Download IB Economics SL Unit 2: Macroeconomics

IB Economics SL: City Honors School IB Economics SL Unit 2: Macroeconomics Mr. R.S. Pyszczek, Jr. City Honors School IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity The Circular Flow of Income Model Pgs 234-­‐236 l 
Describe, using a diagram, the circular flow of income between households and firms in a closed economy with no government. l 
IdenQfy the four factors of producQon and their respecQve payments (rent, wages, interest and profit) and explain that these consQtute the income flow in the model. l 
Outline that the income flow is numerically equivalent to the expenditure flow and the value of output flow. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity The Circular Flow of Income Model l 
Describe, using a diagram, the circular flow of income in an open economy with government and financial markets, referring to leakages/ withdrawals (savings, taxes and import expenditure) and injecQons (investment, government expenditure and export revenue). l 
Explain how the size of the circular flow will change depending on the relaQve size of injecQons and leakages. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity The Circular Flow of Income Model l  Outline that the income flow is numerically equivalent to the expenditure flow and the value of output flow. l  Describe, using a diagram, the circular flow of income in an open economy with government and financial markets, referring to leakages/ withdrawals IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity The Circular Flow of Income Model The diagram below displays the Circular Flow of resources, goods and services in a naQon with a closed economy and no government sector. To fully understand how producQve resources, goods and services and money flow from households to firms and from firms to households through voluntary exchanges in a naQon’s product and resource markets let’s examine our role(s) in this diagram. IB Economics SL: City Honors School Unit 2: Macroeconomics IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity The Circular Flow of Income Model* One of the main basic economic models is the circular-­‐flow model, which describes the flow of money and products throughout the economy in a very simplified way. The model represents all of the players in an economy as either households or firms (companies), and it divides markets into two categories: l 
Markets for goods and services (Product Markets) l 
Markets for factors of producQon (Factor or Resource Markets) h\p://economics.about.com/od/economics-­‐basics/ss/The-­‐Circular-­‐Flow-­‐Model_3.htm#step-­‐heading IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity The Circular Flow of Income Model In the Product (goods and services) Markets, households buy finished products from firms that are looking to sell what they make. In this transacQon, money flows from households to firms, and this is represented by the direcQon of the arrows on the lines labeled “$$$$” that are connected to the “Product Market” box IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity The Circular Flow of Income Model The term “factors of producQon” refers to anything that is used by a firm in order to make a final product. Some examples of factors of producQon are labor (the work done by people), capital (the machines used to makes products), land, and so on. Labor markets are the most commonly discussed form of a Factor Market, but it’s important to remember that factors of producQon can take many forms. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity The Circular Flow of Income Model When households provide labor to firms, they can be thought of as the sellers of their Qme or work product. (Technically, employees can more accurately be thought of as being rented rather than being sold, but this is usually an unnecessary disQncQon.) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity The Circular Flow of Income Model Therefore, the funcQons of households and firms are reversed in factor markets as compared to in goods and services markets. Households provide labor, capital, and other factors of producQon to firms, and this is represented by the direcQon of the arrows on the “Labor, capital, land, etc.” lines on the diagram above. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity The Circular Flow of Income Model In the other side of the exchange, firms provide money to households as compensaQon for the use of factors of producQon, and this is represented by the direcQon of the arrows on the “$$” lines that connect to the “Factor Markets” box. IB Economics SL: City Honors School Unit 2: Macroeconomics IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Leakages-­‐ Is money leaving that simple circular flow and does not directly go back to the Households. Lets say for instance, that household #1 earns an income of $2,000 a month, they put $200 in savings. The money is going to the bank then the bank writes up a financial claim. The bank is then able to use that money to loan to firms. Leakages lead to a decrease in economic acQvity. If the sum of all the leakages is more than the injecQons there tends to be unemployment or deflaQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Examples of Leakages* l 
Savings: Households saving a porQon of their income which than allows the bank to give businesses/firms a loan. l 
Taxes: The government is deducQng a porQon of the households income which then goes directly back to the household where eligible. This transacQon is called transfer payments, such as subsidies, AISH, Employment Insurance and CPP. l 
Import spending: Is money leaving a country to pay for imported goods made by other countries. It is simply goods coming into a country and money leaving that country. Resources:Dr.Power's Class Discussion, Principles of Macreconomics.Sayre Morris-­‐ Page 92-­‐94, Google Books IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Injec6ons-­‐ Is spending that is not dependent on the current level of income. Money that is received by firms that does not come directly from the households. An example of injecQons is investment spending it results in a physical increase in plant or equipment. Another way to look at investment spending is an increase in the economy’s stock of capital goods. It is money that enters the circular flow. An example is spending from firms and the government and not directly from households. InjecQons lead to an increase in economic acQvity. If the sum of all the injecQons are more than the leakages there tends to be expansion or inflaQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Examples of Injec6ons* l 
Investment Spending: Is when businesses buy capital goods funded by loans from the bank. l 
Government Spending: Is when the Government buys goods and services from other businesses using net taxes. l 
Export Spending: Goods leaving the country and money coming in from the selling of the goods. Resources: Dr.Power's Class Discussion, Principles of Macreconomics.Sayre Morris-­‐ Page 92-­‐94, Google Books IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP), and Gross NaQonal Product (GNP) or Gross NaQonal Income (GNI) l  DisQnguish between GDP and GNP/GNI as measures of economic acQvity. l  DisQnguish between the nominal value of GDP and GNP/GNI and the real value of GDP and GNP/GNI. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP), and Gross NaQonal Product (GNP) or Gross NaQonal Income (GNI) l  DisQnguish between total GDP and GNP/GNI and per capita GDP and GNP/GNI. l  Examine the output approach, the income approach and the expenditure approach when measuring naQonal income. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP), and Gross NaQonal Product (GNP) or Gross NaQonal Income (GNI) l 
Evaluate the use of naQonal income staQsQcs, including their use for making comparisons over Qme, their use for making comparisons between countries and their use for making conclusions about standards of living. l 
Explain the meaning and significance of “green GDP”, a measure of GDP that accounts for environmental destrucQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP), and Gross NaQonal Product (GNP) or Gross NaQonal Income (GNI) l 
Evaluate the use of naQonal income staQsQcs, including their use for making comparisons over Qme, their use for making comparisons between countries and their use for making conclusions about standards of living. l 
Explain the meaning and significance of “green GDP”, a measure of GDP that accounts for environmental destrucQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP)*Pgs. 237-­‐250 GDP is the monetary value of all the finished goods and services produced within a country's borders in a specific Qme period, though GDP is usually calculated on an annual basis. It includes all of private and public consumpQon, government outlays, investments and exports less imports that occur within a defined territory. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP) GDP is commonly used as an indicator of the economic health of a country, as well as to gauge a country's standard of living. CriQcs of using GDP as an economic measure say the staQsQc does not take into account the underground economy -­‐ transacQons that, for whatever reason, are not reported to the government. Others say that GDP is not intended to gauge material well-­‐being, but serves as a measure of a naQon's producQvity, which is unrelated. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP) Strengths for using GDP:* l 
GDP is considered the broadest indicator of economic output and growth. l 
Real GDP takes inflaQon into account, allowing for comparisons against other historical Qme periods. l 
The Bureau of Economic Analysis issues its own analysis document with each GDP release, which is a great investor tool for analyzing figures and trends, and reading highlights of the very lengthy full release IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP) Weaknesses of using GDP:* l 
Data is not very Qmely -­‐ it is only released quarterly. l 
Revisions can change historical figures measurably (the difference between 3% and 3.5% GDP growth is a big one in terms of monetary policy l 
The Black-­‐markets or underground markets are not included in the data IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP)* How do we calculate it? GDP = C + G + I + NX IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP) How do we calculate it? GDP = C + G + I + NX "C" is equal to all private consumpQon, or consumer spending, in a naQon's economy. ConsumpQon/Consumer Spending IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP) How do we calculate it? GDP = C + G + I + NX "G" is the sum of Government Spending. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP) How do we calculate it? GDP = C + G + I + NX "I" is the sum of all the country's businesses spending on capital. Investment IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP) How do we calculate it? GDP = C + G + I + NX "NX" is the naQon's total net exports, calculated as total exports minus total imports. (NX = Exports -­‐ Imports) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross NaQonal Product (GNP)* GNP is an economic staQsQc that includes GDP, plus any income earned by residents from overseas investments, minus income earned within the domesQc economy by overseas residents. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross NaQonal Product (GNP)* GNP is a measure of a country's economic performance, or what its ciQzens produced (i.e. goods and services) and whether they produced these items within its borders. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross NaQonal Income (GNI)* The sum of a naQon’s gross domesQc product (GDP) plus net income received from overseas. Gross naQonal income (GNI) is defined as the sum of value added by all producers who are residents in a naQon, plus any product taxes (minus subsidies) not included in output, plus income received from abroad such as employee compensaQon and property income. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross NaQonal Income (GNI) GNI measures income received by a country both domesQcally and from overseas. In this respect, GNI is quite similar to Gross NaQonal Product (GNP), which measures output from the ciQzens and companies of a parQcular naQon, regardless of whether they are located within its boundaries or overseas. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP), and Gross NaQonal Product (GNP) or Gross NaQonal Income (GNI) To convert a naQon’s GDP to GNI, three terms need to be added to the former: 1) net compensaQon receipts, 2) net property income receivable and 3) net taxes (minus subsidies) receivable on producQon and imports. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP), and Gross NaQonal Product (GNP) or Gross NaQonal Income (GNI) Let’s use Canada’s 2010 GDP and GNI numbers to understand the reconciliaQon between these two measures of economic output. l 
Canada’s GDP in 2010 = $1,624.6 million (~ $1.62 billion) l 
Net compensaQon receipts = 0 IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP), and Gross NaQonal Product (GNP) or Gross NaQonal Income (GNI) Let’s use Canada’s 2010 GDP and GNI numbers to understand the reconciliaQon between these two measures of economic output. l 
Net property income receivable = -­‐$28.2 million (note the negaQve sign) l 
Net taxes = 0 IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Economic Ac6vity Measures of Economic AcQvity: Gross DomesQc Product (GDP), and Gross NaQonal Product (GNP) or Gross NaQonal Income (GNI) Let’s use Canada’s 2010 GDP and GNI numbers to understand the reconciliaQon between these two measures of economic output. l 
