Economics Terms

Microeconomics

Demand

Demand

• Quantity of goods or services that consumers are willing and able to buy at any price level at a specific period in time.

Law of Demand

• As the price of the products falls, the quantity demanded of product will usually increase of ceteris paribus.

Non-Price Determinants of Demand

• Income
  • Normal goods' demand increases with increasing income.
  • Inferior goods' demands decreases with increasing income.
  • Income Effect
    • As prices fall, real income increases.
    • Increased purchasing power.
• Price of Other Products
  • Related goods compete with each other.
    • Substitution effect.
  • Complementary goods work together.
• Tastes and Preferences
• Number of Consumers
• Future Expectations
  • Future price
  • Future economy

Additional Factors Affecting Demand

• Age structure (tastes and preferences)
• Income distribution (purchasing power)
• Government policy changes
• Seasonal changes (tastes and preferences)

Law of Diminishing Demand

• As additional units of a good or service are consumed, the marginal utility will decline.

Price Elasticity of Demand

Elasticity

• The responsiveness of one variable to the change in the other.

PED

• Price elasticity of demand is the measure of responsiveness of demand to changes in price.

PED Formula

• Price elasticity of Demand (PED) = the percentage change in quantity demanded of the product (QD) divided by percentage change in the price of the product (P)
• PED = %ΔQD/%ΔP

PED Values

• PED = 0
  • Perfectly price inelastic demand
  • Only in theory
• PED = ∞
  • Perfectly price elastic demand
  • Global trade markets and perfect competition are close to 1 PED
• PED > 1
  • Price elastic demand
• 0 < PED < 1
  • Price inelastic demand
• PED = 1
  • Unit elastic demand

Determinants of PED

• Number and closeness of substitutes
• Necessity of product
• Proportion of income spent on goods
• Time period considered

PED of Primary Commodities and Manufactured Products

• Primary commodities tend to have lower PED than manufactured products.
  • They usually have price inelastic demand.

Common Types of Elastic Goods

• Many substitutes
• Luxury goods
• Large portion of income
• Non-Addictive
• Plenty of time to decide, not urgent to purchase

Income Elasticity of Demand

YED

• Describes how the change in people's incomes causes an increase or decrease in demand for a good.

YED Formula

• YED = percentage change in demand/percentage change in income
• YED = %ΔQD/%ΔY

YED Values

• YED > 0
  • Normal goods
• 0 < YED < 1
  • Necessity goods
• YED = 0
  • Necessity goods
• YED > 1
  • Luxury goods
• YED < 0
  • Inferior goods

Engel Curves

• Show the relationship between income and quantity demanded.

Sectors of an Economy

• Primary
  • Primary commodities such as agriculture, mining, forestry.
• Secondary
  • Goods produced from primary commodities such as clothes, cars, houses, books and paper.
• Tertiary
  • Goods that are not yet tangible but improve quality of life such as entertainment, healthcare, insurance and education

Supply

Supply

• The amount of goods or services that producers are willing and able to offer at any price level during a specific time period.
• The quantity of a good suppliers are able to supply at any price level is the effective supply.

Law of Supply

• As the price of a product rises, the quantity supplied of the product will usually increase ceteris paribus.

Non-Price Determinants of Supply

• Costs of Production
• State of Technology
• Government Intervention
• Future Expectations
  • Future price
  • Future economy
• Price of Related Goods
  • Joint Supply
    • Goods derived from the same product, second good is often a by-product
  • Competitive Supply
    • Goods using similar resources and processes
• Global Events and Crises
• Number of Sellers

Law of Diminishing Returns

• The decrease in marginal output of a production process as the amount of a single factor of production is incrementally increased, ceteris paribus.

Marginal Costs

• The increase in quantity supplied compared to the total cost of production.

Price Elasticity of Supply

PES

• The quickness and the extent to which suppliers will respond to changes in the selling price.

PES Formula

• PES = Percentage change in quantity supplied/ percentage change in price
• PES = %ΔQs/%ΔP

PES Values

• PES < 1
  • Price inelastic supply
• PES > 1
  • Price elastic supply
• PES = 0
  • Perfectly price inelastic supply
  • Occurs when supply is fixed
• PES = ∞
  • Perfectly price elastic supply
  • Global trade markets can be assumed to have PES = ∞
• PES = 1
  • Unitary elasticity of supply.

Determinants of PES

• Time Period Considered
• Mobility and Flexibility of Production
• Unused Capacity
• Storability
• Rate of Production Costs

PES of Primary Commodities and Manufactured Products

• Manufactured goods have more elastic PES than primary commodities.

Market Equilibrium

Market Clearing Price

• All produced goods are sold at the market clearing price.

Price Mechanisms

• Signal information to consumers and producers
• Ration scarce resources
  • Resource allocation
• Give incentives to consumers and producers

Total Revenue

• The money a good will be making at a specific price level.
• TR = QD x P

Total Revenue and PED

• Inelastic PED
  • Price: increase
  • TR: increase
• Elastic PED
  • Price: increase
  • TR: decrease

Government Intervention

Intervention

• Government involvement in markets

Reasons for Intervention

• To earn government revenue
• To support firms
• To support households on low incomes
• To influence the level of production
• To influence the level of consumption
• To correct market failure
• To promote equity

Surplus

• Marginal social benefit of either producers or consumers

Producer Surplus

• Excess of the actual earnings that a producer makes from a given quantity of output, over and above the amount the producer would be prepared to output.

Consumer Surplus

• Extra satisfaction or utility gained by consumers from paying a price that is lower than that which they are prepared to pay.

Total Surplus

• producer surplus + consumer surplus = total/community/social surplus

Allocative Efficiency

• Ideal combination of goods and services in a society.
• Optimum Allocation = optimum distribution of resources.
• Results in the maximum possible total surplus at equilibrium (Qs = Qd)
• A free market should ideally automatically adjust to an allocatively efficient combination.

Failure of Allocative Efficiency

• Surplus is not maximized

Indirect Taxes

• Applied to the price of goods
• Specific Tax
  • Fixed amount of tax per unit sold.
• Percentage/ Ad valoreum tax
  • Fixed percentage charged on selling of the good.

Purpose of Indirect Taxes

• Collecting revenue.
• Discourages consumption of certain goods.
• Redistributes wealth.
• Corrects allocative inefficiencies.

Impact of Indirect Taxes

• Price: increase
• Quantity: decrease
• Government: Increase in revenue
• Producer: Decrease in revenue
• Consumer: Higher expenditure
• Community welfare: Decrease
• Allocative Efficiency: Inefficient

Subsidies

• Government funding of the production of certain goods to increase their supply.

Purpose of Subsidies

• Increased producer revenues
• Make basic necessities more affordable
• To support the growth of ap articular industry
• Encourage the consumption of a particular good or service

Market Failure

Market Failure

• Market failure occurs when a market is not perfect.
  • Resources are not allocated in an optimal manner.
  • Community surplus is not maximized.

Market Failure Graphs

• MPC
  • Marginal private costs
  • The cost for firms to produce an additional unit of a good or service.
• MSC
  • Marginal social costs
  • The total cost to society is when an additional unit of a good or service is produced.
  • MSC = MPC + cost to society
• MPB
  • Marginal private benefit
  • The benefit to consumers of consuming an additional unit of a good or service.
• MSB
  • Marginal private benefit
  • The total benefit to society when an additional unit of a good or service is consumed.
  • MSC = MPB + benefits to society

Optimal Social Quantity

• Equilibrium where MSB = MSC

Externalities

• When third parties, who are uninvolved, are affected by the benefits and costs involved in producing or consuming a particular good.
• Not normally reflect in the price of a good.

Positive Externalities

• Positive effects experienced by third parties that come from consuming or producing a good.

Negative Externalities

• Negative effects experienced by third parties that come from consuming or producing a good.

Merit Goods

• Goods that are beneficial to consumers and society as a whole and are usually under-provided.

Demerit Goods

• Goods that are harmful to consumers and society as a whole and are usually over- provided.

Negative Externalities of Production

• MSC > MPC
• There is over-production.

Positive Externalities of Production

• MSC < MPC
• There is underproduction.

Negative Externalities of Consumption

• MPB > MSB
• There is over-consumption.

Positive Externalities of Consumption

• MPB < MSB
• There is under-consumption.

Government Responses to Externalities

Negative Externalities of Production

• Legislation
• Carbon Tax
• Tradable Emission Permits

Positive Externalities of Production

• Subsidies
• Direct Government Provision

Negative Externalities of Consumption

• Indirect Taxes
• Regulations or Bans
• Negative Advertising

Positive Externalities of Consumption

• Subsidies
• Direct Government Provision
• Positive Advertisements and Public Awareness Campaigns
• Compulsory Regulation

Types of Government Interventions

Legislation

• Governments can pass laws regarding environmental standards that firms must comply with.

• Advantages:
  • Easy to apply
  • Can have a big impact
• Limitations
  • Cost of production increases
    • Possibly leading to unemployment and the costs of enforcing policies
  • Legislations might be ineffective
  • Legislations might be too harsh or not harsh enough
  • Legislations make it more difficult for local firms to compete with competitors who don't have the same legislations to abide by

Carbon Tax

• A carbon tax is a tax levied on the carbon emissions from producing goods and services.

• Advantages:
  • Government revenue
  • Easy to apply
• Limitations:
  • Difficult to measure
  • Difficult to calculate tax

Tradable Emission Permits

• Permission to pollute permits that enforce a quota of emissions.
• An eco-friendly firm can sell its permit for profit.

• Advantages:
  • Encourages firms to lower cost.
  • Free market sets price of a permit.
  • Cooperation among businesses.
• Limitations:
  • Difficult to set an acceptable level of pollution, difficult to measure pollution.
  • Incorrect adjustment of permits can lead to adverse effects.

Subsidies

• The government supports beneficial firms by funding them.

• Advantages:
  • Encourages promotion of the industry and lowers costs for firms.
• Limitations
  • The opportunity cost of using government funds.
  • Risk of reducing competition in the market.

Direct Government Provision

• The government produces the beneficial goods themselves.

• Advantages:
  • Government is in full control.
• Limitations:
  • High costs and opportunity cost.
  • Lack of expertise by the government.
  • Private firms discouraged from joining market.

Indirect Taxes

• Taxes are designed to correct negative externalities called Pigouvian taxes.

• Advantages:
  • Increases the cost of the good quickly.
  • Provides government revenue.
• Limitations
  • Addictive goods have price inelastic demand, causing small decreases in demand.
  • Creation of black markets.
  • Indirect taxes are regressive.

Regulations or Bans

• A regulation or full ban to make the product illegal.

• Advantages:
  • Reduces demand.
  • Low cost.
• Limitations:
  • Slow to implement.
  • Government spending required.
  • Difficulties enforcing regulations.
  • Backlash from consumers regarding free-will.
  • Potential rise of black markets.

Negative Advertising

• Government could fund negative advertising.

• Advantages:
  • Aims to reduce demand naturally.
• Limitations:
  • High cost and opportunity costs for the government
  • Studies are unclear on how effective advertising is especially on young adults and teenagers.

