PREBAC Economics 4 Past Paper 2025 PDF

**Economics 4\ **PREBAC 2025 **[Summary]** {#summary.TOCHeading} ========================= [**Growth:** 4](#growth) [Aggregate demand: 4](#aggregate-demand) [Determinants of aggregate demand: 4](#determinants-of-aggregate-demand) [Aggregate supply: 4](#aggregate-supply) [Determinants of aggreg...

**Economics 4\ **PREBAC 2025 **[Summary]** {#summary.TOCHeading} ========================= [**Growth:** 4](#growth) [Aggregate demand: 4](#aggregate-demand) [Determinants of aggregate demand: 4](#determinants-of-aggregate-demand) [Aggregate supply: 4](#aggregate-supply) [Determinants of aggregate supply: 4](#determinants-of-aggregate-supply) [Short and long run aggregate supply: 4](#short-and-long-run-aggregate-supply) [Aggregate demand and aggregate supply curve: 5](#aggregate-demand-and-aggregate-supply-curve) [Economic growth: 5](#economic-growth) [Actual growth: 5](#_Toc187861763) [Potential growth: 5](#_Toc187861764) [Limitations of GDP: 5](#_Toc187861765) [Economic welfare: 5](#_Toc187861766) [Output gap: 6](#_Toc187861767) [Policies to promote Potential growth: 6](#policies-to-promote-potential-growth) [Production possibility curve (PPC): 6](#_Toc187861769) [Reasons for a change in the potential of an economy: 7](#reasons-for-a-change-in-the-potential-of-an-economy) [Policies to promote Economic growth: 7](#policies-to-promote-economic-growth) [Consequences of Economic growth: 8](#consequences-of-economic-growth) [Economic cycle: 9](#economic-cycle) [The different phases of the Business cycle: 9](#the-different-phases-of-the-business-cycle) [Causes of the cycle: 10](#causes-of-the-cycle) [Indicators of the cycle: 10](#indicators-of-the-cycle) [Sustainable economic growth: 11](#_Toc187861777) [Inclusive economic growth: 11](#_Toc187861778) [Policies to mitigate the impact of economic growth on the environment: 11](#policies-to-mitigate-the-impact-of-economic-growth-on-the-environment) [**Inflation:** 12](#inflation) [Inflation: 12](#_Toc187861781) [Inflation target rate: 12](#_Toc187861782) [How inflation is measured: 12](#how-inflation-is-measured) [Causes for inflation: 12](#causes-for-inflation) [Impacts of inflation: 13](#impacts-of-inflation) [Solutions for inflation: 14](#solutions-for-inflation) [Incomes policy: 14](#_Toc187861787) [Monetary policies: 14](#_Toc187861788) [Deflation: 15](#_Toc187861789) [Impacts of deflation: 15](#impacts-of-deflation) [Disinflation: 15](#_Toc187861791) [Phillips curve: 15](#phillips-curve) [Short and long run for the Phillips curve: 16](#short-and-long-run-for-the-phillips-curve) [Unanticipated and anticipated inflation: 17](#_Toc187861794) [Other definitions: 17](#other-definitions) [**Unemployment:** 18](#unemployment) [Unemployment: 18](#_Toc187861797) [How unemployment is measured: 18](#how-unemployment-is-measured) [Causes for unemployment: 18](#causes-for-unemployment) [Types of unemployment: 19](#types-of-unemployment) [Consequences of unemployment: 20](#consequences-of-unemployment) [Why governments might be concerned about unemployment: 20](#why-governments-might-be-concerned-about-unemployment) [The cost of unemployment to the individual: 20](#_Toc187861803) [Solutions for unemployment: 21](#solutions-for-unemployment) [Demand-side policies: 21](#_Toc187861805) [Supply-side policies: 22](#_Toc187861806) [Tax wedge graph: 23](#tax-wedge-graph) [Keynesian economic view: 23](#_Toc187861808) [Opportunity cost of reducing unemployment: 24](#_Toc187861809) [Government perspective on unemployment: 24](#government-perspective-on-unemployment) [Labor market imperfections and their impact on unemployment: 25](#_Toc187861811) [Other definitions: 25](#other-definitions-1) [**Monetary VS Fiscal policies:** 26](#monetary-vs-fiscal-policies) [Monetary policy: 26](#_Toc187861814) [Fiscal policy 26](#_Toc187861815) **[Growth:]** ========================= [Aggregate demand:] ------------------------------- The total amounts of goods and services demanded or total expenditure on goods and services in an economy. AD = C + I + G + (X-M) Aggregate demand = Consumption + Investment + Government + (Export-Import) ### Determinants of aggregate demand: The four main determinants are: - **Changes in interest rates affecting Consumption and Investment:** If interest rates fall then firms are more likely to invest leading to an increase in AD. - **Changes in income and wealth:** If consumers' incomes rise then they are likely to spend more thus increasing AD. - **Changes in inflation expectations:** If inflation is expected to increase then people are likely to spend now, thus increasing AD. - **Currency exchange rate changes:** If the value of your currency rises then imports will increase because they are cheaper, but exports will fall because they cost more in terms of the other currency. [Aggregate supply:] ------------------------------- The total value of goods and services produced in the economy. ### Determinants of aggregate supply: - **Production costs including wages:** If wages increase leading to a rise in production costs, then AS is likely to be reduced. - **Technological innovations:** These may increase the productivity of labor and capital leading to an increase in AS. - **Producer taxes and subsidies:** Taxes have a negative effect, while subsidies have a positive effect on AS. - **Quality of labor and capital:** An improvement in the education of the workforce is likely to increase productivity and thus AS. ### Short and long run aggregate supply: **Short run:** As prices increase, more will be supplied: Even though production costs will rise, the rise in prices will more than cover this. **Long run:** If all resources are fully employed (AS reaches full capacity), there