Canada’s 2010 GNI = $1,624.6 + (-­‐28.2) = $1,596.4 million (~$1.60 billion) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity The Business Cycle Short-­‐Term FluctuaQons and Long-­‐Term Trend Pgs. 254 l 
Explain, using a business cycle diagram, that economies typically tend to go through a cyclical pa\ern characterized by the phases of the business cycle. l 
Explain the long-­‐term growth trend in the business cycle diagram as the potenQal output of the economy. l 
DisQnguish between a decrease in GDP and a decrease in GDP growth. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity The Business Cycle Economies go through a regular pa\ern of ups and downs in the value of GDP. This is known as the “business cycle” (someQmes you also see it referred to as the “economic cycle”). IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity The Business Cycle* The business cycle is characterized by four main phases: l  Boom: high levels of consumer spending, business confidence, profits and investment. Prices and costs also tend to rise faster. Unemployment tends to be low as growth in the economy creates new jobs IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity The Business Cycle* The business cycle is characterized by four main phases: l  Recession: falling levels of consumer spending and confidence mean lower profits for businesses – which start to cut back on investment. Spare capacity increases + rising unemployment as businesses cut back and reduce stocks IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity The Business Cycle* The business cycle is characterized by four main phases: l  Slump /Depression: a prolonged period of declining GDP -­‐ very weak consumer spending and business investment; many business failures; rapidly rising unemployment; prices may start falling (deflaQon) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity The Business Cycle* The business cycle is characterized by four main phases: l  Recovery: things start to get be\er; consumers begin to increase spending; businesses feel a li\le more confident and start to invest again and build stocks; but it takes Qme for unemployment to stop growing IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity The Business Cycle* Timing and shape of the business cycle is affected by many factors, including: l 
Changes in the level of business and consumer confidence l 
AlternaQng periods of stocking and de-­‐stocking l 
Changes in the value of consumer spending and business investment l 
Changes in government policy which can induce a change in the economy IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity The Business Cycle* There are, however, some drawbacks for an economy that is growing rapidly: l 
The risk of demand pull inflaQon if actual growth exceeds potenQal growth l 
Increased inequality if the benefits of growth are not evenly distributed l 
Increased demand for imports and a trade deficit IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity The Business Cycle (ßClick for Video) Economic growth is the increase in the market value of the goods and services produced by an economy over Qme. It is convenQonally measured as the percent rate of increase in real gross domesQc product, or real GDP. Of more importance is the growth of the raQo of GDP to populaQon (GDP per capita), which is also called per capita income. An increase in growth caused by more efficient use of inputs is referred to as intensive growth. GDP growth caused only by increases in inputs such as capital, populaQon or territory is called extensive growth. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.1 The Level of Overall Economic Ac6vity Theory of Knowledge: Poten6al Connec6ons What is the empirical evidence for the existence of the business cycle? How do we decide whether this evidence is sufficient? IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The AD Curve Pgs. 257-­‐271 l  DisQnguish between the microeconomic concept of demand for a product and the macroeconomic concept of aggregate demand. l  Construct an aggregate demand curve. l  Explain why the AD curve has a negaQve slope. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The AD Curve* The total amount of goods and services demanded in the economy at a given overall price level and in a given Qme period. It is represented by the aggregate-­‐demand curve, which describes the relaQonship between price levels and the quanQty of output that firms are willing to provide. Normally there is a negaQve relaQonship between aggregate demand and the price level. Also known as "total spending". IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The AD Curve* Aggregate demand is the demand for the gross domesQc product (GDP) of a country, and is represented by this formula: Aggregate Demand (AD) = C + I + G + (X-­‐M) C = Consumers' expenditures on goods and services. I = Investment spending by companies on capital goods. G = Government expenditures on publicly provided goods and services. X = Exports of goods and services. M = Imports of goods and services. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The AD Curve* IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Components of AD l  Describe consumpQon, investment, government spending and net exports as the components of aggregate demand. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Components of AD There are four components of Aggregate Demand (AD); ConsumpQon (C), Investment (I), Government Spending (G) and Net Exports (X-­‐M). AD = C + I + G + (X-­‐M) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Determinants of AD or Causes of Shixs in the AD Curve l 
Explain how the AD curve can be shixed by changes in consumpQon due to factors including changes in consumer confidence, interest rates, wealth, personal income taxes (and hence disposable income) and level of household indebtedness. l 
Explain how the AD curve can be shixed by changes in investment due to factors including interest rates, business confidence, technology, business taxes and the level of corporate indebtedness. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Determinants of AD or Causes of Shixs in the AD Curve l 
Explain how the AD curve can be shixed by changes in government spending due to factors including poliQcal and economic prioriQes. l 
Explain how the AD curve can be shixed by changes in net exports due to factors including the income of trading partners, exchange rates and changes in the level of protecQonism. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Components of AD Four Components of Aggregate Demand (AD) 1) ConsumpQon* l 
This is made by households, and someQmes consumpQon accounts for the larger porQon of aggregate demand. An increase in consump<on shi=s the AD curve to the right. (See next slide) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) An increase in consump<on shi=s the AD curve to the right. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Components of AD: Factors that affect ConsumpQon* l 
Consumer Confidence – If consumers are confident about future income, job stability, and the economy is growing and stable, spending is likely to increase. However, job insecurity and uncertainty over income is likely to delay spending. An increase in consumer confidence shixs AD to the right. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Components of AD: Factors that affect ConsumpQon* l 
Interest Rates – Lower interest rates tend to increase consumpQon because larger goods are usually purchased on credit and if interest rates are low, then its cheaper to borrow. Consumers mostly borrow to buy houses, which is one of the biggest purchases and lower interest rates means lower mortgage payments, so households can spend more on other goods. Some Economists argue that lower interest rates also make saving less a\racQve, but there is no real evidence. So, lower interest rates increase Aggregate Demand. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Components of AD: Factors that affect ConsumpQon* • 
Consumer Debt – If a consumer has a lot of debt, he is unlikely to buy more since he would have to pay his debt off first. Low consumer debt increases consumpQon and aggregate demand. l  Wealth – Wealth are assets held by a household, such as property or stocks. An increase in property is likely increase to consumpQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Components of AD 2) Investment* l 
This is spending by firms on capital, not households. Investment is the most volaQle component of AD. An increase in investment shi=s AD to the right in the short run and helps improve the quality and quanQty of Factors of ProducQon in the long run IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Components of AD: Factors that affect Investment* l 
Interest Rates – Firms borrow from banks to make large capital intensive purchases, and if the interest rate decreases, it becomes cheaper for firms to invest and provides incenQve for firms to take risk. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Components of AD: Factors that affect Investment* l 
Business Confidence – If firms are confident about the economy and its future growth, they are more likely to invest. l 
Investment Policy – If governments provide incenQves such as tax breaks, subsidies, loans at lower interest rates then investment can increase. However, corrupQon and bureaucracy deters investment. l 
Na6onal Income – As firms increase output, they would need to invest in new machines. This relaQonship is known as The Accelerator. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Components of AD Factors that affect Investment* 3) Government Spending l 
Government spending forms a large total of aggregate demand, and an increase in government spending shi=s aggregate demand to the right. Government spending is categorized into transfer payments and capital spending. Transfer payments include pensions and unemployment benefits and capital spending is on things like roads, schools and hospitals. Governments spend to increase the consumpQon of health services, educaQon and to re-­‐
distribute income. They may also spend to increase aggregate demand. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) The Components of AD 4) Net Exports l 
Imports are foreign goods bought by consumers domesQcally, and exports are domesQc goods bought abroad. Net exports is the difference between exports and imports, and this factor can be net imports too, if imports are greater than exports. An increase in net exports shi=s aggregate demand to the right. The exchange rate and trade policy affects net exports. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) Level of NaQonal Income ConsumpQon* The percentage of naQonal income that goes towards consumpQon is determined by the naQon’s average propensity to consume (APC). APC is found by dividing the level of consumpQon (C) by the level of naQonal income (Y). APC = C/Y IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) Level of NaQonal Income Savings* At lower levels of income, households tend to consume with a greater proporQon of their income than at higher income levels. The average propensity to save (APS) is savings (S) divided by naQonal income (Y); this tells us the percentage of a naQon’s income that is saved. APS = S/Y IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) Level of NaQonal Income Taxes* All governments collect taxes. The percentage of the naQon’s income collected in taxes tells us the average rate of taxaQon (ART). The ART is found by dividing the total taxes collected in a country (T) by the naQonal income (Y). ART = T/Y IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) Level of NaQonal Income Imports* Finally, households may consume goods or services produced abroad, which counts as imports to a naQon and is thus not included as part of the naQons aggregate demand and is subtracted from GDP. The average propensity to import (APM) is a percentage of naQonal income spent on imports. APM = M/Y IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Demand (AD) Level of NaQonal Income All of a naQons income goes towards consumpQon, savings, paying taxes or buying imports. Therefore: APC + APS + ART + APM = 1 ConsumpQon increases at a decreasing rate with income. The higher the naQons income of households, the lower the average propensity to consume. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) The Meaning of Aggregate Supply Pgs. 274-­‐284 l 
Describe the term aggregate supply. l 
Explain, using a diagram, why the short-­‐run aggregate supply curve (SRAS curve) is upward sloping. l 
Explain, using a diagram, how the AS curve in the short run (SRAS) can shix due to factors including changes in resource prices, changes in business taxes and subsidies and supply shocks. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) The Meaning of Aggregate Supply* The total supply of goods and services produced within an economy at a given overall price level in a given Qme period. It is represented by the aggregate-­‐supply curve, which describes the relaQonship between price levels and the quanQty of output that firms are willing to provide. Normally, there is a posiQve relaQonship between aggregate supply and the price level. Rising prices are usually signals for businesses to expand producQon to meet a higher level of aggregate demand. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) The Meaning of Aggregate Supply* A shix in aggregate supply can be a\ributed to a number of variables. These include changes in the size and quality of labor, technological innovaQons, increase in wages, increase in producQon costs, changes in producer taxes and subsidies, and changes in inflaQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) ShiUs in the AS curve can be caused by the following factors:* l 