Positive Advertisements and Public Awareness Campaigns

• The government funds positive advertisements and campaigns

• Advantages:
  • Aim to increase demand naturally.
• Limitations:
  • High costs and opportunity costs.
  • Might be ineffective towards certain populations.
  • Lots of research required.

Compulsory Regulation

• People are forced to consume the good by law.

• Advantages:
  • Shifts demand effectively
• Limitations
  • Government must provide for free
  • Anger from residents
  • Costs of enforcing law

Sustainability

Sustainability

• Sustainability is the ability of current generations to meet their needs and maintaining resources and ecosystems so that the ability of future generations to meet their own needs isn't sacrificed.

Common Pool Resources

• They are resources that are rivalrous but non-excludable.
• They are often overused until exhaustion without some form of intervention.

Rivalrous

• A good when consumed, cannot be consumed by another person.

Non-Excludable

• A good that someone cannot be excluded or prevented from using. Goods that have no price and are available to use without payment.

Tragedy of the Commons

• The tragedy of the commons is the consequence of everyone acting in their own self-interest when using common pool resources.
  • Without intervention, it leads to the eventual complete depletion of the common pool resource.

Free Rider Problem

• If some producers try to limit their use of a common pool resource, other producers will take advantage of the unused resource, rather than saving it for the future.

Sustainability Solutions

• Government Responses
• Collective self governance
• International Cooperation

Government Responses to Sustainability Threats

• Carbon emission caps and taxes
• Subsidies for clean and renewable technologies (clean technology)

Collective Self Governance

• Participation of industries in the measures planned and taken to resolve environmental sustainability issues.

International Cooperation

• Countries must cooperate to develop, set and enforce policies designed to slow, halt, and reverse climate change

Challenges of International Cooperation

• Lack of shared responsibility.
• Not all countries produce large CO2 emissions.
  • The countries most affected by sustainability issues often have the smallest climate impact
• Inequality of resources
  • Not all countries have the ability to devote resources to combat climate change.
• Political disagreements

Behavioral Economics

Homo Economicus

• A theoretical model of the average person.
• Rational and has perfect information.
• Unbiased and full-self control.
• Consistent preferences and maximizes own utility.

Consumer Rationality Limitations

• Limitations on consumer rationality contradict the idea that all consumers make rational decisions.
• Categorized into cognitive biases, bounded rationality and types of choices.

Cognitive Biases

• Thinking patterns that result in limited consumer rationality.
• Rule of Thumb
  • Mental shortcuts (heuristics) for decision-making.
• Anchoring
  • When people rely on a piece of information that is not necessarily relevant as a reference point when making a decision.
• Framing
  • The way choices are presented as a simple change of the "frame" that may affect the choice made.
• Availability
  • Recalling examples of similar events their available memory to make a current decision.

Bounded Rationality

• The idea is that consumers and firms are bounded by their knowledge, information and ability, and therefore cannot be ideally rational.
• Bounded Self-Control
  • The idea that individuals, even when they know what they want, may not be able to act in their best interest.
• Bounded Selfishness
  • The idea that people do not always maximize utility or self-interest, but also have concern for the well-being of others.
• Choice Architecture
  • The design of environments is based on the idea that the layout, sequence and range of choices available affect the decisions made by consumers.

Types of Choices

• Default Choice
  • When a choice is made by default, meaning that when given a choice, it is the option that is selected when one does not do anything.
• Restricted Choice
  • When the choice of a consumer is restricted by the government or other authority.
• Mandated Choice
  • Choices made by consumers who are required to state whether or not they wish to take parts in an action.
  • The choice must be made by law.
• Nudge Theory
  • Nudges (prompts or hints) are used to influence the choices made by consumers in order to improve the well-being of people and society.

Rationality of Business Economics

• Classically, firms have always been considered profit-maximizers.

Profit Maximizing

• A possible objective of firms that involves producing the level of output where profits are greatest.

Alternative Objectives

• In reality, businesses typically have other objectives besides profit.

Corporate Social Responsibility

• When firms aim to create and maintain an ethical and environmentally responsible image.

Increasing Market Share and Growth

• A strategy to increase power in a market by increasing the amount of overall sales.

Satisficing

• When a firm strives to achieve several objectives rather than simply focusing on one.

Asymmetric Information

• Where one party in an economic transaction has access to more or better information than another.

Adverse Selection

• A situation where one participant has more information than another before the transaction occurs.

Moral Hazard

• A situation where one participant takes on more risk because they understand they will not pay the consequences of that risk.
• Happens after the transaction.

Government Responses to Asymmetric Information

• Legislation
  • The government may try to ensure all parties have adequate access to information by legislation.
• Regulation
  • The government may try to enforce monitoring of industries to reduce the impact of market failure.
• Private Responses
  • Firms may choose to implement changes to improve information symmetries.

Signaling

• When participants who have more information communicate the information to the other party.

• Advantages
  • Cost-effective
    • Increases amounts of information to all participants
    • Improves efficiency
• Limitations
  • False information
  • Time consuming

Screening

• When participants who lack information force others to reveal information.

Influences on Economic Choices

• Wants and needs
• Income
• Marketing
• Familiarity
• Price
• Quality
• Environmental factors
• Wealth
• Culture
• Values
• Availability

Rational Producer Behavior

Perfect Competition

• A theoretical scenario where buyers will only buy from the cheapest seller in the market.

Features of Perfect Competition

• Perfect Knowledge and Access
• Homogenous Products
• A Large Number of Buyers and Sellers
• Sellers are Price Takers
• Free Entry and Exit into the Markets

Perfect Competition Market Structure

• Many small firms
• Identical/homogeneous products (many substitutes)
• Low or no barrier to entry
• Perfect knowledge and access for everyone
• No market power
  • Firms are price takers
• Highly efficient
• Situations close to perfect competition are not preferred by firms due to no profit

Monopolistic Competition

• Many firms
• Differentiated products
• Low barriers to entry
• Limited market power
• Rely heavily on branding and advertising
• Everyone has a really small monopoly for their own brand
• Each firm tries to increase the size of its monopoly
• Normal profits in the long-run

Oligopolies

• A small number of firms control the market.
  • Occurs when there are very high barriers to entry.
  • Products differentiated through branding.
  • High chance of collusions.
• Interdependence between firms

Collusions

• A collusion is when multiple firms come together to try and control the market.

Cartels

• A cartel is when a group of companies work together to set a certain price level.

Duopoly

• When only two large firms control a market.
• Structurally similar to an oligopoly.

Markets

• A market is where people who are willing and able to purchase a good, service or resource can carry out an exchange with those who are willing and able to provide that same good, service or resource.

Different Types of Markets

• Product markets
• Factor markets
• Financial markets
• Stock markets

Supply in Markets

• In a monopoly there is only one supplier, meaning that they can decide to price.
• With multiple suppliers, the market price decides the price.

Natural Monopolies

• Forms when it is most efficient to have only one firm in a market.
• Due to very high fixed costs requiring economies of scale.

Pricing in Markets

• Barriers of Entry
  • Requires firms to make a large investment to enter the market.
• Efficiency
• Competition

Market Power

• The ability of a firm to raise the market price of a good or service above the marginal cost.

Market Structure

• Number and size of firms in the industry.
• Nature of barriers to entry to the industry (extent to which the market is contestable).
• Degree and intensity of price and non-price competition in the market.

Types of Barriers to Entry

• Economies of Scale
  • Production becomes cheaper with increasing quantity due to fixed costs being relatively smaller.
• Innovative Technology
  • Complicated technology used in production might not be available to those trying to enter the market.
• Geography or Ownership of Raw Materials
• Government Created Barriers

Profit Maximizing

• Marginal returns = marginal costs
  • Profit maximizing point

Efficiency of Producer Behavior

• Allocative efficiency: MC = AR
  • Social optimum level of production
• Productive efficiency: MC = AC
  • Firm Produces the product at its lowest possible unit cost.
• Perfect Competition Efficiency: MC = AC, MC = MR and MC = AR

Advantages of Perfect Competition

• Allocatively efficient
• Offers the lowest price possible for consumers, productively efficient
• High competition ensures inefficient producers exit the market
• The market is very responsive to consumers tase/demand

Disadvantages of Perfect Competition

• Unrealistic
• No economies of scale
• Lack of product variety
• Unable to engage in R&D to improve efficiency

Profits and Loss in the Short and Long Run of Perfect Competition

• Abnormal profits and loss can only be made in the short run.
• In the long run there can only be normal profits as firms join or leave the market.

Normal Profits

• Normal profit = Revenues – (Implicit costs + Explicit costs)

Monopoly

• Single dominant firm
• Unique product
• Extremely high barriers to entry
• Dominant market power
  • Firms are price makers
• Depends on how narrowly the industry is defined

Pure Monopoly

• A pure monopoly is when only one company controls an entire market.
• No competition.

Practical Monopoly

• In practical terms, it counts as a monopoly if a firm controls more than 25% of a market.

Sources of Market Power

• Economies of Scale
• Natural Monopolies
• Legal Barriers
• Branding
• Anti-Competitive Behavior
• Control Over Natural Resources
• Cartels

Features of Economies of Scale

• Specialization
  • Management can be put on the function of their expertise
• Division of labor
• Bulk buying
• Financial economies
  • Large firms can raise financial capital more easily (lower interest)
• Large machinery
• Promotion economies

Game Theory

• The study of how individuals behave in strategic conditions.

Types of Collusions

• Formal Collusion
  • When firms openly agree on the price that they will charge although sometimes it may be agreement on market share or on marketing expenditure instead.
• Tacit Collusion
  • When firms charge the same prices without any formal collusion.

Competition in Oligopolies

• Due to high interdependence, lowering prices can lead to price wars.

Macroeconomics

Objectives of Macroeconomics

Economic Growth

• Economic growth is measured using Real GDP which accounts for inflation.

Low Unemployment Rate

• Unemployment means one of the factors of production, labor, is not being used efficiently.

Low and Stable Inflation

• Around 2% stable inflation rate.

Sustainable National Debt

• A debt less than 60% of GDP.

Fair Income Distribution

• A fair difference between high and low income, but avoiding poverty.

Equity

• Equal and fair opportunities.

Environmental Sustainability

• Development and growth that does not compromise the resources of future generations.

Economic Structure

Free Market Economies

• The means of production are owned by private hands such as individuals or enterprises.
• Demand and supply decide wages.
• Demand decides what is produced.

Planned Economies

• Government owns the means of production.
• The government decides how the market should function.
• Collective ownership.
• State decides what and how much is produced.

Mixed Economies

• The means of production aren't owned by the government but the government uses central planning.
• Mixed economies have both private and public sectors.

Disadvantages of Free Economies

• Exploitation and allocative inefficiencies due to market failure.

Disadvantages of Planned Economies

• Risk of corruption.
• Government can make decisions that are harmful or don't reflect the needs of the people.

Circular Flow Model

• Provides a basis for calculations of GDP and GNI.
• Households provide factors of production to businesses who pay in wages.
• Businesses provide goods and services paid for by consumer purchasing.