is no ability to increase output so that any increase in demand can only be met by a rise in prices. [Aggregate demand and aggregate supply curve:] ---------------------------------------------------------- Pe: Inflation equilibrium\ Ye: Output equilibrium Aggregate Demand (AD) -- The Tutor Academy [Economic growth: ] ------------------------------- An increase in the production potential or real level of output of an economy. It is possible to distinguish between actual and potential growth in national output. It is often referred to as GDP, or *real GDP*. []{#_Toc187861763.anchor}Actual growth: The rate of growth in national output or the increase in output when all resources are fully employed. []{#_Toc187861764.anchor}Potential growth: The rate at which the economy could increase. Nominal GDP: Total value of goods and services at current prices. It can be misleading due to price level changes Real GDP: Nominal GDP adjusted for changes in inflation, sometimes called GDP at constant prices. It is more accurate for measuring economic growth. []{#_Toc187861765.anchor}[Limitations of GDP:] GDP does not account for income inequality. It also excludes non-market activities, who still contribute to economic welfare. GDP also doesn\'t measure environmental degradation, meaning an economy could seem to be growing while harming long-term sustainability. It also fails to capture the overall quality of life (health, education, happiness). Finally, it doesn\'t include underground economies such as the black market. []{#_Toc187861766.anchor}Economic welfare: Refers to the overall well-being and standard of living of individuals in an economy, considering factors such as income, employment, access to goods and services, and quality of life, including health and education. []{#_Toc187861767.anchor}Output gap: The difference between actual output in the economy and the potential output given the resources available. [Policies to promote Potential growth:] --------------------------------------------------- - **Investment in education and training:** Enhances labor productivity. - **Research and development incentives:** Encourages innovation and technological progress. - **Tax incentives for business investment:** Firms will be able to invest in capital technology. - **Infrastructure development:** Better infrastructure improves efficiency in transportation, communication and production. - **Reducing business regulations and barriers:** Boosts entrepreneurship and competition. - **Immigration of skilled workers:** Expands the labor force and fills skill gaps. []{#_Toc187861769.anchor}[Production possibility curve (PPC):] It shows the maximum possible output combinations of two goods an economy can produce with given resources and technology.  A: Inefficient X: Impossible ### Reasons for a change in the potential of an economy: - **Increase:** - *[Improvements in technology:]* More efficient production methods allow the economy to produce more. - *[Better management techniques:]* Improved organization and decision making in firms can increase output and productivity. - *[Better capital:]* Investment in modern infrastructure boosts production. - **Decrease:** - *[Natural disaster:]* Some events can destroy infrastructure and disrupt economic activity. - *[Running out of non-renewable energy:]* Depletion of key resources like oil or gas can limit industrial production and economic growth. - *[War:]* Conflicts damage infrastructure, reduce the labor force and divert resources away from productive activities. [Policies to promote Economic growth:] -------------------------------------------------- - **Demand-side policies:** - *[Government expenditure:]* Mainly in the form of investment in infrastructure. Improved transport facilitates production as everything flows freely. - *[Tax cuts:]* Individuals can spend more, and firms invest more. - *[Depreciation of the currency]* - *[Lower interest rates:]* Individuals can spend more, and firms invest more. - *[Higher real wages:]* More spending. - **Supply-side policies:** - *[Increased investment:]* Spending on capital goods is likely to increase output and improve quality leading to greater sales and better labor productivity. - *[Improved technology:]* More can be produced with the same quantity of capital. Will likely lead to greater labor productivity. - *[Higher labor productivity, including education and training:]* Affects both the quantity and quality of goods and services. Improving it leads to a more skilled workforce, leading to greater labor productivity. - *[Larger workforce]* - *[Discovery or development of natural resources:]* Has stimulated growth in many countries (Saudi Arabia, etc.). [Consequences of Economic growth:] ---------------------------------------------- - **Benefits:** - *[Rise in the standard of living:]* Leads to reduction of absolute poverty. - *[Improved education and health:]* Literacy rate should rise as infant mortality and death rates should fall together with the number of people dying from disease. - *[More goods and services:]* More wants can be satisfied. - *[Increased sales:]* As people have more money, they'll spend it. This will offer more opportunities for businesses to invest. - *[Increased tax revenue:]* To fund better infrastructure, schools, hospitals, etc. This increase will come from more output/higher incomes and profits rather than from higher taxes. - *[Increase in business and consumer confidence:]* Growth should encourage to take business a positive view of the economy and to want to invest and use new technology. - **Costs:** - *[Environmental damage:]* Damages the landscape by extracting resources. - *[Utilization of resources:]* Scarce resources are