Economics Pre-Bac

A. Employment
Number unemployed = those of working age who are without work, but who are available for work
at current wage rates.
Full employment = A situation in which all available labor resources are being used in the most
economically efficient way. The remaining unemployment is frictional. In practice, full
employment is not possible
The two most common measures of unemployment are the standardized unemployment rate (those
available for work and seeking work) and claimant unemployment (claiming benefits).
Unemployment can be divided into disequilibrium and equilibrium unemployment.

Types of unemployment
There are two main categories of unemployment: equilibrium unemployment and disequilibrium
unemployment.

Disequilibrium unemployment

Disequilibrium unemployment: when real wages in the economy are above the equilibrium level.
The graph shows the aggregate demand and supply of labour in the whole economy.
The aggregate supply curve (ASL) shows the number of workers willing to accept jobs at the current
wage rate. The curve is relatively inelastic because the workforce cannot change significantly.
However the curve is not totally inelastic because: a) a higher wage rate will encourage some
people to enter the labour market (parents) and b) the unemployed will be more willing to accept
job offers rather than searching for a better paid job.
The aggregate demand curve (ADL) slopes downwards. The higher the wage rate, the more firms
are trying to substitute their labour force for machines or economise on labour.
The labour market is in equilibrium at We. At W2 the labour market is in disequilibrium, there is an
excess supply of labour of A-B.

For disequilibrium to occur, 2 conditions must hold:

The aggregate supply of labour must exceed the aggregate demand.

The wage rate must not immediately fall back to We.

Causes of disequilibrium unemployment

1. Real-wage unemployment
Real-wage unemployment is where trade unions use their power to drive wages above the marketclearing level.
2. Demand-deficient(Keynesian) or cyclical unemployment
Demand-deficient unemployment is associated with recessions. As the economy moves into a
recession, consumer demand falls. After a while, firms will start to cut back on production and the
labour they employ. The ADL curve shifts to the left. The deeper the recession becomes, the higher
the demand-deficient unemployment will be.
(3.)Growth in the labour supply
If labour supply rises with no corresponding increase in the demand of labour, the equilibrium real
wage rate will fall, causing more unemployment. However, this tends not to be a serious problem
because the supply of labour changes relatively slowly.

Equilibrium unemployment

Equilibrium unemployment is the difference between those who would like employment at the
current wage rate and those willing and able to take a job.
Even when the labour market is in equilibrium not everyone looking for a job will be employed. In
the diagram. The horizontal difference between N and ASL represents the people who are looking
for work. Qe represents the equilibrium level of employment and the distance D E represents the
equilibrium level of unemployment, also known as natural level of unemployment.
Causes of equilibrium unemployment
1. Frictional (search) unemployment
Frictional unemployment occurs when people leave their jobs and are then unemployed for a period
of time while looking for a new job. This type of unemployment occurs as a result of imperfection
in the labour market. Employers are not fully informed about what labour is available and vice
versa. It often takes time for workers to find jobs and in the meantime they are unemployed.

2. Structural unemployment
Structural unemployment is where the structure of the economy changes. Employment in some
industries may expand while in others it reduces. There are two main reasons for this:

A change in the pattern of demand. Some industries experience declining demand, due to a
change in consumers taste. Some goods may go out of fashion, while others are facing more
competition, e.g. shift from coal to other fuels, causing structural unemployment in mining
areas.
A change in the methods of production (technological unemployment), occurs as a result of
labour-saving technology.

Structural unemployment often occurs in particular regions, known as regional unemployment.

The level of structural unemployment will depend on three factors:
1. The degree of regional concentration of industry
2. The speed of change of demand and supply in the economy
3. The immobility of labour

3. Seasonal unemployment
Seasonal unemployment occurs when the demand for certain types of labour is lower at certain
times of the year.

Economic and social consequences of unemployment

Direct costs:
-

Personal costs unemployed

Broader costs to the economy:

1.
2.
3.
4.
5.

