ABHISHEK MAITY2013MACROECONOMICSAbhishek Maity, KIS, 20121
 Chapter 1: Introduction to Macroeconomics Chapter 2: Aggregate Demand Chapter 3: Aggregate Supply Chapter 4: Macroeco...
ABHISHEK MAITYSEMESTER 2, 2013UNEMPLOYMENTAbhishek Maity, KIS, 20123
 Low Unemployment Low inflation or Price Stability Stable economic growth Equitable distribution of income TOK – Is t...
Define unemployment:“Unemployment is the condition of someone of workingage who is able and willing to work, actively se...
 Geographical disparities Age disparities Ethnic differences Gender disparitiesAbhishek Maity, KIS, 20126
Recent college or school graduate looking for employmentImmigrantsPeople who have lost their jobsPeople who have resig...
People who lost their jobs and are seeking new onesEmigrantsRetireesThe deceasedPeople returning to higher education...
Underemployment vs. UnemploymentPart-time workersOver qualified workersPeople who have “given up”This decreases the L...
It is the ratio of the number of people in the labor force tothe entire working age population in the economy.LFPR has b...
Changes in the LFPR can distort the unemployment figures.“Hidden unemployment”Abhishek Maity, KIS, 201211
 Individual : Decreased household income and purchasing power Increased levels of psychological and physical illness, s...
Abhishek Maity, KIS, 201213
Remove minimum wagesAbolish trade unionsFlaws of solutions?Harm poor workersHard to get rid of unionsAbhishek Maity, ...
Frictional and SeasonalStructuralCyclical (Demand deficient)Abhishek Maity, KIS, 201215
Frictional:Short – three months or lessUsually between jobs and voluntaryProspect for new employment is generally posi...
Structural:Making workers redundantChange in preferencesTransition in economic natureForeign laborTechnologyIt is a...
The natural rate of unemployment (NRU) comprises:SeasonalFrictionalStructuralAbhishek Maity, KIS, 201218
Moves with the machinations of the business cycle.Caused by a fall in ADDemand for labor falls pushing down wages and p...
In 2009 in the US, there were 13 million people who losttheir jobs, however, there were 3 million job vacanciesthat opene...
Abhishek Maity, KIS, 201221Type ofUnemploymentDescription Causes Possible SolutionsFrictionalPeople who are in betweenjobs...
Goal is occupational flexibilityLong term solution – education.Retraining programsSubsidies to companies with training...
Reduce unemployment benefits.Reduce regulations (deregulate) for hiring and firing.PROBLEMS?Lower benefits increases i...
Demand-Side Policies: Shifts AD (reduce deflationary gap)Expansionary fiscal policy – lower taxes and spendingLooser mo...
Supply-Side Policies: Shifts LRASUseful for reducing natural rate of unemployment.Quality of labor force and flexibilit...
How does the government get money for a budget deficit?Selling government or treasury bonds/billsIt is a form of saving...
Discuss the economic consequences of unemployment.Discuss the social and personal consequences ofunemployment.With the ...
ABHISHEK MAITYSEMESTER 2, 2013INFLATIONAbhishek Maity, KIS, 201228
“Inflation is a sustained increase of the average level ofprices. The inflation rate is the percentage by which theprice ...
The average price level is measured through a “priceindex”.Weighted average price of goods and services a typicalconsume...
Core or Fundamental InflationFood and energy prices can fluctuate based on a variety ofreasons, so items that are typica...
Abhishek Maity, KIS, 201232
Calculating load weighted averages and CPI from data.[Data Response Questions]Abhishek Maity, KIS, 201233
 What is a “typical” person? Errors in data collection. Patterns of consumption differ from different demographics so p...
An alternative price index to the CPI.PPI includes prices that producer’s receive for goods (notservices), at all stages...
Loss of purchasing power in the event of sticky wages.Effect on savingsValue of savings might decrease if savings inter...
There is “good” deflation and “bad” deflationGOOD:Supply side increases – better productivity – LRASincrease will mean ...
… of “bad” deflationUnemployment increasesBusiness profits decrease – investments reduceCost to debtors increase.Abhis...
Demand Pull InflationWhen aggregate demand increases[DIAGRAM]Cost Push InflationWhen the cost of production increases...
Combination of Demand-Pull and Cost-Push Inflation.Known as the Inflationary Spiral.AD ↑  (if economy is near full emp...
Milton Friedman and the MonetaristsLoose Monetary Policy causes the AD ↑ causing a form ofDemand Pull inflation.[DIGRAM...
