4 The macro economy Employment/unemployment, - PowerPoint Presentation

1. 4 The macro economyEmployment/unemployment, The circular flow of income

2. Difficulties involved in measuring unemploymentMeasuring unemployment seems at first easy: just count up all those who are unemployed. It is not, however, that simple. Firstly, there are different ways of measuring unemployment and these can varybetween countries.The International Labour Organization (ILO) uses the labour force survey and this is used for international comparisons. The UK also use the claimant count, which relates to those registered as unemployed and 'claiming the jobseeker's allowance. Those people who are not eligible for this, or-who have not registered/are not included-This-results in the labour force survey giving a higher figure than the claimant count. The labour force survey, however, is subject to sampling errors and may not be entirely representative.In addition to the possibility of different measures, there are a number of other problems:Inactive workers.Discouraged workersPart-time workersUnreported legal employmentUnreported illegal employment08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com2

3. Policies to correct unemploymentPolicies depend both on how the causes of unemployment are viewed and also on the time period.In the short term both fiscal and monetary policies can be used. Fiscal . policy will involve: the cutting of taxes for consumers, both direct and indirect, so as to increase consumption (C); cutting of taxes on companies, such as corporation or profits tax, so as to encourage greaterinvestment (I); and a direct increase in government expenditure (G). As C,I and G are all part of aggregate demand (AD) this will then increase, leading to a rise in output, income and employment, see Figure 1.Figure 1 shows that any increase in a component of AD will shift it from AD to AD I leading to greater output, income and employment at Y1 1£ however, AD increases by too much to AD2, then inflation rises from p to P1' This could lead to the long run Phillips curve1. An increase in aggregate demand08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com3

4. where attempts to reduce unemployment have no real effect except to increase inflation.Using monetary policy, the rate of interest can be cut or a policy such as quantitative easing used. Reducing interest rates -ill: encourage consumers to save less and spend more (as the opportunity cost of doing so has fallen) and to borrow more; encourage firms to invest more as the cost of borrowing has fallen; cause a fall in the exchange rate leading to a rise in exports.The effect on AD can again be shown by figure 2.In the long run, supply-side policies would be effective in improving labour productivity by training or retraining and by providing better education and health services. Figure 2 shows that shifting AS toAS1 will overcome any inflationary effects of increasing AD and at the same time increase output, income and employment from Y to Y1.2. Operation of supply-side policy08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com4

5. The circular flow of income:Closed and open economiesThe circular flow of income is a way of Showing that money flows between households, or individuals, firms and government in an economy. If there is no foreign trade then this is called a closed economy. With foreign trade it becomes an open economy.Componentsof different types of economies08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com5

6. The circular flow of income between household firms, government and the international economyThe circular flow of income refers to the idea that money is provide to the factors of production in exchange for their services. In turn the owners of these factors then spend the money on the goods and services which are provided. In other words, the flow of money is like a circle. In Figure households supply labour and in return receive income. They spend this, consumption, and get in return goods and services.In reality some people save and this is a withdrawal or leakage from the system, reducing the circular flow. This is the same with taxes and imports where the money flows out to other economies. Equally, more money can be injected into the system through investment by firms, government expenditure and exports where money flows in from other economies .In an open economy we would need to show money from exports coming into the system and money for imports leaving the system.08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com6

7. Average and marginal propensities to save and consumeThe average propensities measure the total of consumption or saving as a proportion of total income. The average propensity to consume(APC) is total consumption as a proportion of total income (Y). It is measured as:As a person's income rises the APC will fall as that person can now afford to save out of their income and thus consume less of any increase. The opposite will be true of the average propensity to save (APS). Indeed, at low levels of income consumers mar i save by drawing on savings to help their consumption level. APS is measured by:The marginal propensity to consume ( MPC) refers to the proportion of any change in income which is consumed, and is measured as:where zx stands for change in. Similarly, the Marginal propensity to save (MPS) is the proportion of any change in income that is saved:** As with APC and APS, MPC declines as income rises, while MPS rises08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com7

8. The multiplierThe multiplier effect happens all the time in an economy. It represent the amount by which any change in injections (J) is increased or decreased to give the final change in national income. If a government, for example increases its expenditure this results in a greater change in national income.To explain, this assume that we have a very simple economy with only consumers (C) and investors (I). If investment increases by $100 and consumers always spend 80 per cent of any increase in the income (MPC = 0.8) then they will, in turn, spend $80 and save (S) $20. This will continue until there is nothing left to spend as shown below.I = $100 + C = (8O+ 64 + 51.2 + ..... ) = $500S = (20 + 16 + 12.8 + ….) = $100There are two different, but related, changes to note:1. National income has risen by $500 which is 5X the initial injection. This because the value of the multiplier (k) is 5. This is derived from the following equation:2. Savings have increased to $100, which equals the amount invested.This is because Injections = Withdrawals.In a simple economy Y = C + S. In this situation which is same as 1- MPC. In the equation in point 1 above, the MPS is 0.2. 08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com8