Unemployment benefits are a cost to the tax payers

Unemployment represents a loss of output actual output is below potential output
The government loses tax revenues
Firms loose the profits that could have been made, had there been full employment.
Other workers lose any additional wages they could have earned from higher national output

Policies to affect unemployment

Unemployment can be affected by both supply-side and demand-side policies. The government
firstly relies on monetary and fiscal policy to maintain a stable rate of economic growth and so
causing more employment. Secondly, supply-side policies, and in particular active labour market
strategies and other welfare and education reforms, are used to reduce the structural aspects of the
unemployment problem. Both supply-side and demand-side policies need to be used together to

decrease unemployment. Only increasing aggregate demand will cause inflation and wont attack
the structure of the unemployment problem.

B. Price stability
Inflation = a general rise in prices of goods and services in an economy over a period of time.
Real growth values = values of the rate of growth of GDP after taking inflation into account.
Inflation leads to a fall in the purchasing power or value of money.
The rate of inflation is measured by the annual percentage change in the level of consumer prices
using the consumer price index (CPI). (Target Eurozone = 2 %)

Causes of inflation
1. Demand-pull inflation
Demand-pull inflation is caused by continuing rises in aggregate demand. The AD curve shifts to
the right and firms will respond by raising prices and increasing output (move up along the AS
curve).
Demand-pull inflation is typically associated with a booming economy. Many economists argue
that this is a counterpart of demand-deficient unemployment.

2. Cost-push inflation
Cost-push inflation is associated with continuing rises in costs and causes a leftward shift in the AS
curve. If firms face a rise in cost, they will raise their prices, passing the costs on to the consumer
and cutting back on production. The leftward shift causes the price level to rise and the output to
fall.

Types of cost-push inflation:

Wage-push inflation: where trade unions push up wage rates

Profit-push inflation: where firms use their monopoly to push up prices.
Import-price-push inflation: where import prices rise independently of aggregate demand.

3.Structural (demand-shift) inflation

When the pattern of demand or supply changes in the economy, certain industries will experience
increased demand (higher prices) and others decreased demand (lower prices).
However, the main cause of inflation is an excess supply of money.
Quantity theory of money: the level of prices in the economy depends on the quantity of money: the
greater the supply of money, the higher the level of prices.

Economic and social consequences of inflation

1. Redistribution: inflation redistributes wealth to those with assets (e.g. property) that rise
rapidly during inflation and away from those with savings whose value is eroded by
inflation (pensioners).
2. Uncertainty and lack of investment: inflation tends to cause uncertainty. It is difficult for
firms to predict their costs during inflation and may be discouraged from investing
reducing economic growth
3. Balance of payments: inflation is likely to worsen the balance of payments. If the prices of
products in a country rise, imports will rise and exports will fall.
4. Resources: extra resources are likely to be used to cope with the effects of inflation.

Policies to control inflation

Inflation can be reduced by policies that slow down aggregate demand or boost the rate of growth
of aggregate supply. The main policies are to do this are:
1. Fiscal policy: if the government believes AD is too high, it may reduce its own or it can
choose to raise direct taxes so that government borrowing (the budget deficit) is reduced.
This helps to take money out of the circular flow of income.
2. Monetary policy: to reduce AD it can increase interest rates to reduce consumer and
investment spending.
3. Supply side economic policies: Supply side policies include those that seek to increase
productivity, competition and innovation all of which can maintain lower prices.

C. Trade cycles
Business cycle (= Trade cycle, Cycle de Juglar, Cycle classique)

In the long run, actual growth tends to follow this phases:

1. Recession. During this phase there is little or no growth or even a decline in output.
Unemployment is high and inflation is low. (Recession = 2 quarters of negative growth)
2. The upturn. In this phase, an economy is recovering and growth in actual output resumes.
There is less unemployment and inflation starts to rise
3. Peaking out. During this phase growth slows down. Unemployment is low and inflation is
high.
4. Downterm. During this phase there is little or no growth or even a decline in output. There
is more unemployment and less inflation.

The multiplier process

The multiplier effect can have a big effect on the business cycle. An initial change in aggregate
demand can have a much greater final impact on the level of national income. This is commonly
known as the multiplier effect and it comes about because injections of demand into the circular
flow of income stimulate further rounds of spending and this can lead to a much bigger effect on
equilibrium output and employment.