used up at a faster rate. - *[Opportunity cost:]* If a country is on its production possibility frontier, then more investment will be made in capital goods instead of consumer goods. This will cause current consumption to fall. - *[Labor composition change:]* Technical progress may replace labor with machines. - *[Unequal benefits:]* Growth means changes in the economic structure, meaning some people will become unemployed while others gain more. Growth might also mean workers will have to learn new skills or work longer. - *[Lower quality of life:]* Rapid urbanization leads to poor housing and overcrowding. Growth can also cause the production of weapons, cigarettes and other demerit goods. [Economic cycle: ] ------------------------------ The way in which economic growth fluctuates over a period of time. Business Cycle - Definition, How to Measure and 6 Different Stages ### The different phases of the Business cycle: - **Boom (Peak):** Economic growth is high and there is low unemployment. Consumers have more disposable income, so they spend more, giving firms more money to invest, creating higher quality output. Economic growth also creates better productivity as firms and government invest more in training and education. However, growth creates inflation. - **Downturn (Recession):** The period when economic growth slows down before becoming a recession. - **Recession (Through):** Due to the rise of inflation, consumers start to spend less as prices grow, firms now have less revenue, so they need to lay off employees, creating higher unemployment. During a recession, governments will try to lower inflation and create more employment. They will give incentives to firms so that they invest or employ more. - Recession is defined as two consecutive quarters without economic growth. - **Recovery (Expansion):** The period when the economy comes out of a recession and starts doing better. Employment rises, the growth too, as inflation comes back to a normal level again. Automatic stabilizers: The way in which elements of fiscal policy, such as tax and transfer systems, can help counter swings in the business cycle without direct government intervention. Quantitative easing: Where a Central Bank buys a financial asset from banks and other private sector businesses with new electronically created money. [Causes of the cycle:] ---------------------------------- - **Interest rates:** If they are cut, borrowing costs fall, which can lead to higher spending and economic growth. The Central Bank needs to raise interest rates to reduce inflation, or else it will lead to a recession. - **Changes in house prices:** A rise can create a positive effect which leads to higher consumer spending. A fall leads to lower consumer spending and bank losses. - **Consumer and business confidence:** If there is a succession of bad economic news, people will be discouraged from spending and investing. - **Stock:** Change in stock levels can affect demand in the economy. Mangers might not want to increase their output in the short term in case the boom doesn't last. - **Multiplier effect:** A fall in investment may cause a bigger final fall in real GDP. - **Accelerator effect:** If the growth rate falls, firms will reduce investment because output will likely rise slowly. - **Credit cycle:** If too many loans are given at the same time, banks don't have liquidity. - **Supply-side** [Indicators of the cycle:] -------------------------------------- - **Leading indicators:** Changes in these factors may indicate future changes. - *[Consumer confidence surveys:]* If consumers become more confident, then they are more likely to spend in the future - *[New car registrations:]* This is often an indicator of confidence. - *[Recruitment advertising:]* An increase in the number of jobs being advertised highlights the fact that firms are feeling positive and are looking to expand. - *[Mortgage applications:]* If the number of applications for mortgages increases, then this reveals something about the confidence of households. - *[Share prices:]* An increase in share prices suggests that there is more demand from investors to own companies. This suggests that they believe demand is going to rise. - **Lagging indicators:** Indicators that alter after changes in the economic cycle. For example, unemployment tends to lag behind the economic cycle. When a recession starts, employers take time to decide if they should let go their staff or not. []{#_Toc187861777.anchor}[Sustainable economic growth:] A rate of growth which can be maintained over the long run without creating significant costs for future generations. []{#_Toc187861778.anchor}Inclusive economic growth: Economic growth that is distributed fairly across society and creates opportunities for all. [Policies to mitigate the impact of economic growth on the environment:] ------------------------------------------------------------------------------------ - **Renewable energy sources:** These include solar, wind and hydroelectric. Using these reduces the environmental damage from coal, gas and oil extraction. - **Sustainable transport:** Including bus rapid transit and electric vehicles. These would reduce climate pollution and the use of oil. - **Promote benefits of sustainable agriculture and forestry:** Land use changes from forestry and agriculture account for 25% of human generated greenhouse gas emissions. Diversifying crops and cattle can give farmers additional sources of income and reduce the risks to them of more unpredictable weather. - **Use natural barriers:** In coastal areas, land has been drained causing environmental damage. **[Inflation:]** ============================ []{#_Toc187861781.anchor}[Inflation:] A sustained