Yes, it gives the Central Banks maneuverability tocounteract “liquidity traps”.There are other positives like the Mudell...
Contractionary Policies for Demand Pull Inflation:MonetaryFiscalSupply-Side Policies for Cost Push Inflation:Trying t...
The Spanish Price Revolution – 16th to 17th CenturyThe Chinese Perfumed Paper Money Problem – 11thCenturyShaving coins ...
Named after William PhillipsWork on unemployment in the 50s at LSEMONIAC computer.The relationship between rate of inf...
The original Phillips Curve was “Rate of Change of Wages”against “Unemployment”At low unemployment levels, wages will be...
Abhishek Maity, KIS, 201247
Data after the 1970s showed that Inflation andUnemployment may both simultaneously rise!StagflationAlso using supply-si...
Milton Friedman and The Monetarists adapted the PhillipsCurve to the Neo Classical LRAS.A change from the SRPC to the LR...
Explain the main consequences of inflation.Evaluate the methods that might be used to reduceinflation.Using an appropri...
ABHISHEK MAITYSEMESTER 2, 2013ECONOMICGROWTHAbhishek Maity, KIS, 201251
Difference between Real and Nominal GDPReal GDP growth rate and Real GDPEven if GDP growth rate is decreasing, as long ...
Positive Consequences:Non-inflationary growth [DIAGRAM]Quality of lifeHigher tax revenue for the governmentRepayment ...
Discuss the possible consequences of economic growth.Using an appropriate diagram, explain how economicgrowth may bring ...
ABHISHEK MAITYSEMESTER 2, 2013EQUITYDISTRIBUTION IN INCOMEAbhishek Maity, KIS, 201255
“Fairness” of income and wealth in the economy. It is notequality.The goal is to bridge the gap between the rich and the...
They may be born into low income households.They may have received poor, or no education.They may suffer from poor nutr...
Low living standardsLack of access to sufficient health careLow levels of educationPoor quality of human capital – res...
Unequal incomes lead to people working harder to earnmore money.If all kinds of jobs and transfer payments equated then ...
In the turn of the 20th Century Max Lorenz came up withstudying income inequalities.Plot of cumulative percentage of tot...
Abhishek Maity, KIS, 201261
Please be wary that even country’s with high HDI can havea high Gini Index.There is no strict correlation between level ...
Please be wary that even country’s with high HDI can havea high Gini Index.There is no strict correlation between level ...
Taxation – The Laffer CurveDirect – income taxIndirect – VAT, sales taxProgressive (tax slabs/brackets)Regressive – m...
Consider the following tax brackets and calculate theaverage tax rate for:Person 1 (low income) - $15,000Person 2 (midd...
Abhishek Maity, KIS, 201266
As a supply side policy to incentivize higher earnings, risk,entrepreneurship.To reduce the complexity of progressive sy...
It is a controversial idea – redistributing income.What constitutes a “reasonable condition”?Consider the poverty line ...
Corporate paid insurance and benefits might lead to lowerunemployment.High taxes might result in lower entrepreneurial a...
 Person A (low income) – earns $20,000 per year and spends$14,000 on goods and services. Person B (middle income) – earn...
Absolute poverty is the minimum income necessary tosatisfy basic needs.The 2008 World Bank Global Poverty Level is set a...
It might help accelerate growth:Access to resources – education, healthcareLabor force improves as a resultAD will inc...
Transfer paymentsSocial health insurancePublic educationImproving the quality and access to education andhealthcare se...
ABHISHEK MAITYSEMESTER 2, 2013MONETARY ANDFISCAL POLICYAbhishek Maity, KIS, 201274
The Government BudgetSources of RevenueTaxationTypes of ExpendituresCurrent – Day to day expensesCapital – public in...
G > T – Budget deficit – National debt growsG < T – Budget surplus – National debt shrinksG = T – Balanced budget – Nat...
Increase government spending (G)Reduce taxesCauses an increase in aggregate demandKeynesian vs. Neo Classical impact o...
Decrease government spending (G)Increase taxesCauses a decrease in aggregate demandKeynesian vs. Neo Classical impact ...
Abhishek Maity, KIS, 201279
Crowding Out EffectAutomatic StabilizersMitigating a downturn [DIAGRAM]Cooling off an over-heating economy [DIAGRAM]Ab...
Spending on transfer payments and current spending isunlikely to have an impact on LRAS.Capital spending increases LRAS...
Relationship betweentax rates andgovernment revenue.“Arithmetic effect” vs.“Economic effect”It need not be singlepeak t...