The accelerator effect

Also the accelerator effect can have an impact on the business cycle. When consumer demand is
rising strongly, businesses may increase investment to expand their production capacity and meet
the extra demand. This is known as the accelerator effect. The accelerator effect can also work in
the other direction. A slowdown in consumer demand can create excess capacity and may lead to a
fall in planned investment demand

Counter-Cyclical policy:
An economic or financial policy is called countercyclical if it works against the cyclical
tendencies in the economy. That is, countercyclical policies are ones that cool down the economy
when it is in an upswing, and stimulate the economy when it is in an downturn.

Keynesian economics advocates the use of automatic countercyclical policies to lessen the impact
on the business cycle. One example of an automatic countercyclical fiscal policy is a progressive
tax. By taxing a larger proportion of income when the economy expands, a progressive tax tends to
decrease demand when the economy is booming, thus slowing the boom down.
Other groups of economists such as monetarism and new classical macroeconomics, hold that
countercyclical policies may be counterproductive, and therefore favor a laissez-faire fiscal policy
which means waiting until the economy is counteracting itself.

D. Economic growth
Actual growth = the percentage annual increase in national output or GDP
Potential growth = the speed at which the economy could grow. It is the percentage annual
increase in the economys capacity to produce
Potential output = the output that could be produced if there were full employment of resources
Desired growth Governments try to achieve high rates of economic growth over the long term.
Governments also try to achieve stable growth, avoiding recessions and excessive short-term
growth that cannot be sustained.

Determinations of growth
Potential growth can increase through increasing the quantity and quality of resources. Two of the
major factors contributing to potential economic growth are:

An increase in resources natural resources, labour or capital. The quantity of capital can be
increased by investment in the economy. If there is an increase in the working population,
there will be an increase in potential output. Supply-side policies
An increase in the efficiency of these resources. The productivity of capital can be increased
by technological improvements and the more efficient use of the capital stock. The
productivity of labour can be increased by better education, training, motivation and
organisation. Supply-side policies

Actual growth can be increased by:

A growth in aggregate demand. Demand-side policies

A growth in potential output

If actual output is below potential output, actual growth can temporarily exceed potential growth, if
aggregate demand is rising sufficiently. In the long run however, actual growth can grow only as
fast as potential output will permit.

Means of achieving growth

How can the government increase a countries growth rate?
1. A government may focus on the demand or supply side of an economy. The may attempt to
create enough aggregate demand to ensure that firms wish to invest and that potential output
can be realised. They may also try to increase aggregate supply by concentrating on
measures to increase potential output: training, measures to encourage research and
development and innovation.
2. Secondly, they may focus on market-orientated and interventionist policies. Many
economists believe that the best option to encourage economic growth is in a market where
private enterprise is allowed to flourish: where entrepreneurs may achieve rewards from
investing into new techniques and products. Such economists therefore wish policies to free
up the market. Others however, argue that a free market will cause cyclical fluctuations and
cause uncertainty that will discourage investment. Such economists therefore advocate
active intervention by the government.

Benefits and costs to economic growth

Benefits:
1. Increased level of consumption. Economic growth will lead to higher real income per
head. This can lead to higher levels of consumption of goods and services and so will
increase human welfare.
2. Help avoid other macroeconomic problems. Without a growth in productive potential,
peoples demand for higher incomes will likely lead to higher inflation, balance of payments
crises (more imports) etc.
3. Easier to redistribute incomes to the poor. As peoples income rise, they automatically
pay more taxes. Therefore there is more government money available for benefits.
4. Society may feel that it can afford to care more for the environment. As people grow
richer, they may become less preoccupied with their own consumption and more concerned
to live in a clean environment.
Costs:
1. Short-run opportunity cost of growth. To achieve faster growth, firms will have to invest
more and so leading to less consumption in the short-run.
2. (Growth may generate extra demand). The more people have, the more they want.
3. Quality of life may suffer. Longing working hours, greater stress etc.
4. Environmental costs. The higher the consumption, the higher is likely to be the level of
pollution and waste.
5. Non-renewable resources. Some resources will run out more rapidly shortages for
future generations
6. Effects on distribution of income. While some people may gain from a higher standard of
living, others are likely to lose.