Injections (Inflow) and Leakages (Outflow)

• Government
  • Taxes (outflow)
  • Government spending (inflow)
• Financial Institutions
  • Savings (outflow)
  • Investments (inflow)
• Foreign Countries
  • Exports (outflow)
  • Imports (inflow)

Gross Domestic Product

• The total monetary value of all final goods and services produced domestically within a year.

Variables Excluded by GDP

• Intermediate goods
  • Goods used in the production of final goods and services.
• Non-Production Transactions
  • Used goods
  • Financial transactions
• Illegal Activities
  • Black markets
  • Unregistered sellers

Gross National Income

• The total income of a nation's people and businesses.
• GNI considers a country's businesses (even if they are operating abroad) but not foreign ones operating in the country.

Measuring GDP

• Output Method
• Income Method
• Expenditure Method

Output Method

• The total value of all of goods and services produced within a nation.

• Advantages:
  • Allows for good statistical data based on sectors.
• Limitations:
  • Does not include informal economic activities.

Income Method

• The total income earned within a nation.

• Advantages:
  • Relatively simple if all jobs are registered.
• Limitations
  • Does not include unregistered payments.
  • Corruption and criminal activities could distort statistics.
  • Informal jobs not counted.

Expenditure Method

• The total amount of money spent on goods and services in an economy.

• Advantages:
  • Accounts for additional variables in open economies.

GDP Formula

• GDP = C + I + G + (X-M)

GNI Formula

• GNI = GDP + (incomes flowing into a country - incomes flowing out of the country)

Nominal GDP/GNI

• GDP/GNI measured in current prices that does not acount for inflation.

Real GDP/GNI

• GDP/GNI that is adjusted for inflation.

Calculating Real GDP/GNI

• Real GDP/GNI = (Nominal GDP/GNI)/(100/Price deflator)

GDP/GNI Per Capita

• GDP/GNI divided by population.

• Advantages
  • Easy to compare countries
  • Informs policymakers and agendas
  • Gives an indication of average income (GDP per capita)
• Limitations
  • Overestimates quality of life
  • Does not account for inequality or income disparity.
  • Difficult to measure and contains inaccuracies.
  • Does not account for improvement of quality.

Additional Tools to Understand Economies

• Human Development Index
• Purchasing Power Parity
• Big Mac Index
• UN Happiness Index
• OECD Better Life Index
• Happy Planet Index
• GDP Per Capita

Economic Growth

• Economic growth is the increase of market value of the goods and services produced by an economy over time.
• Economical thinking is based on the idea of endless growth.

• Advantages
  • Economic growth increases the standard of living.
  • Technological innovations and increased efficiency.
  • Consumer economy offers a wide range of options for people.
• Limitations
  • Economies cannot reasonably grow endlessly, especially by continuing our historically extensive ways of economic growth.
  • Distribution of gains from growth among people and states.
  • Consumer economy is damaging to the environment.
  • Economic fluctuation can have drastic consequences due to the size of the economy.

Business Cycle

• Economies that use GDP go through variations, where economic activity is increased or decreased over time.

Employment of Resources

• Employment of resources is the use of resources such as materials, people and time.

Stages of the Business Cycle

• Expansion
• Peak
• Contraction
• Trough

Expansion

• There is positive growth in real GDP.

• Exports increase.
• Reduced unemployment
• Increasing employment of resources
• Wages increase
• Increasing demand
• Increased economic growth
• Increased efficiency/capacity
• Some inflation

Peak

• Economic growth slows down.

• Exports flatten out
• Highest employment
• Overemployment of resources
• Demand flattens out
• Economic growth flattens out
• High inflation

Contraction

• Right after the peak and it is when the economic growth begins to decrease.

• Demand decreases.
• Wages are often decreased.
• Prices in some sectors may fall (deflation).
• Increased unemployment.
• Unused capacity (low economic employment).

• If the contraction lasts six months (two quarters) or more, it is termed a recession, characterized by negative economic growth and increased unemployment of resources.
  • If it the decline in real GDP is more than 10% it is called a depression.

Trough

• The lowest point in a contraction.

• Highest unemployment.
• Very low demand.
• Lowest wages.
• Low efficiency and high unused capacity.

Long Term Growth Trends

• While there are short term fluctuations, in the long term there is generally gradual economic growth.
• This trend is also called the potential output.
  • It is the level of output produced when there is full employment.

Full Employment

• The level of employment when unemployment is equal to the natural rate of unemployment.

Factors of Natural Rate of Unemployment

• Availability of unemployment benefits
• Trade union power
• Extent of labor market regulations
• Wage-setting practices by firms

Aggregate Demand

Aggregate Demand (AD)

• The total demand for goods and services produced in an economy at a given average price level in a certain time period.

Aggregate Demand Formula

• AD = C + I + G + (X-M)

Non-Price Determinants of Aggregate Demand

• Consumer Spending (C)
• Investment (I)
• Government Spending (G)
• Net Exports (X-M)

Consumer Spending

• The spending done by households as they purchase goods and services from firms.

Determinants of Consumer Spending

• Taxes (Income taxes and VAT)
• Wealth (house prices, change in value stocks and shares)
• Interest Rates
• Consumer Confidence/Expectations of future
• Debts of Households

Investment

• The investments and purchases by businesses.

Determinants of Investment

• Interest rates
• Business confidence
• Technology
• Business taxes
• Corporate Indebtedness

Government Spending

• Spending by the government using their budget.

Determinants of Government Spending

• Political priorities
• Economic priorities

Net Exports

• Exports have a positive affect on AD while imports have a negative affect on AD.

Determinants of Net Exports

• Income of trading partners
• Change in trade policies
• Health and safety requirements
• Exchange rates
  • Higher currency value leads to more imports and less exports
  • Lower currency value leads to less imports but more exports

Aggregate Supply

Short-Run Aggregate Supply (SRAS)

• Total quantity of real output (real GDP) offered at different possible price levels in the short run.

Determinants of SRAS

• Costs and Availability of Resources
  • Wage rates
  • Costs of raw materials
  • Price of imports
• Government Intervention
  • Indirect taxes or subsidies
• Supply shocks

Long-Run Aggregate Supply (LRAS)

• Equal to the potential output of an economy.

Determinants of LRAS

• Land
• Labor
• Entrepreneurship
• Capital

Land Shifting LRAS

• Increase in Quantity
  • Land reclamation
  • Increased access to supply of resources
  • Discovery of new resources
• Increase in Quality
  • Technological advancements that allow for increased access to resources or the discovery of new resources.
  • Fertilizers
  • Irrigation

Labor + Entrepreneurship Shifting LRAS

• Increase in Quantity
  • Increase in birth rate
  • Immigration
  • Decrease in the natural rate of unemployment
• Increase in Quality
  • Education
  • Training
  • Re-training
  • Apprenticeship programs

Captial

• Increase in Quantity
  • Investment
• Increase in Quality
  • Technological advancements that contribute to more efficient capital
  • Research and development

Deflationary Gap

• When the equilibrium level of real output is less than the potential output as a result of a decrease in AD or SRAS.

Inflationary Gap

• When the equilibrium level of real output exceeds the potential output as a result of an increase in AD or SRAS.

Stagflation

• Decrease in real GDP and an increase in unemployment rates simultaneously.

Neoclassical Aggregate Supply

• A market in disequilibrium will always correct naturally.
• Wages are flexible and can easily change.
• Government intervention is not needed.

Keynesian Aggregate Supply

• A market in disequilibrium may stay in disequilibrium for extended periods.
• Wages are "sticky" and do not change easily.
• During a recession, the government must increase government spending to correct the recession, even if it must borrow funds.

Monetary Policy

Monetary Policy

• The activities conducted by a central bank using the money supply and interest rates to regulate an economy.
• A type of demand-side policy, focuses on AD.

Central Bank

• A national bank of a country that controls the money supply using monetary policy manages the domestic currency.

Money Supply

• The total amount of money in circulation in an economy.

Bonds

• Loans by the government to pay for government spending.

Central Bank Functions

• Determines the money supply and interest rate
• Prints money and mints coins
• "Last Resort" lender for commercial banks
• Open market operations
  • Buying/selling bonds
• Regulates the banking system
  • Required reserve ratio

Printing Money and Minting Coins

• Control the money supply
• Replace old or illegible banknotes
• Regulate counterfeit notes by implementing security features within the notes

Changing Interest Rates

• Low interest rates can stimulate consumption and investment.
• High interest rates encourage saving.
• Commercial banks generally follow the interest rate of the central bank.

Last Resort Lender for Commercial Banks

• Can guarantee deposits if confidence is lost in the banking system and people rush to take out their money.
  • Can limit withdrawals or give loans to banks

Open Market Regulations

• Buying bonds back by the central bank increases money supply
• Selling bonds by the central bank takes money out of circulation and into the the hands of the central bank.

Regulating the Banking System

• The required reserve ratio is used to ensure that commercial banks don't take too much risk.
• The RRR is a percentage or portion of deposits that must be kept readily available in reserves.

Goals of Monetary Policy

• Low and Stable Inflation
• Long Term Growth and Stability
• Reducing Business Cycle Fluctuations
• External Balance

Creation of Money

• Commercial banks have the ability to create money through loans and credit.
  • Banks are only required to keep the reserve requirement amount.
  • The remaining amount of deposits may be loaned out.

Expansionary Monetary Policy

• Buying bonds
• Lowering reserve requirement (RRR)
• Lowering lending rates
• Quantitative easing

Contractionary Monetary Policy

• Selling bonds
• Raising the reserve requirement (RRR)
• Raising interest rates
• Quantitative tightening

Demand for Money

• The willingness and ability of firms and consumers to use money at a given interest rate.

Determinants of the Demand for Money

• Transactions Motive
  • Individuals demand money for physical goods and services.
• Precautionary Motive
  • Individuals demand money as a precaution for unexpected costs.
• Speculative Motive
  • Individuals demand money because they want to hold it due to low confidence regarding the future.

Determining Money Supply and Interest Rate

• The relationship between the quantity of money and interest rate is inverse.

Nominal Interest Rate

• The interest rate quoted by banks that does not include inflation adjustments.

Real Interest Rate

• An interest rate with inflation take into account.

Approximate Formula for Real Interest Rate

• real interest rate = nominal interest rate - inflation rate

Proper Formula for Real Interest Rate

• (1 + nominal interest rate)/(1 + inflation rate) = 1 + real interest rate
  • Formula uses decimal forms

Advantages of Monetary Policy

• Flexibility
  • Relatively quick to put in place and small changes possible allowing for specific outcomes.
• Reversible
  • Any changes with unintended consequences can be quickly reversed.
• No Political Intervention
  • As the central bank is usually an independent body, it can implement policies quicker.
• An absence of "crowding out"
  • Policies do not require the government to take on debt and thus cannot lead to crowding out.

Limitations of Monetary Policy

• Time Lags
  • Policies may be delayed, as it may take a number of months before there is a noticeable effect on demand.
• Dependent on Business and Consumer Confidence
  • When low consumer and business confidence, relatively ineffective.
• Ineffective at Low Interest Rates
  • Limited impact when interest rates are already low as interest rates cannot (normally) go below 0%.
• Conflict with other government objectives.
  • The goal of maintaining low and stable inflation might conflict with other objectives.