Fiscal policy has a direct impact on the AD.A decrease in taxes might help supply side effects.Monetary policy might be...
There is a time lagDetection lagAdministrative lagExecution or impact lagLarge deficit spending may increase national...
It is a link – a proxy, and a store of value.The Banking System: “the two-tier system”The Central BankCommercial Banks...
Role of the Central Bank?Banker to the government and other commercial banksSole note-issuing authority.Issues and red...
These are financial intermediariesBrings borrowers and lenders togetherThey are profit oriented – depends on the “sprea...
Demand for money refers to the want for liquidityOpportunity cost of holding cashLiquidity Preference (Keynes):Transac...
Money Demand for various levels of income.[DIAGRAM]Note: if interest rates are too low, money demandbecomes perfectly e...
Exogenous – not affected by AD[DIAGRAM]Includes all cash and coins and current accounts – i.e.money available for trans...
[Money Supply and Money Demand Diagram]Remember MS is perfectly inelasticInterest rate is the MS and MD equilibriumAbhi...
Demand Side Policy – increase ADEasy or Loose Monetary Policy – expansionaryReasons?Tight Monetary Policy – contractio...
It is an art and a scienceAdvantages:FlexibleSize and Speed can varyReversibleAbhishek Maity, KIS, 201293
Disadvantages:Might fail – liquidity trapConsumption depends on many things and not justinterest ratesTime lagsIneffe...
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Macroeconomics

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IBDP Economics. Lecture slides for Macroeconomics

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  • Resource: International Labor Organization
  • Resource: International Labor Organization
  • Chinese migration and East European migration – 300 million people!Could unemployment lead to terrorism? Palestine – 45% unemployed due to Israeli blockades.
  • Why is the Total Labor Force (TLF) positively sloped?Real Wage and Classical Unemployment.
  • A lot of market-oriented economists feel that regulation reduces “labor market flexibility”
  • Discretionary – deliberate change in the policyAutomatic – increases in transfer payments may increase G as deficit budget exists.
  • Macroeconomics

    1. 1. ABHISHEK MAITY2013MACROECONOMICSAbhishek Maity, KIS, 20121
    2. 2.  Chapter 1: Introduction to Macroeconomics Chapter 2: Aggregate Demand Chapter 3: Aggregate Supply Chapter 4: Macroeconomic Equilibrium Chapter 5: Unemployment Chapter 6: Inflation Chapter 7: Economic Growth Chapter 8: Equitable Distribution of IncomeAbhishek Maity, KIS, 20122
    3. 3. ABHISHEK MAITYSEMESTER 2, 2013UNEMPLOYMENTAbhishek Maity, KIS, 20123
    4. 4.  Low Unemployment Low inflation or Price Stability Stable economic growth Equitable distribution of income TOK – Is there an order of priority for these objectives? Are such acriteria external to economic theory, that is normative?Abhishek Maity, KIS, 20124
    5. 5. Define unemployment:“Unemployment is the condition of someone of workingage who is able and willing to work, actively seekingemployment, but unable to work.”How unemployment rate is calculated:UR = # of unemployed/labor force * 100Practice question:In country X there are 60 million people, 70% areavailable for work, while 39 million are currentlyemployed.Calculate the UR in X.Abhishek Maity, KIS, 20125
    6. 6.  Geographical disparities Age disparities Ethnic differences Gender disparitiesAbhishek Maity, KIS, 20126
    7. 7. Recent college or school graduate looking for employmentImmigrantsPeople who have lost their jobsPeople who have resignedPeople trying to return to workMedical leaveStay at home parentsAbhishek Maity, KIS, 20127
    8. 8. People who lost their jobs and are seeking new onesEmigrantsRetireesThe deceasedPeople returning to higher educationMedical leavePeople who have simply given up – “Hiddenunemployment”Abhishek Maity, KIS, 20128
    9. 9. Underemployment vs. UnemploymentPart-time workersOver qualified workersPeople who have “given up”This decreases the Labor Force Participation Rate (LFPR)Abhishek Maity, KIS, 20129
    10. 10. It is the ratio of the number of people in the labor force tothe entire working age population in the economy.LFPR has been increasing in most countries in recent years.Impact on the PPCWhat can the government do to promote LFPR?Reduce benefitsAccess to education and job trainingHelp minority groupsOther policies?Abhishek Maity, KIS, 201210
    11. 11. Changes in the LFPR can distort the unemployment figures.“Hidden unemployment”Abhishek Maity, KIS, 201211