Underdevelopment
Underdevelopment is a term often used to refer to economic underdevelopment, associated with
lack of access to job opportunities, health care, drinkable water, food, education and housing. Most
Sub-Saharan African countries remain largely underdeveloped. Most countries that are now fully
developed have never been underdeveloped, thought they have been undeveloped.
Characteristics
Underdevelopment takes place when resources are not used to their full socio-economic potential,
with result that local or regional development is slower in most cases than it should be. It is often
the result of internal and external factors that dont allow countries to develop enough.
Underdeveloped nations are characterized by a wide disparity between the rich and the poor, and an
unhealthy balance of trade.
Consequences
The economic and social development of many developing countries has not been even. They have
an unequal balance which results from their dependence upon primary products for their export
receipts. These commodities are: a) often in limited demand in the industrialized countries (e.g. tea,
coffee, bananas); b) vulnerable to replacement by synthetic substitutes (cotton etc.) or c) are
experiencing shrinking demand with the evolution of new technologies that require a smaller
amount of raw materials (e.g. many metals).
Prices of these products cannot be raised as this will cause the use of replacement goods, nor can
production be expanded as this rapidly decreases price. Consequently, the primary commodities
upon which most of the developing countries depend are subject to considerable short-term price
fluctuation, which makes the export income of the developing countries unstable and vulnerable.
Development therefore remains hard.

Sustainable development
The term sustainable means lasting and to maintain. The term sustainable development means:
development that meets the needs of the present without compromising the ability of future
generations to meet their own needs. Each generation should pass on at least as much capital as it
inherits, including physical capital (infrastructure, machinery), intellectual capital (knowledge and
technology) and environmental capital (environmental quality and natural resources).
The current government focuses on four main objectives:
1) Social progress which recognises the needs of everyone. Everyone should share the benefits
of increased prosperity and a clean and safe environment. Needs must not be met by treating
others (including future generations) unfairly.
2) Protection of the environment: we must limit environmental threats to protect human health,
safety and things we value (wildlife, landscapes etc)
3) Efficient use of natural resources: we need to make sure that non-renewable resources are
used efficiently and that alternatives are developed. Renewable resources should be used in
ways that do not endanger or cause serious damage or pollution to the resources.

4) Maintain high and stable economic growth and employment: so that everyone can share in
high living standards and greater job opportunities.
Since resources are limited and wants are virtually unlimited, sustainable development is very
important.

E. International Trade
The balance of payments
A countrys balance of payments account records all transactions between the residents of that
country and the rest of the world. It shows the countrys payments to or deposits in other countries
(debits) and its receipt or deposits from other countries (credits)
Exchange rate = the rate at which one national currency exchanges for another.
There are three main parts of the balance of payments account: the current account, the capital
account and the financial account.
The current account
The current account records payments for: imports and exports of goods and services, incomes
flowing into and out of the country and net transfers of money in and out of the country.

The trade in goods account (visibles).

- Exports > Imports (Surplus)
- Imports > Exports (Deficit)
Trade in services
Income flows: wages, interests and profits
Current transfer of money: government contributions and transfer of money by private
individuals and firms.

The capital account

The capital account is the record of transfers of capital to and from abroad (fixed assets, projects)
The financial account
The financial account is the record of flows of money into and out of the country for the purpose of
investment or as deposits in banks or other financial institutions.
Direct and portfolio investment. This account covers primarily long-term investment

Direct investment: the acquisition or sale of assets.

- Money invested from abroad in a company in this country = inflow of money (Credit)
- Money invested in a company abroad = outflow of money (Debit)

Portfolio investment Shared

- Buying of shares in this country (Credit)
- Buying of shares abroad (Debit)

Other financial flows Short term monetary flows

Deposits in and loans to this country (Credit)

Deposits in and loans to abroad (Debit)

Flows to and from the reserves.

Drawing on reserves (Credit)

Building up reserves (Debit)

When all the components of the balance of payments account are taken together, the balance of
payments should exactly balance.
If the balance of payments is not in balance, the rate of exchange would have to adjust until they
were, or the government would have to intervene to make them equal.
When the statistics are compiled, a number of errors are likely to occur mainly because of imperfect
information. To correct this a Net errors and omission item is included. This is an adjustment to
ensure that the two sides balance.