Fiscal Policy

Fiscal Policy

• When the government intervenes in the market using taxation or government spending.
• Demand-side policy, focuses on AD.

Budget

• The government creates a budget yearly that outlines their revenue and how they plan to spend money.

• Budget deficit = government spending > government revenue
  • Requires government to take on debt.
• Budget surplus = government spending < government revenue
• Balanced budget = government spending = government revenue

Government Revenue Resources

• Direct and Indirect Taxation
  • Income taxes and sales tax
• Sales of State-Owned Goods/Services
  • State-owned businesses or enterprises often gain revenue.
• Selling State-Owned Assets
  • Privatization: the process of transferring ownership of a firm to the private sector from the government.

Types of Taxes

• Direct taxes (progressive/proportional)
  • Income tax
  • Corporate tax
  • Wealth tax
• Indirect taxes (regressive)
  • VAT, GST, tariffs

Progressive Taxes

• Taxation where the proportion of tax paid increases as income increases.

Regressive Taxes

• Taxation where the proportion of tax paid increases as income decreases.

Proportional Taxes

• A system of taxation where tax is levied at a constant rate as income rises.

Government Spending

• Current Expenditures
  • The daily cost of keeping the government operational.
• Capital Expenditures
  • The sum of all building and infrastructure financed by the government.
• Transfer Payments
  • A singular type of payment from the government to individuals typically to redistribute income or aid citizens.

Goals of Fiscal Policy

• Low and stable inflation rate
• Low unemployment
• Promoting a stable environment for economic growth
• Reducing business cycle fluctuations
• External balance.
• Equitable Distribution of Income
  • Progressive direct taxes
  • Indirect taxes on luxury goods

Expansionary Fiscal Policy

• Increased government spending
• Reduced taxation

Contractionary Fiscal Policy

• Reduced government spending
• Increased taxation

Advantages of Fiscal Policy

• Specified Sector
  • Able to target specific sectors of an economy.
• Automatic
  • Effective in a recession
    • Automatic stabilizers
• Tangible Impact
  • Direct impact of AD.

Limitations of Fiscal Policy

• Political Pressure
  • Differing political parties have different beliefs on what is best for the economy.
• Time Lags
  • The government takes time to notice a problem, develop a policy, and then implement that policy.
  • Policies take time to be effective.
• Sustainable Debt Difficulties
  • Governments must spend money to stimulate the economy if needed.
• Crowding Out
  • When government spending on the public sector drives down the private sector spending.
• Targeted
  • It is hard to make it achieve precise outcomes.

Debt

• Debt is the total amount of money that a government owes to its creditors, both domestic and foreign.

Negative Effects of Debt

• Crowding Out
• Higher Taxation
• Difficulty Responding to Emergencies

Keynesian Multiplier

• When the government spends money, there is a far larger affect on aggregate demand than just the value of the injection itself.

Circular Flow and Government Spending

• Marginal Propensity to Save (MPS)
• Marginal Rate of Taxation (MRT)
• Marginal Propensity to Consume (MPC)
• Marginal Propensity to Import (MPM)

Keynesian Multiplier Formulas

• Multiplier = 1/(1-MPC)
• Multiplier = 1/(MPS + MPT + MPM)
• Change in GDP = Keynesian multiplier * the change in expenditure

Crowding Out

• When government spending on the public sector drives down private sector spending.

Automatic Stabilizers

• Progressive taxes
  • Higher taxation when wages are high in an expansion
  • Less taxation when wages are low in a contraction
• Unemployment benefits
  • Few unemployment benefits when there is low unemployment rate in an expansion
  • More unemployment benefits when there is high unemployment rate in a contraction

Market-Based Policies

Market- Based Policies

• Designed to increase LRAS indirectly by allowing the free-market to regulate itself through the invisible hand.
• Supply-side policy, focuses on LRAS.

Policies to Increase Competition

• Deregulation
  • Removing rules and restrictions so firms may behave freely.
• Privatization
  • This occurs when the government transfers ownership of a firm or industry to the private sector.
• Trade Liberalization
  • Removing barriers to trade with other nations to allow for free movement of imports/exports.
• Anti-Monopoly Regulation
  • Regulations that are designed to prevent one firm from dominating the market and reducing competition.
• Labor Market Policies
  • The government has a role in creating a more educated, efficient and skilled workforce.
  • The labor market should be competitive and flexible.

Policies Aimed at Creating Flexibility and Competitiveness in the Labor Market

• Reducing or removing unemployment benefits
  • Reduced if they are high enough to discourage or disincentivize qualified or skilled individuals to pursue employment.
• Removing Minimum Wages
  • Minimum wages is a type of wage floor and therefore creates inefficiency in the labor market.
• Discouraging or Minimizing the Power of Labor Unions
  • Labor unions always push for higher wages and may interfere with efficiency if workers choose to go on strike.
• Incentive-Related Policies
  • Implemented to encourage the aggregate supply with a focus on capital and labor.
    • Income tax cuts
    • Reduced unemployment benefits
• Increase in Capital
  • Incentives Given to Firms
    • Cuts to corporate tax
    • Cuts to capital gains tax

Interventionist Policies

Interventionist Policies

• Involve the government directly intervening in the economy to increase the quality or quantity of the factors of production.
• Supply-side policy, focuses on LRAS.

Education and Training

• Government spending on education is designed to improve human capital which improves the quality of workers.

Healthcare

• Access to high quality healthcare ensures that workers are healthy and able to be productive leading to increased efficiency.

Research and Development

• Direct investment for innovation and new technology.

Industrial Policies

• The targeting of development in specific industries or sectors in the economy.

Demand-Side Effects of Supply-Side Policies

Positive Demand-Side Effects

• Industrial Policies
  • AD increases through government spending and increased consumption due to creating jobs.
• Reducing Personal Income Tax
  • Cutting taxes increases disposable income for workers leading to a higher consumption.

Negative Demand-Side Effects

• Reducing Unemployment Benefits
  • Individuals that were relying on unemployment benefits now must cut back on excess or additional spending.
• Minimum Wage Reduction
  • Reducing the minimum wage results in workers receiving lower incomes and leading to a decrease in consumption.

Fiscal Policy Effects on the Supply Side

• Increase in Spending
  • Typically government spending is targeted to improve factors of production, increasing LRAS.
• Expansionary Fiscal Policy
  • Lower household taxes increases incentive to work harder and be more productive.
  • Lower corporate taxes lead to increased investment and R&D.

Effectiveness of Supply-Side Policies

Advantages of Market-Based Policies

• Improved Resource Allocation
  • Reduced interference in markets should improve resource allocation.
• No Burden on Government Budget
  • Market-based policies typically do not negatively impact the government budget.
  • Reducing transfer payments might reduce strain on budget.

Limitations of Market-Based Policies

• Equity
  • Reducing transfer payments and taxes can lead to increased inequality and inequity.
• Time Lags
• Vested Interests
  • Lobbyists have the ability to influence political decisions
• Sustainbility
  • Reducing regulations may lead to environmental damage and unsafe working conditions.

Strengths of Supply-Side Policies

• Direct Support of Sectors Important for Growth
  • Interventionist policies can target specific sectors for economic growth by providing resource and funds to aid their growth.

Limitations of Interventionist Policies

• Costs
  • Supply-side policies can be expensive.
  • Increased budget deficit and debt.
    • crowding out effect
    • debt servicing costs
  • Opportunity costs of spending
• Time Lags

Unemployment

Unemployment

• The amount of people who are willing, able and actively seeking employment, but unable to find it.

Labor Force

• The amount of people of working age (18-65) who are employed or unemployed seeking work.
• Criteria:
  • Willing to work
  • Able to work
  • Seeking employment

Unemployment Rate

• Unemployment rate = number of unemployed/total labor force * 100%

Hidden Unemployment

• Discouraged Workers
• Underemployment

Reasons for Being Considered Unemployed

• Losing their jobs
• Resigning
• Leaving school but not finding work
• Trying to return to work after having left it
• Immigrants looking for work

Reasons for Being Not Considered Unemployed

• Finding jobs
• Retiring
• Going back into education
• Choosing to stay at home to look after children
• Emigrating to another country
• Giving up on looking for a job
• Passing away

Difficulties in Measuring Unemployment

• Definitions
  • Some countries use different definitions for unemployment or lack quality in their data
• Underemployment
  • Workers that have part-time jobs and want to work full-time and/or highly-skilled qualifications and not working on the level are not fully utilizing their potential efficiency.
• Discouraged Workers
  • Workers that have stopped looking for employment but would like to work.
• Issues with Race, Age, Different Regions and Gender Information
  • Race, age and gender gaps in unemployment are typically not calculated.
• Informal Jobs
  • People employed as unregistered workers or illegal jobs.

Natural Rate of Unemployment

• The rate of unemployment when there is full employment.
• The percentage of people structurally, frictionally and seasonally unemployed.

Economic Costs of Unemployment

• Loss of GDP
• Loss of tax revenue
• Increased unemployment benefit cost
• Loss of income for individuals
• Greater income inequality

Personal Costs of Unemployment

• Increased debt
• Increased stress, anxiety and depression
• Social Costs
• Increased crime rate
• Loss of access to healthcare

Types of Unemployment

• Cyclical Unemployment
• Frictional Unemployment
• Seasonal Unemployment
• Structural Unemployment

Cyclical Unemployment

• Unemployment occurs due to a recession or a reduction in aggregate demand.
  • Assuming that the demand for labor correlates with the aggregate demand.
• Occurs in recessions due to sticky wages.

Reasons for Sticky Wages

• Avoiding discontent and unmotivated workers
• Contracts and union power

Frictional Unemployment

• Transitional unemployment as people are switching between occupations.

Seasonal Unemployment

• Occurs when specific jobs are only offered periodically during certain times in the year.

Structural Unemployment

• Occurs when there is a change in demand for particular skills in the labor market.
  • Such as technological changes, geographical changes (globalization), changes in consumer taste, or changes in patterns of demand for particular skills.

Solutions to Cyclical Unemployment

• The government needs to increase AD to combat the recession.

Solutions to Frictional Unemployment

• Improving the flow of information and reducing benefits.

Solutions to Seasonal Unemployment

• The economy needs to implement policies aimed at increasing education and flexibility in the labor market and reduced benefits.

Solutions to Structural Unemployment

• Increasing education (supply side interventionist policy)
• And flexibility in the labor market like:
  • lower unemployment benefits
  • no regulations around and hiring and firing (supply side marked-based)
• Interventionist approaches lead to opportunity costs.
• Market-based approaches lead to inequity.

Solutions to General Unemployment

• An effective welfare system allows those who are unemployed to stay out of poverty and find new employment.

Inflation and Deflation

Inflation

• The sustained increase in the average price level.

Disinflation

• The average price level is continuing to rise but at a slower rate.

Causes of Inflation

• Cost-Push
  • Inflation as a result of an increase in the costs of production in the economy, such as an increase in the price of raw materials, imports or labor.
• Demand-Pull
  • Inflation as a result of an increase in AD.
• Money Supply
  • If there is too much money in circulation, spending is increased, resulting in an increase in AD and therefore inflation.