changes in size & quality of the labor force available for producQon l 
changes in size & quality of capital stock through investment l 
technological progress and the impact of innovaQon IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) ShiUs in the AS curve can be caused by the following factors:* l 
changes in factor producQvity of both labor and capital l 
changes in unit wage costs (wage costs per unit of output) l 
changes in producer taxes and subsidies l 
changes in inflaQon expectaQons -­‐ a rise in inflaQon expectaQons is likely to boost wage levels and cause AS to shix inwards IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) In the diagram above -­‐ the shix from AS1 to AS2 shows an increase in aggregate supply at each price level might have been caused by improvements in technology and producQvity or the effects of an increase in the acQve labor force. An inward shix in AS (from AS1 to AS3) causes a fall in supply at each price level. This might have been caused by higher unit wage costs, a fall in capital investment spending (capital scrapping) or a decline in the labor force. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) The Meaning of Aggregate Supply (SRAS)* In the short run, aggregate supply responds to higher demand (and prices) by bringing more inputs into the producQon process and increasing uQlizaQon of current inputs. In the long run, however, aggregate supply is not affected by the price level and is driven only by improvements in producQvity and efficiency. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) AlternaQve Views of Aggregate Supply l 
Explain, using a diagram, that the monetarist/new classical model of the long-­‐ run aggregate supply curve (LRAS) is verQcal at the level of potenQal output (full employment output) because aggregate supply in the long run is independent of the price level. l 
Explain, using a diagram, that the Keynesian model of the aggregate supply curve has three secQons because of “wage/price” downward inflexibility and different levels of spare capacity in the economy. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) * AlternaQve Views of Aggregate Supply Long run aggregate supply is determined by the producQve resources available to meet demand and by the producQvity of factor inputs (labor, land and capital). In the short run, producers respond to higher demand (and prices) by bringing more inputs into the producQon process and increasing the uQlizaQon of their exisQng inputs. Supply does respond to change in price in the short run. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) AlternaQve Views of Aggregate Supply In the long run we assume that supply is independent of the price level (money is neutral) -­‐ the producQve potenQal of an economy (measured by LRAS) is driven by improvements in producQvity and by an expansion of the available factor inputs (more firms, a bigger capital stock, an expanding acQve labor force etc.). As a result we draw the long run aggregate supply curve as verQcal. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) Improvements in producQvity and efficiency cause the long-­‐run aggregate supply curve to shix out over the years. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) Shixing the Aggregate Supply Curve over the Long Term l 
Explain, using the two models above, how factors leading to changes in the quanQty and/or quality of factors of producQon (including improvements in efficiency, new technology, reducQons in unemployment, and insQtuQonal changes) can shix the aggregate supply curve over the long term. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Aggregate Supply (AS) Short Run and Long Run IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Equilibrium Short-­‐Run Equilibrium l  Explain, using a diagram, the determinaQon of short-­‐run equilibrium, using the SRAS curve. l  Examine, using diagrams, the impacts of changes in short-­‐ run equilibrium. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Equilibrium Equilibrium in the Monetarist/New Classical Model l 
Explain, using a diagram, the determinaQon of long-­‐run equilibrium, indicaQng that long-­‐run equilibrium occurs at the full employment level of output. l 
Explain why, in the monetarist/new classical approach, while there maybe short-­‐term fluctuaQons in output, the economy will always return to the full employment level of output in the long run. l 
Examine, using diagrams, the impacts of changes in the long-­‐run equilibrium. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Equilibrium Equilibrium in the Keynesian Model l 
Explain, using the Keynesian AD/AS diagram, that the economy may be in equilibrium at any level of real output where AD intersects AS. l 
Explain, using a diagram, that if the economy is in equilibrium at a level of real output below the full employment level of output, then there is a deflaQonary (recessionary) gap. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Equilibrium Equilibrium in the Keynesian Model l 
Discuss why, in contrast to the monetarist/new classical model, the economy can remain stuck in a deflaQonary (recessionary) gap in the Keynesian model. l 
Explain, using a diagram, that if AD increases in the verQcal secQon of the AS curve, then there is an inflaQonary gap. l 
Discuss why, in contrast to the monetarist/new classical model, increases in aggregate demand in the Keynesian AD/AS model need not be inflaQonary, unless the economy is operaQng close to, or at, the level of full employment. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.2 Aggregate Demand and Aggregate Supply Equilibrium Theory of Knowledge: Poten6al Connec6ons Business confidence is a contribu<ng factor to the level of AD. What knowledge issues arise in aDemp<ng to measure business confidence? The Keynesian and Monetarist posi<ons differ on the shape of the AS curve. What is needed to seDle this ques<on: empirical evidence (if so, what should be measured?), strength of theore<cal argument, or factors external to economics such as poli<cal convic<on? IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment The Meaning of Unemployment Pgs. 285-­‐299 l 
Define the term unemployment. l 
Explain how the unemployment rate is calculated. l 
Explain the difficulQes in measuring unemployment, including the existence of hidden unemployment, the existence of underemployment, and the fact that it is an average and therefore ignores regional, ethnic, age and gender dispariQes. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment The Meaning of Unemployment* Be out of work and willing to accept suitable job (labor) or start an enterprise (prospecQve entrepreneur) if the opportunity arises, and acQvely looking for ways to obtain a job or start and enterprise. ~InternaQonal Labor OrganizaQon IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment The Meaning of Unemployment* Full employment and Underemployment: A society is almost never fully employed, but one of the goals is to reach full employment. Full employment has two condiQons: Everyone who wants to work is working, and the rate of inflaQon is stable. When the economy is at full employment, there is no cyclical unemployment but sQll fricQonal and structural unemployment. This is defined as natural unemployment. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment The Meaning of Unemployment* l 
You are only classified as unemployed if you go and register with the government as available for work. l 
The labor force is defined as those of 16 years of age or older who are employed plus all those who are unemployed seeking work. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment The Meaning of Unemployment* UR = Unemployment Rate UR = Number of Unemployed X 100 Labor Force IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment The Meaning of Underemployment* As unemployment Americans find part Qme, temporary, and seasonal work, the official unemployment rate could decline. However, this does not necessarily mean more Americans are working in their desired capacity. It will conQnue to be important to track underemployment-­‐ to shed light on the true state of the U.S. workforce, and the millions of Americans who are searching for full-­‐Qme employment. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Consequences of Unemployment l 
Discuss possible economic consequences of unemployment, including a loss of GDP, loss of tax revenue, increased cost of unemployment benefits, loss of income for individuals, and greater dispariQes in the distribuQon of income. l 
Discuss possible personal and social consequences of unemployment, including increased crime rates, increased stress levels, increased indebtedness, homelessness and family breakdown. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Consequences of Unemployment Individual Consequences of Unemployment* l 
Decreased household income and purchasing power l 
Decreased quality of life (standard of living) l 
Increased levels of psychological and physical illness, including stress and depression IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Consequences of Unemployment Social Consequences of Unemployment* l 
Downward pressure on wages for the unemployed. l 
Increased poverty and crime l 
TransformaQon of tradiQonal socieQes IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Consequences of Unemployment Economic Consequences of Unemployment* l 
Lower level of Aggregate Demand (AD) l 
Under uQlizaQon of the naQons resources l 
Brain Drain (see WNY 1990’s-­‐Present) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Consequences of Unemployment Economic Consequences of Unemployment* l 
Diminished tax base l 
A turn towards protecQonism and isolaQonist policies l 
Increased budget deficits l 
loss of output IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Consequences of Unemployment Economic Consequences of Unemployment* l 
Increased transfer payments l 
Increased taxes, increased burden on workers l 
Increased difficulty for labor market entrants -­‐ employers have more choices, they favor experienced workers l 
Unemployed workers lose their skills, become irrelevant IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Consequences of Unemployment The individual, social and economic consequences of unemployment are not limited to those outlined previously, but it should be clear that the costs of unemployment are wide ranging, thus making low unemployment a worthy and important goal for macroeconomic policy makers. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Types and Causes of Unemployment l 
Describe, using examples, the meaning of fricQonal, structural, seasonal and cyclical (demand-­‐deficient) unemployment. l 
DisQnguish between the causes of fricQonal, structural, seasonal and cyclical (demand-­‐deficient) unemployment. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Explain, Using a Diagram, that Cyclical Unemployment is Caused by a Fall in Aggregate Demand. l 
Explain, using a diagram, that structural unemployment is caused by changes in the demand for parQcular labour skills, changes in the geographical locaQon of industries, and labour market rigidiQes. l 
Evaluate government policies to deal with the different types of unemployment IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment FricQonal Unemployment* l 
FricQonal unemployment is another type of unemployment within an economy. It is the Qme period between jobs when a worker is searching for or transiQoning from one job to another. FricQonal unemployment is always present to some degree in an economy. It occurs when there is a mismatch between the workers and jobs. The mismatch can be related to skills, payment, work Qme, locaQon, seasonal industries, a}tude, taste, and other factors. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment FricQonal Unemployment l 
FricQonal unemployment is influenced by voluntary decisions to work based on each individual's valuaQon of their own work and how that compares to current wage rates as well as the Qme and effort required to find a job. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Structural Unemployment* l 
Structural unemployment is one of the main types of unemployment within an economic system. It focuses on the structural problems within an economy and inefficiencies in labor markets. Structural unemployment occurs when a labor market is not able to provide jobs for everyone who is seeking employment. There is a mismatch between the skills of the unemployed workers and the skills needed for the jobs that are available. It is oxen impacted by persistent cyclical unemployment. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Structural Unemployment l 
For example, when an economy experiences long-­‐term unemployment individuals become frustrated and their skills become obsolete. As a result, when the economy recovers they may not fit the requirements of new jobs due to their inacQvity . IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment The Natural Rate of Unemployment (NRU)* l 
The natural rate of unemployment, someQmes called the structural unemployment rate, was developed by Friedman and Phelps in the 1960s. It represents the hypotheQcal unemployment rate that is consistent with aggregate producQon being at a long-­‐run level. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment The Natural Rate of Unemployment (NRU)* l 