increase in the general price level over a given period. It is often measured with the consumer price index (CPI), which tracks the changes in the price of a basket of goods and services. []{#_Toc187861782.anchor}Inflation target rate: The target rate is a central banking policy that revolves around adjusting monetary policy to achieve a specified annual rate of inflation which is 2%. This is because 2% is low enough to maintain price stability and it reduces the risks of deflation occurring at the same time. In Europe, the European Central Bank (ECB) is responsible for achieving the target rate. ### How inflation is measured:  **Consumer Price Index (CPI):** The way it is typically measured, it compares the price of a typical basket of goods and services of a household with the price of the same basket the year before. **Harmonized Index of Consumer Prices (HICP):** The way it is measured in the Euro area, it measures the change over time in the prices of consumer goods and services acquired, used or paid for by euro area households. All countries in the Euro area follow the same methodology, ensuring that the date for one country can be compared with the date of another. [Causes for inflation:] ----------------------------------- - **Demand-pull inflation:** The type of inflation that occurs when people get richer and have more money to spend, the demand is growing faster than the supply. If firms can't meet the demand, they will increase their prices. They may invest in extra capacity, but this can take time to come online. In the short term, aggregate supply is likely to be price inelastic because firms may not be able to recruit staff easily or produce more given the existing equipment. This means that an increase in demand will affect prices more than output. Demand-pull inflation is characterized by shortages, low levels of stock, long waiting lists and queues. In this situation, firms will be eager to produce more as soon as possible. - **Cost-push inflation:** The type of inflation that occurs when the cost of supplying goods and services is increased, so the rise in costs is passed on to customers. It can be caused by three different factors: - *[Rise in the cost of raw materials:]* This forces up the costs of production for firms. - *[Wages pushed up:]* If trade unions are powerful enough, they'll negotiate to increase the wages of the workers, so that they have a better quality of life. However, productivity doesn't increase as much as it is, so businesses face higher costs. In order to cover these costs and keep their profit, businesses raise the prices of their products. - *[Monopolies:]* They can raise prices due to lack of competition. Producers use the wage rise to justify price increases. - **Monetary inflation:** The type of inflation that occurs when there is too much money for the amount of goods. If money supply increases at a faster rate than aggregate supply of goods, the general price level will rise. For example, if the government wants to stimulate the economy to create more jobs, they will increase the money supply. By doing so, there is an increase in money, in the government debt, and an increase in loans. As the supply of money being higher, there is more money in the economy for the same amount of goods, so prices will increase. [Impacts of inflation:] ----------------------------------- **Damaging business confidence:** It can damage the confidence in the economy because of fears about the future impact on costs, reducing the level of investment. This is a key concern because it can affect demand in the economy and its future growth. **Menu costs:** If prices are increasing, this creates costs for firms because they may have to update their promotional material to reflect the higher prices. For example, this means reprinting brochures, updating price lists, and changing vending machines. **Shoe leather costs:** With higher rates of inflation, individuals and firms may have to search more to find the best returns on their savings. The cost of searching around is called "Shoe leather costs". **International competitiveness:** If the prices of firms in one country are increasing faster than those of their trading partners, then this may make the country's products uncompetitive compared with those of foreign firms. This may reduce the earnings from exports and increase the spending on imports. This will affect the balance of payments adversely. Domestically, that country may also struggle to compete because imports will be relatively cheaper. **Unemployment:** If inflation is caused by increasing costs, businesses may seek to reduce costs in other ways to remain competitive. This may affect employment with firms making redundancies in an attempt to keep costs down. [Solutions for inflation:] -------------------------------------- []{#_Toc187861787.anchor}Incomes policy: Incomes policy is a way for governments to control cost-push inflation. As they could not want to reduce demand as it would lead to even lesser output in the economy, they may introduce wage restraints in the public sector, where it can control wages. It may also introduce wage controls across the economy to prevent wages from increasing too fast. However, incomes policies can lead to frustration on the part of employers, who want to offer more money to reward and attract good-quality employees. Employees may also be frustrated and look for better-paid jobs abroad; this may lead to the loss of good employees and a loss of competitiveness. []{#_Toc187861788.anchor}Monetary policies: Defined as actions taken by a country\'s central bank to control money supply, interest rates, and inflation to stabilize the economy and promote growth. - **Reducing