    12. 12.  Individual : Decreased household income and purchasing power Increased levels of psychological and physical illness, stress, and depression Social: Downward pressure on wages of the employed Increased poverty and crime Transformation of traditional societies Economic: Lower AD Under-utilization of economy’s resources Brain drain Protectionism and isolationism policies Increased budge deficitsAbhishek Maity, KIS, 201212
    13. 13. Abhishek Maity, KIS, 201213
    14. 14. Remove minimum wagesAbolish trade unionsFlaws of solutions?Harm poor workersHard to get rid of unionsAbhishek Maity, KIS, 201214
    15. 15. Frictional and SeasonalStructuralCyclical (Demand deficient)Abhishek Maity, KIS, 201215
    16. 16. Frictional:Short – three months or lessUsually between jobs and voluntaryProspect for new employment is generally positive.Solutions – reduce unemployment benefitsSeasonal:Employment on requirementAlso a kind of voluntary unemploymentMight have off-setting seasonal employmentSolutions – information, reduce benefits, encouragementAbhishek Maity, KIS, 201216
    17. 17. Structural:Making workers redundantChange in preferencesTransition in economic natureForeign laborTechnologyIt is a natural outcome of the evolution of an economy“Creative destruction” ~ Joseph SchumpterInnovation and progress destroys old methodsLonger in term than frictional or seasonal unemploymentSolutions? – Retraining, education, awareness campaignsAbhishek Maity, KIS, 201217
    18. 18. The natural rate of unemployment (NRU) comprises:SeasonalFrictionalStructuralAbhishek Maity, KIS, 201218
    19. 19. Moves with the machinations of the business cycle.Caused by a fall in ADDemand for labor falls pushing down wages and pricesGraphical interpretation.Abhishek Maity, KIS, 201219
    20. 20. In 2009 in the US, there were 13 million people who losttheir jobs, however, there were 3 million job vacanciesthat opened up that could not easily be filled. Why do youthink this was the case? What could be the potential longterm outcome of this scenario?Structural unemployment – mismatch of jobsFall in housing prices reduce mobility of laborEven in recovery there could be continued mismatchWage wars may lead to inflationUnemployment benefits might increaseAbhishek Maity, KIS, 201220
    21. 21. Abhishek Maity, KIS, 201221Type ofUnemploymentDescription Causes Possible SolutionsFrictionalPeople who are in betweenjobs or looking for their firstjob. Generally very shortterm. Part of NRUYoung workers enteringthe market. Workerswho voluntarily quit for abetter jobReduce unemploymentbenefits. Improve informationsymmetry between supply anddemand of labor.SeasonalStructuralCyclical (Demand-Deficient)Natural (NRU)
    22. 22. Goal is occupational flexibilityLong term solution – education.Retraining programsSubsidies to companies with training for their workers.Tax breaks to companies who hire.Relocation tax credit to increase labor mobility.Support of apprenticeship programs.PROBLEMS?High opportunity cost.Only effective in the long run.Abhishek Maity, KIS, 201222
    23. 23. Reduce unemployment benefits.Reduce regulations (deregulate) for hiring and firing.PROBLEMS?Lower benefits increases inequity and fairness.Loss in guarantees of working conditions.Abhishek Maity, KIS, 201223
    24. 24. Demand-Side Policies: Shifts AD (reduce deflationary gap)Expansionary fiscal policy – lower taxes and spendingLooser monetary policy – increasing money supply orlowering interest ratesPROBLEMS?Opportunity cost and no guarantee of success if CC is low.Time lagInflation – especially at full-employment levelsNOTE:Discretionary Fiscal Policy verses Automatic StabilizersAbhishek Maity, KIS, 201224
    25. 25. Supply-Side Policies: Shifts LRASUseful for reducing natural rate of unemployment.Quality of labor force and flexibility and adaptability.PROBLEMS?Opportunity cost.Large time lagNOTE:Ideally, the best course of action is a mix of supply anddemand side policies.Abhishek Maity, KIS, 201225
    26. 26. How does the government get money for a budget deficit?Selling government or treasury bonds/billsIt is a form of savingsThis increases demand for savings or real loanable funds inthe economy.The consequence of this is called “crowding out”.[Diagram] – loanable funds verses InvestmentsInterest rates ↑ causing Investments ↓The extent of “Crowding Out” is debatable – Keynesians sayit won’t occur at below full employment. Neo Classicalbelieve it is a significant problem.Abhishek Maity, KIS, 201226
