Macroeconomic Objectives Chapter 15 PDF

MACROECONOMIC OBJECTIVES CHAPTER 15 Lecturer: N. Malimba Learning outcomes  How economic growth is measured and why is it important  About the business cycle and its primary phases  How unemployment and inflation are measured  About the types of unemployment and inflation and their variou...

MACROECONOMIC OBJECTIVES CHAPTER 15 Lecturer: N. Malimba Learning outcomes  How economic growth is measured and why is it important  About the business cycle and its primary phases  How unemployment and inflation are measured  About the types of unemployment and inflation and their various economic impacts  About measuring income inequality 2 2 ECONOMIC GROWTH · Economists define economic growth as either: · An increase in Real GDP occurring over some period of time when GDP is defined as the value of final goods and services produced within the borders of the country in a particular period. · The term “real” refers to the fact that prices are kept constant over time (adjusted for inflation). · The term “nominal” GDP – total value of goods without adjusting for inflation. To measure growth would we need to consider real or nominal GDP? Growth: Increase in real GDP or real GDP per capita; Calculated as a % growth rate per year/quarter. 3 3 ECONOMIC GROWTH · Can also be measured in terms of Real GDP per capita: · Whereby economic growth is measured by the total value of goods and services is divided over the population of the country. Economic growth as a goal · The expansion of total output relative to population results in rising real wages and incomes and, thus, higher standards of living. An economy that is experiencing economic growth is better able to meet people’s wants and resolve socioeconomic problems. · Growth lessens the burden of scarcity. A growing economy can consume more today while increasing its capacity to produce more in the future. 4 4  Arithmetic growth · Economists pay so much attention to small changes in economic growth because those changes really matter. The mathematical approximation called the rule of 70 provides a quantitative grasp of the effect of economic growth. · Approximate number of years required to double to double real GDP = __________70____________ Annual percentage rate of growth · Example, A 3% annual rate of growth will double real GDP in about 23 years (=70/3). 5 5 Institutional structures that promote economic growth · How does a country begin the process of economic growth? And how does it sustain growth in the economy once it has begun? · Growth-promoting institutional structures include: · Strong Property rights – are required to promote quick and sustainable economic growth. People will not invest if they feel that dictators or criminals would steal their money or their projected returns. · Patents and copyrights – Patents and copyrights provide a significant financial incentive for inventors and authors to innovate and create by granting them the exclusive right to market and sell their products. · Efficient financial Institutions – Banks, as well as stock and bond markets, appear to be vital to modern economic growth. These institutions channel household savings toward the businesses. · Literacy and widespread education – New technologies are not developed in the absence of well-educated scientists and innovators. And it is hard to put those technologies to good use without a highly educated workforce. · Free trade – By allowing nations to specialize, free trade fosters economic growth. · A competitive market system – Prices and profits are the signals that inform enterprises what and how much to make in a market economy. 6 6  Expanding economy… Economic growth expansion of the Production Possibilities Frontier (or boundary) What are the main sources of economic growth? – Increasing inputs (land; labour; capital) – Increasing productivity (outputs per unit of input) 7 7 Main Sources of Growth 1. Supply · Increase in the quantity and quality of natural resources · Increase in the quantity and quality of human resources · Increases in the supply of capital goods · Improvements in technology 2. Demand factors · Increase in households, businesses and government expenditure on goods and services. Thus, providing a market for the new output and potential output. 3. Efficiency Factor · In addition to full employment, the economy should achieve economic efficiency if it is to maximise the amount of satisfaction derived from scarce resources. 4. Labour and productivity · Society may boost its real production and income in two ways: (1) by expanding its resource inputs, and (2) by increasing the productivity of those inputs. In any given year, a country's real GDP is determined by labour input (measured in hours) multiplied by labour productivity (measured as real output per hour of work). · Real GDP = Hours of work x Labour productivity. 8 8  Text slide Growth Global heading set in Arial In general, “advanced” (developed) countries have slower growth rates than “emerging” (developing) countries. Economists attribute this to the combination of economic maturity, diminishing returns on investment, demographic trends, market saturation, and structural reform opportunities in emerging markets generally leads to lower economic growth in developed countries compared to their emerging counterparts. 