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Unemployment - people of working age who are actively looking for a job but are not employed
Underemployment - people of working age with part-time jobs when they would rather work full
The economy is wasting resources by not using them fully.
Labor force - number of employed people + number of unemployed people of working age
Excludes: children, retired, people who cant work, and people who dont want to work
unemployment rate = (number of unemployed)/(labor force) x 100
An accurate rate is hard to get because of hidden unemployment.
Unemployment figures:
include unemployed people actively looking for work. It excludes discouraged workers
(unemployed workers who have given up job-searching).
dont distinguish between full-time and part-time employment and counts part-time workers
as full-time
doesnt distinguish on type of work
dont include people on retraining programs or those who retire early
dont include people working in the underground/informal economy
The national unemployment does not account for differences that arise due to population groups
region, gender, ethnic groups, age, occupation/skill
Loss of real output - output produced is less
than what the economy is capable of
Loss of income for unemployed workers -
workers worse off financially
Loss of tax revenue - unemployed people
have no income, so they dont pay income
Costs to the govt - less tax revenue for
other goods/services and social problems will
cost tax revenue.
Unequal distribution of income -
unemployed become poorer and employed
maintain income
Difficulties finding work - unemployed may
lose skills and jobs require new skills
Personal problems - unemployed will be
stressed and will result in problems
Greater social problem - high rates of
unemployments can cause serious social
Structural unemployment - demand changes, location changes, and labor market rigidities
Changes cause demand for new skills; leads to mismatch between supplied/demanded skills
Firms relocate to foreign countries, because the production costs may be cheaper there.
Labor market rigidities - factors preventing supply and demand forces from working in labor
market: minimum wage, labor union/wage bargaining, employment protection laws,
unemployment benefits
Frictional unemployment - workers between jobs; fired, quit, or wanting a better job
certain amount of frictional unemployment inevitable, due to incomplete information
Seasonal unemployment - demand for labor changes due to seasonal changes
The 3 types of unemployment above are considered inevitable & make up natural unemployment
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Cyclical unemployment (demand-deficient)

unemployment that arises when the economy produces less than

its potential output
occurs during downturns of business cycle (recessionary gap);
decrease in AD
AD decrease causes real GDP decrease, and firms lay off workers
Keynesian concept representable in both models
usually involve government policies to increase AD to eliminate
recessionary gap.
Potential output (Yp): unemployment = natural rate. Cyclical
unemployment = 0.
Recessionary gap (less than Yp): unemployment > natural rate.
Cyclical unemployment present.
Inflationary gap (more than Yp): unemployment < natural rate.
Cyclical unemployment = 0.
Different parts of unemployment requires different types of
government policies.
10.2 Low and stable rate of inflation
Inflation - sustained increase in general price level
Deflation - sustained decrease in general price level
Disinflation - a decrease in the rate of inflation
Price indices are used to measure inflation or deflation. Its the measure of average price in a
base period.
Consumer Price Index (CPI) - measure of cost of living of typical household. A hypothetical
basket with lots of goods is created and the value is cost. The same basket has its value
calculated for later years. The percentage change shows whether there is inflation/deflation.
Different inflation rates for different income
earners based on consumption patterns
Different inflation rates depending on
cultural/regional factors
Consumption changes when prices change
Consumption changes due to discount stores
Consumption changes due to new products.
Product quality change
International comparisons
Comparability over time (less over longer
periods of time)
Some goods have highly volatile prices
because of wide supply/demand swings. This
can cause problems if they are included in
the CPI.
Economists measure a core rate of inflation,
which is usually a CPI without volatile food/
energy items.
PPI is several price indices of prices received by producers at different stages.
Measure price level changes from producer point of view.
Can be seen as a predictor for CPI change
% change in real income (purchasing power) = % change in nominal income - rate of inflation
If the price level increases, your nominal income increases, but your real (purchasing power) income
remains the same.
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Cyclical Unemployment

Redistribution effects - inflation redistributes

income; some people become better and
others worse off
People with have fixed or slow increasing
incomes/wages become worse off because
of the price level changes
Cash holders are worse off because the
purchasing power decreases
Savers of money become worse off because
they need to have an interest rate equal to
inflation rate
Lenders may be worse off
Borrowers gain because the money borrowed
is probably worse off
Payers of fixed or slow increasing incomes
have to pay less
Uncertainty - People cant really predict the
future and have to be more cautious
Menu costs - firms have to adjust prices and
reprint menus and advertisements and they