    27. 27. Discuss the economic consequences of unemployment.Discuss the social and personal consequences ofunemployment.With the help of a diagram, explain two possible causes ofstructural unemployment.Explain the difficulty in obtaining accurate unemploymentrate data.Evaluate the policies that are available to a governmentthat wishes to reduce its country’s unemployment.Using diagrams and examples distinguish between thedifferent types of unemployment.Explain using relevant diagrams “crowding out” theory.Abhishek Maity, KIS, 201227
    28. 28. ABHISHEK MAITYSEMESTER 2, 2013INFLATIONAbhishek Maity, KIS, 201228
    29. 29. “Inflation is a sustained increase of the average level ofprices. The inflation rate is the percentage by which theprice index has risen between two periods.”Example:If a bottle of Coke costs Rs. 10 in 2009, and there is 10.9%inflation in 2009, how much will the bottle cost in 2010?The opposite of inflation is “deflation”NOTE: “Disinflation” –the rate of inflation is decreasing.Abhishek Maity, KIS, 201229
    30. 30. The average price level is measured through a “priceindex”.Weighted average price of goods and services a typicalconsumer faces.It is called the Consumer Price Index (CPI)Some year is chosen as a “base” or “reference” year forthis basket of goods and services and the cost is indexed.Price index of base year will always be 100.By creating an index we get rid of units to makecomparisons more easily.Abhishek Maity, KIS, 201230
    31. 31. Core or Fundamental InflationFood and energy prices can fluctuate based on a variety ofreasons, so items that are typically unrelated to thefundamentals of the economy are isolated, permitting amore accurate interpretation of the workings of aneconomy.Abhishek Maity, KIS, 201231
    32. 32. Abhishek Maity, KIS, 201232
    33. 33. Calculating load weighted averages and CPI from data.[Data Response Questions]Abhishek Maity, KIS, 201233
    34. 34.  What is a “typical” person? Errors in data collection. Patterns of consumption differ from different demographics so pricesfaced by them will differ. Weights are usually fixed – so the price of one particular goodchanging can have a skewing effect on CPI even if people substitute.Substitution Bias New goods are not taken into account. New Product Bias Improvement in quality of goods are not accounted for. Quality Bias. Different countries have different ways of measuring inflation. Sometimes prices may fluctuate resulting in “unclean” data. CPI does not take into consideration intermediate goods needed bymanufacturers.Abhishek Maity, KIS, 201234
    35. 35. An alternative price index to the CPI.PPI includes prices that producer’s receive for goods (notservices), at all stages of production process, includingsemi finished and intermediate goods and raw materials.Changes in PPI are considered as “leading indicators” offuture consumer inflation rates because PPI picks up pricechanges that a typical consumer will face before thosechanges actually materialize.Abhishek Maity, KIS, 201235
    36. 36. Loss of purchasing power in the event of sticky wages.Effect on savingsValue of savings might decrease if savings interest rate islower than the inflation rateEffects on interest rates – increases with inflationDecrease in international competitivenessUncertainty – consumer and business confidencedecreasesLabor unrestAbhishek Maity, KIS, 201236
    37. 37. There is “good” deflation and “bad” deflationGOOD:Supply side increases – better productivity – LRASincrease will mean prices decrease and real outputincreases.BAD:Demand side decrease – if AD decreases, real outputdecreases and prices decrease.Abhishek Maity, KIS, 201237
    38. 38. … of “bad” deflationUnemployment increasesBusiness profits decrease – investments reduceCost to debtors increase.Abhishek Maity, KIS, 201238
    39. 39. Demand Pull InflationWhen aggregate demand increases[DIAGRAM]Cost Push InflationWhen the cost of production increases causing the SRASto shift left[DIAGRAM]Abhishek Maity, KIS, 201239
    40. 40. Combination of Demand-Pull and Cost-Push Inflation.Known as the Inflationary Spiral.AD ↑  (if economy is near full employment) thenInflation ↑  cost of production ↑ and SRAS moves left.Higher wages can lead to an “illusion” of more moneycausing AD ↑ again…[DIAGRAM]Abhishek Maity, KIS, 201240
    41. 41. Milton Friedman and the MonetaristsLoose Monetary Policy causes the AD ↑ causing a form ofDemand Pull inflation.[DIGRAM]Abhishek Maity, KIS, 201241
    42. 42. Yes, it gives the Central Banks maneuverability tocounteract “liquidity traps”.There are other positives like the Mudell-Tobin effect ofinvestments.Abhishek Maity, KIS, 201242