The natural rate of unemployment is a combinaQon of structural and fricQonal unemployment. It is present in an efficient and expanding economy when labor and resource markets are at equilibrium. The natural unemployment rate occurs within an economy when disturbances are not present. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low Unemployment Cyclical Unemployment* l 
Cyclical unemployment is a type of unemployment that occurs when there is not enough Aggregate Demand in the economy to provide jobs for everyone who wants to work. In an economy, demand for most goods falls, less producQon is needed, and less workers are needed. With cyclical unemployment the number of unemployed workers is greater than the number of job vacancies. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon, DisinflaQon and DeflaQon Pgs. 300-­‐327 l 
DisQnguish between inflaQon, disinflaQon and deflaQon. l 
Explain that inflaQon and deflaQon are typically measured by calculaQng a consumer price index (CPI), which measures the change in prices of a basket of goods and services consumed by the average household. l 
Explain that different income earners may experience a different rate of inflaQon when their pa\ern of consumpQon is not accurately reflected by the CPI. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon* l 
InflaQon is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflaQon rises, every dollar you own buys a smaller percentage of a good or service. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon: l 
The value of a dollar does not stay constant when there is inflaQon. The value of a dollar is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflaQon goes up, there is a decline in the purchasing power of money. For example, if the inflaQon rate is 2% annually, then theoreQcally a $1 pack of gum will cost $1.02 in a year. Axer inflaQon, your dollar can't buy the same goods it could beforehand. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of DisinflaQon:* l 
A slowing in the rate of price inflaQon. DisinflaQon is used to describe instances when the inflaQon rate has reduced marginally over the short term. Although it is used to describe periods of slowing inflaQon, disinflaQon should not be confused with deflaQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of DisinflaQon: l 
DisinflaQon is commonly used by the Federal Reserve to describe situaQons of slowing inflaQon. Instances of disinflaQon are not uncommon and are viewed as normal during healthy economic Qmes. Although someQmes confused with deflaQon, disinflaQon is not considered to be as problemaQc because prices do not actually drop and disinflaQon does not usually signal the onset of a slowing economy. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of DeflaQon* l 
A general decline in prices, oxen caused by a reducQon in the supply of money or credit. DeflaQon can be caused also by a decrease in government, personal or investment spending. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of DeflaQon l 
The opposite of inflaQon, deflaQon has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression. Central banks a\empt to stop severe deflaQon, along with severe inflaQon, in an a\empt to keep the excessive drop in prices to a minimum. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of DeflaQon l 
Declining prices, if they persist, generally create a vicious spiral of negaQves such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans by companies and individuals. To counter deflaQon, the Federal Reserve (the Fed) can use monetary policy to increase the money supply and deliberately induce rising prices, causing inflaQon. Rising prices provide an essenQal lubricant for any sustained recovery because businesses increase profits and take some of the depressive pressures off wages and debtors of every kind. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of DeflaQon l 
DeflaQonary periods can be both short or long, relaQvely speaking. Japan, for example, had a period of deflaQon lasQng decades starQng in the early 1990's. The Japanese government lowered interest rates to try and sQmulate inflaQon, to no avail. Zero interest rate policy was ended in July of 2006. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of the Consumer Price Index (CPI)* AKA “Headline InflaQon” l 
A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportaQon, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of the Consumer Price Index (CPI) l 
The U.S. Bureau of Labor StaQsQcs measures two kinds of CPI staQsQcs: CPI for urban wage earners and clerical workers (CPI-­‐W), and the chained CPI for all urban consumers (C-­‐CPI-­‐U). Of the two types of CPI, the C-­‐CPI-­‐U is a be\er representaQon of the general public, because it accounts for about 87% of the populaQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of the Consumer Price Index (CPI) l 
CPI is one of the most frequently used staQsQcs for idenQfying periods of inflaQon or deflaQon. This is because large rises in CPI during a short period of Qme typically denote periods of inflaQon and large drops in CPI during a short period of Qme usually mark periods of deflaQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon, DisinflaQon and DeflaQon l 
Explain that inflaQon figures may not accurately reflect changes in consumpQon pa\erns and the quality of the products purchased. l 
Explain that economists measure a core/underlying rate of inflaQon to eliminate the effect of sudden swings in the prices of food and oil, for example. l 
Explain that a producer price index measuring changes in the prices of factors of producQon may be useful in predicQng future inflaQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon, DisinflaQon and DeflaQon* l 
The Producer Price Index (PPI) is a weighted index of prices measured at the wholesale, or producer level. A monthly release from the Bureau of Labor StaQsQcs (BLS), the PPI shows trends within the wholesale markets (the PPI was once called the Wholesale Price Index), manufacturing industries and commodiQes markets. All of the physical goods-­‐producing industries that make up the U.S. economy are included, but imports are not. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon, DisinflaQon and DeflaQon l 
The PPI release has three headline index figures, one each for crude, intermediate and finished goods on the naQonal level: 1)
PPI Commodity Index (crude): This shows the average price change from the previous month for commodiQes such as energy, coal, crude oil and the steel scrap. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon, DisinflaQon and DeflaQon l 
The PPI release has three headline index figures, one each for crude, intermediate and finished goods on the naQonal level: 2)
PPI Stage of Processing (SOP) Index (intermediate): Goods here have been manufactured at some level but will be sold to further manufacturers to create the finished good. Some examples of SOP products are lumber, steel, co\on and diesel fuel. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon, DisinflaQon and DeflaQon l 
The PPI release has three headline index figures, one each for crude, intermediate and finished goods on the naQonal level: 3)
PPI Industry Index (finished): Final stage manufacturing, and the source of the core PPI. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon, DisinflaQon and DeflaQon l 
The core PPI figure is the main a\racQon, which is the finished goods index minus the food and energy components, which are removed because of their volaQlity. The PPI percentage change from the prior period and annual projected rate will be the most printed figure of the release. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon, DisinflaQon and DeflaQon l 
The PPI looks to capture only the prices that are being paid during the survey month itself. Many companies that do regular business with large customers have long-­‐term contract rates, which may be known now but not paid unQl a future date. The PPI excludes future values or contract rates. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon, DisinflaQon and DeflaQon PPI Strengths:* l 
Most accurate indicator of future CPI l 
Long "operaQng history" of data series IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon, DisinflaQon and DeflaQon PPI Strengths:* l 
Good breakdowns for investors in the companies surveyed (mining, commodity info, some services sectors) l 
Can move the markets posiQvely l 
Data is presented with and without seasonal adjustment IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on The Meaning of InflaQon, DisinflaQon and DeflaQon PPI Weaknesses:* l 
VolaQle elements, such as energy and food, can skew the data. l 
Not all industries in the economy are covered. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on Consequences of InflaQon l 
Discuss the possible consequences of a high inflaQon rate, including greater uncertainty, redistribuQve effects, less saving, and the damage to export compeQQveness. Consequences of DeflaQon l 
Discuss the possible consequences of deflaQon, including high levels of cyclical unemployment and bankruptcies. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on Consequences of InflaQon: Maintaining a Stable Price Level* l 
Loss of Purchasing Power l 
Lower Real Interest Rates for Savers l 
Higher Nominal Interest Rates for Borrowers l 
ReducQon of InternaQonal CompeQveness IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on Consequences of DeflaQon: Supply Side DeflaQon* l 
Lower Oil Prices l 
More ProducQve Labor Force l 
AppreciaQon of the NaQon’s Currency IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on Consequences of DeflaQon: Supply Side DeflaQon* l 
Lower Minimum Wage l 
Be\er Infrastructure l 
Lower Corporate taxes IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on Types and Causes of InflaQon l 
Explain, using a diagram, that demand-­‐pull inflaQon is caused by changes in the determinants of AD, resulQng in an increase in AD. l 
Explain, using a diagram, that cost-­‐push inflaQon is caused by an increase in the costs of factors of producQon, resulQng in a decrease in SRAS. l 
Evaluate government policies to deal with the different types of inflaQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on Types and Causes of InflaQon: Demand Pull InflaQon* l 
An increase in any of the components of a naQons Aggregate Demand (AD) will lead to an increase in the naQon’s price level l 
Demand Pull InflaQon is when too many consumers are chasing too few goods (scarcity), so the average price of goods and services in a naQon rises IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on Types and Causes of InflaQon: Demand Pull InflaQon* l 
Demand Pull InflaQon is illustrated by an outward shix of AD when a naQon is at or near it’s full employment level of output. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Low and Stable Rate of Infla6on Types and Causes of InflaQon: Cost-­‐Push InflaQon* l 
An Increase in Oil Prices l 
An increase in the nominal wage rate l 
DepreciaQon of the naQon’s currency l 
Natural Disaster or War l 
Higher taxes on firms IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth The Meaning of Economic Growth l 
Define economic growth as an increase in real GDP. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth The Meaning of Economic Growth* l 
Define economic growth as an increase in real GDP. l 
Economic growth is an increase in the total output of goods and services (GDP) in a naQon over Qme IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Causes of Economic Growth l 
Describe, using a producQon possibiliQes curve (PPC) diagram, economic growth as an increase in actual output caused by factors including a reducQon in unemployment and increases in producQve efficiency, leading to a movement of a point inside the PPC to a point closer to the PPC. l 
Describe, using a PPC diagram, economic growth as an increase in producQon possibiliQes caused by factors including increases in the quanQty and quality of resources, leading to outward PPC shixs. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Causes of Economic Growth: ProducQon PossibiliQes Curve l 
A curve depicQng all maximum output possibiliQes for two or more goods given a set of inputs (resources, labor, etc.). The PPF assumes that all inputs are used efficiently. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Causes of Economic Growth: ProducQon PossibiliQes Curve l 
As indicated on the chart above, points A, B and C represent the points at which producQon of Good A and Good B is most efficient. Point X demonstrates the point at which resources are not being used efficiently in the producQon of both goods; point Y demonstrates an output that is not a\ainable with the given inputs. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Causes of Economic Growth: ProducQon PossibiliQes Curve l 
Among others, factors such as labor, capital and technology will affect where the producQon possibility fronQer lies. The PPF is also known as the producQon possibility or transformaQon curve. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Causes of Economic Growth l 
Describe, using an LRAS diagram, economic growth as an increase in potenQal output caused by factors including increases in the quanQty and quality of resources, leading to a rightward shix of the LRAS curve. l 
Explain the importance of investment for economic growth, referring to investment in physical capital, human capital and natural capital. l 
Explain the importance of improved producQvity for economic growth. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Causes of Economic Growth: Long Run Aggregate Supply (LRAS) l 