the aggregate demand:** To control demand-pull inflation, the government will want to reduce the level of the aggregate demand in the economy relative to supply. This may be done using deflationary fiscal or restrictive monetary policies such as reduced government expenditure, higher taxes or higher interest rates. The government might want to reduce investments or increase withdrawals into the economy. - **Raising interest rates:** Higher interest rates make borrowing more expensive and saving more attractive. This reduces consumer spending and business investment, lowering aggregate demand and helping to control inflation. - **Controlling money supply:** The central bank can reduce the amount of money circulating in the economy by limiting credit creation or selling government bonds, helping to lower inflation. []{#_Toc187861789.anchor}[Deflation:] Deflation occurs when there is a sustained fall in the general price level in an economy over a given period. It means that there is negative inflation in the economy. This may be due to: - **Supply is growing faster than demand:** In certain markets, supply is increasing rapidly due to developments in technology. This causes deflation in these specific markets. - **Aggregate demand falling:** Aggregate demand could be falling for multiple reasons, such as interest rates being too high, or because households lack confidence in the economy. If deflation is caused by a lack of aggregate demand, this is unwelcome because it is likely to be associated with high unemployment. ### Impacts of deflation: **Deflating spiral:** As prices fall, consumers and businesses may delay purchases and investments, anticipating even lower prices in the future. This decreased demand can result in lower production, job cuts, and increased unemployment. Additionally, deflation increases the real burden of debt, as the money value rises, it becomes more difficult to repay a loan. Deflating spirals are a big concern for governments. **Lower profits for firms:** Firms will have lower profits as they will have lower prices. This means that there are less funds for investment, delaying the purchase of new machinery. **Redundancies:** Firms may lay off workers to make their business more efficient. This happens when firms try to reduce costs and increase profits as they want to stay competitive. To do so, and because they are under pressure for money, the managers lay off workers who are redundant (unnecessary). []{#_Toc187861791.anchor}[Disinflation:] When the purchasing power of the currency is rising at a slower rate. [Phillips curve: ] ------------------------------ Shows the relationship between the rate of inflation and the rate of unemployment. ### Short and long run for the Phillips curve: - **Short run:** In the short run, there is a trade-off between the rate of inflation and the rate of unemployment; the government can reduce unemployment below the natural rate at the expense of faster-growing prices. If the economy is at full employment equilibrium, all unemployment is voluntary. If the government increases spending, this will create demand-pull inflation, and prices will grow faster than wages. Even if prices grow, it might not be the case for wages, because they've generally been negotiated for a given period. Also, employees are often slow to realize that inflation is happening (due to money illusion). With prices growing faster than wages, real wages fall, this makes it cheaper to employ people, making unemployment fall. If the government brings down spending in the economy, then, with lower demand, inflation may be reduced and, in the short run, prices will grow more slowly than wages. This is again because wages are slow to change due to contracts and because it takes time for employees to fully notice changes in inflation. If prices are growing more slowly than wages, then real wages have increased so employees are more expensive to hire. This will lead to fewer people being employed and unemployment rising. - **Long run:** In the long run, if the government increases spending, employees will notice that their purchasing power has decreased and will want higher wages compensating for the inflation. If they manage to match wages increase to the price increases, then wages and the economy will be back to where they started (except that prices and wages will grow faster). Unemployment too is at a normal rate again. Therefore, in the long run, there has been no trade-off between inflation and unemployment. If the government brings down spending, in the long run, because of high levels of unemployment and because they realize that inflation has fallen, employees will accept lower pay increases. This would mean that real wages were back to where they were originally. All that has changed is that prices and wages are now growing at a lower rate. Once again, there is no trade-off between the rate of inflation and the rate of unemployment in the long run. Phillips curve: Phillips Curve - Learn How Employment and Inflation are Related []{#_Toc187861794.anchor}[Unanticipated and anticipated inflation:] There is a significant difference between the two. If you know that prices are going to rise, and you have strong bargaining power, then you can demand higher wages to compensate. However, if inflation rises in an unanticipated way, and your pay increase rate is lower than inflation rate, then you will be worse off in real terms. If inflation is often unanticipated, then this will lead to high levels of uncertainty in the economy, which may deter investment and affect spending, and impact saving decisions. The impact can also vary depending on the rate of inflation and how sustained it is. If there are higher rates for a