    43. 43. Contractionary Policies for Demand Pull Inflation:MonetaryFiscalSupply-Side Policies for Cost Push Inflation:Trying to increase the LRASWhat kind of inflation is it, anyway?We don’t usually know for sureCombination of both types of policiesGovernments are generally short-sighted – and thepublic is generally gullible, uneducated and non-thinking.Abhishek Maity, KIS, 201243
    44. 44. The Spanish Price Revolution – 16th to 17th CenturyThe Chinese Perfumed Paper Money Problem – 11thCenturyShaving coins in the Medieval times in Europe.Germany in the Second World WarArgentinaZimbabweAbhishek Maity, KIS, 201244
    45. 45. Named after William PhillipsWork on unemployment in the 50s at LSEMONIAC computer.The relationship between rate of inflation or rate ofchange in real wages and unemployment.Inflation and Unemployment are inversely related.Abhishek Maity, KIS, 201245
    46. 46. The original Phillips Curve was “Rate of Change of Wages”against “Unemployment”At low unemployment levels, wages will be higher as thereis competition for laborAt high unemployment, people are willing to work for less.Inflation replaced “rate of change of wages” as wages isthe primary cost in the firm – wages feed the change inprice levels.Abhishek Maity, KIS, 201246
    47. 47. Abhishek Maity, KIS, 201247
    48. 48. Data after the 1970s showed that Inflation andUnemployment may both simultaneously rise!StagflationAlso using supply-side economics, there can be deflationand decrease in unemployment as wellCaused the Phillips Curve to be rejected.Abhishek Maity, KIS, 201248
    49. 49. Milton Friedman and The Monetarists adapted the PhillipsCurve to the Neo Classical LRAS.A change from the SRPC to the LRPC.[DIAGRAM]LRPC shows the natural rate of unemployment at a giveninflation rate.Supply-side policies can reduce the LRPC.Natural Rate of Unemployment (NRU) is very difficult tocalculate.Abhishek Maity, KIS, 201249
    50. 50. Explain the main consequences of inflation.Evaluate the methods that might be used to reduceinflation.Using an appropriate diagram, explain why there might bea trade-off between unemployment and inflation in theshort run.Evaluate the extent to which demand-side policies areeffective in reducing inflation.With the help of a diagram explain the concept ofInflationary Spiral.Data Response Questions (DRQ)Abhishek Maity, KIS, 201250
    51. 51. ABHISHEK MAITYSEMESTER 2, 2013ECONOMICGROWTHAbhishek Maity, KIS, 201251
    52. 52. Difference between Real and Nominal GDPReal GDP growth rate and Real GDPEven if GDP growth rate is decreasing, as long as it ispositive, the economy is growing.Negative real GDP growth rate in two consecutivequarters means recession.Growth rate of developed versus developing economies.Deflationary gap and PPC. [DIAGRAM]Growth and PPC [DIAGRAM]Abhishek Maity, KIS, 201252
    53. 53. Positive Consequences:Non-inflationary growth [DIAGRAM]Quality of lifeHigher tax revenue for the governmentRepayment of debtsLow unemploymentNegative Consequences?InflationStress and deterioration in family lifeEnvironmental damage - ChinaAbhishek Maity, KIS, 201253
    54. 54. Discuss the possible consequences of economic growth.Using an appropriate diagram, explain how economicgrowth may bring about an increase in potential output.Using an appropriate diagram, explain how investmentmay result in economic growth.Abhishek Maity, KIS, 201254
    55. 55. ABHISHEK MAITYSEMESTER 2, 2013EQUITYDISTRIBUTION IN INCOMEAbhishek Maity, KIS, 201255
    56. 56. “Fairness” of income and wealth in the economy. It is notequality.The goal is to bridge the gap between the rich and thepoor.Presently, globally, the top 300 wealthy own the samewealth as the bottom 3 billion.And that is just for declared wealth!Abhishek Maity, KIS, 201256
    57. 57. They may be born into low income households.They may have received poor, or no education.They may suffer from poor nutrition and healthcare.They may have found it necessary to find work beforecompleting their education.Abhishek Maity, KIS, 201257
    58. 58. Low living standardsLack of access to sufficient health careLow levels of educationPoor quality of human capital – resulting in long termconsequences.Societal unrest!Abhishek Maity, KIS, 201258
    59. 59. Unequal incomes lead to people working harder to earnmore money.If all kinds of jobs and transfer payments equated then theeconomy would collapse as no one would have anincentive to work harder.Abhishek Maity, KIS, 201259