Long run aggregate supply is determined by the producQve resources available to meet demand and also by the producQvity of factor inputs (labor, land and capital). Changes in technology also affect the potenQal level of naQonal output in the long run. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Causes of Economic Growth: Long Run Aggregate Supply (LRAS) l 
In the short run, producers respond to higher demand (and prices) by bringing more inputs into the producQon process and increasing the uQlizaQon of their exisQng inputs. Supply does respond to change in price in the short run -­‐ we move up or down the short run aggregate supply curve. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Causes of Economic Growth: Long Run Aggregate Supply (LRAS) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Causes of Economic Growth Sources of ProducQvity Growth: Physical Capital* l 
Economies with greater quanQQes of capital per worker experience a greater level of output per hour of labor and, therefore, a higher level of economic growth. l 
Increases in capital stock result from high levels of private investment, as firms replace old capital and expand exisQng factories to meet AD over Qme. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Causes of Economic Growth: Physical Capital Developing human capital alone is not enough to create economic growth. Economies must also invest in developing physical capital. Physical capital is the tools, factories, and equipment that are used in the producQon process. As the stock of physical capital increases, the naQon experiences capital deepening. Capital deepening refers to the amount of capital available to each worker. Capital deepening provides for a more producQve labor force. The average American worker is backed by $130,000 worth of physical capital. This is one of the reasons for America's producQvity edge. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Causes of Economic Growth l 
Sources of ProducQvity Growth: Human Capital l 
Human beings are of economic value. They contribute to economic growth of a firm and the naQon. l 
The be\er educated or trained a worker is, the more producQve they are? IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Consequences of Economic Growth l 
Discuss the possible consequences of economic growth, including the possible impacts on living standards, unemployment, inflaQon, the distribuQon of income, the current account of the balance of payments, and sustainability. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Consequences of Economic Growth: Economic Consequence* l 
The economic consequence of growth in per capita GDP is an increase in the average level of income and consumpQon in a naQon IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Consequences of Economic Growth: Non-­‐Economic Consequence* l 
ExternaliQes (both PosiQve and NegaQve) l 
InflaQon l 
Resource DepleQon l 
Structural Unemployment IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Economic Growth Consequences of Economic Growth: Non-­‐Economic Consequence* l 
ComposiQon of output (capital vs. consumer goods) l 
ComposiQon of output (military vs Civilian or Guns vs Bu\er dilemma) l 
Unequal income distribuQon l 
Effect on Balance of Payments IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income The Meaning of Equity in the DistribuQon of Income l 
Explain the difference between equity in the distribuQon of income and equality in the distribuQon of income. l 
Explain that due to unequal ownership of factors of producQon, the market system may not result in an equitable distribuQon of income. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income The Meaning of Equity in the DistribuQon of Income* l 
Equality vs. Equity l 
l 
l 
l 
Equity refers to fairness in economics. Equity requires a level playing field on which individuals in society can all have a fair shot at achieving economic success. Equity ulQmately promotes greater equality in income distrbuQon Equality means minimizing the dispariQes in income and wealth among a naQons households. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Indicators of Income Equality/Inequality l 
Analyze data on relaQve income shares of given percentages of the populaQon, including deciles and quinQles. l 
Draw a Lorenz curve and explain its significance. l 
Explain how the Gini coefficient is derived and interpreted. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Indicators of Income Equality/Inequality: Lorenz Curve* l 
A graphical representaQon of wealth distribuQon developed by American economist Max Lorenz in 1905. On the graph, a straight diagonal line represents perfect equality of wealth distribuQon; the Lorenz curve lies beneath it, showing the reality of wealth distribuQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Indicators of Income Equality/Inequality: Lorenz Curve* l 
The difference between the straight line and the curved line is the amount of inequality of wealth distribuQon, a figure described by the Gini coefficient. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Indicators of Income Equality/Inequality: Lorenz Curve* Graphical representaQon of the Gini coefficient l 
The graph shows that the Gini coefficient is equal to the area marked A divided by the sum of the areas marked A and B. that is, Gini = A / (A + B). It is also equal to 2*A due to the fact that A + B = 0.5 (since the axes scale from 0 to 1) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Indicators of Income Equality/Inequality: Lorenz Curve* l 
The Lorenz curve can be used to show what percentage of a naQon's residents possess what percentage of that naQon's wealth. For example, it might show that the country's poorest 10% possess 2% of the country's wealth. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Poverty l 
DisQnguish between absolute poverty and relaQve poverty. l 
Explain possible causes of poverty, including low incomes, unemployment and lack of human capital. l 
Explain possible consequences of poverty, including low living standards, and lack of access to health care and educaQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Poverty* A state or condiQon in which a person or community lacks the financial resources and essenQals to enjoy a minimum standard of life and well-­‐being that's considered acceptable in society. Poverty status in the United States is assigned to people that do not meet a certain threshold level set by the Department of Health and Human Services. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Poverty* Poverty rates in the United Sates, the percentage of U.S. populaQon with poverty status, are calculated by the U.S. Bureau of Census, and precludes insQtuQonalized people, people living in military quarters, those living in college dormitories and individuals under the age of 15. Poverty rates are an important staQsQc to follow as a global investor, as a high poverty rate is oxen indicaQve of larger scale issues within the country in quesQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Poverty* An internaQonal monetary threshold under which an individual is considered to be living in poverty. It is calculated by taking the poverty threshold from each country -­‐ given the value of the goods needed to sustain one adult -­‐ and converQng it to dollars. The internaQonal poverty line was originally set to roughly $1 a day. When purchasing power parity and all goods consumed are considered in the calculaQon of the line, it allows organizaQons to determine which populaQons are considered to be in absolute poverty. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Poverty* Using the internaQonal poverty line to determine how well off a populaQon is can be misleading, as the line can be low enough that adding a small amount of addiQonal income will not create an appreciable difference in a person's quality of life. In addiQon, it can be difficult to quanQfy other indicators, such as educaQon and health, thus masking the total economic impact on a populaQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Causes of Poverty* Poverty is explained by individual circumstances and/or characterisQcs of poor people. Some examples are: l 
Amount of educaQon, skill, experience, intelligence & access l 
Health, handicaps, age, mental health.
IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Causes of Poverty* Poverty is explained by individual circumstances and/or characterisQcs of poor people. Some examples are: l 
Work orientaQon, Qme horizon, culture of poverty (generaQonal). l 
DiscriminaQon, together with race, sex, etc.
IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Consequences of Poverty* l 
The effects of poverty are most oxen interrelated so that one problem hardly ever occurs alone. For instance, bad sanitaQon makes it easier to spread around old and new diseases, and hunger and lack of water make people more vulnerable to them. l 
Impoverished communiQes oxen suffer from discriminaQon and end up caught in cycles of poverty. Let's find out just what this means concretely. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Consequences of Poverty* Homelessness, poor health, hunger—poverty’s consequences can be severe. Growing up in poverty can harm children’s well-­‐being and development and limit their opportuniQes and academic success. And poverty imposes huge costs on society through lost producQvity and higher spending on health care and incarceraQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income The Role of TaxaQon in PromoQng Equity l 
DisQnguish between direct and indirect taxes, providing examples of each, and explain that direct taxes may be used as a mechanism to redistribute income. l 
DisQnguish between progressive, regressive and proporQonal taxaQon, providing examples of each. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income The Role of TaxaQon in PromoQng Equity: Direct Taxes* l 
A tax that is paid directly by an individual or organizaQon to the imposing enQty. A taxpayer pays a direct tax to a government for different purposes, including real property tax, personal property tax, income tax or taxes on assets. Direct taxes are different from indirect taxes, where the tax is levied on one enQty, such as a seller, and paid by another, such a sales tax paid by the buyer in a retail se}ng. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income The Role of TaxaQon in PromoQng Equity: Direct Taxes* l 
A direct tax cannot be shixed to another individual or enQty. The individual or organizaQon upon which the tax is levied is responsible for the fulfillment of the tax payment. Indirect taxes, on the other hand, can be shixed from one taxpayer to another. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income The Role of TaxaQon in PromoQng Equity: Indirect Taxes* l 
A direct tax cannot be shixed to another individual or enQty. The individual or organizaQon upon which the tax is levied is responsible for the fulfillment of the tax payment. Indirect taxes, on the other hand, can be shixed from one taxpayer to another. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income The Role of TaxaQon in PromoQng Equity: Indirect Taxes* l 
Indirect taxes can also be defined as fees that are levied equally upon taxpayers, no ma\er their income. This is a primary reason why they are thought of as taxes that are passed on, as the price of the tax is compensated for by simply increasing the overall price of the good or service. Some economists argue that indirect taxes lead to an inefficient marketplace and alter market prices that don't match their equilibrium price. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income The Role of TaxaQon in PromoQng Equity: Indirect Taxes* l 
A tax that increases the price of a good so that consumers are actually paying the tax by paying more for the products. An indirect tax is most oxen thought of as a tax that is shixed from one taxpayer to another, by way of an increase in the price of the good. Fuel, liquor and cigare\e taxes are all considered examples of indirect taxes, as many argue that the tax is actually paid by the end consumer, by way of a higher retail price. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Other Measures to Promote Equity l 
Explain that governments undertake expenditures to provide directly, or to subsidize, a variety of socially desirable goods and services (including health care services, educaQon, and infrastructure that includes sanitaQon and clean water supplies), thereby making them available to those on low incomes. l 
Explain the term transfer payments, and provide examples, including old age pensions, unemployment benefits and child allowances. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Other Measures to Promote Equity: Transfer Payments* l 
In the United States, a payment made to individuals by the federal government through various social benefit programs. l 
In Canada, a payment made to the provinces and territories by the federal government. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income Other Measures to Promote Equity: Transfer Payments* l 
Transfer payments are made by the U.S. Federal Government to individuals through programs such as Social Security, Welfare and Veteran's benefits. l 
Transfer payments are made by the Canadian Federal Government to the provinces and territories through the EqualizaQon Program, Canada Health Transfer and Canada Social Transfer. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income The RelaQonship Between Equity and Efficiency l 