Money illusion - people feel better off when

their nominal income increase even though
they dont really have extra real income.
International competitiveness - Exports
become more expensive if the price level of
that country increases and thus there will be
more imports than exports.
Governments prefer a low and stable rate of
inflation, not zero rate, because a zero rate is
really close to deflation. Ideal rate ~2-3%
Demand-pull inflation - inflation caused by increases in AD, which is
called by changes in the AD determinants. Involves excess of AD over AS
at full employment - and there would be an increase in AD.
Cost-push inflation - inflation caused by production cost increases or
supply-side shocks.
Only analyzed in monetarist model and not in the Keynesian model.
Not a recessionary gap because the SRAS curve, not the AD curve
SRAS decrease can cause stagflation.
Deflation is not as common in the world:
Wages dont fall easily
Price wars may occur
Firms want to avoid menu costs arising from price changes.
Redistribution effects with effects opposite of inflation
Uncertainty, menu costs
Risk of deflationary spiral - deflationary spiral is a series of events that make the deflation worse
and consumers spend less because they expect the price to fall.
Risk of bankruptcies and crisis - real value of debt increases during a deflation and thus makes it
harder for firms or consumers to pay back the debt
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Usually a decrease in AD leads to a bad deflation and an increase in AS leads to a good

Bad because associated with recession.
Good deflation associated with expansion (LRAS shift to right).
Deflation still isnt good because it discourages spending, and is sometimes a greater threat
than inflation.
Economic growth - increase in real GDP, expressed in % change (per
capita) over period of time.
Growth rates can impact a countrys performance.
Reductions in unemployment and increases in productive efficiency can
cause growth of actual output (diagram A)
A shift of the PPC means that an economy can produce more of the
two goods (diagram B), but does not mean that output increases - only
the possibilities. The factors that cause these PPC shifts are:
quantity increase of resources
quality increase of resources
PPCs can also shift inwards.
Capital - resources that can produce future benefits
Physical capital - capital from investments, spending for machines.
Human capital - skills, ability, knowledge, and health of workers.
Natural capital - land or natural resources; everything under the
land, everything on land, and the ecosystem of the country
Land - given by nature and doesnt change
Natural capital - can be destroyed or improved
Investment can apply to the three factors of production, and can be
done by the private sector or the public sector. Investment is needed to
build capital.
Increase in quantity of physical capital - increase in number of
machines, tools, etc. in an economy.
Increase in quality of physical capital - technological advances.
A technological advanced incorporated into capital good is embodied into new capital.
Increase in quantity of labor is not always growth. The quality of labor is more important because
it increases the productivity of the workers.
Natural capital has two types: commodities and ecological resources
Marketable commodities can contribute to growth but are not essential. Some countries, like
Taiwan, have high rates of growth even while producing only a little marketable commodities.
Ecological goods and common access resources are important to long-term growth.
Environmental destruction will cause future generations to have an unsustainable economy.
Productivity - quantity of output produced for each hour of work of working population (real
GDP/total hours worked). Improvement in productivity increases produced output => growth
In the AD-AS model, rightward LRAS shifts cause economic growth
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Diagram A
Diagram B

In the PPC, outward shifts cause growth relating to increasing possibilities, and the movement of
production points is the results of increasing efficiency.
Equity - condition of being fair or just
Equality - equal with respect to something
Some think that it is fair to have income equality, but others think that it is more equitable for
those who work more to get more income.
Ownership of factors of production is unequal, and the prices vary enormously. Some people in
the labor market earn more than others because of special skills.
Results in the distribution of income being unequal because some people have more factors of
production than others.
A quintile is a 20% portion of a countrys population. Income is distributed by quintiles, and if
income were equally distributed, every quintile will receive 20% of the income.
To be more realistic, the poorest quintile receives less than 20% of income, and the richest
20% receives more than 20% of income.
Can also be split into deciles (10%), or quartiles (25%).
A Lorenz curve shows degree of income equality in an
The percentages are cumulative: 40 shows the lower
The closer the Lorenz curve is to the income equality
line, the greater the equality of income distribution.
The Gini coefficient is (area between diagonal and Lorenz
curve)/(entire area under 45 line).
It has a value between 0 and 1. Zero means perfect
income inequality. The closer the coeff. is to 1, the
greater the inequality.
Poverty is the inability to satisfy minimal consumption
Absolute poverty is measured with a poverty line (minimum income level needed for a family to
sustain sufficiently).
World Bank defined lines: less than $1.25/day (extreme poverty), less than $2/day (moderate
Taking % of population whose income falls below the poverty line.
Many developing countries also have national poverty line, and those with a higher income will
have higher national poverty lines, so a higher percentage of people there will be considered
Relative poverty compares incomes of individuals with the median incomes. Related to equality
of income.
Even though people can buy basic necessities, they cant afford goods/services that are typical
in a society. Usually the percentage is 50% of median income.
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Many factors can cause poverty:

