8

THE DATA OF MACROECONOMICS Chapter 23: Measuring a Nations Income

Microeconomics Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets.

Macroeconomics Macroeconomics is the study of the economy as a whole. Its goal is to explain the economic changes that affect many households, firms, and markets at once.

Macroeconomics answers questions such as the following: Why is average income high in some countries and low in others? Why do prices rise rapidly in some time periods while they are more stable in others? Why do production and employment expand in some years and contract in others?

THE ECONOMYS INCOME AND EXPENDITURE

When judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning. For an economy as a whole, income must equal expenditure because: Every transaction has a buyer and a seller. Every dollar of spending by some buyer is a dollar of income for some seller.

THE MEASUREMENT OF GROSS DOMESTIC PRODUCT

Gross domestic product (GDP) is a measure of the income and expenditures of an economy. It is the total market value of all final goods and services produced within a country in a given period of time. The equality of income and expenditure can be illustrated with the circular-flow diagram.

GDP is the market value of all final goods and services produced within a country in a given period of time. GDP is the Market Value . . . Output is valued at market prices.

. . . Of All Final . . . It records only the value of final goods, not intermediate goods (the value is counted only once).

. . . Goods and Services . . . It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, house cleaning, doctor visits).

. . . Produced . . . It includes goods and services produced in the period were considering, not transactions involving goods produced in the past.

. . . Within a Country . . . It measures the value of production within the geographic confines of a country.

. . . In a Given Period of Time. It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).

THE COMPONENTS OF GDP

GDP includes all items produced in the economy and sold legally in markets. What Is Not Counted in GDP? GDP excludes most items that are produced and consumed at home and that never enter the marketplace. It excludes items produced and sold illicitly, such as illegal drugs.

GDP (Y) is the sum of the following: Consumption (C) Investment (I) Government Purchases (G) Net Exports (NX)

Y = C + I + G + NX Consumption (C): The spending by households on goods and services, with the exception of purchases of new housing.

Investment (I): The spending on capital equipment, inventories, and structures, including new housing.

Government Purchases (G): The spending on goods and services by local and central governments. Does not include transfer payments because they are not made in exchange for currently produced goods or services.

Net Exports (NX): Exports minus imports.

This table shows total GDP for the UK economy in 2009 and the breakdown of GDP among its four components.

REAL VERSUS NOMINAL GDP

Nominal GDP values the production of goods and services at current prices. Real GDP values the production of goods and services at constant prices. An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator.

Table 2 Real and Nominal GDP

The GDP Deflator The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced. The GDP deflator is calculated as follows:
Nominal GDP 100 Real GDP

GDP deflator =

Converting Nominal GDP to Real GDP Nominal GDP is converted to real GDP as follows:

Real GDP20XX

Nominal GDP20XX 100 GDP deflator20XX

GDP AND ECONOMIC WELL-BEING

GDP is the best single measure of the economic well-being of a society. GDP per person tells us the mean income and expenditure of the people in the economy. Higher GDP per person indicates a higher standard of living. GDP is not a perfect measure of the happiness or quality of life, however. Some things that contribute to well-being are not included in GDP. The value of leisure. The value of a clean environment. The value of almost all activity that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work.

SUMMARY
Because every transaction has a buyer and a seller, the total expenditure in the economy must equal the total income in the economy. Gross Domestic Product (GDP) measures an economys total expenditure on newly produced goods and services and the total income earned from the production of these goods and services. GDP is the market value of all final goods and services produced within a country in a given period of time. GDP is divided among four components of expenditure: consumption, investment, government purchases, and net exports. Nominal GDP uses current prices to value the economys production. Real GDP uses constant base-year prices to value the economys production of goods and services. The GDP deflatorcalculated from the ratio of nominal to real GDPmeasures the level of prices in the economy. GDP is a good measure of economic well-being because people prefer higher to lower incomes. It is not a perfect measure of well-being because some things, such as leisure time and a clean environment, arent measured by GDP.

Chapter 24: Measuring the Cost of Living

Inflation is the term used to describe a situation in which the economys overall price level is rising. The inflation rate is the percentage change in the price level from the previous period.