9. If all withdrawals (W) are considered then the multiplier will be:Here MRT is the marginal rate of tax. and MPM is the marginal propensity to import.This means that if the marginal propensity to save is 0.2 and of imports is 0.1 while the marginal rate of tax is 0.1 then the valuemultiplier is:Notice that the effect of increasing the withdrawals is to reduce the value of the multiplier because more money leaks out of the circular flow.If the multiplier is now put together with injections the formula is : Y = (I + G + X) k = ΔJ X k. Keynesian multiplierThere are many different multipliers, bur the one used here is the traditional Keynesian multiplier. Many economists now doubt whether there is a real multiplier effect for some injections, but it isclear that the opening of a new factory in an area will not only create jobs directly, bur will lead to more demand in shops, increasing their incomes and thus demand for labour, leading to these people having more money, and so on.08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com9

10. Aggregate expenditure (AE)Using a Keynesian model of income determination. and assuming that aggregate supply is horizontal in the short run, en the equilibrium level of real national income is determined by demand . In the circular flow of income, for it to be in equilibrium planned expenditure must equal planned production.AE function, meaning, components and their determinantsIn a closed economy AE consists of Consumption(C), Investment (I) and Government expenditure (G ).In Figure , the 45° line is where planned expenditure equals to real national income.In many cases even when Y = 0 there will be some consumption. This is called autonomous consumption.The consumption line is shown by the equation C = a+b(MPC)Y.Y,Y1 and Y2 are points of equilibrium. The effect of adding ininvestment is to increase equilibrium income from Y to Y1 while the addition of government expenditure shifts it to Y2.Aggregate expenditure equilibriumAn open economy adds net exports (exports (X) - imports (M)) so AE = C + 1+ G + (X-M).The slope of the consumption line is determined by the relationship between consumption and income, called the marginal propensity to consume. This is calculated as follows: where C is greater than Y and APS is greater than 1, then household must be using their savings, or borrowing, in order to support their consumption. This is called dissaving. In the Figure this is anywhere to the left of the 450 line.08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com10

11. Determinant of consumption08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com11The level of consumption is determined by:Income, as shown above.Wealth, i.e. assets. If a consumers' wealth increases then the consumption function will shift upwards. This could be because house prices rise faster than inflation.Rate of interest - if this falls then consumers are likely both to save less and to borrow more, both increasing consumption.Expectations - if consumers are optimistic about the future, e.g. the expect their incomes to rise, then they may increase consumption in anticipation of this happening.Income distribution - the rich tend to have a lower MPC than the poor so if income is redistributed from the rich to the poor consumption is likely to rise.

12. Determinant of Investment08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com12The level of investment is determined by:The rate of interest: as interest rates fall investment increases because it is cheaper to borrow money.Demand: firms will want to invest more if they expect demand to increase as the return on investment will rise.Innovation and technology: innovations and new technology will both lead to more investment as they raise the productivity of capital goods.Taxes on company profits: many governments, e.g. Ireland, have lowered corporation tax to encourage greater investment.

13. Determinant of Government Expenditure08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com13The level of government expenditure is determined by:Political factors - governments have found it easy co increase expenditure, but politically difficult co reduce it. This can be seen in many European countries in the period 2010 onwards.The need to maintain low inflation, full employment and economic growthProvision of merit and public goods to help reduce income inequality.Ability to borrow money.

14. Determinant of Net Export08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com14The level of net exports is determined by:GDP of a country: as this increases so do imports.GDP of other countries: if other countries' GDP rises so should exports to them.Exchange rates: a fall in a country's exchange rates should assuming the Marshall-Lerner condition improve net exports.Competitiveness: if this increases, e.g:-higher productivity, then also should net exports.

15. 08/18/2020Mohammad Ziaul Alam, HOD,DEBS_CIDER, zia-academy.com15Cambridge International AS and A Level Economics by Colin Bamford and Susan Grant2. AS And A level Economics by Andrew Gillespie3. AS Economics by Terry Cook4. Economics for IBDP by Jocelyn Blink and Ian Dorton5. Principles of Economics for ISC class XII by Asis Banerjee and Debashis mazumdar