9 9  The Business Cycle · Business cycles are alternating rises and declines in the level of economic activity. Lipsey (1998) defined the business cycle as the constant ebb and flow of business activity that occurs around the long-term trend (Potential GDP). GDP Growt h Time Alt Definition: Recurring increases and decreases in the level of economic activity over periods of years; consists of peak, recession, trough, and recovery phases. 10 10  Phases of the Business Cycle · Peak – Growth reaches a max – unsustainable/ inflationary (excess risk) - results in an economic downturn. · Expansion - Positive economic activity. Economic growth increases. Low interest rates, increasing confidence. · A recession – Negative economic activity. Economic growth slows. Low confidence. Increasing interest rates. · Trough – The economy reaches a low point & begins to recover. Cut interest rates to ensure recovery. 11 11  UNEMPLOYEMENT – Narrow definition · The term unemployment refers to a situation where a person actively searches for employment but is unable to find work. · Unemployed persons according to StatsSA are those (15-64) who: - were not employed in the reference week - Actively looked for work or to start a business in the 4 weeks preceding the reference week -were available for work (but couldn’t secure work) - Had not actively looked for work but had a job or business to start in the future 12 12  Unemployment – Expanded definition The expanded definition according to StatsSA are those (aged 15-64) who: - Fall under official unemployment (Searched and available for work) - Were available for work but are discouraged work-seekers or have other reasons for not searching NB: the unemployment definition doesn’t include people who leave the workforce for reasons such as retirement, higher education and disability. 13 13  Measuring unemployment Unemployed + employed = workforce Unemployment rate = % of people in the workforce who are unemployed · Unemployment = Unemployed/Labour Force x 100 14 14  Working Example… Narrow definition: ·U = U/LF x 100 ·U = (7242/22 237) x 100 = 32.6% Broad definition: ·Remember: Labour force and unemployed now includes “discourage workers” ·U = (7242+3131 )/(22 237 +3131) x 100 = 40.9% 15 Causes of Unemployment Types of unemployment: –Frictional –Always there – new job seekers, moving jobs, etc. –Structural –Mismatch between skills & jobs –Cyclical –Recession - lower employment; –Expansion - increasing employment Question What type of unemployment do you think is prevalent in South Africa? 16  Why does unemployment matter? Economic consequences : – Uneven distribution of the costs of unemployment - inequality (skill level; age; race & ethnicity; gender; province) – waste of potential output – political instability and crime discourage investment Social consequences : – loss of human capital (skills lost) – crime and social unrest – political instability – poverty and declining welfare 17  Inflation Inflation is a rise in prices, which can be translated as the decline of purchasing power over time. The rate at which purchasing power drops can be reflected in the average price increase of a basket of selected goods and services over some period of time. The rise in prices, which is often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods. (purchasing power decline) Rate of inflation: rate at which the price level is rising (%).  Measuring the rate of inflation · The CPI is a measure that examines the weighted average of prices of a basket of goods and services that are of primary consumer needs. They include transportation, food, and medical care. CPI is used to measure the changes in the cost of living for the average household. Rate of inflation = CPI (new) - CPI (old) X 100 CPI (old) 19 CPI in South Africa and inflation targeting Inflation Target: The SA Reserve Bank aims to keep the consumer inflation between 3% and 6%. Through controlling money supply. Inflation targeting used to increase transparency, control inflation and ensure economic stability (Source: StatsSA, 2022) 26 20  Headline and core inflation · Headline Inflation refers to the total inflation within an economy, including all items in the consumer price index (CPI). This measure captures the overall change in prices, including volatile elements such as food and energy prices. Because these components can be highly sensitive to supply shocks, geopolitical events, or natural disasters, headline inflation can often be more volatile and may not always reflect the underlying trend of price changes in the economy. · Core Inflation, on the other hand, excludes certain volatile items like food and energy to provide a clearer picture of the long-term inflation trend. By removing these items, core inflation offers a more stable and consistent measure of price changes, making it useful for policymakers, particularly central banks, in assessing the effectiveness of monetary policy and predicting future inflation trends. 21 21 Using the CPI numbers to calculate inflation (i)What was the inflation rate between May 2021 and May 2022? (ii)What does this mean for households? (i) [(103.1 – 96.8)/96.8] x 100 = 6.51% (ii) This means that, on average, the “basket” or “bundle” of goods that households buy increased in price by nearly 6.51%, reducing their purchasing power. 