THE CONSUMER PRICE INDEX

The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer. The Office of National Statistics reports the CPI each month. It is used to monitor changes in the cost of living over time. When the CPI rises, the typical family has to spend more money to maintain the same standard of living.

HOW THE CONSUMER PRICE INDEX IS CALCULATED

Fix the Basket: Determine what prices are most important to the typical consumer. The Office of National Statistics (ONS) identifies a market basket of goods and services the typical consumer buys. The ONS conducts regular consumer surveys to set the weights for the prices of those goods and services.

Find the Prices: Find the prices of each of the goods and services in the basket for each point in time. Compute the Baskets Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times. Choose a Base Year and Compute the Index: Designate one year as the base year, making it the benchmark against which other years are compared. Compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100.

Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period. The Inflation Rate The inflation rate is calculated as follows:
CPI in Year 2 - CPI in Year 1 100 CPI in Year 1

Inflation Rate in Year 2 =

Calculating the Consumer Price Index and the Inflation Rate: Another Example Base Year is 2002. Basket of goods in 2002 costs 1,200. The same basket in 2010 costs 1,436. CPI = (1,436/ 1,200) 100 = 119.7 Prices increased 19.7 percent between 2002 and 2010.

PROBLEMS IN MEASURING THE COST OF LIVING

PROBLEMS IN MEASURING THE COST OF LIVING

The CPI is an accurate measure of the selected goods that make up the typical bundle, but it is not a perfect measure of the cost of living. Substitution bias Introduction of new goods Unmeasured quality changes Substitution Bias The basket does not change to reflect consumer reaction to changes in relative prices. Consumers substitute toward goods that have become relatively less expensive. The index overstates the increase in cost of living by not considering consumer substitution.

Introduction of New Goods The basket does not reflect the change in purchasing power brought on by the introduction of new products. New products result in greater variety, which in turn makes each euro more valuable. Consumers need less money to maintain any given standard of living.

Unmeasured Quality Changes If the quality of a good rises from one year to the next, the value of a euro rises, even if the price of the good stays the same. If the quality of a good falls from one year to the next, the value of a euro falls, even if the price of the good stays the same. The ONS tries to adjust the price for constant quality, but such differences are hard to measure.

The substitution bias, introduction of new goods, and unmeasured quality changes cause the CPI to overstate the true cost of living. The issue is important because many government programs use the CPI to adjust for changes in the overall level of prices.

Harmonized Indices of Consumer Prices The same method is used to calculate CPI throughout the EU This allows for direct comparison of inflation rates among EU member states.

The GDP Deflator versus the Consumer Price Index

The GDP deflator is calculated as follows:

GDP deflator =

Nominal GDP 100 Real GDP

The ONS calculates other prices indexes: The producer price index, which measures the cost of a basket of goods and services bought by firms rather than consumers. Economists and policymakers monitor both the GDP deflator and the consumer price index to gauge how quickly prices are rising. There are two important differences between the indexes that can cause them to diverge. The GDP deflator reflects the prices of all goods and services produced domestically, whereas... the consumer price index reflects the prices of all goods and services bought by consumers. The consumer price index compares the price of a fixed basket of goods and services to the price of the basket in the base year (only occasionally does the ONS change the basket)... whereas the GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year.

CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATION Price indexes are used to correct for the effects of inflation when comparing money figures from different times.

Money Figures from Different Times Do the following to convert (inflate) MPs salary in 1911 to a figure in 2009 pounds:

Indexation

When some money amount is automatically corrected for inflation by law or contract, the amount is said to be indexed for inflation.

Real and Nominal Interest Rates Interest represents a payment in the future for a transfer of money in the past. The nominal interest rate is the interest rate usually reported and not corrected for inflation. It is the interest rate that a bank pays. The real interest rate is the nominal interest rate that is corrected for the effects of inflation. You borrowed 1,000 for one year. Nominal interest rate was 15%. During the year inflation was 10%.