Inflationary Spiral

• Demand-pull inflation and cost-push inflation combined can cause an inflationary spiral.
  • Higher prices lead to demand for higher wages which leads to higher production costs, further driving prices higher.
• An inflationary spiral can lead to hyperinflation.

Costs of High Inflation Rate

• Uncertainty
  • Lack of confidence leads to businesses and consumers being careful, reducing their consumption and investment.
  • Leads to over-consumption if expected future prices are higher.
• Redistributive Effects
  • Low income households are affected more than higher income households, leading to inequity.
• Saving Effects
  • If the inflation rate is greater than an interest rate, you are better off not saving money.
• Decrease in Economic Growth
  • A decrease in purchasing power and uncertainty leads suppliers and consumers to reduce economic activity.
• Damage to Exports
  • Inflation makes domestic goods more expensive for trading partners

Solutions to Inflation

• Contractionary demand-side policies.
  • Fiscal
    • Increasing taxation
    • Reducing government spending
  • Monetary
    • Raise interest rates
    • Reduce money supply

Deflation

• A sustained decrease in the average price level.
• A negative inflation rate.

Good Deflation

• LRAS curve shifts to the right, there is a reducing in price level but also economic growth.
• Leads to increased purchasing power for those with less income.

Bad Deflation

• Occurs when AD falls.
• Reduced GDP.

Costs of Deflation

• Uncertainty
  • Lack of confidence leads to businesses and consumers being careful.
• Deferred Consumption
  • Consumers defer to spend money as their money is gaining value.
• Cyclical Unemployment
  • Deflation typically indicates falling economic output, meaning firms may have to lay-off workers.
• Increase in Real Value of Debt
  • Size of real debt grows as money gains in purchasing power.
• Re-Distributive Effects
  • Winners: fixed income earners and lenders (banks).
    • The money earned from interest payments or from fixed incomes has far more purchasing power.
  • Losers: borrowers and providers of fixed incomes (e.g. government).
    • Borrowers have to pay higher interest and fixed income providers have to pay more for income as deflation increases the purchasing power of these fixed amounts.
• Policy Ineffectiveness
  • Even with the use of expansionary monetary and fiscal policies, it will be difficult to convince firms and consumers to borrow money.

Consumer Price Index (CPI)

• The average price of goods and services that consumers typically buy expressed as an index.
• These goods and services are called the "market basket".

Price Index

• Given as a number 100 + x (unless there is deflation, where it is 100 -x).
• Always compared with a chosen base year, with index = 100.

Inflation Rate

• The percentage change in prices from year to year.
  • Always compared to the previous year.
• Inflation rate = market basket of current year/market basket of previous year * 100%

Calculating CPI

• The total market basket is the sum of all the prices for each year of every good in the market basket.
• CPI = price of market basket (current year)/price of market basket (base year) * 100

CPI Weighted Index

• Certain product categories can be weighted, to have a greater affect on the market basket.

Phillips Curve

• Suggests an inverse relationship between unemployment and inflation.
• Not true in the long run

Growth and Debt

Positive Consequences of Economic Growth

• Increasing incomes leading to improved living standards.
• Advancements in technology and infrastructure.
• Higher tax revenues, more government spending projects.
  • Reduction of income inequalities
• Better education and greater demand for freedom and democracy.
• Needed to support a growing population.

Negative Consequences of Economic Growth

• Sacrificing leisure time and personal relationships due to overworking.
• Preoccupation with material wants.
• Structural change in economy from agriculture to industry and services leading to structural unemployment.

Budget Deficit

• government spending > government revenue
• Government needs to take on debt.

Budget Surplus

• government spending < government revenue
• Surplus can be used to pay off debts.

Government Debt

• The accumulation of government budget deficits.

Debt to GDP Ratio

• To measure the sustainability of government debt, the debt-to-GDP ratio is used.
  • Debt-to-GDP ratio = Debt/GDP
  • A recommended Debt to GDP ratio is 0.6, or 60%.

Costs of High Government Debt

• Interest Rates
  • Debt-servicing is the repayment of principal/interest on debt owed.
• Credit Ratings
  • The rating represents an assessment of how likely a government is able to repay its debt.
    • Countries with low credit ratings are unlikely to be given loans.
• Impact on Future Government Spending
  • Paying back debts uses up government budget.

Factors Indicating the Sustainability of Debt

• Political stability
• Composition of debt: loan duration, loan provider
• Vulnerability of economy: level of development, dominant sector (primary, secondary, tertiary, quaternary)

Inequality

Equality

• Situations where economics are the same for all.

Equity

• Everyone is given fair and equal opportunities for success.

Economic Inequality

• Unequal distribution of wealth, assets, or incomes in society.

Social Mobility

• The ability of people to climb or fall within the economic sectors of society.

Most Notable Types of Economic Inequality

• Unequal Income Distribution
• Unequal Wealth Distribution

Income

• Income is the monthly earnings in a households.
  • Interests on savings
  • Rental income
  • Salary
  • Business profits
  • Dividend on investments

Wealth

• The value of the person's total assets minus their total liabilities.
  • Liabilities = debt like mortgages, students loans, car loans, and credit card debts.

Assets

• Tangible Assets
  • Property
  • Housing
• Non-Tangible Assets
  • Investments in stocks and bonds

Solutions to Economic Inequality

• Universal Basic Income
• Increase in Progressive Income Tax

Universal Basic Income

• Universal transfer payment to every citizen to raise income levels.
  • These funds are much more valuable to the poor as it takes them out of poverty.

Advantages of Universal Basic Income

• Reduces need for other transfer payments, saving time and money.
• Eliminates poverty completely
• Redistributive policy as it benefits those with lower incomes more.
• Encourages spending
• Less uncertainty due to having guaranteed income

Limitations of Universal Basic Income

• Very expensive
• UBI given to the rich might be considered as "wasted"
• Requires to be implemented on a very wide scale, together with other redistributive policies like high progressive taxation.
  • This can make it difficult and slow to implement.

Solutions to Unequal Wealth Distribution

• Wealth taxes
  • Property tax
  • Inheritance tax
• Philanthropy

Gini Coefficient

• The measure of the distribution of income within an economy.
• A higher Gini coefficient means that there is more unequal the income distribution.

Poverty

Absolute Poverty

• Absolute poverty is where people earn below internationally defined levels of income.
  • Usually defined as $3 a day or less.

Relative Poverty

• The income is lower than the average level of income in that economy.

Working Poverty

• Being in poverty despite being employed.

Causes of Poverty and Economic Inequality

• Inequality of Opportunity
  • People in the same society don't have access to the same opportunities.
• Resource Ownership
  • Wealth inherited in the form of stocks, companies or property gives some greater advantages compared to low-income citizens.
• Different Levels of Human Capital
  • State sectors often struggle to ensure a high quality of education leading to low levels of human capital in a society.
• Discrimination
  • Discrimination through hiring practices and payment for services often leads to certain groups being proportionately disadvantaged.
• Unequal Status and Power
  • Can lead to discrimination or unequal legal representation.
• Government Taxation and Benefits
  • Certain policies favor individuals with high wealth and income.
• Globalization and Technological Change
  • With increasing globalization and changes in technology, certain countries are left behind without desirable training or skills leading to increases in unemployment.
• Market-Based Policies
  • These policies aim to increase LRAS by increasing competition, labor reform, and increasing incentives.
    • Reduced minimum wages
    • Reduced unemployment benefits
    • Deregulation leading to less protection of workers
    • Reducing power of labor unions leading to leading to less protection of workers
    • Tax/business cuts increasing inequality

Impact of Income and Wealth Inequality

• Reduced economic growth due to lower consumption and productivity
• Reduced standards of living
• Reduced social stability

The Role of Governments to Reduce Poverty, Income Inequality and Wealth Inequality

• Indirect Taxes
  • Luxury taxes
  • Reduced VAT on necessity goods
• Direct Taxes
  • Progressive Personal Income Taxes
  • Wealth Taxes
  • Corporate Taxes
    • Could drive out firms or lead to tax evasion.

• Reducing Inequality of Human Capital
  • Interventionist policies: providing education, training programs and healthcare
• Funding Schools in Low-Income Areas
  • Scholarships, grants, loans or free university.
• Transfer Payments
  • Universal Basic Income
  • Means-Tested Payments
    • Pensions
    • Unemployment Benefits
    • Child Allowances
• Targeted Spending
  • Spending on education, health care and infrastructure in low-income communities.
• Policies to Reduce Discrimination
• Minimum Wages

Advantages of Minimum Wage

• Avoids working poverty
• Incentive to find work
• Higher motivation and productivity
• Increased consumption by lower-income households
• Allows low-income households to provide better opportunities for their children and escape the poverty trap
• Reduce inequality

Limitations of Minimum Wage

• Higher production costs for firms, making them less willing to hire
• Encourages firms to replace human labor with machines
• Higher prices due to higher production costs

Single Indicators for Measuring Poverty

• Single indicators use only 1 factor to measure poverty.

Examples of Single Indicators

• International Poverty Line (Absolute poverty)
• Birth Rates
• Primary Sector Dependency
• Large Informal Economy
• Minimum Income Standards

Composite Indicators for Measuring Poverty

• Compute multiple single indicators to form an accurate measure of the multi-dimensional concepts.

Examples of Composite Indicators

• Human Development Index (HDI)
• Multidimensional Poverty Index (MPI)

Challenges in Measuring Poverty

• Imperfect Data
  • Surveying is difficult especially in countries where resources are stretched.
• Difficult to Define Poverty
  • Absolute poverty, relative poverty, acute poverty, income poverty, multidimensional poverty.
• Minimum Income Standards
  • Each country typically has its own poverty line which can be used to determine the number of people in poverty.
• Political Motives
  • Countries can have political motives to make poverty statistics look better.
• Intra-Household Poverty
  • By measuring poverty on a h​ousehold basis, individual poverty is not included.

Global Economy

Free Trade

Free Trade

• No barriers to trade between countries.
• Considered to be the most allocatively efficient system.

Benefits of Free International Trade

• Increased Competition
  • International trade allows for firms in other countries to compete with one another, leading to increased competition and higher quality.
• Lower Prices
  • Countries are able to specialize and use economies of scale to decrease their costs of production and sell their products at a lower price.
• Greater Choice
  • Free trade enables domestic consumers to have a greater choice as they are able to select goods and services domestically and internationally.
• Acquisition of Resources
  • Each country has access to specific natural resources.
  • Free trade allows for countries to sell their resources for production in other countries.
• Foreign Exchange Earnings
  • Foreign exchange earnings refer to financial gains made by currencies exchanging on the global market.
• Access to Larger Markets
  • Individual firms would have access to a global market instead of being limited to their domestic market.
  • Free trade allows companies to become multi-national and gain more consumers.
• Economies of Scale
  • Larger markets allow firms to gain larger revenue.
  • Firms have the option to invest that revenue into increasing efficiency and lowering costs.
• More Efficient Resource Allocation
  • Free trade allows countries to allocate their resources more efficiently.
  • This is because free trade allows countries to specialize in the areas they are best at.