long time are more damaging than low rates for a short time. [Other definitions:] -------------------------------- Malign deflation: A sustained decline in the general level of prices in an economy due to a slump in demand. Stagflation: An economic situation characterized by high and rising unemployment and inflation. Price inflation: A sustained increase in the general level of prices in an economy. Imported inflation: Rising prices were caused by an increase in the cost of imports following a fall in the value of the exchange rate of the importing country's currency. Hyperinflation: Rapidly rising inflation at phenomenal rates during which the currency ceases to be a store of value of acceptable medium of exchange. Indexation: The technique of adjusting certain payments by a price index to preserve their real value or purchasing power. **[Unemployment:]** =============================== []{#_Toc187861797.anchor}[Unemployment:] Those people of working age who are actively seeking work at the current wage but are not currently in employment. [How unemployment is measured:] ------------------------------------------- **Unemployment rate**: The number of people unemployed expressed as the proportion of the active labor force that is unemployed.  **Labor Force Survey (LFS):** A way to measure unemployment which is based on interviews with people to determine those who want to work, but who are not employed. In the UK for example, the LFS is the official way of measuring unemployment. **Claimant count:** A way to measure unemployment by measuring the number of individuals who are claiming unemployment-related benefits at any moment. This is a relatively straightforward figure to gather but may be misleading because governments can change the conditions under which people can claim such benefits. It is therefore open to abuse by governments because, to reduce unemployment, they can simply make claiming more difficult. [Causes for unemployment:] -------------------------------------- - **Classical unemployment** This occurs when the real wage remains too high for equilibrium. This will lead to an excess supply of labor (more people want to work than are demanded because of the relatively high real wages). Real wages may be too high because employees continue to demand high wages even when prices are falling. The downward stickiness of nominal wages in this situation (because employees resist nominal pay cuts) leads to higher real wages. Real wages may also be too high if trade unions push the wages above the equilibrium rate. This unemployment should put downward pressure on wages to reduce the real wage, but this may take time to take effect. The extent to which real wage unemployment exists depends on whether you think that money wages are flexible upwards and downwards, or whether you think that factors such as negotiated contracts and trade unions mean that money wages can stay away from the real wage equilibrium for some time. - **Cyclical:** A type of unemployment that occurs when demand is low throughout the economy. For example, there may be a recession with negative GDP growth. Demand for labor is a derived demand, so if demand for goods and services is generally low, then this will lead to less demand for employees and more unemployment. - **Frictional:** Unemployment that can't be removed. It consists of those who are moving from one job to another but have not yet started this new work. - **Seasonal:** In certain industries, demand for labor varies depending on the time of the year. (agriculture, building, tourism) - **Structural:** This is caused by a permanent fall in demand for the products of an industry. It is caused by either resources being exhausted or by a country losing its comparative advantage. It is often associated with rising labor costs causing labor-intensive industries to move to low-cost countries. - **Technological:** This is a form of structural unemployment caused by technology replacing labor. [Types of unemployment:] ------------------------------------ Involuntary unemployment: Made up of those who are able and willing to work at the given real wage, but who are not in employment. This is because there is a lack of jobs available. This is due to a lack of demand in the economy. Voluntary unemployment: Made up of those who are in the labor force and are looking for work but are not yet willing or able to accept work at the given real wage rate. This is shown by the difference in any real wage rate between the job acceptance and the labor force curves. The job acceptance curve shows the number of people who are willing and able to accept a job at a given real wage rate. It increases as the real wage increases because people will be less willing to wait around in the labor force as the rewards of taking a job increase. The *labor force curve* shows the number of people at work or looking for work. involuntary-unemployment [Consequences of unemployment:] ------------------------------------------- ### Why governments might be concerned about unemployment: - **Lower income in each region:** This will occur because fewer people are working, and will lead to less spending on local goods, leading to even more unemployment. This lowers the living standards in the region. - **More social problems:** As people have lower incomes and more free time, they will commit more crimes. - **Higher government spending:** More people rely on unemployment benefits and welfare programs, increasing public expenditure. - **Less income for the government:** The government will earn less money from direct taxation because people don\'t have an income, and they\'ll earn less from indirect taxation as people will spend less. - **Less