Real interest rate = Nominal interest rate Inflation = 15% - 10% = 5%

Summary

The consumer price index shows the cost of a basket of goods and services relative to the cost of the same basket in the base year. The index is used to measure the overall level of prices in the economy. The percentage change in the CPI measures the inflation rate. The consumer price index is an imperfect measure of the cost of living for the following three reasons: substitution bias, the introduction of new goods, and unmeasured changes in quality. The GDP deflator differs from the CPI because it includes goods and services produced rather than goods and services consumed. In addition, the CPI uses a fixed basket of goods, while the GDP deflator automatically changes the group of goods and services over time as the composition of GDP changes. Money figures from different points in time do not represent a valid comparison of purchasing power. Various laws and private contracts use price indexes to correct for the effects of inflation. The real interest rate equals the nominal interest rate minus the rate of inflation.

9 THE REAL ECONOMY IN THE LONG RUN Chapter 25: Production and Growth
A countrys standard of living depends on its ability to produce goods and services. Within a country there are large changes in the standard of living over time. In the UK over the past century or so, average income as measured by real GDP per person has grown by about 1.3 per cent per year. This rate of increase might not sound very impressive but it means that GDP per person doubles every 50 years. Annual growth rates that seem small become significant when compounded for many years. Growth rates vary greatly. In some East Asian countries GDP per person has grown at a rate of about 7 per cent per year in recent decades. At this rate, GDP person doubles in just ten years. Productivity refers to the amount of goods and services produced for each hour of a workers time. A nations standard of living is determined by the productivity of its workers.

ECONOMIC GROWTH AROUND THE WORLD

Living standards, as measured by real GDP per person, vary significantly among nations. The United Kingdom is an advanced economy. In 2006, its GDP per person was $35,580. Mexico is a middle-income country. In 2006, its GDP per person was $11,410. Mali is a poor country. In 2006, its GDP per person was only $1,130. The poorest countries have average levels of income that have not been seen in the UK for many decades.

PRODUCTIVITY: ITS ROLE AND DETERMINANTS

Productivity plays a key role in determining living standards for all nations in the world. Why Productivity Is So Important Productivity refers to the amount of goods and services that a worker can produce from each hour of work. To understand the large differences in living standards across countries, we must focus on the production of goods and services.

How Productivity Is Determined The inputs used to produce goods and services are called the factors of production. The factors of production directly determine productivity. The Factors of Production Physical capital Human capital Natural resources Technological knowledge Physical Capital is a produced factor of production. It is an input into the production process that in the past was an output from the production process. is the stock of equipment and structures that are used to produce goods and services. Tools used to build or repair automobiles. Tools used to build furniture. Office buildings, schools, etc.

Human Capital the economists term for the knowledge and skills that workers acquire through education, training, and experience Like physical capital, human capital raises a nations ability to produce goods and services.

Natural Resources inputs used in production that are provided by nature, such as land, rivers, and mineral deposits. Renewable resources include trees and forests. Nonrenewable resources include petroleum and coal. can be important but are not necessary for an economy to be highly productive in producing goods and services.

Technological Knowledge societys understanding of the best ways to produce goods and services.

Human capital refers to the resources expended transmitting this understanding to the labor force.

FYI: THE PRODUCTION FUNCTION

Economists often use a production function to describe the relationship between the quantity of inputs used in production and the quantity of output from production. Y = A F(L, K, H, N) Y = quantity of output A = available production technology L = quantity of labour K = quantity of physical capital H = quantity of human capital N = quantity of natural resources F( ) is a function that shows how the inputs are combined.

A production function has constant returns to scale if, for any positive number x, xY = A F(xL, xK, xH, xN) That is, a doubling of all inputs causes the amount of output to double as well. Production functions with constant returns to scale have an interesting implication. Setting x = 1/L, Y/ L = A F(1, K/ L, H/ L, N/ L) Where: Y/L = output per worker K/L = physical capital per worker H/L = human capital per worker N/L = natural resources per worker The preceding equation says that productivity (Y/L) depends on physical capital per worker (K/L), human capital per worker (H/L), and natural resources per worker (N/L), as well as the state of technology, (A).

ECONOMIC GROWTH AND PUBLIC POLICY

Governments can do many things to raise productivity and living standards. Government Policies That Raise Productivity and Living Standards Encourage saving and investment. Encourage investment from abroad Encourage education and training. Establish secure property rights and maintain political stability. Promote free trade. Promote research and development.