Trade Protectionism

• The government applies various policies to protect local firms from competition with international firms.

Types of Trade Protection

• Tariff
  • A tax placed on imported goods.
• Quota
  • A physical limit on the number of value of goods that are allowed to be imported
• Subsidy
  • Money is given to domestic producers to increase competition and reduce domestic price
• Administrative Barriers
  • Health standards, paperwork, "red tape" and embargoes.
  • Becomes qualitatively more difficult to import goods into a country.

Tariff Effectiveness

• Goods with Elastic Demand
  • Any tariff on a good with elastic demand generates large change in quantity demanded and encourages consumers to switch to domestic producers.
• Goods with Inelastic Demand
  • Due to lack of available substitutes from domestic producers, tariffs on inelastic goods are not effective.

Winners of a Tariff

• Protected Firms
  • Face reduced competition and increased sales
• Government
  • Revenue from the tariff

Losers of a Tariff

• Consumers
  • Higher prices and reduced choice
• Society
  • Deadweight welfare loss

Types of Administrative Barriers

• Product Standards
• Health and safety regulations
• Voluntary Export Restraint Agreement
  • Agreement between two countries to limit the amount of exports/imports.
• "Buy National" Policies
  • A marketing campaign to encourage domestic consumers to support local, domestic firms.

Arguments in Favor of Protectionism

• Protection of infant (sunrise) industries
  • Important for developing countries so their industries can be built up.
• National security
  • Protecting strategic industries, such as steel production or military.
• Health and safety
  • Protecting industries so that they meet health and safety standards which might not be met by imported goods.
• Environmental standards
  • Protecting certain industries so that they meet required environmental standards.
• Anti-dumping
  • Dumping is selling below cost price, which can be harmful for an economy.
• Unfair competition
  • Protectionism such as tariffs can be used to create fair competition between local goods and imported goods which might have benefits such as lots of subsidies.
• Balance of payments correction
  • Protectionism can be used to balance inflow and outflow so that an economy's currency is more stable.
• Government revenue
  • Tariffs are a great way to collect government revenue, especially for lower-income economies.
• Protection of jobs
  • Free trade can lead to unemployment in certain industries that get outcompeted.
• Economically least developed country (ELDC) diversification
  • To diversify industries, lower developed countries might use protectionism to protect growing industries.

Arguments Against Protectionism

• Misallocation of resources
  • Consumers demand greater quantities of goods at lower prices.
  • Foreign importers can typically offer those goods at lower prices compared to domestic producers but protectionist policies prevent the allocation of resources.
• Retaliation
  • When one country imposes tariffs or quotas, the trading partner may retaliate causing a trade war.
    • Trade wars often lead to higher prices for both parties, an increase in production costs and potentially unemployment.
• Increased costs
  • When raw materials have a tariff or quota imposed on them, the cost of production increases.
• Higher prices
  • Consumers must pay a higher price for a good than they should compared to free trade.
    • This is due to increased costs of production.
• Less choice
  • Protectionism limits imports and choices for domestic consumers.
  • These policies limit the variety of goods available as there are less options brought on by trade.
• Less incentive for domestic producers to improve
  • Protectionist policies limit competition from international competition and provides no incentive for domestic producers to improve efficiency, quality, or engage in research and development.
• Reduced export competitiveness
  • As your country's producers pay more for imported materials, domestic producers must charge higher prices to cover increased costs.
  • This increase in price leads to a less competitive market for exports.

Comparative Advantage

• While some countries might have absolute advantages in producing both of two goods, some countries might have a comparative advantage as they have to sacrifice less of one good to produce more of the other.

Limitations of Comparative Advantage

• Only 2 goods and 2 countries producing
  • Simplified and unrealistic
• Assumption of homogenous goods
  • In reality there might be a difference in quality
• Assumption of free trade
• Assumption that factors of production stay in the country
• Assumption of full employment
• Assumption of perfect information
• Assumption that technology is fixed
• No calculation of the cost of transportation between countries

Economic Integration

• Involves agreements between two or more countries to phase out or eliminate trade barriers between them.

World Trade Organization

• An international body that sets the rules for global trading and resolves disputes between its member countries.
  • Hosts trading negotiations.
  • Archive for trade agreements.

Stages of Economic Integration

1. Preferential Trade Agreements
2. Free Trade Area
3. Customs Union
4. Common Markets
5. Monetary Union
6. Complete Economic Integration

Preferential Trade Agreements (PTA)

• Where a country agrees to give preferential access for certain products to one or more trading partners.

Types of PTA

• Unilateral
  • A country provides preferential trading policies for another without receiving the same treatment in return.
• Bilateral
  • An agreement between two countries to phase out or eliminate trade-related barriers.
• Multilateral
  • An agreement between many countries to lower tariffs or other protectionist measures.
• Regional Trade Agreements (RTA)
  • Regional trade agreements are between a group of countries usually within a geographical region to lower or eliminate trading barriers.

Trading Blocs

• A trading bloc is a group of countries that have agreed to reduce protectionist measures like tariffs and quotas between them.

Free Trade Area (FTA)

• An agreement between two or more countries to phase-out or eliminate trade barriers between them.
• Members of the agreement are free to maintain their own trading policies towards non-members.

Customs Union

• An agreement between countries to phase out or eliminate tariffs and other trade barriers and establish a common external barriers towards non-members.

Common Markets

• When a group of countries agree not only to free trade of goods and services but also to the free movement of capital and labor.

Monetary Union

• When two or more countries share the same currency and have a common central bank.

Complete Economic Integration

• Members would have no control of economic policy, full monetary union, and complete harmonization of fiscal policy.

Advantages of Trading Blocs

• Trade Creation
• Greater access to markets offers potential for economies of scale.
• Free movement of labor.
  • There are more opportunities for individuals in member countries.
• Membership in a trading bloc may allow for stronger bargaining power in multilateral negotiations.
• A world made up of large trading blocs has far easier negotiations.
  • This is because many members have common interests so its easier to satisfy the majority.
• Greater political stability and cooperation would prevent disagreements and wars.

Disadvantages of Trading Blocs

• Trade Diversion
• Loss of sovereignty
  • Countries must give up the idea of being fully independent and autonomous.
• Challenge to multilateral trading negotiation.
  • Countries may have social, political, historical and economic differences that make the development of trading blocs difficult.

Advantages of Membership of a Monetary Union

• No more exchange-rate fluctuations between countries.
  • As all countries in a monetary union use the same currency, there is no exchange-rate fluctuation.
  • This leads to a reduction in uncertainty and an increase in cross-border investment and trade.
• Monetary union currencies are more stable against speculation.
  • Monetary union currencies, such as the euro, have the enhanced credibility of being used in a large currency zone.
• Business confidence tends to improve.
  • There is less of a perceived risk involving trading among member countries.
    • Increased trade and reduced uncertainty leads to internal growth and trade growth.
• Transaction costs are eliminated within the monetary union.
  • There is no transaction fee as countries have the same currency.
• A common currency makes price difference more obvious between countries.
  • Over time this should lead to prices equalizing over borders.
  • There is a much smaller price difference in goods between EU members than between non-EU members.

Disadvantages of Membership of a Monetary Union

• Interest rates are no longer decided by individual countries.
  • As all monetary union members share a common central bank, they no longer decide their own interest rate.
  • Thus it can no longer be used as a monetary policy tool to influence inflation, unemployment rate and economic growth rate.
  • This issue is most prominent if one member country is experiencing issues not experienced by other countries.
    • Issues experienced by many members are addressed by the central bank.
• Without fiscal integration, a monetary union might be weak.
  • Without a common treasury, harmonized tax rates and a common budget, fiscally irresponsible countries might threaten the stability of the union.
• Individual countries are not able to adjust exchange rates to affect international competitiveness.
• The initial costs of converting the individual currency to the common currency are very large.
  • They include the costs of taking back old currencies, printing and distributing new currencies, converting databases and software, re-pricing goods and services and recalibrating machinery that uses coins and notes (such as ATMs).

International Labor Organization (ILO)

• Aims to provide equal opportunities for safe and fair-pay labor to all women and men around the world.
• Decide on policies by working together with labor unions, employers and governments.

World Trade Organization (WTO)

• An international body that sets the rules for global trading and resolves disputes between its member countries.
• Hosts negotiations.

WTO Functions

• Administering and archiving WTO trade agreements
• Forum for trade negotiations
• Handling trade disputes
• Monitoring trading policies
• Technical assistance and training for developing economies
• Cooperation with other international organizations

WTO Principles

• Non-discrimination
• Openness of trade: lowering all trade barriers among nations
• Predictability and transparency
  • Prevents unexpected rising of trade barriers.
• Promotion of fair competition
  • This principle attempts to assess the fairness of trade transactions and responses.
• Privileging less developed countries
  • More time to adhere, flexibility and other special privileges
  • This is aimed at improving equity between more developed countries and lesser developed countries who don't have the resources to participate effectively all the time.
• Protecting the environment, sustainability

Unequal Bargaining Power

• More developed countries (MDCs) are able to send highly-trained delegates and representatives o the WTO regularly, leading to them potentially receiving preferential treatment.
• World trade leaders like the EU, USA and China have significantly more power when negotiating due to their influence and impact.

Disputes over Primary Products

• Developed countries offer large subsidies in agriculture, driving down price while developing countries lack subsidies and cannot compete in the international agricultural market.
• MDCS prefer raw materials due to the greater margin of processing and manufacturing.

Trade Creation

• When higher-cost imports are replaced by lower-cost imports due to the formation of a trading bloc or trade agreement.

Trade Diversion

• When lower-cost imports are replaced by higher-cost imports due to the formation of a trading bloc or trade agreement.

Exchange Rates

Exchange Rate

• The value of one currency expressed in terms of another currency

Exchange Rate Regimes

• Fixed exchange rate
• Floating exchange rate
• Managed exchange rate

Foreign Exchange Market (FOREX)

• Marketplace for exchanging currencies around the globe.
  • When one country demands more of a currency, they must supply their own in the Forex market.

Influences to the Demand and Supply of a Currency

• Foreign demand for exports
• Domestic demand for imports
• Inward/outward foreign direct investment (FDI)
• Inward/outward portfolio investment (bonds, shares)
• Remittances (transfer of money from abroad)
• Speculation
• Relative inflation rates
  • When inflation rates lower in one country it makes their products more attractive (not as expensive)
• Relative interest rates
• Relative growth rates
• Central bank intervention

Floating Exchange Rate

• An exchange rate system where the exchange rate is determined solely by the market demand and market supply of the currency in the foreign exchange market without any central bank intervention.

Appreciation

• When the price of a currency increases in a floating exchange rate system.

Depreciation

• A decrease in the value of a currency in terms of another currency in a floating or managed exchange rate system.

Fixed Exchange Rates

• An exchange rate system where the exchange rate is fixed, or pegged, to the value of another currency (or to the average value of a selection of currencies or some other commodity such as gold) and maintained there with appropriate central bank intervention.

Revaluation

• Revaluation is an increase in the value of a currency in a fixed exchange rate system.

Devaluation

• Devaluation is a decrease in the value of a currency in a fixed exchange rate system.