Evaluate government policies to promote equity (taxaQon, government expenditure and transfer payments) in terms of their potenQal posiQve or negaQve effects on efficiency in the allocaQon of resources. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income The RelaQonship Between Equity and Efficiency: Transfer Payments* l 
In economics, a transfer payment (or government transfer or simply transfer) is a redistribuQon of income in the market system. These payments are considered to be non-­‐exhausQve because they do not directly absorb resources or create output. In other words, the transfer is made without any exchange of goods or services. Examples of certain transfer payments include welfare (financial aid), social security, and government making subsidies for certain businesses (firms). IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Equity in the Distribu6on of Income The RelaQonship Between Equity and Efficiency: Transfer Payments* l 
Transfer payments are not a part of the naQonal income so they are cut from naQonal income to get n.n.p in order to arrive naQonal income such payments are bad debts incurred by banks, payments of pensions, charity, scholarships etc. In the UK they have several transfer payments such as EMA and a job seeker's allowance. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Theory of Knowledge: Poten6al Connec6ons What criteria can be used to order macroeconomic objec<ves in terms of priority? Are such criteria external to economics (that is, norma<ve)? Is economic growth always beneficial? What could be meant by the word “beneficial”? Is there always a cost to economic growth? IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Theory of Knowledge: Poten6al Connec6ons The no<on of fairness can be approached from a number of perspec<ves—
equality of opportunity, maximizing the income of the least well-­‐off group, and absolute equality of income. Which of these no<ons seems to be most aDrac<ve? Why? Examine what each of these perspec<ves suggests is a fair distribu<on of income. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.3 Macroeconomic objec6ves Theory of Knowledge: Poten6al Connec6ons Equality of opportunity implies correc<ng for social advantage (for example, government might devote more resources to the educa<on of a child brought up in less prosperous circumstances than one brought up in a comfortable home whose parents are university lecturers). How far should the state go in making such correc<ons? Should all parents be forced to read to their children so that no child should be at a disadvantage? Should the state aDempt to correct for the uneven distribu<on of natural abili<es such as IQ (intelligence quo<ent) by devo<ng propor<onally more resources to children of less than average IQ. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget Sources of Government Revenue l 
Explain that the government earns revenue primarily from taxes (direct and indirect), as well as from the sale of goods and services and the sale of state-­‐
owned (government-­‐ owned) enterprises. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget Sources of Government Revenue* l 
Government revenue is money received by a government. It is an important tool of the fiscal policy of the government and is the opposite factor of government spending. Revenues earned by the government are received from sources such as taxes levied on the incomes and wealth accumulaQon of individuals and corporaQons and on the goods and services produced, exports and imports, non-­‐taxable sources such as government-­‐owned corporaQons' incomes, central bank revenue and capital receipts in the form of external loans and debts from internaQonal financial insQtuQons. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget Types of Government Expenditures l 
Explain that government spending can be classified into current expenditures, capital expenditures and transfer payments, providing examples of each. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget Types of Government Expenditures* l 
Government spending or expenditure includes all government consumpQon, investment, and transfer payments. In naQonal income accounQng the acquisiQon by governments, of goods and services for current use, to directly saQsfy the individual or collecQve needs of the community, is classed as government final consumpQon expenditure. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget Types of Government Expenditures* l 
Government acquisiQon of goods and services intended to create future benefits, such as infrastructure investment or research spending, is classed as government investment (government gross capital formaQon). These two types of government spending, on final consumpQon and on gross capital formaQon, together consQtute one of the major components of gross domesQc product. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget Types of Government Expenditures* l 
Government spending can be financed by government borrowing or taxes. Changes in government spending are a major component of fiscal policy used to stabilize the macroeconomic business cycle. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Budget Outcome l 
DisQnguish between a budget deficit, a budget surplus and a balanced budget. l 
Explain the relaQonship between budget deficits/ surpluses and the public (government) debt. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Budget Outcome: Budget Deficit (loss of money)* l 
A status of financial health in which expenditures exceed revenue. The term "budget deficit" is most commonly used to refer to government spending rather than business or individual spending. When referring to accrued federal government deficits, the term "naQonal debt” is used. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Budget Outcome: Budget Deficit (loss of money)* l 
The opposite of a budget deficit is a budget surplus, and when inflows equal ou€lows, the budget is said to be balanced. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Budget Outcome: Budget Deficit (loss of money) l 
In the early 20th century, few industrialized countries had large fiscal deficits. This changed during the First World War, a Qme in which governments borrowed heavily and depleted financial reserves. Industrialized countries reduced these deficits unQl the 1960s and 1970s despite years of steady economic growth. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Budget Outcome: Budget Deficit (loss of money)* l 
Budget deficits as a percentage of GDP may decrease in Qmes of economic prosperity, as increased tax revenue, lower unemployment and economic growth reduce the need for government programs such as unemployment insurance. If investors expect higher inflaQon rates, which would reduce the real value of debt, they are likely to require higher interest rates on future loans to governments. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Budget Outcome: Budget Deficit (loss of money) l 
Countries can counter budget deficits by promoQng economic growth, reducing government spending and increasing taxes. By reducing onerous regulaQons and simplifying tax regimes, a country can improve business confidence, thereby prompQng improved economic condiQons while increasing treasury inflows from taxes. Reducing government expenditures, including on social programs and defense, and reforming enQtlement programs, such as state pensions, can result in less borrowing. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Budget Outcome: Budget Surplus (excess of money)* l 
A situaQon in which income exceeds expenditures. The term "budget surplus" is most commonly used to refer to the financial situaQons of governments; individuals speak of "savings" rather than a "budget surplus." A surplus is considered a sign that government is being run efficiently. A budget surplus might be used to pay off debt, save for the future, or to make a desired purchase that has been delayed. A city government that had a surplus might use the money to make improvements to a run-­‐down park, for example. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Budget Outcome: Budget Surplus (excess of money) l 
When spending exceeds income, the result is a budget deficit, which must be financed by borrowing money and paying interest on the borrowed funds, much like an individual spending more than he can afford and carrying a balance on a credit card. A balanced budget occurs when spending equals income. The U.S. government has only had a budget surplus in a few years since 1950. The Clinton administraQon (1993-­‐2001) famously cured a large budget deficit and created a surplus in the late 1990s. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Budget Outcome: Balanced Budget (equality of money)* l 
A situaQon in financial planning or the budgeQng process where total revenues are equal to or greater than total expenses. A budget can be considered balanced in hindsight, axer a full year's worth of revenues and expenses have been incurred and recorded; a company's operaQng budget for an upcoming year can also be called balanced based on predicQons or esQmates. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Budget Outcome: Balanced Budget (equality of money) l 
The phrase "balanced budget" is commonly used in reference to official government budgets. For example, governments may issue a press release staQng that they have a balanced budget for the upcoming fiscal year, or poliQcians may campaign on a promise to balance the budget once in office. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Budget Outcome: Balanced Budget (equality of money) l 
It is important to understand that the phrase "balanced budget" can refer to either a situaQon where revenues equal expenses or where revenues exceed expenses, but not where expenses exceed revenues. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy Fiscal Policy and Short-­‐Term Demand Management l 
Explain how changes in the level of government expenditure and/or taxes can influence the level of aggregate demand in an economy. l 
Describe the mechanism through which expansionary fiscal policy can help an economy close a deflaQonary (recessionary) gap. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy Fiscal Policy and Short-­‐Term Demand Management* l 
Government spending policies that influence macroeconomic condiQons. Through fiscal policy, regulators a\empt to improve unemployment rates, control inflaQon, stabilize business cycles and influence interest rates in an effort to control the economy IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy Fiscal Policy and Short-­‐Term Demand Management l 
Fiscal policy is largely based on the ideas of BriQsh economist John Maynard Keynes (1883–1946), who believed governments could change economic performance by adjusQng tax rates and government spending. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy Fiscal Policy and Short-­‐Term Demand Management l 
To illustrate how the government could try to use fiscal policy to affect the economy, consider an economy that’s experiencing a recession. The government might lower tax rates to try to fuel economic growth. If people are paying less in taxes, they have more money to spend or invest. Increased consumer spending or investment could improve economic growth. Regulators don’t want to see too great of a spending increase though, as this could increase inflaQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy Fiscal Policy and Short-­‐Term Demand Management l 
Another possibility is that the government might decide to increase its own spending – say, by building more highways. The idea is that the addiQonal government spending creates jobs and lowers the unemployment rate. Some economists, however, dispute the noQon that governments can create jobs, because government obtains all of its money from taxaQon – in other words, from the producQve acQviQes of the private sector. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy Fiscal Policy and Short-­‐Term Demand Management l 
One of the many problems with fiscal policy is that it tends to affect parQcular groups disproporQonately. A tax decrease might not be applied to taxpayers at all income levels, or some groups might see larger decreases than others. Likewise, an increase in government spending will have the biggest influence on the group that is receiving that spending, which in the case of highway spending would be construcQon workers.. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy Fiscal Policy and Short-­‐Term Demand Management l 
Fiscal policy and monetary policy are two major drivers of a naQon’s economic performance. Through monetary policy, a country’s central bank influences the money supply. Regulators use both policies to try to boost a flagging economy, maintain a strong economy or cool off an overheated economy. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy Fiscal Policy and Short-­‐Term Demand Management l 
Construct a diagram to show the potenQal effects of expansionary fiscal policy, outlining the importance of the shape of the aggregate supply curve. l 
Describe the mechanism through which contracQonary fiscal policy can help an economy close an inflaQonary gap. l 
Construct a diagram to show the potenQal effects of contracQonary fiscal policy, outlining the importance of the shape of the aggregate supply curve. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy In Panel (a), the economy faces a recessionary gap (YP − Y1). An expansionary fiscal policy seeks to shiU aggregate demand to AD2 to close the gap. In Panel (b), the economy faces an infla6onary gap (Y1 − YP). A contrac6onary fiscal policy seeks to reduce aggregate demand to AD2 to close the gap.
IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy The Impact of AutomaQc Stabilizers l 
Explain how factors including the progressive tax system and unemployment benefits, which are influenced by the level of economic acQvity and naQonal income, automaQcally help stabilize short-­‐term fluctuaQons. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy The Impact of AutomaQc Stabilizers* l 
Economic policies and programs that are designed to offset fluctuaQons in a naQon's economic acQvity without intervenQon by the government or policymakers. The best-­‐known automaQc stabilizers are corporate and personal taxes, and transfer systems such as unemployment insurance and welfare. AutomaQc stabilizers are so called because they act to stabilize economic cycles and are automaQcally triggered without explicit government intervenQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy The Impact of AutomaQc Stabilizers l 
AutomaQc stabilizers act in a manner that is against the prevailing economic trend. For example, in a progressive taxaQon structure, the share of taxes in naQonal income falls when the economy is booming and rises when the economy is in a slump. This has the effect of cushioning the economy from changes in the business cycle. Similarly, total net transfer payments such as unemployment insurance decline when the economy is in an expansionary phase, and rise when the economy is mired in recession. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy Fiscal Policy and its Impact on PotenQal Output l 
Explain that fiscal policy can be used to promote long-­‐term economic growth (increases in potenQal output) indirectly by creaQng an economic environment that is favorable to private investment, and directly through government spending on physical capital goods and human capital formaQon, as well as provision of incenQves for firms to invest. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy The Government Budget The Role of Fiscal Policy EvaluaQon of Fiscal Policy l 
Evaluate the effecQveness of fiscal policy through consideraQon of factors including the ability to target sectors of the economy, the direct impact on aggregate demand, the effecQveness of promoQng economic acQvity in a recession, Qme lags, poliQcal constraints, crowding out, and the inability to deal with supply-­‐ side causes of instability. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.4 Fiscal policy Theory of knowledge: Poten6al Connec6ons In one sense the imposi<on of taxes by government on individuals amounts to a restric<on of individual freedom. How can we know when such government interference in individual freedom is jus<fied? IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy Interest Rates Interest Rate DeterminaQon and the Role of a Central Bank l 
Describe the role of central banks as regulators of commercial banks and bankers to governments. l 
Explain that central banks are usually made responsible for interest rates and exchange rates in order to achieve macroeconomic objecQves. l 
Explain, using a demand and supply of money diagram, how equilibrium interest rates are determined, outlining the role of the central bank in influencing the supply of money. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy Interest Rates Interest Rate DeterminaQon and the Role of a Central Bank* l 
The acQons of a central bank, currency board or other regulatory commi\ee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through acQons such as increasing the interest rate, or changing the amount of money banks need to keep in the vault (bank reserves). IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy Interest Rates Interest Rate DeterminaQon and the Role of a Central Bank l 
In the United States, the Federal Reserve is in charge of monetary policy. Monetary policy is one of the ways that the U.S. government a\empts to control the economy. If the money supply grows too fast, the rate of inflaQon will increase; if the growth of the money supply is slowed too much, then economic growth may also slow. In general, the U.S. sets inflaQon targets that are meant to maintain a steady inflaQon of 2% to 3%. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy Interest Rates Interest Rate DeterminaQon and the Role of a Central Bank* l 
Monetary policy operates by steering short-­‐term interest rates, thereby influencing economic developments, in order to maintain price stability for the euro area over the medium term. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy Interest Rates Interest Rate DeterminaQon and the Role of a Central Bank l 
The ECB has adopted a specific strategy to ensure the successful conduct of monetary policy. The ECB has defined price stability as a year-­‐on-­‐year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below 2%. In the pursuit of price stability, the ECB aims at maintaining inflaQon rates below, but close to, 2% over the medium term. l 
The strategy also includes an analyQcal framework for the assessment of all relevant informaQon and analysis needed to take monetary policy decisions. This framework is based on two pillars: economic analysis and monetary analysis IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy Interest Rates Interest Rate DeterminaQon and the Role of a Central Bank l 
The primary objecQve of the ECB’s monetary policy is to maintain price stability. This is the best contribuQon monetary policy can make to economic growth and job creaQon. l 
Monetary policy decisions are taken by the ECB's Governing Council. The Council meets every month to analyse and assess economic and monetary developments and the risks to price stability and to decide on the appropriate level of the key interest rates, based on the ECB's strategy. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management l 
Explain how changes in interest rates can influence the level of aggregate demand in an economy. l 
Describe the mechanism through which easy (expansionary) monetary policy can help an economy close a deflaQonary (recessionary) gap. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management* l 
One of several specific aggregate demand determinants assumed constant when the aggregate demand curve is constructed, and that shixs the aggregate demand curve when it changes. An increase in interest rates cause a decrease (lexward shix) of the aggregate curve. A decrease in interest rates an increase (rightward shix) of the aggregate curve. Other notable aggregate demand determinants include the federal deficit, inflaQonary expectaQons, and the money supply. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management l 
Interest rates are the annual charge for borrowing funds, usually specified as a percent of the amount borrowed. Changes in interest rates affect the overall expense of borrowing and thus expenditures undertaken with the borrowed funds. Higher interest rates tend to decrease expenditures and lower interest rates lead to an increase in expenditures. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management l 
Suppose, for example, that the Federal Reserve System decides to implement expansionary monetary policy. Fearing an impending recession on the business-­‐cycle horizon, they decide to expand the money supply with a corresponding decrease in interest rates IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management l 
A decline in interest rates can enQce the business sector to boost investment expenditures. For example, a 1 percentage point interest rate decline (such as from 10 percent to 9 percent) can reduce the total interest cost on a $10 million construcQon loan by $300,000 over a five-­‐year repayment period. This saving is bound to convince a few firms to undertake extra investment expenditures. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management l 
AlternaQvely, the Federal Reserve System might decide to implement contracQonary monetary policy. Fearing the onset of higher inflaQon, the Fed might decide to reduce the money supply and subsequently increase interest rates. Higher interest rates have the opposite effect on both business investment and household consumpQon as lower rates. The interest cost of construcQng a new factory is higher. So too is the interest expense of buying a new car. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management l 
Construct a diagram to show the potenQal effects of easy (expansionary) monetary policy, outlining the importance of the shape of the aggregate supply curve. l 
Describe the mechanism through which Qght (contracQonary) monetary policy can help an economy close an inflaQonary gap. l 
Construct a diagram to show the potenQal effects of Qght (contracQonary) monetary policy, outlining the importance of the shape of the aggregate supply curve. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management: Expansionary IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management: Expansionary l 
Lower the discount rate l 
Buy bonds on the open market l 
Lower the reserve raQo IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management: Expansionary Monetary Policy l 
Achieves: Increased growth, reduced unemployment l 
But risks: l 
l 
InflaQon Lower exchange rate= expensive imports IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management: ContracQonary IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management: ContracQonary l 
Raise the discount rate l 
Sell bonds on the open market l 
Raise the reserve raQo IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and Short-­‐Term Demand Management: ContraQonary Monetary Policy l 
Achieves: Reduced InflaQon l 
But risks: l 
l 
Reduced Growth & Increased Unemployment Lower exchange rate= reduced exports IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and InflaQon TargeQng l 
Explain that central banks of certain countries, rather than focusing on the maintenance of both full employment and a low rate of inflaQon, are guided in their monetary policy by the objecQve to achieve an explicit or implicit inflaQon rate target. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and InflaQon TargeQng l 
The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed in Germany in June 1998 and works with the other naQonal banks of each of the EU members to formulate monetary policy that helps maintain price stability in the European Union. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy Monetary Policy and InflaQon TargeQng l 
The European Central Bank has been responsible for the monetary policy of the European Union since January 1, 1999, when the euro currency was adopted by the EU members. The responsibiliQes of the ECB are to formulate monetary policy, conduct foreign exchange, hold currency reserves and authorize the issuance of bank notes, among many other things. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy EvaluaQon of Monetary Policy l 
Evaluate the effecQveness of monetary policy through consideraQon of factors including the independence of the central bank, the ability to adjust interest rates incrementally, the ability to implement changes in interest rates relaQvely quickly, Qme lags, limited effecQveness in increasing aggregate demand if the economy is in deep recession and conflict among government economic objecQves. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy EvaluaQon of Monetary Policy: SQmulaQng Growth During Recession; Strengths l 
Speed: quick to react to the economy l 
Control: Have no distracQons or long debates on policy l 
No poliQcs: the economy is bigger than party poliQcs l 
No Crowding Out: Consumers and Government will have equal access IB Economics SL: City Honors School Unit 2: Macroeconomics 2.5 Monetary policy The Role of Monetary Policy EvaluaQon of Monetary Policy: SQmulaQng Growth During Recession; Weaknesses l 
Investors are reluctant to borrow: interest rates scare off investors l 
Time Lags: some Qme needs to be allowed for implementaQon l 
Changes in elasQcity of investment: decrease in interest rates may cause delay in investment. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies The Role of Supply-­‐Side Policies Supply-­‐Side Policies and the Economy l 
Explain that supply-­‐side policies aim at posiQvely affecQng the producQon side of an economy by improving the insQtuQonal framework and the capacity to produce (that is, by changing the quanQty and/or quality of factors of producQon). l 
State that supply-­‐side policies may be market-­‐based or intervenQonist, and that in either case they aim to shix the LRAS curve to the right, achieving growth in potenQal output. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies The Role of Supply-­‐Side Policies Supply-­‐Side Policies and the Economy* l 
Supply-­‐side economics is be\er known to some as "Reaganomics," or the "trickle-­‐down" policy espoused by 40th U.S. President Ronald Reagan. He popularized the controversial idea that greater tax cuts for investors and entrepreneurs provide incenQves to save and invest, and produce economic benefits that trickle down into the overall economy. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies The Role of Supply-­‐Side Policies Supply-­‐Side Policies and the Economy* l 
Like most economic theories, supply-­‐side economics tries to explain both macroeconomic phenomena and -­‐ based on these explanaQons -­‐ offer policy prescripQons for stable economic growth. In general, supply-­‐side theory has three pillars: tax policy, regulatory policy and monetary policy. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies The Role of Supply-­‐Side Policies Supply-­‐Side Policies and the Economy l 