The Importance of Saving and Investment One way to raise future productivity is to invest more current resources in the production of capital.

Diminishing Returns and the Catch-Up Effect As the stock of capital rises, the extra output produced from an additional unit of capital falls; this property is called diminishing returns. Because of diminishing returns, an increase in the saving rate leads to higher growth only for a while. In the long run, the higher saving rate leads to a higher level of productivity and income, but not to higher growth in these areas. The catch-up effect refers to the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich.

Investment from Abroad Governments can increase capital accumulation and long-term economic growth by encouraging investment from foreign sources. Investment from abroad takes several forms: Foreign Direct Investment Capital investment owned and operated by a foreign entity. Foreign Portfolio Investment Investments financed with foreign money but operated by domestic residents. Education For a countrys long-run growth, education is at least as important as investment in physical capital. In the developed economies of Western Europe and North America States, each year of schooling raises a persons wage, on average, by about 10 percent. Thus, one way the government can enhance the standard of living is to provide schools and encourage the population to take advantage of them. An educated person might generate new ideas about how best to produce goods and services, which in turn, might enter societys pool of knowledge and provide an external benefit to others. One problem facing some poor countries is the brain drainthe emigration of many of the most highly educated workers to rich countries.

Health and Nutrition Human capital usually refers to education but it can also refer to other investments in people such as investments in improved health. Robert Fogel, has suggested that a significant factor in long-run economic growth is improved health from better nutrition. He estimates that in Great Britain in 1780 about 1/5 people were so malnourished that they were incapable of manual labour. From 1775 to 1975, the average caloric intake in Great Britain rose by 26 per cent and the height of the average man rose by 3.6 inches (around 10 cm). Fogel won the Nobel Prize in Economics in 1993 for his work in economic history. In his Nobel lecture he concluded that improved gross nutrition accounts for roughly 30 per cent of the growth of per capita income in Britain between 1790 and 1980.

Property Rights and Political Stability Property rights refer to the ability of people to exercise authority over the resources they own. An economy-wide respect for property rights is an important prerequisite for the price system to work. It is necessary for investors to feel that their investments are secure. Free Trade A country that eliminates trade restrictions will experience the same kind of economic growth that would occur after a major technological advance. When a country exports wheat and imports steel, the country benefits in the same way as if it had invented a technology for turning wheat into steel. Some countries engage in . . . inward-orientated trade policies, avoiding interaction with other countries. outward-orientated trade policies, encouraging interaction with other countries. Research and Development The advance of technological knowledge has led to higher standards of living. Most technological advance comes from private research by firms and individual inventors. Government can encourage the development of new technologies through research grants, tax breaks, and the patent system. Population Growth Economists and other social scientists have long debated how population growth affects a society Population growth interacts with other factors of production: Stretching natural resources Diluting the capital stock Promoting technological progress

SUMMARY
Economic prosperity, as measured by real GDP per person, varies substantially around the world. The average income of the worlds richest countries is more than ten times that in the worlds poorest countries. The standard of living in an economy depends on the economys ability to produce goods and services. Productivity depends on the amounts of physical capital, human capital, natural resources, and technological knowledge available to workers. Government policies can influence the economys growth rate in many ways. The accumulation of capital is subject to diminishing returns. Because of diminishing returns, higher saving leads to a higher growth for a period of time, but growth will eventually slow down. Also because of diminishing returns, the return to capital is especially high in poor countries.

Chapter 26: Saving, Investment, and Financial System

The Financial System The financial system consists of the group of institutions in the economy that help to match one persons saving with another persons investment. It moves the economys scarce resources from savers to borrowers.

FINANCIAL INSTITUTIONS IN THE ECONOMY

The financial system is made up of financial institutions that coordinate the actions of savers and borrowers. Financial institutions can be grouped into two different categories: financial markets and financial intermediaries. Financial Markets Stock Market Bond Market Financial Intermediaries Banks Investment Funds Financial markets are the institutions through which savers can directly provide funds to borrowers. Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers.

Financial Markets The Bond Market A bond is a certificate of indebtedness that specifies obligations of the borrower to the holder of the bond. Characteristics of a Bond Term: The length of time until the bond matures. Credit Risk: The probability that the borrower will fail to pay some of the interest or principal.