Foreign Reserve Assets

• Stores of foreign currencies or other assets such as deposits, bonds or commodities like gold.

Fixed Exchange Rate Intervention Methods

• Using their reserves of foreign currencies to buy or sell foreign currencies.
  • Buy currency to increase demand.
  • Sell currency to increase supply.
• By changing interest rates.
  • Increased interest rate increases the demand for a currency as people want to save in that currency.
  • Decreased interest rate decreases demand for that currency.
  • Might interfere with monetary policy.

Managed Exchange Rate

• An exchange rate that floats in the foreign exchange markets but is subject to intervention from time to time by domestic monetary authorities, to prevent undesirable movements in the exchange rate.
• Generally an upper and lower limit are set.
  • Within the limits there is no intervention.
  • These limits aren't publicized to prevent speculation.

Advantages of Fixed Exchange Rate Regimes

• Economic stability
• Ease of policy and legislation as the exchange rate doesn't change
• Reduced speculation in the FOREX market.

Limitations of Fixed Exchange Rate Regimes

• Difficult and time consuming to adjust
• Might interfere with monetary policy and other policies with different goals.
• Requirement of currency reserves to reset the exchange rate.
• Setting the level of a fixed exchange rate system is complex.
• An exchange at an artificially low level may create international disagreement.

Advantages of Floating Exchange Rate Regimes

• Easily adjustable (automatic)
• No need to use interest levels and that tool can be kept for monetary policy
• No requirement of currency reserves

Limitations of Floating Exchange Rate Regimes

• Susceptible to speculation and large exchange rate swings (uncertainty).
• Might create even more inflation when there is a case of inflation in an economy.
  • Inflation leads to less exports, which causes a weaker currency, which leads to more expensive imports, leading to further inflation.
• Complex how currency value changes and they do not necessarily self-adjust.

Advantages of a High Exchange Rate

• Downward pressure on inflation
  • Due to reduced production and final product costs thanks to cheaper imports.
• More imports can be bought 
• A high value of a currency forces domestic producers to improve their efficiency otherwise their products will be too expensive for foreign countries (international competitiveness)

Disadvantages of a High Exchange Rate

• A high exchange rate may cause increased imports as foreign goods are now cheaper in comparison.
  • As AD is defined as C+I+G+(X-M), if imports, M, increases, then AD will decrease.
  • If AD decreases then there will be unemployment.
• Damage to export industries (difficult to compete)
• Damage to domestic industries (imports relatively inexpensive, difficult to compete)
• Living standards
  • Countries overly reliant on tourism or trade can experience significant impacts on standards of living due to damage to the economy.
  • Unemployment caused by increased imports can also reduce living standards.

Advantages of a Low Exchange Rate

• Greater employment in export industries, products are relatively inexpensive.
• Greater employment domestically,
  • In import industries, imports are more expensive than they were.
• This may encourage domestic consumers to buy domestically produced goods.

Disadvantages of a High Exchange Rate

• Upward pressure on inflation.
• A low value of the currency will make imported final goods and services, imported raw materials and imported components more expensive.
  • This increases production costs, which reduces AS, causing an increased average price level.
• More difficult to pay back government debt.
  • Government loans will be more difficult to pay for as they are often in US dollars, which will be more valuable compared to the domestic currency if it has a low exchange rate.

Balance of Payments

Balance of Payments (BOP)

• A record of the value of all transactions of a country with the rest of the world over a period of time.
• Keeps track of a country's money inflow and outflow.

Debit

• Money flowing out

Credit

• Money flowing in

Main Components of BOP

• BOP = Current account + (Capital account + Financial account) = 0

Current Account Balance

• Current account balance = Balance of trade in goods + Balance of trade in services + Net income flows + Net transfers

Components of Current Account

• Balance of Trade in Goods
• Balance of Trade in Services
• Income
• Current Transfers

Balance of Trade in Goods

• Revenue received from exports of tangible goods minus expenditure on imports of tangible goods over a given period of time.

Balance of Trade in Services

• Revenue received from exports of services minus the expenditure on the imports of services over a given period of time.
• Includes:
  • Banking
  • Insurance
  • Tourism

Balance of Trade in Income

• Net monetary movement of profit, interest and dividends moving into and out of the country over a given period of time.
• Includes:
  • Foreign branches of domestic firms that earn profits.
  • Profits and interest from investment in foreign banks or financial institutions.
  • Dividends from investments into foreign companies.

Current Transfers

• Net unilateral transfers from abroad.
• Includes:
  • Foreign aid and grants
  • Remittances
  • Private gifts

Current Account Deficit

• Net exports of goods and services + net income + net current transfers < 0
  • Generally means that imports > exports

Current Account Surplus

• Net exports of goods and services + net income + net current transfers > 0
  • Generally means that exports < imports

Components of Capital Account

• Capital Transfers
• Transaction in non-production, non-financial assets

Capital Transfers

• Net monetary movements gained or lost through actions such as transfers of goods and financial assets by migrants, debt forgiveness, etc.
• Includes:
  • The transfers of goods and financial assets of migrants entering or leaving the country
  • Debt forgiveness
  • Transfer relating to the sale of fixed assets (tangible assets that firms own and use in production that have a useful life of at least one year )
  • Gift taxes
  • Inheritance taxes.

Transaction in non-production, non-financial assets

• Net international sales and purchases of non-produced assets.
• Includes:
  • Land
  • Rights to natural resources and intangible assets like patents
  • Copyrights
  • Brand names or franchises

Financial Account

• Measures the net change in foreign ownership of domestic financial assets.

Components of Financial Account

• Direct Investment
• Portfolio Investment
• Reserve Assets

(Foreign) Direct Investment

• The purchase of long-term assets with the aim of gaining a lasting interest in a company or economy.
• Includes:
  • Purchasing of stocks or shares
  • Buying of property
  • Purchase of a business

Portfolio Investment

• Short-term investments into foreign companies or economies.
• Includes:
  • Buying and selling of stocks with short-term profits in mind
  • Buying and selling of treasury bills and government bonds

Reserve Assets

• The net flows of foreign currencies and commodities held by central banks in reserve.

Current Account and Exchange Rate

• Current account deficits and surpluses are automatically adjusted under a floating exchange rate system.
  • CA surplus leads to appreciation.
  • CA deficit leads to depreciation.

Financial Account and Exchange Rate

• Uncertainty and interest rates affect FA flows.
  • FA surplus results in appreciation.
  • FA deficit results in depreciation.

Consequences of a Persistent Current Account Deficit

• Downward pressure on currency exchange rate
• Increases interest rates
• Increased foreign ownership of domestic assets
• Indebtedness caused by persistent negative net exports.
• Credit ratings reduced if the country fails to service its financial account debt.
• Demand side policies are difficult to use due to needing to consider CA deficit.
• Economic growth is slowed down due to reduced domestic production.

Methods to Correct a Persistent Current Account Deficit

• Expenditure switching
  • Switching consumption from imports to domestic goods by the use of protectionist measures.
• Supply-side policies
  • Increase competitiveness of domestic producers

Effectiveness of Expenditure Switching

• Ineffective against goods with price inelastic demand.

Effectiveness of Supply-Side Policies to Correct a CA Deficit

• Solves the issue of why there are more imports than exports by improving the quality and quantity of factors of production.
• Opportunity costs of interventionist policies.
• Inequity caused by market-based policies.

Consequences of a Persistent Current Account Surplus

• Difficult to maintain due to fluctuating domestic consumption and investment
• Upward pressure on currency exchange rates
• Inflation due to increased AD
• Increasing exports causes increased AD, increasing employment
• Exports become less competitive

Marshal-Lerner Condition

• A condition stating that depreciation or devaluation of a currency will lead to an improvement in the current account balance if the sum of the price elasticity of demand for exports plus the price elasticity of demand for imports is greater than one.
  • PED for exports + PED for imports > 1

The J-Curve Effect

• Following devaluation or a sharp depreciation, a trade deficit will typically widen before it starts improving.
• Occurs because Marshall-Lerner condition takes time to be satisfied.

Sustainable Development

Economic Development

• A multidimensional concept involving a sustained increase in living standards that implies higher levels of income and thus greater access to goods and services, better education and health, a better environment to live in as well as individual empowerment.

Classical vs New Economic Development

• Development was formerly measured traditionally using real GDP with the understanding that increases in income lead to development.
  • Our current understanding of economic development is more encompassing.

Sustainable Development

• Refers to the degree to which the current generation is able to meet its needs today but still conserve resources for the sake of future generations.

UN Sustainable Development Goals (SDGs)

• No Poverty
  • End poverty in all its forms everywhere.
• Zero Hunger
  • End hunger, achieve food security and improved nutrition and promote sustainable agriculture.
• Good Health and Well-Being
  • Ensure healthy lives and promote well being for all at all ages.
• Quality Education
  • Ensure inclusive and equitable equality education and promote lifelong learning opportunities for all.
• Gender Equality
  • Achieve gender equality and empower all women and girls.
• Clean Water and Sanitation
  • Ensure availability and sustainable management of water and sanitation for all.
• Affordable and Clean Energy
  • Ensure access to affordable, reliable, sustainable and modern energy for all.
• Decent Work and Economic Growth
  • Promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all.
• Industry, Innovation and Infrastructure
  • Build resilient infrastructure, promote inclusive and sustainable industrialization and foster innovation.
• Reduced Inequalities
  • Reduce inequality within and among countries.
• Sustainable Cities and Communities
  • Make cities and settlements inclusive, safe, resilient and sustainable.
• Responsible Consumption and Production
  • Ensure sustainable consumption and production patterns.
• Climate Action
  • Take urgent action to combat climate change and its impacts.
• Life Below Water
  • Conserve and sustainably use the oceans, seas and marine resources for sustainable development.
• Life on Land
  • Protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification and halt and reverse land degradation and halt biodiversity loss.
• Peace, Justice and Strong Institutions
  • Promote peaceful and inclusive societies for sustainable development , provide access to justice for all and build effective, accountable and inclusive institutions at all levels.
• Partnership for the Goals
  • Strengthen the means of implementation and revitalize the global partnership for sustainable development.

Poverty and Sustainability

• Poverty creates an unsustainable relationship between people and natural resources.
  • Typical unsustainable practices are:
    • Deforestation
    • Overhunting
    • Land degradation
    • Pollution.
• Those in poverty prioritize their livelihoods over living sustainably.

Indicators

• An indicator is a certain measured characteristic.

Single Indicators for Measuring Economic Development

• A single indicator is the measure of a single characteristic of development.

Examples of Single Indicators for Measuring Economic Development

• Income
  • GDP/GNI per capita at purchasing power parity (PPP)
  • Absolute and relative poverty headcounts
• Health and education
  • Life expectancy at birth
  • Infant mortality rate
  • Average years of schooling
  • Expected years of schooling
    • Typically until a specific age, such as until 12 or 17 years old for example.
  • Adult literacy rate
• Economic or social inequality indicators
  • Income inequality
    • Most commonly using the Gini coefficient
  • Access to resources by social group
  • Gender ratio for average years of schooling
  • Gender representation in the government
• Energy indicators
  • Source of energy
    • The proportion of energy that comes from renewable sources such as hydropower, solar or wind compared to the energy that comes from non-renewable sources such as coal or gas.
  • Renewable energy usage
  • Energy consumption per capita
• Environmental indicators
  • Carbon footprint
  • Ecological footprint

Composite Indicators for Measuring Economic Development

• The measure of multiple characteristics of development.