28 22  Types of inflation 1. Demand-pull – Spending (aggregate demand) > production (aggregate supply) – Caused by economic growth, central bank increasing money supply too fast (decreasing interest rates), increasing exports, increasing government spending, inflation expectations. – How does it affect economy? – Reduce purchasing power, economic instability/labour disputes 2. Cost-push inflation – Caused by increases in the costs of production (supply shocks); – reduces GDP/production 29 23  Effects of inflation · Who is hurt by inflation? 1. Fixed Income receivers - eroded purchasing power e.g., Landlords 2. Savers – the declining real value of money 3. Creditors – money they receive from debts has less value · Who is least affected by inflation? · Flexible income receivers · Debtors (private and/or government) 24  Hyperinflation · Hyperinflation is often described as a period of inflation of 50% or more per month. Adverse effects - Normal economic relationships are distorted. Producers do not know what to charge for their products, and consumers don’t know what to pay. - Production declines as producers hoard materials and stockpile finished products in anticipation of price increases. - Investment declines as savers refuse to extend credit that would be repaid with a lower value. - Economic collapse and political chaos 25  Causation · Hyperinflation is always caused by governments instituting highly imprudent expansions of the money supply, which produces chaotic total spending and serves demand-pull inflation. Motivation Sometimes, the government finds itself in a situation in which it cannot obtain adequate revenue through tax collection or borrowing to fund its expenditure and resorts to printing more money. Consider the timeline after the World War. Germany needed to pay reparations, yet its economy was in disarray. Termination Hyperinflation ends when governments cut their spending down to or below the amount of revenue that they can obtain through taxes and borrowing. + 26  Inflation Targeting in SA · Inflation Targeting is a objective that the SARB sets out to achieve to maintain stable prices and a sound financial system in SA. It involves using numerous tools at their disposal to ensure that inflation in the country is contained within a 3% - 6% bracket. · Tools used for inflation targeting - Interest rates - Government Expenditure - Reserve requirements 27 The Phillips Curve The Phillips curve measures the relationship between inflation and unemployment. The curve reflects that inflation and unemployment have a stable and inverse relationship. It is based on the notion that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment. The Phillips Curve · The curve indicates a trade-off between inflation and unemployment, and fiscal and monetary policy can influence the rate of economic growth and inflation. · High unemployment would indicate the implementation of expansionary policies. Increasing Gov Exp and decreasing Tax to increase aggregate demand. · Low unemployment would indicate the exercising of contractionary policies to reduce inflation and overheating. 29  INCOME INEQUALITY · Income inequality refers to how unevenly income is distributed throughout a population. The less equal the distribution, the greater the income inequality. Income inequality is often accompanied by wealth inequality, which is the uneven distribution of wealth. · A way of measuring is to divide the population into 10 numerically equal groups, or deciles, and examine the % of total personal income received by each decile. · Income inequality in South Africa is among the highest in the world. Table 15.6 (in your textbook) represents the shares of income among the populations deciles. 30  The Lorenz Curve and Gini ratio · The Gini Coefficient has been commonly used to measure income inequality in South Africa. · It ranges from 0 -1, where 0 indicates perfect equality (all individuals have the same income) and 1 indicates perfect inequality (1 individual has the same income and the rest have none). To understand the Gini Coefficient, one must first understand the Lorenz Curve, which orders all observations and then plots the cumulative percentage of the population against the cumulative percentage of the resource. 31  The Lorenz Curve · An equality diagonal represents perfect equality: at every point, cumulative population equals cumulative income. · The Lorenz curve measures the actual distribution of income. Blue line – Equality Diagonal Population = A Income B B – Lorenz Curve C – Difference Between C Equality and Reality 32  Calculating the Gini ratio · Gini Ratio = Area between Lorenz curve and diagonal Total area below the diagonal Gini Ratio = A( Grey Area) A+C ( Grey area + white area below diag.) Effects of government redistribution · One economic function of government is to redistribute income. · Gov redistribution in SA is through the progressive tax system where individuals pay a higher percentage of its income in tax if it earns more income. · Together with growth of job opportunities, grants and other payments are the important means of alleviating poverty and inequality in South Africa 33  Causes of Income Inequality · Ability · Education and training · Discrimination · Preferences and Risks · Unequal distribution of wealth · Market Power · Luck, connections and misfortune · Greater demand for highly skilled workers · Demographic changes · International Trade 34