The Stock Market Stock represents a claim to partial ownership in a firm and is therefore, a claim to the profits that the firm makes. The sale of stock to raise money is called equity financing. Compared to bonds, stocks offer both higher risk and potentially higher returns. Stocks are traded on exchanges such as the London Stock Exchange and the Frankfurt Stock Exchange.

The Stock Market

Most newspaper stock tables provide the following information: Price (of a share) Volume (number of shares sold) Dividend (profits paid to stockholders) Price-earnings ratio Financial Intermediaries Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers. Banks take deposits from people who want to save and use the deposits to make loans to people who want to borrow. pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans.

Investment Funds An investment fund is an institution that sells shares to the public and uses the proceeds to buy a portfolio, of various types of stocks, bonds, or both. They allow people with small amounts of money to easily diversify.

Other Financial Institutions Pension funds Insurance companies Pawnbrokers Credit unions Loan sharks

SAVING AND INVESTMENT IN THE NATIONAL INCOME ACCOUNTS Recall that GDP is both total income in an economy and total expenditure on the economys output of goods and services:

Y = C + I + G + NX

Some Important Identities Assume a closed economy one that does not engage in international trade: Y=C+I+G Now, subtract C and G from both sides of the equation: Y C G =I The left side of the equation is the total income in the economy after paying for consumption and government purchases and is called national saving, or just saving (S). Substituting S for Y - C - G, the equation can be written as: S=I National saving, or saving, is equal to: S=I S=YCG S = (Y T C) + (T G) The Meaning of Saving and Investment National Saving National saving is the total income in the economy that remains after paying for consumption and government purchases.

Private Saving Private saving is the amount of income that households have left after paying their taxes and paying for their consumption.

Private saving = (Y T C) Public Saving Public saving is the amount of tax revenue that the government has left after paying for its spending.

Surplus and Deficit If T > G, the government runs a budget surplus because it receives more money than it spends. The surplus of T - G represents public saving. If G > T, the government runs a budget deficit because it spends more money than it receives in tax revenue.

Public saving = (T G) For the economy as a whole, saving must be equal to investment. S=I

THE MARKET FOR LOANABLE FUNDS

We will assume for simplicity that the economy has only one financial market: the market for loanable funds. The market for loanable funds is the market in which those who want to save supply funds and those who want to borrow to invest demand funds. Loanable funds refers to all income that people have chosen to save and lend out, rather than use for their own consumption.

Supply and Demand for Loanable Funds The supply of loanable funds comes from people who have extra income they want to save and lend out. The demand for loanable funds comes from households and firms that wish to borrow to make investments. The interest rate is the price of the loan. It represents the amount that borrowers pay for loans and the amount that lenders receive on their saving. The interest rate in the market for loanable funds is the real interest rate and all references in this chapter to the interest rate should be understood to refer to the real interest rate. Financial markets work much like other markets in the economy. The equilibrium of the supply and demand for loanable funds determines the real interest rate.

Government Policies That Affect Saving and Investment

Taxes and saving Taxes and investment Government budget deficits Policy 1: Saving Incentives Taxes on interest income substantially reduce the future payoff from current saving and, as a result, reduce the incentive to save. A tax decrease increases the incentive for households to save at any given interest rate. The supply of loanable funds curve shifts to the right. The equilibrium interest rate decreases. The quantity demanded for loanable funds increases.

If a change in tax law encourages greater saving, the result will be lower interest rates and greater investment.

Policy 2: Investment Incentives An investment tax credit increases the incentive to borrow. Increases the demand for loanable funds. Shifts the demand curve to the right. Results in a higher interest rate and a greater quantity saved. If a change in tax laws encourages greater investment, the result will be higher interest rates and greater saving.

Policy 3: Government Budget Deficits and Surpluses When the government spends more than it receives in tax revenues, the short fall is called the budget deficit. The accumulation of past budget deficits is called the government debt. Government borrowing to finance its budget deficit reduces the supply of loanable funds available to finance investment by households and firms. This fall in investment is referred to as crowding out. The deficit borrowing crowds out private borrowers who are trying to finance investments.