    60. 60. In the turn of the 20th Century Max Lorenz came up withstudying income inequalities.Plot of cumulative percentage of total income andcumulative percentage of total population.A good representation of understanding not just incomeinequalities but also which deciles have the largestdiscrepancies.[DIAGRAM]Please note that the Lorenz curve only takes into accountpresent income, not wealth.Abhishek Maity, KIS, 201260
    61. 61. Abhishek Maity, KIS, 201261
    62. 62. Please be wary that even country’s with high HDI can havea high Gini Index.There is no strict correlation between level ofdevelopment in a country and income equality.For example:US (HDI Rank 13) – 40.8 Gini IndexEthiopia (HDI Rank 171) – 29.8 Gini IndexIncome equality is not necessary to raise the standard ofliving.Abhishek Maity, KIS, 201262
    63. 63. Please be wary that even country’s with high HDI can havea high Gini Index.There is no strict correlation between level ofdevelopment in a country and income equality.For example:US (HDI Rank 13) – 40.8 Gini IndexEthiopia (HDI Rank 171) – 29.8 Gini IndexIncome equality is not necessary to raise the standard ofliving.Abhishek Maity, KIS, 201263
    64. 64. Taxation – The Laffer CurveDirect – income taxIndirect – VAT, sales taxProgressive (tax slabs/brackets)Regressive – might worsen income inequalityProportionalTransfer PaymentsGovernment Spending for Essential Goods and ServicesAbhishek Maity, KIS, 201264
    65. 65. Consider the following tax brackets and calculate theaverage tax rate for:Person 1 (low income) - $15,000Person 2 (middle income) - $38,000Person 3 (high income) - $90,000Abhishek Maity, KIS, 201265Income ($) %0 - 5,000 05,001 - 20,000 2020,001 - 40,000 4040,000+ 50
    66. 66. Abhishek Maity, KIS, 201266
    67. 67. As a supply side policy to incentivize higher earnings, risk,entrepreneurship.To reduce the complexity of progressive systems.Might actually help increase tax revenue.Abhishek Maity, KIS, 201267
    68. 68. It is a controversial idea – redistributing income.What constitutes a “reasonable condition”?Consider the poverty line issue.Neo Classical Economists argue against any form ofgovernment interference stating that governmentintervention leads to inefficiencies in the system.Abhishek Maity, KIS, 201268
    69. 69. Corporate paid insurance and benefits might lead to lowerunemployment.High taxes might result in lower entrepreneurial activities.Movement of money to “tax havens”Lower taxes help economic growth.Free market theorists argue that rather than redistributionof income, the government should promote long runactions:Ensure rightsBetter judicial systemPromote competitionBetter infrastructureAbhishek Maity, KIS, 201269
    70. 70.  Person A (low income) – earns $20,000 per year and spends$14,000 on goods and services. Person B (middle income) – earns $45,000 per year and spends$30,000 on consumer items. Person C (high income) – earns $120,000 per year and spends$80,000 on stuff. Calculate each of their average rate of total tax (direct +indirect) based on the data.Abhishek Maity, KIS, 201270Income ($) %10,001 - 30,000 2030,001 - 50,000 4050,000+ 50Sales Tax 20
    71. 71. Absolute poverty is the minimum income necessary tosatisfy basic needs.The 2008 World Bank Global Poverty Level is set at $1.25(PPP) per day.Relative poverty is how much a household’s income fallsbelow the national average.Poverty is a vicious cycle.Abhishek Maity, KIS, 201271
    72. 72. It might help accelerate growth:Access to resources – education, healthcareLabor force improves as a resultAD will increase as the MPC for poor people is higher.Social tensions will be lower – reduces uncertainty and riskfor investors.Abhishek Maity, KIS, 201272
    73. 73. Transfer paymentsSocial health insurancePublic educationImproving the quality and access to education andhealthcare service is the most effective route to equity.Access to better roads, infrastructure, and sanitation.A healthier population with better education, training andskills will increase labor productivity.A better judicial system and lower corruptions are alsoimportant.Abhishek Maity, KIS, 201273
    74. 74. ABHISHEK MAITYSEMESTER 2, 2013MONETARY ANDFISCAL POLICYAbhishek Maity, KIS, 201274
    75. 75. The Government BudgetSources of RevenueTaxationTypes of ExpendituresCurrent – Day to day expensesCapital – public investment spendingRedistribution policiesAbhishek Maity, KIS, 201275
    76. 76. G > T – Budget deficit – National debt growsG < T – Budget surplus – National debt shrinksG = T – Balanced budget – National debt remains sameNational/Public debt vs. External DebtAbhishek Maity, KIS, 201276
