. Direct taxes Income tax is progressive and helps to redistribute income. These tax bands help narrow the income gap and so help reduce inequality. Indirect taxes In contrast, indirect taxes are regressive meaning that, as a percentage of income, the proportion of tax paid declines at higher income levels, and, as such, the burden of the tax is largely on the poor. This means that, as a rule, indirect taxes widen the income gap. The progressive effects of direct tax, and regressive effects of indirect tax generally cancel each other out.

37. Explain that governments undertake expenditures to provide directly, or to subsidize, a variety of socially desirable goods and services (including health care services, education, and infrastructure that includes sanitation and clean water supplies), thereby making them available to those on low incomes. Benefits in kind Benefits in-kind are those services, such as healthcare and education, that are provided free or heavily discounted at the point of consumption. These benefits can make a considerable impact on final income, increasing it considerably for the poorest, and narrowing the gap between rich and poor.

37. Explain that governments undertake expenditures to provide directly, or to subsidize, a variety of socially desirable goods and services (including health care services, education, and infrastructure that includes sanitation and clean water supplies), thereby making them available to those on low incomes. The National Minimum Wage The long-term aim of a minimum wage is to remove the problem of poverty pay, which exists when the earnings from paid work do not result in a living wage and fail to push people out of poverty. Policies to reduce unemployment: Unemployment is a major cause of poverty and inequality. Unemployment can be reduced by: Government sponsored job creation schemes. A monetary or fiscal stimulus to aggregate demand. Active labor market policies to increase employability, such as re-training schemes. Welfare-to-work schemes which encourage labor market participation.

38. Explain the term transfer payments, and provide examples, including old age pensions, unemployment benefits and child allowances. A transfer payment is a payment from the government to an individual for which no good or service is exchanged. In order to be eligible to receive them, an individual has to fall below a certain income threshold or to be experiencing economic hardship. Transfer payments existing in most developed countries include: Unemployment benefits Social security benefits Nutritional subsidies Higher education grants and tuition subsidies Welfare benefits

39. Evaluate government policies to promote equity (taxation, government expenditure and transfer payments) in terms of their potential positive or negative effects on efficiency in the allocation of resources. A tax system that punishes innovation, productivity and hard work is clearly undesirable and should therefore be avoided. However, a tax system including progressive marginal income taxes combined with regressive indirect taxes ensures that both the rich and the poor share a portion of the nation’s tax burden. Yet it also ensures that those with the greatest ability to pay bear the largest burden while those whose ability to pay the lowest benefit from the public and transfer payments that the government provides. This reduces the inequality of income distribution and corrects for the market failures that results in a free

39. Evaluate government policies to promote equity (taxation, government expenditure and transfer payments) in terms of their potential positive or negative effects on efficiency in the allocation of resources. Criticisms of progressive taxes and benefits Taxes and benefits clearly compensate for the failure of labor markets to provide sufficient original income for all citizens. However, such intervention can be criticized because: It may create a disincentive effect, which occurs when individuals are discouraged from working hard because they pay more of their income in taxes. It may create moral hazard, where some individuals may not look for ways to improve their own position because the state provides insurance against poverty, unemployment, and disability.

39. Evaluate government policies to promote equity (taxation, government expenditure and transfer payments) in terms of their potential positive or negative effects on efficiency in the allocation of resources. Progressive Tax A tax in which people with more income pay a larger percentage in taxes. Regressive Tax A tax in which people with more income pay a smaller percentage in taxes. Proportional Tax A tax in which people pay the same percentage of income in taxes regardless of their incomes. in-kind transfers to the poor given in the form of goods and services rather than cash

39. Evaluate government policies to promote equity (taxation, government expenditure and transfer payments) in terms of their potential positive or negative effects on efficiency in the allocation of resources.

M 10/3/ECONO/HP 2/ENG/TZ 2/XX/M+ 4. With the aid of a diagram, explain how an increase in transfer payments to the poorest households in a nation is likely to affect the Lorenz curve and the Gini coefficient of that nation. Candidates may include: a definition of transfer payments a definition of the Lorenz curve a definition of the Gini coefficient a diagram illustrating a Lorenz curve and the Gini coefficient an explanation that an increase in transfer payments to the poorest households can lead to an improvement in income distribution, by increasing the incomes of lower income groups an explanation that an improvement in income distribution will cause the Lorenz curve to move towards the line of absolute equality an explanation that the Gini coefficient (index) will become

M 13/3/ECONO/HP 1/ENG/TZ 1/XX/M b) Evaluate government policies to promote equity in terms of their effects on efficiency in the allocation of resources. [15 marks] Answers may include: definitions of equity, efficiency in the allocation of resources theory of how government policies (taxation, government expenditure on merit goods and subsidies and transfer payments) may promote equity but possibly reduce efficiency in the allocation of resources diagrams to show indirect taxes and subsidies and their implications for efficiency in the allocation of resources examples of government policies to promote greater income equality in particular countries and their effects on the achievement of efficiency synthesis and evaluation. Evaluation may include: consideration of the trade off between equity and efficiency, and whether transfer payments and progressive taxation reduce incentives to work. Government provision of merit goods may be less efficient than private provision. The use of indirect taxes and/or subsidies may move the economy closer to, or further away from, the position of allocative efficiency. Poverty reduction and investment in human capital may be consistent with the achievement of both improved income equality and efficiency.

M 09/3/ECONO/HP 2/ENG/TZ 2/XX/M+ 4. Explain the possible impact on the distribution of income of a government shifting its main source of tax revenue from progressive direct taxes to regressive indirect taxes. Candidates may include any of the following: explanation of progressive direct taxes explanation of regressive indirect taxes examples of direct and indirect taxes impact of a reduction in direct taxes on the distribution of income impact of a rise in indirect taxes on the distribution of income in terms of equality and equity use of the Lorenz curve.

N 07/3/ECONO/HP 2/ENG/TZ 0/XX/M+ 4. With the use of examples, explain the difference between a progressive and a regressive tax. explanation of a progressive tax: one where the average rate of tax rises as income rises; the notion of ability to pay example: the direct or income taxes levied by governments explanation of a regressive tax: a tax unrelated to income; bears hardest on those least able to pay example: the indirect or fixed rate taxes levied on the purchase of goods and services explanation: that progressive taxes raise revenue, are difficult to avoid and are used to re-distribute income from rich to poor explanation/comparison where regressive taxes raise revenue, are avoidable, are inequitable and represent a “hidden” tax. Very useful in targeting goods and services with inelastic demand (including demerit goods)