A budget deficit decreases the supply of loanable funds. Shifts the supply curve to the left. Increases the equilibrium interest rate. Reduces the equilibrium quantity of loanable funds.

SUMMARY
When government reduces national saving by running a deficit, the interest rate rises and investment falls. A budget surplus increases the supply of loanable funds, reduces the interest rate, and stimulates investment. The financial system is made up of financial institutions such as the bond market, the stock market, banks, and investment funds. All these institutions act to direct the resources of households who want to save some of their income into the hands of households and firms who want to borrow. National income accounting identities reveal some important relationships among macroeconomic variables. In particular, in a closed economy, national saving must equal investment. Financial institutions attempt to match one persons saving with another persons investment. The interest rate is determined by the supply and demand for loanable funds. The supply of loanable funds comes from households who want to save some of their income. The demand for loanable funds comes from households and firms who want to borrow for investment. National saving equals private saving plus public saving. A government budget deficit represents negative public saving and, therefore, reduces national saving and the supply of loanable funds. When a government budget deficit crowds out investment, it reduces the growth of productivity and GDP.

Chapter 28: Unemployment

IDENTIFYING UNEMPLOYMENT Categories of Unemployment The problem of unemployment is usually divided into two categories. The long-run problem and the short-run problem: The natural rate of unemployment The cyclical rate of unemployment Natural Rate of Unemployment The natural rate of unemployment is unemployment that does not go away on its own even in the long run. It is the amount of unemployment that the economy normally experiences. Cyclical Unemployment Cyclical unemployment refers to the year-to-year fluctuations in unemployment around its natural rate. It is associated with with short-term ups and downs of the business cycle. Describing Unemployment Three Basic Questions: How does government measure the econom ys rate of unemployment? What problems arise in interpreting the unemployment data? How long are the unemployed typically without work?

Unemployment may be measured in two ways. A monthly survey of households the Labour Force Survey in the UK. The claimant count.

Each adult is placed into one of three categories: Employed Unemployed Not in the labour force

Labour Force The labour force is the total number of workers, including both the employed and the unemployed.

The unemployment rate is calculated as the percentage of the labour force that is unemployed.

The labour force participation rate is the percentage of the adult population that is in the labour force.

It is difficult to distinguish between a person who is unemployed and a person who is not in the labour force. Discouraged workers, people who would like to work but have given up looking for jobs after an unsuccessful search, dont show up in unemployment statistics. Other people may claim to be unemployed in order to receive financial assistance, even though they arent looking for work. Most spells of unemployment are short. Most unemployment observed at any given time is long-term. Most of the economys unemployment problem is attributable to relatively few workers who are jobless for long periods of time. In an ideal labour market, wages would adjust to balance the supply and demand for labour, ensuring that all workers would be fully employed. Frictional unemployment refers to the unemployment that results from the time that it takes to match workers with jobs. In other words, it takes time for workers to search for the jobs that are best suit their tastes and skills. Structural unemployment is the unemployment that results because the number of jobs available in some labour markets is insufficient to provide a job for everyone who wants one. Job search the process by which workers find appropriate jobs given their tastes and skills. results from the fact that it takes time for qualified individuals to be matched with appropriate jobs.

This unemployment is different from the other types of unemployment. It is not caused by a wage rate higher than equilibrium. It is caused by the time spent searching for the right job.

Search unemployment is inevitable because the economy is always changing. Changes in the composition of demand among industries or regions are called sectoral shifts. It takes time for workers to search for and find jobs in new sectors. Government programmes can affect the time it takes unemployed workers to find new jobs. These programmes include the following: Government-run employment agencies Public training programs Unemployment insurance

Government-run employment agencies give out information about job vacancies in order to match workers and jobs more quickly. Public training programs aim to ease the transition of workers from declining to growing industries and to help disadvantaged groups escape poverty.