Low incomes - poverty is defined by

income falling below a certain level.
Unemployment - even though
unemployment benefits are given, they
are still lower than work received income.
Low levels of human capital - theres
usually a positive relationship between
skill and income levels
Low levels of capital/land ownership -
some have no resources to rely on, such
as a home or stocks that would give them
an income advantage.

Discrimination - social groups can be

discriminated against and receive less pay
Geography - people living in isolated places
have limited choices
Age - older people may have pension, but
they are usually low.
Limited social services - those with low
income rely on social services, but if they are
reduced, the people may have to purchase
these services.
Poverty - poverty can cause even more
Poverty comes with several consequences
Low living standards - low income
causes low living standards
Lack of access to health care &
education - this lowers productivity and
income even more
Higher mortality rate - limited health
care and poor nutrition can cause many
Social problems - crime rates, drugs,
Inability to realize full potential - people
cant realize their full potential and talent is
then wasted. May result in lower economic
There are several ways that can promote equity
Transfer payments - payments made by
govt to individuals just to redistribute
income. Vulnerable groups receive the
transfer payments and include pensions,
benefits, grants, etc. Made possible by
govt tax collection.
Provision of merit goods - Merit goods
would be underconsumed if the market
controlled income distribution. Education
and health care are considered
fundamental rights. Subsidized to make
sure they are affordable. Tax revenue
used to ensure provision of good.
Government intervention - minimum wage
legislation, food price ceilings, and farmer
price floors.
Taxation - allows redistribution to take place
by lowering income inequality
Direct taxes - taxes paid directly to the government by taxpayer, and the revenue is used to fund
many govt spending
Personal income taxes - most important source of tax revenue; paid by households on all
forms of income
Corporate income taxes - corporations are businesses that have formed a legal body that is
separate from its owners. corporate income taxes are taxes on corporation profits
Wealth taxes - property taxes and inheritance taxes
Social insurance contributions (payroll tax) - taxes paid by workers and their employers that
are paid into specific funds, like insurance and health care. They are earmarked, because they
are spent on a specific purpose.
Indirect taxes - taxes that are paid indirectly through suppliers
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General expenditure (sales) tax - tax on good/service spending and are a fixed % of retail
price. The EU and other countries uses a value added tax and is a tax paid on value added by
each producer.
Excise tax - tax paid on specific goods and services
Customs duties (tariffs) - tax applied on imports
Proportional taxation - constant tax rate; as income increases, fraction income paid is constant
Progressive taxation - increasing tax rate; as income increases, fraction of income paid increases
The more progressive a tax system, the more equal the distribution of income becomes
Regressive taxation - decreasing tax rate; as income increases, fraction paid decreases
Makes income distribution less equal
Corporate income taxes and social insurance contributions are usually proportional.
Indirect taxes are regressive.
Taxes affect allocation of resources.
Intended to move economy to more efficient allocation.
Most taxes are not made with the intention of correcting market failure, though.
Can even cause some inefficiency because they change the relative price of goods - and since
prices without market failure make the best resource allocation, taxes can cause inefficiency.
A very progressive tax system can cause a higher degree of income distribution, but this will also
be as a disincentive work or save.
Sales taxes are usually set on all goods and services, so there is no relative price change and thus
no impact. But they are regressive and lead to unequal distribution.
Some necessities excluded from some taxes to make them more affordable, increasing equity,
but then relative price has changed.
Some argue that taxes affecting allocation is mainly theoretical, and that in the real world, they
arent significant enough to reduce growth.
Progressive taxes can make business cycle fluctuations not as serious.
Greater equality can cause more efficient use of resources.
Some argue that transfer payments may have undesirable consequences because they are
disincentives for some to accept work. Others argue that it prevents these vulnerable groups that
may face poverty.
Transfer payments also lower effects of fluctuations.
There are opportunity costs when the govt subsidizes or provides merit goods.
Government intervention conflicts with resource allocation and leads to loss of social surplus and
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