investment:** If firms lose confidence in the economy, they\'ll want to put less money into long-term projects until unemployment falls. []{#_Toc187861803.anchor}The cost of unemployment to the individual: For individuals, unemployment causes loss of income and lower morale. As the individual will not have an income, he will benefit from the unemployment benefit. This benefit will fulfil his needs but will leave him with enough disposable income to fulfil his wants. This might encourage him to commit crimes, as it is an easy way to make money. Additionally, due to lack of employment, the individual might feel very alone, which can cause lower morale and therefore depression. The longer an individual stays unemployed, the less likely he is to ever work again as he might lose his skills. Hysteresis: A phenomenon that occurs when people are unemployed for a length of time, they become increasingly less likely to ever work. The longer someone is unemployed, the more their skills will go out of date, their network will become less relevant and their experience less useful. They gradually become less employable. Cost of unemployment to government: - **Loss of income tax revenue:** Unemployment leads to reduced income tax. - **Higher welfare spending:** More money is spent on unemployment benefits and social programs. - **Increased healthcare costs:** Long-term unemployment can lead to stress-related illnesses, adding pressure to public health services. - **Slower economic growth:** Lower consumer spending and weak demand reduce overall GDP growth, making it harder for the government to manage public finances. Cost of unemployment to the economy: - **Unemployment is a waste of resources:** The economy operates below its potential, meaning valuable labor is unused, leading to lower output. - **Lower consumer spending:** With less disposable income, demand for goods and services falls, slowing economic growth and business expansion. - **Lower investment and business confidence:** Firms may delay investments or expansion due to uncertainty about economic stability. - **Potential rises in taxes:** In order to fund welfare programs, the government might have to increase taxes, reducing even further disposable income and investment. [Solutions for unemployment:] ----------------------------------------- []{#_Toc187861805.anchor}Demand-side policies: Demand-side policies are a way that government can try to boost the aggregate demand and provide jobs for those who are involuntarily unemployed, which is individuals who have the necessary skills and who want to work, but for whom there have been a lack of jobs available. *Demand-side policies include:* - **Cutting direct taxes to boost spending by firms and households** - \+ Increased disposable income and hiring from firms - \- Inflation - **Increased government spending by firms and households** - \+ Boosts aggregate demand - \- Inflation - **Lower interest rates** - **Furlough:** Fiscal stimulus, like in the USA during the Covid. Demand-side policies raise the level of demand in the economy. To produce more, firms need to employ more labor, so the demand for labor shifts to the right.  []{#_Toc187861806.anchor}Supply-side policies: When voluntary unemployment happens, the problem is not a lack of jobs, but rather a question of whether individuals have the required skills to work or want to accept a job. If the government were to increase spending to provide more jobs, then those would not solve the problem. What is needed here is help for individuals to get work that is there already; that is supply-side policies. Shifts in Supply Curve *Supply-side policies include:* - **Invest in training to provide the skills that people need to get jobs in other** **industries** - \+ Improve workers quality leading to more jobs - -- Delay and brain drain (skilled workers leaving elsewhere) - **It could change the benefits and tax system to make being unemployed less of an option:** That is to force people to accept a job by making the gains from being unemployed very low. If the ratio of benefits from working is higher, more people can be encouraged to join the labor force, but it may reduce the number accepting a job - **The government could reduce the tax wedge:** Taxes drive a wedge between the pay that employees receive and their take-home pay. ### Tax wedge graph:  []{#_Toc187861808.anchor}Keynesian economic view: Keynes believed that full employment is essential for a strong economy because it maximizes productivity and prevents wasted resources, while still allowing the economy to operate fine alone. To him, unemployment is primarily caused by insufficient demand in the economy. He argued that market forces weren't strong enough alone to achieve full employment, especially during a recession. That's why he considered the government responsible for the economic cycle, because through injections, or other policies like tax cuts, the government can boost the demand in the economy, helping it reach full employment. Unemployment to Keynes was a major economic problem that reduces the output of the economy as well as the living standards, and it is primordial for the government to try and keep it as low as possible. **Advantages:** - *[Higher economic output:]* Full employment ensures all resources are used efficiently, maximizing the GDP. - *[Improved living standards:]* More people earning wages leads to higher consumption and better quality of life. - *[Reduced social issues:]* Lower unemployment means fewer social problems like poverty and crime. - *[Higher government revenue:]* If there is full employment, then the government will have a higher income as everybody is employed and has to pay taxes. **Disadvantages:** - *[Risk