Unemployment insurance is a government programme that partially protects workers incomes when they become unemployed. Offers workers partial protection against job losses. Offers partial payment of former wages for a limited time to those who are laid off. Unemployment insurance increases the amount of search unemployment. It reduces the search efforts of the unemployed. It may improve the chances of workers being matched with the right jobs. Structural unemployment occurs when the quantity of labour supplied exceeds the quantity demanded. Structural unemployment is often thought to explain longer spells of unemployment. Why is there Structural Unemployment? Minimum wage laws Unions Efficiency wages MINIMUM WAGE LAWS

When the minimum wage is set above the level that balances supply and demand, it creates unemployment.

UNIONS AND COLLECTIVE BARGAINING A union is a worker association that bargains with employers over wages and working conditions. In the early 1980s over half of the UK labour force was unionized but this figure fell rapidly over a few years. A union is a type of cartel attempting to exert its market power. The process by which unions and firms agree on the terms of employment is called collective bargaining. A strike may be organized if the union and the firm cannot reach an agreement. A strike refers to when the union organizes a withdrawal of labour from the firm. A strike makes some workers better off and other workers worse off. Workers in unions (insiders) reap the benefits of collective bargaining, while workers not in the union (outsiders) bear some of the costs.

By acting as a cartel with the ability to strike or otherwise impose high costs on employers, unions usually achieve above-equilibrium wages for their members. Critics argue that unions cause the allocation of labour to be inefficient and inequitable. Wages above the competitive level reduce the quantity of labour demanded and cause unemployment. Some workers benefit at the expense of other workers. Advocates of unions contend that unions are a necessary antidote to the market power of firms that hire workers. They claim that unions are important for helping firms respond efficiently to workers concerns. THE THEORY OF EFFICIENCY WAGES

Efficiency wages are above-equilibrium wages paid by firms in order to increase worker productivity. The theory of efficiency wages states that firms operate more efficiently if wages are above the equilibrium level. A firm may prefer higher than equilibrium wages for the following reasons: Worker Health: Better paid workers eat a better diet and thus are more productive. Worker Turnover: A higher paid worker is less likely to look for another job.

A firm may prefer higher than equilibrium wages for the following reasons: Worker Effort: Higher wages motivate workers to put their best effort. Worker Quality: Higher wages attract a better pool of workers to apply for jobs.

SUMMARY
The unemployment rate is the percentage of those who would like to work but dont have jobs. The Office of National Statistics calculates this statistic monthly in the UK. The unemployment rate is an imperfect measure of joblessness. In the UK, most unemployed people find work within a short period of time. Most unemployment observed at any given time is attributable to a few people who are unemployed for long periods of time. One reason for unemployment is the time it takes for workers to search for jobs that best suit their tastes and skills. A second reason why the economy always has some unemployment is minimum wage laws. Minimum wage laws raise the quantity of labour supplied and reduce the quantity demanded. A third reason for unemployment is the market power of unions. A fourth reason for unemployment is suggested by the theory of efficiency wages. High wages can improve worker health, lower worker turnover, increase worker effort, and raise worker quality.

Chapter 30: Money Growth and Inflation

The Meaning of Money Money is the set of assets in an economy that people regularly use to buy goods and services from other people. THE CLASSICAL THEORY OF INFLATION Inflation is an increase in the overall level of prices. Hyperinflation is an extraordinarily high rate of inflation. Inflation: Historical Aspects Inflation in the UK exceeded 20% per year in the mid-1970s. In the late 1990s and early 2000s UK inflation has been low and stable at around 2% per year. For long periods in the nineteenth century, some countries experienced deflation, meaning decreasing average prices. Hyperinflation refers to high rates of inflation such as Germany experienced in the 1920s and Zimbabwe in 2007-08.

The quantity theory of money is used to explain the long-run determinants of the price level and the inflation rate. Inflation is an economy-wide phenomenon that concerns the value of the economys medium of exchange. When the overall price level rises, the value of money falls. The money supply is a policy variable that is controlled by the central bank. Through instruments such as open-market operations, the central bank directly controls the quantity of money supplied.

Money demand has several determinants, including interest rates and the average level of prices in the economy. People hold money because it is the medium of exchange. The amount of money people choose to hold depends on the prices of goods and services. In the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply.

The Quantity Theory of Money The quantity of money available in the economy determines the value of money. The primary cause of inflation is the growth in the quantity of money.