    77. 77. Increase government spending (G)Reduce taxesCauses an increase in aggregate demandKeynesian vs. Neo Classical impact of increasing ADDeficit – Budget and TradeHigh inflationCrowding outAbhishek Maity, KIS, 201277
    78. 78. Decrease government spending (G)Increase taxesCauses a decrease in aggregate demandKeynesian vs. Neo Classical impact of decreasing ADSlow down in growth or even a recessionIncreased unemploymentAbhishek Maity, KIS, 201278
    79. 79. Abhishek Maity, KIS, 201279
    80. 80. Crowding Out EffectAutomatic StabilizersMitigating a downturn [DIAGRAM]Cooling off an over-heating economy [DIAGRAM]Abhishek Maity, KIS, 201280
    81. 81. Spending on transfer payments and current spending isunlikely to have an impact on LRAS.Capital spending increases LRASConsider positive externalities.Lower tax rate might unleash more work and investmentsbut tax revenue is also important.Prudent fiscal policy might be more useful at economicbooms or at full employment levels.Abhishek Maity, KIS, 201281
    82. 82. Relationship betweentax rates andgovernment revenue.“Arithmetic effect” vs.“Economic effect”It need not be singlepeak though, norperfectly symmetrical.Abhishek Maity, KIS, 201282
    83. 83. Fiscal policy has a direct impact on the AD.A decrease in taxes might help supply side effects.Monetary policy might be ineffective in a deep recession.Unemployment benefits and progressive taxes work asautomatic stabilizers.Positive externality of capital spending.Maybe even green technologies.If the multiplier is greater than one, increase ingovernment spending can be very powerful.Abhishek Maity, KIS, 201283
    84. 84. There is a time lagDetection lagAdministrative lagExecution or impact lagLarge deficit spending may increase national debtInflationary pressures from fiscal spendingCrowding out private investments“Expansionary Bias”Widening trade deficitContractionary fiscal policy is hard to implement.It is not easily reversible!Some argue against the multiplier effect as well.Abhishek Maity, KIS, 201284
    85. 85. It is a link – a proxy, and a store of value.The Banking System: “the two-tier system”The Central BankCommercial BanksAbhishek Maity, KIS, 201285
    86. 86. Role of the Central Bank?Banker to the government and other commercial banksSole note-issuing authority.Issues and redeems government bondsManages government banking accountMonetary policy to manage inflation and growthExchange rate policy management“Credit Crunch” and “Bailouts” – institute of last resortsRegulates and supervises commercial banks and sets cashreserve ratio.Abhishek Maity, KIS, 201286
    87. 87. These are financial intermediariesBrings borrowers and lenders togetherThey are profit oriented – depends on the “spread”Charge of different rates, based on circumstancesCash reserve ratio – what can be lent out is much morethan the actual cash deposits.Abhishek Maity, KIS, 201287
    88. 88. Demand for money refers to the want for liquidityOpportunity cost of holding cashLiquidity Preference (Keynes):Transactions motive: Need money to buy goods andservicesPrecautionary motive: To meet unexpected expenses.Speculative motive: This demand is inversely proportionalto the interest rates.Abhishek Maity, KIS, 201288
    89. 89. Money Demand for various levels of income.[DIAGRAM]Note: if interest rates are too low, money demandbecomes perfectly elastic.Abhishek Maity, KIS, 201289
    90. 90. Exogenous – not affected by AD[DIAGRAM]Includes all cash and coins and current accounts – i.e.money available for transactions.Central Bank can change money supply using the followingtools:Change cash reserve ratioDiscount rateOpen market operations – bond transactions –“quantitative easing”Abhishek Maity, KIS, 201290
    91. 91. [Money Supply and Money Demand Diagram]Remember MS is perfectly inelasticInterest rate is the MS and MD equilibriumAbhishek Maity, KIS, 201291
    92. 92. Demand Side Policy – increase ADEasy or Loose Monetary Policy – expansionaryReasons?Tight Monetary Policy – contractionaryReasons?Abhishek Maity, KIS, 201292
    93. 93. It is an art and a scienceAdvantages:FlexibleSize and Speed can varyReversibleAbhishek Maity, KIS, 201293
    94. 94. Disadvantages:Might fail – liquidity trapConsumption depends on many things and not justinterest ratesTime lagsIneffective in fixed exchange rate systems [more later]Effectiveness is reduced by increased borrowable marketsAbhishek Maity, KIS, 201294

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