However, the single idea behind all three pillars is that producQon (i.e. the "supply" of goods and services) is most important in determining economic growth. The supply-­‐side theory is typically held in stark contrast to Keynesian theory which, among other facets, includes the idea that demand can falter, so if lagging consumer demand drags the economy into recession, the government should intervene with fiscal and monetary sQmuli. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies The Role of Supply-­‐Side Policies Supply-­‐Side Policies and the Economy l 
This is the single big disQncQon: a pure Keynesian believes that consumers and their demand for goods and services are key economic drivers, while a supply-­‐sider believes that producers and their willingness to create goods and services set the pace of economic growth IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies The Role of Supply-­‐Side Policies Supply-­‐Side Policies and the Economy l 
In economics we review the supply and demand curves. The lex-­‐hand chart below illustrates a simplified macroeconomic equilibrium: aggregate demand and aggregate supply intersect to determine overall output and price levels. (In this example, output may be gross domesQc product and the price level may be the Consumer Price Index.) The right-­‐hand chart illustrates the supply-­‐side premise: an increase in supply (i.e. producQon of goods and services) will increase output and lower prices. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies The Role of Supply-­‐Side Policies Supply-­‐Side Policies and the Economy IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies The Role of Supply-­‐Side Policies Supply-­‐Side Policies and the Economy l 
Supply-­‐side actually goes further and claims that demand is largely irrelevant. It says that over-­‐producQon and under-­‐producQon are not sustainable phenomena. Supply-­‐siders argue that when companies temporarily "over-­‐produce," excess inventory will be created, prices will subsequently fall and consumers will increase their purchases to offset the excess supply. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Investment in Human Capital l 
Explain how investment in educaQon and training will raise the levels of human capital and have a short-­‐term impact on aggregate demand, but more importantly will increase LRAS. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Investment in Human Capital* l 
A measure of the economic value of an employee's skill set. This measure builds on the basic producQon input of labor measure where all labor is thought to be equal. The concept of human capital recognizes that not all labor is equal and that the quality of employees can be improved by invesQng in them. The educaQon, experience and abiliQes of an employee have an economic value for employers and for the economy as a whole. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Investment in Human Capital l 
Economist Theodore Schultz invented the term in the 1960s to reflect the value of our human capaciQes. He believed human capital was like any other type of capital; it could be invested in through educaQon, training and enhanced benefits that will lead to an improvement in the quality and level of producQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Investment in New Technology l 
Explain how policies that encourage research and development will have a short-­‐term impact on aggregate demand, but more importantly will result in new technologies and will increase LRAS. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Investment in New Technology l 
Spending on capital goods such as new factories & other buildings machinery & vehicles l 
Much new investment includes advances in technology l 
Investment is an important component of AD, and is a factor affecQng compeQQveness of a country in a globalizing world l 
In market economies, most investment is done by private sector businesses but a substanQal amount of new capital is purchased by the government (state sector) IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Investment in Infrastructure l 
Explain how increased and improved infrastructure will have a short-­‐term impact on aggregate demand, but more importantly will increase LRAS. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Investment in Infrastructure* l 
The basic physical systems of a business or naQon. TransportaQon, communicaQon, sewage, water and electric systems are all examples of infrastructure. These systems tend to be high-­‐cost investments, however, they are vital to a country's economic development and prosperity. Infrastructure projects may be funded publicly, privately or through public-­‐
private partnerships. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Investment in Infrastructure l 
SomeQmes private companies will choose to invest in a country's infrastructure development as part of a business expansion effort. For example, an energy company might build pipelines and railways in a country where it wants to refine petroleum. This investment can benefit both the company and the country. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Investment in Infrastructure l 
Infrastructure is also an asset class that tends to be less volaQle than equiQes over the long term and generally provides a higher yield. As a result, some companies and individuals like to invest in infrastructure for its defensive characterisQcs. Individuals and insQtuQons can invest in infrastructure through infrastructure funds and can even choose specialized funds, such as those that invest in transportaQon infrastructure or water infrastructure. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Industrial Policies l 
Explain that targeQng specific industries through policies including tax cuts, tax allowances and subsidized lending promotes growth in key areas of the economy and will have a short-­‐term impact on aggregate demand but, more importantly, will increase LRAS. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Industrial Policies* l 
The Industrial Policy plan of a country, someQmes shortened IP, is its official strategic effort to encourage the development and growth of the manufacturing sector of the economy. The government takes measures "aimed at improving the compeQQveness and capabiliQes of domesQc firms and promoQng structural transformaQon." A country's infrastructure (transportaQon, telecommunicaQons and energy industry) is a major part of the manufacturing sector that usually has a key role in IP. It is also the case that industries fail dismally to add to such a growing body of manufacturing industries. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Interven6onist Supply-­‐Side Policies Industrial Policies l 
Industrial policies are sector specific, unlike broader macroeconomic policies. They are oxen considered to be intervenQonist as opposed to laissez-­‐faire economics. Examples of horizontal, economy wide policies are Qghtening credit or taxing capital gain, while examples of verQcal, sector-­‐specific policies comprise protecQng texQles from imports or subsidizing export industries. Free market advocates consider industrial policies as intervenQonist measures typical of mixed economy countries. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies Policies to Encourage CompeQQon l 
Explain how factors including deregulaQon, privaQzaQon, trade liberalizaQon and anQ-­‐ monopoly regulaQon are used to encourage compeQQon. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies Policies to Encourage CompeQQon l 
Supply-­‐side policies are mainly micro-­‐economic policies designed to make markets and industries operate more efficiently and contribute to a faster underlying-­‐rate of growth of real naQonal output l 
Successful policies have the effect of shixing the LRAS curve to the right leading to a rise in potenQal output IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies Policies to Encourage CompeQQon l 
Most governments believe that improved supply-­‐side performance is the key to achieving sustained growth without causing a rise in inflaQon. l 
Supply-­‐side reform on its own is not enough to achieve this growth. There must also be a high enough level of AD so that the producQve capacity of an economy is actually brought into play. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies Policies to Encourage CompeQQon l 
Key concepts to focus on are incenQves, enterprise, technology, mobility, flexibility and efficiency. l 
Improve incenQves and invest in people’s skills l 
Increase labor and capital producQvity l 
Increase the occupaQonal and geographical mobility of labor IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies Policies to Encourage CompeQQon l 
Increase capital investment and research and development spending by firms l 
PromoQng more compeQQon and sQmulate a faster pace of invenQon and innovaQon l 
Provide a pla€orm for sustained non-­‐inflaQonary growth of an economy l 
Encourage the start-­‐up and expansion of new businesses / enterprises IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies Labor Market Reforms l 
Explain how factors including reducing the power of labour unions, reducing unemployment benefits and abolishing minimum wages are used to make the labour market more flexible (more responsive to supply and demand). IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies Labor Market Reforms: Cu}ng government spending and taxes and policies to cut government borrowing l 
Laws to control trade union powers l 
Reducing red-­‐tape to cut the costs of doing business l 
Measures to improve the flexibility of the labour market / reforming employment laws IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies Labor Market Reforms: l 
Policies to boost compeQQon such as deregulaQon and tough anQ-­‐monopoly and anQ-­‐
cartel laws l 
PrivaQzaQon of state assets (selling off public sector businesses into the private sector) l 
Opening up an economy to overseas trade and investment l 
Opening up an economy to inward labor migraQon IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies Labor Market Reforms: l 
Many of the tradiQonal legal protecQons enjoyed by the trade unions have been taken away – including restricQons on their ability to take industrial acQon. The result has been a decrease in strike acQon in virtually every industry and a significant improvement in industrial relaQons in the UK l 
Improved partnerships between trade unions and employers can make a big contribuQon to raising producQvity and improving the flexibility of workers in their jobs IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies IncenQve-­‐Related Policies l 
Explain how factors including personal income tax cuts are used to increase the incenQve to work, and how cuts in business tax and capital gains tax are used to increase the incenQve to invest. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies IncenQve-­‐Related Policies l 
Economists who support supply-­‐side policies believe that lower rates of income tax provide a short-­‐term boost to demand, and they improve incenQves for people to work longer hours or take a new job – because they get to keep more of the money they earn. l 
Cu}ng tax rates for lower paid workers may help to reduce the extent of the ‘unemployment trap’ – where people calculate that they may be no be\er off from working than if they stay outside the labor force. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Market-­‐Based Supply-­‐Side Policies IncenQve-­‐Related Policies l 
Do lower taxes always help to increase the acQve labour supply in the economy? It seems obvious that lower taxes should boost the incenQve to work because tax cuts increase the reward from a job. But some people may choose to work the same number of hours and simply take a rise in their post-­‐tax income! Millions of other workers have li\le choice over the hours that they work. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Evalua6on of Supply-­‐Side Policies The Strengths and Weaknesses of Supply-­‐ Side Policies l 
Evaluate the effecQveness of supply-­‐side policies through consideraQon of factors including Qme lags, the ability to create employment, the ability to reduce inflaQonary pressure, the impact on economic growth, the impact on the government budget, the effect on equity, and the effect on the environment. IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Evalua6on of Supply-­‐Side Policies The Strengths and Weaknesses of Supply-­‐ Side Policies l 
Recessions are oxen the result of negaQve demand-­‐side shocks that hit real incomes of consumers and demand and profits for businesses l 
The consequences show through in higher unemployment, a fall in capital investment and an increasing rate of business failures IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Evalua6on of Supply-­‐Side Policies The Strengths and Weaknesses of Supply-­‐ Side Policies l 
There is a danger that a deep recession and slow recovery will have harmful effects on the supply side leading to a reducQon in the growth rate of potenQal GDP and a loss of producQve capacity. This is known as a hysteresis effect l 
Most macroeconomic policies in a recession center on boosQng demand and confidence in a bid to generate a rebound in output, jobs and incomes within the circular flow and prevent hysteresis IB Economics SL: City Honors School Unit 2: Macroeconomics 2.6 Supply-­‐Side Policies Theory of Knowledge: Poten6al Connec6ons How can we know whether government should support pure research, which might contribute to the sum total of human knowledge but which might never have an impact on technology? What other knowledge issues are relevant to investment in pure research? Investment in educa<on and training is a common supply-­‐side policy. What other reasons could there be for suppor<ng the educa<on of the popula<on? What knowledge issues arise in answering the ques<on as to whether government should shoulder this responsibility or whether it should be le= to the market?