Nominal variables are variables measured in monetary units. Real variables are variables measured in physical units. According to Hume and others, real economic variables do not change with changes in the money supply. According to the classical dichotomy, different forces influence real and nominal variables. Changes in the money supply affect nominal variables but not real variables. The irrelevance of monetary changes for real variables is called monetary neutrality. The velocity of money refers to the speed at which the money changes hands, travelling around the economy from wallet to wallet.

V = (P Y)/M Where: V = velocity P = the price level Y = the quantity of output M = the quantity of money Rewriting the equation gives the quantity equation:

MV=PY The quantity equation relates the quantity of money (M) to the nominal value of output (P Y).

The quantity equation shows that an increase in the quantity of money in an economy must be reflected in one of three other variables: the price level must rise, the quantity of output must rise, or the velocity of money must fall.

The Equilibrium Price Level, Inflation Rate, and the Quantity Theory of Money The velocity of money is relatively stable over time. When the central bank changes the quantity of money, it causes proportionate changes in the nominal value of output (P Y). Because money is neutral, money does not affect output.

: Money and Prices during Four Hyperinflations Hyperinflation is inflation that exceeds 50 percent per month. Hyperinflation occurs in some countries because the government prints too much money to pay for its spending.

When the government raises revenue by printing money, it is said to levy an inflation tax. An inflation tax is like a tax on everyone who holds money. The inflation ends when the government institutes fiscal reforms such as cuts in government spending. The Fisher effect refers to a one-to-one adjustment of the nominal interest rate to the inflation rate.

According to the Fisher effect, when the rate of inflation rises, the nominal interest rate rises by the same amount. The real interest rate stays the same.

THE COSTS OF INFLATION A Fall in Purchasing Power? Inflation does not in itself reduce peoples real purchasing power. Shoeleather costs Menu costs Relative price variability Tax distortions Confusion and inconvenience Arbitrary redistribution of wealth Shoeleather costs are the resources wasted when inflation encourages people to reduce their money holdings. Inflation reduces the real value of money, so people have an incentive to minimize their cash holdings. Less cash requires more frequent trips to the bank to withdraw money from interestbearing accounts. The actual cost of reducing your money holdings is the time and convenience you must sacrifice to keep less money on hand. Also, extra trips to the bank take time away from productive activities. Menu costs are the costs of adjusting prices. During inflationary, it is necessary to update price lists and other posted prices. This is a resource-consuming process that takes away from other productive activities. Inflation distorts relative prices. Consumer decisions are distorted, and markets are less able to allocate resources to their best use. Inflation exaggerates the size of capital gains and increases the tax burden on this type of income. With progressive taxation, capital gains are taxed more heavily. The nominal interest earned on savings is treated as income for income tax purposes, even though part of the nominal interest rate merely compensates for inflation.

The after-tax real interest rate falls when inflation rises, making saving less attractive.

Summary
When the central bank increases the money supply and creates inflation, it erodes the real value of the unit of account. Inflation causes money at different times to have different real values. Rising prices, its more difficult to compare real revenues, costs, n profits over time. Unexpected inflation redistributes wealth among the population in a way that has nothing to do with either merit or need. These redistributions occur because many loans in the economy are specified in terms of the unit of accountmoney. The overall level of prices in an economy adjusts to bring money supply and money demand into balance. When central bank increases the supply of money, it causes the price level to rise. Persistent growth in the quantity of money supplied leads to continuing inflation. The principle of money neutrality asserts that changes in the quantity of money influence nominal variables but not real variables. A government can pay for its spending simply by printing more money. This can result in an inflation tax and hyperinflation. According to the Fisher effect, when the inflation rate rises, the nominal interest rate rises by the same amount, and the real interest rate stays the same. Many people think that inflation makes them poorer because it raises the cost of what they buy. This view is a fallacy because inflation also raises nominal incomes. Economists have identified six costs of inflation: Shoeleather costs Menu costs Increased variability of relative prices Unintended tax liability changes Confusion and inconvenience Arbitrary redistributions of wealth

When banks loan out their deposits, they increase the quantity of money in the economy. Because the central bank cannot control the amount bankers choose to lend or the amount households choose to deposit in banks, the central banks control of the money supply is imperfect.