Reasons for restricting trade

1. Infant industry argument: an industry that has a potential comparative advantage, but which
is yet too underdeveloped to be able to realise this potential. Without protection, these infant
industries will not survive competition from abroad. Protection however, will allow them to
expand and become more efficient.
2. To reduce reliance on goods with little dynamic potential
3. To prevent dumping and other unfair trade practice:

Four methods of restricting trade:

1. Qoutas: limits imposed on the quantity of a good that can be imported.
2. Tariffs (custom duties): taxes on imports
3. Administrative barriers: to exclude imports.

Exchange rates
Floating exchange rates: when the government does not intervene in the foreign exchange
markets, but allows the exchange rates to be freely determined by demand and supply.

When UK importers wish to buy goods from the USA, they supply pounds on the foreign exchange
market and demand dollars.
The higher the exchange rate, the more dollars they obtain for their pounds.
Any shift in the demand or supply curves will cause the exchange rate to change. A fall in the
exchange rate of the domestic currency with foreign currencies is called a depreciation. A rise in
the exchange rate is called an appreciation. A shift in the demand or supply can be caused by:

Policies
Demand-side policies
Fiscal policy
For many years, fiscal policy was generally associated with managing the level of aggregate
demand in order to expand (reflate) or contract (deflate) the economy.
Fiscal policy is the part of a governments economic policy aimed at achieving its economic
objective through the use of the fiscal instruments of taxation, public spending and the budget
deficit (borrowing) or surplus.
Demand-side fiscal policy, Keynesian fiscal policy, operates through increasing or decreasing
aggregate demand.
To increase aggregate demand the government increased government spending or cut taxes.
Expansionary fiscal policy = the increased governments budget deficit resulting in more demand
into the circular flow of income. ( Demand)
Contractionary (deflationary) fiscal policy is when there are cuts in government spending or tax
increases which reduces the budget deficit, moving the governments finances into surplus and
taking demand out of the economy. ( Demand)
Taxation > Govt. spending = Budget surplus
Taxation < Govt. spending = Budget deficit
When fiscal policy is used to raise or lower taxes and government spending in order to manage
aggregate demand, it is called discretionary fiscal policy. This is regularly adjusted to try to
maintain a high level of employment, while avoiding a big increase in the rate of inflation.

Monetary policy
Monetary policy is aiming to achieve economic objectives by using monetary instruments such as
controls over bank lending and the rate of interest.
Instruments:
1. Interest rates

2. Credit regulations
3. Quantitative easing. (printing money)
By influencing the exchange rate, the level of aggregate demand can be managed, controlling the
rate of inflation. However, monetary policy can also affect employment and growth. Monetary
policy affects C, I and (X M).

Supply-side policies
Supply-side policies focus on aggregate supply. Economists now generally agree that, except in
recessions, the major problems in the economy is producing goods and services that are quality
competitive and price competitive in domestic and export markets. Supply-side policies can affect
unemployment, inflation and growth.
Supply-side policy is almost always pro-market and anti-interventionist. The policies aim to
promote entrepreneurship and popular capitalism. But supply-side policy cannot deliver unless the
private sector does its job in improving labour productivity, innovation and investment.

(National

income)

National income is a measure of a countries standard of living or economic welfare

Methods of calculating national income:
1. The product method: add up all the goods and services produced in a country (gross value
added at basic prices.
2. The income method: income generated from the production of goods and services
3. The expenditure method: is to add up all the expenditure on final output: C + G + I + X M.
Four components of national income:
1.
2.
3.
4.

Government expenditure
Consumer expenditure
Industry expenditure
Foreigner expenditure

Money national income measures the goods and services produced by the economy in monetary
terms at the price level when the output was produced.
Real national income measures the good and services in physical units.
GDP is calculated by GVA + taxes on product subsidies on products. (GVA = the sum of all the
value added by all the industry in the economy).
Limitations of national income to standard of living:
1. They underestimate activity: non-monetised economy (housework) and illegal activity in the
economy.
2. They overestimate activity: pollution and crime is not taken away
3. Disparity in income distribution
We can compare national income between countries by:
1. Converting each countrys currency in a common currency.
2. Purchasing Power Parity (PPP) which means that any PPP currency buys the same quantity
of a good anywhere in the world.
Three alternative ways of measuring National Economic Welfare:
1. HDI: human development index:
i. Life expectancy
ii. Knowledge and education
iii. Standard of living
2. The index of sustainable economic welfare
3. Gross national happiness