of inflation:]* If there is full employment, the economy is going to be in a BOOM. Even if this is good for economic growth, the Boom can lead to inflation as everyone has disposable income and will spend it on wants. This can overheat the economy, pushing it into a recession. If there is inflation, then, with the prices of the goods and services of a country being more expensive, they will be less competitive on the international market. - *[Government debt:]* To achieve full employment, the government might need to inject a lot of money in order to increase the aggregate demand. []{#_Toc187861809.anchor}Opportunity cost of reducing unemployment: The opportunity cost is lowering the interest rates to encourage borrowing and increase spending. Therefore, the increased demand causes higher inflation which is the opportunity cost of trying to reduce unemployment. In addition, the government can increase its spending and cut taxes. This will increase its spending and cut taxes. This will increase demand for goods and services and thus employment. Moreover, with more demand for labor to meet increased production needs, wages will have to rise according to the Phillip's Curve. This means higher consumer spending, which further pushes prices up on a reinforcing cycle. To sum up, the opportunity cost of trying to reduce unemployment is higher inflation as more disposable income will lead to higher demand and eventually higher prices. [Government perspective on unemployment:] ----------------------------------------------------- **Composition of the unemployment figures:** It is important to adjust policies for specific unemployment topics and to understand the causes for the composition of the unemployment figures. For example, high youth unemployment often requires initiatives like training programs, apprenticeship and entry-level job creation to cover experience gaps. On the other hand, employees may benefit more from re-skilling programs to align their skills with evolving job markets. For sectors of the economy, knowing where unemployment is concentrated helps the government identify which industries are struggling. For example, if traditional sectors like manufacturing experience high unemployment due to automation, policies can be put into force to encourage innovation, to provide support and to invest to address unemployment. **Youth unemployment:** Youth unemployment is a big concern because young people are "indicators" of the future labor market. If young people lack skills and experience, they are very likely to find it difficult to get employed in the future. Additionally, if the young population is not working, they are a waste of resources and lower the taxes revenue of the government as they have no income to get taxed. They are perceived as costs addition, youth unemployment is a particular concern for a government since if young people do not work, the quality of their life will fall and eventually lead to increased poverty in the future. This has the potential to cause robberies, and more crimes as the younger population has more free time and no income. []{#_Toc187861811.anchor}[Labor market imperfections and their impact on unemployment:] - **Powerful trade unions:** Trade unions may negotiate for higher wages or better working conditions, but this can make hiring more expensive, leading to fewer job opportunities. - **Unemployment benefit:** If the unemployment benefits are too generous, some people will stop actively seeking jobs, increasing voluntary unemployment. - **High non-wage costs:** If employers have to pay additional costs, such as social security or welfare contributions, then hiring workers, especially low-skilled ones, will be less attractive. - **Labor immobility:** If workers struggle to move to areas where job opportunities are available, unemployment might persist in certain regions. This could be the case because of housing costs, family ties or lack of skills. [Other definitions:] -------------------------------- Full employment: When all those who are willing and able to work at the given wage rate are either in a job or are about to take up a job. Equilibrium unemployment: The difference between those who would like to work and those who are willing and able to take up a job offer at the current wage rate. Disequilibrium unemployment: Occurs where wages are higher than the equilibrium wage. Natural rate of unemployment (NAIRU): The rate of unemployment when the labor market is on equilibrium. Labor force participation rate: Measures the percentage of the population of working age that is economically active. **[Monetary VS Fiscal policies:]** ============================================== []{#_Toc187861814.anchor}[Monetary policy:] Refers to the actions taken by a country's central bank to control money supply, interest rates, and inflation to stabilize the economy. Some examples of monetary policies are: - **Changing the interest rates:** Raising or lowering interest rates to influence borrowing and spending. - **Providing subsidies:** Supporting businesses or industries to stimulate growth. - **Raising** **taxes:** Increasing taxes to reduce inflation or government debts. []{#_Toc187861815.anchor}[Fiscal policy]: Refers to the use of government spending and taxation to influence economic activity and growth. Some examples of fiscal policies are: - **Increasing government** spending: Investing in infrastructure, education, or healthcare to boost demand. - **Cutting taxes:** Reducing income or corporate taxes to encourage spending and investment. - **Providing subsidies:** Supporting businesses or industries to stimulate growth. - **Raising taxes:** Increasing taxes to reduce inflation or government debt.