Examples of Composite Indicators for Measuring Economic Development

• Human Development Index (HDI)
  • GDP per capita - economic well-being
  • Life expectancy - healthcare
  • Average and expected years of schooling - education
• Gender inequality index (GII)
  • Reproductive health
    • Infant mortality, adolescent birth rate
  • Empowerment
    • Government seats, gender ratio in education
  • Economic status
    • Labor force participation gender ratio
• Inequality-adjusted human development index (IHDI)
  • Similar to HDI, but taking into to account the inequalities for life span at birth, education and income.
• Happy planet index (HPI)
  • Divides the components of the HDI by the country's ecological footprint to determine its sustainability.

Advantages of Using Indicators to Measure Development

• Provides data over time to analyze progress and act as a point of comparison.
• Data can determine which specific sectors of development are in urgent need of improvement.
• Data can guide government policy and determine the effectiveness of legislation.

Limitations of Using Indicators to Measure Development

• Indicators presented as an average are flawed by hiding extreme conditions.
• Gathering data is difficult financially and logistically.
• Informal economic activity is hidden, and not easily shown by indicators.
• Cannot capture the complexity of development.

Barriers to Economic Growth and Development

• Poverty traps, or poverty cycles, are a series of events that lead into each other, that make it increasingly difficult for people born into poverty to break out of poverty.

Economic Barriers

• Infrastructure
• Appropriate Technology
• Low Human Capital
• Dependency on Primary Sector
• Lack of Access to International Markets
• Existence of an Informal Economy
• Capital Flight
• Indebtedness

Infrastructure

• Infrastructure is the physical capital in an economy that is often provided by governments.

Importance of Infrastructure in Development and Growth

• Facilitates economic activity
• Ensures protection of citizens
• Poor infrastructure leads to poor supply chains, leading to increased costs of production.
• Includes systems important for well-being of citizens.

Appropriate Technology

• Technology that relies mostly on the relatively abundant factor an economy is endowed with.
  • Typically labor-intensive, requires little capital, small-scale, environmentally friendly, locally made, and affordable.
• Difficult to export and contributes little to economic growth.

Human Capital

• Human capital is the education, training, skills, experience and good health embodied in the labour force of a country.

Causes for Low Human Capital

• Poor education
• Poor healthcare
• Poor job training opportunities

Dependence on the Primary Sector

• The primary sector is anything derived from the factor of production land.
  • Developing countries rely heavily on the primary sector.

Issues with Dependence on the Primary Sector

• Reliance on imports of manufactured goods and services
  • This can lead to reduced economic growth, especially if there are more imports than exports.
• Instability
  • Unpredictable changes in prices and yields (crops/mine).
• Exchange Rate issues
  • High demand for raw materials leads to an exchange rate increase lowering export competitiveness in other sectors.
• Political and Civil unrest
  • Land and natural resources are so valuable here, there is frequently conflict to acquire more.

Lack of Access to International Markets

• Protectionist policies and uncompetitive domestic infant industries make exports difficult.

Formal Economy

• Registered
• Taxes
• Legally Regulated

Informal Economy

• Hidden
• Unrecorded
• Unregulated

Disadvantages of a Large Informal Economy

• Lower incomes
• Underemployment
• Lack of safety net for entrepreneurs as they are not registed.
  • Thus they get no unemployment benefits.
• Lack of government revenue leading to less money for public goods such as education or healthcare.
• Potentially illegal economic activity resulting in human rights issues and worker exploitation.

Capital Flight

• Capital Flight is an outflow of money from an economy.
  • Due to negative political, social, or economic changes.

Disadvantages of Capital Flight

• Interest rates will rise in hopes of keeping money in the economy.
  • Discourages business and consumer loans, reducing consumption and investment.
• The government may enact control over funds leaving the country.
  • Deters foreign investors as they may not be able to remove funds.
• Demand-Side policies have less of an impact due to uncertainty and unwillingness to spend.
• Lower domestic investment.
• In the long-run, capital flight is typically associated with large foreign debt.

Indebtedness

• Countries take on debt to:
  • To service debts already owed.
    • Pay the principle on the loan
  • Finance current expenditures
  • Finance long-term goals such as infrastructure, healthcare and industrial projects.
• Debt limits the government budget, preventing beneficial spending.

Geographic Barriers

• Landlocked Countries
• Climate
• Disease

Landlocked Countries

• Landlocked countries don't have direct access to the sea.
  • Prevents economic integration as all imports and exports have to enter and exit through another country.

Climate

• Each country lives in a different biome with varying climate conditions.
  • Extreme climates can limit economic growth, especially for agriculture-reliant LDCs.

Disease

• Each country has different endemic diseases native to its region.
• Widespread or dangerous diseases can impact economic development and growth.
  • An unhealthy workforce results in low human capital
  • Sick people cannot work and in countries with no safety nets, these people fall into a cycle of poverty.
  • Sick people are unable to devote time to increasing human capital (education, training).
  • Impacts on well-being and relationships

Political Barriers

• Governance
• Political Systems
• Corruption

Governance

• The decision-making or processes within an organization or an institution.

Effective Governance Traits

• Transparent
• Accountable
• Consensus oriented
• Equitable and inclusive
• Follows rule of law
• Responsive

Political Systems

• Democratic political systems theoretically provide the greatest governance.

Corruption

• Abuse of power for private gain.

Types of Corruption

• Bribery
• Embezzlement
• Extortion
• Blackmail

Institutional Barriers

• Legal Systems
• Property and Land Rights
• Taxation System and Structure
• Banking System

Legal Systems

• Laws should uphold core foundations of ideal legal systems such as accountability, just laws, accessible and affordable justice, and transparency.

Property and Land Rights

• Systems need to exist to organize and structure the means of owning, selling and regulating property.
  • Prevents hostility and unrest.

Taxation System and Structure

• Tax revenues allow governments to boost economic growth and development through government spending.
  • LDCs receive less tax revenue due to low incomes and large informal economies, and are dependent on tariffs and indirect taxes.

Banking System

• Banking systems in low-income countries take on a significant amount of risk in these areas as individuals typically have no collateral for loans, low savings, and low financial literacy.
  • This leads to high interest rates, which reduces borrowing.

Social Barriers

• Gender Inequality
• Caste and Ethnic Discrimination

Gender Inequality

• Lack of education leads to a lack in human capital
• Unequal income
• Low political representation in government
• Little/no political or educational role models
• Increased sexual and physical violence against women

Caste and Ethnic Discrimination

• Ethnic discrimination hinders economic development/growth resulting in:
  • Higher rates of unemployment and income for minorities
  • Lack of equal access to healthcare, education, and economic opportunities
  • Restriction of freedoms

Economic Growth and Development Strategies

• Trade Liberalization
• Diversification
• Social Enterprise
• Market-Based Policies
  • Trade liberalization
  • Privatization
  • Deregulation
• Interventionist Policies
  • Redistribution
  • Provision of Merit Goods
• Foreign Direct Investment
• Foreign Aid
  • Humanitarian Aid
  • Official Developmental Aid
• Multilateral Development Assistance
  • World Bank
  • International Monetary Fund
• Institutional Change
  • Gender Inequality
  • Corruption

Trade Liberalization

• When countries remove all trade barriers such as tariffs, subsidies, quotas or administrative barriers.

Advantages of Trade Liberalization

• Economic integration in developing countries leads to greater access to a variety of goods at theoretically lower prices and greater quality.
• Increases in exports
• Access to larger markets
• Improved international cooperation
• Efficient resource allocation

Limitations of Trade Liberalization

• Infant industries may be phased out or unable to compete
• Potential increase in domestic unemployment
• More reliant on foreign imports
• Potential exposure to dumping
• Loss of tariff revenue for the government
  • Tariffs might be a large revenue source for developing nations, as imports are always monitored and administered, unlike the informal economy which doesn't generate government revenue.
• More difficult to protect population safety

Diversification

• Reduces the lack the variety of production and exports.
• Diversification provides:
  • Protection from economic shocks to specific sectors
  • Reduces exchange rate fluctuations
  • Promotes growth outside primary sector

Social Enterprise

• A company whose main objective is to have a social impact rather than to make a profit for their owners or shareholders.

Privatization

• When government-owned industries are sold to the private owners.
  • Improves efficiency and promotes competition
  • Decrease in government spending and increase in revenue
  • Equity issues
    • Preferential selling of cheap government-owned industries lead to wealth inequity

Deregulation

• Removing rules and restrictions enforced by the government.
  • Removes barriers for start-up business
  • Lower costs of production
  • Public health and security concerns arise

Redistribution

• Designed to redistribute wealth and income equally in society.
• Includes:
  • Progressive Tax Reform
    • Progressive taxation allows most of the tax burden to fall on those with high income and funds government spending.
  • Transfer payments
    • Countries with established tax revenue can implement transfer payments that give funds directly to lower-income families to provide greater income, opportunity, and well-being.
  • Minimum wage
    • Minimum wage requirements can help protect vulnerable workers from exploitation and increase income equality in society

Provision of Merit Goods

• Free or cheap provision of merit goods such as education, healthcare, and infrastructure.

Foreign Direct Investment

• Occurs when large multinational corporations (MNC) invest in a country.

Inwards FDI Positive Effects

• Increases jobs
• Increases growth and development
• Improves infrastructure
• Improves human capital
  • As MNCs work with and invest in developing countries, they can transfer their knowledge to the workers and governors there.
• Increases government business tax revenue

Inward FDI Negative Effects

• Loss of control of capital
• Over-reliance on foreign firms
• Environmental damage
• High barriers for infant industry competitors

Humanitarian Aid

• Aid for countries where people are struggling to fulfill basic needs.

Official Developmental Aid

• Aid is provided to achieve long-term development.
• Includes:
  • Grants, loans, project/program aid
  • NGO (Non-Governmental Organization)
  • Aid Official Developmental Assistance (ODA)
  • Debt Relief

Multilateral Development Assistance

• Receiving assistance from organizations contributed to by countries.

World Bank

• Goal: Reduce Poverty
• Functions:
  • Provides low-interest loans
  • Policy advice
  • Technical assistance
  • Financial assistance with a strong focus on long-term factors of production growth.

International Monetary Fund

• Goal: Economic Stability
• Functions:
  • Provides conditional loans
  • Economic surveillance
  • Development policy creation

Combatting Gender Inequality

• Addressing and eradicating gender stereotypes
  • Can be done through education and campaigns
• Establish laws prohibiting gender discrimination
• Ensure equal rights under the law
• Promote gender hiring initiatives or quotas

Combatting Corruption

• Establish an effective justice system and the rule of law
• Reform public administrational roles and auditing process to ensure transparency
• Promote freedom of the press
• Close international loopholes that may fund corrupt leaders
• Promote transparency and the power of communities