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6. FULL EMPLOYMENT
Labour market-are individuals able to find a job?
GDP excludes intermediate goods and services. They are used in the production process e.g.
raw materials
Value Added=Sales-Cost of intermediate inputs
2. Expenditure Method
Expenditure on goods and services=value of production
Main Components of Expenditure
Consumption-purchases by Households (C)
Investment-purchases by Firms (I)
Government purchases (G)
Net Exports-net purchases by foreign sector (exports minus imports) (NX)
3. Income Method
GDP=Labour Income+ Capital Income in the production of goods and services
The Income Method is whenever a good or service is produced or sold, the revenue from
the sale is distributed to the workers and the owners of the capital involved in the
production of the good or service
INFLATION
Percentage change in CPI over given period
COSTS OF INFLATION
Shoe-leather cost: inflation reduces the purchasing power
Menu costs-real costs of changing prices
Distorts tax system
Unexpected re-distribution of wealth
Nominal Interest Rates-percentage increase in nominal(dollar) value of financial asset
Real Interest Rate-percentage increase in real purchasing power of financial asset
Real interest rate=relative price of consuming today versus consuming in the future
(Higher real interest rate makes current consumption relatively more expensivereduce current
consumptionincrease in saving)
Standard economics predicts
individuals/households choose a
level of saving that maximises their
current and future welfare
National Saving
In an economy saving is undertaken by:
Households
Business
Government
National saving is a measure of aggregate saving in an economy
Y= C + I + G + NX
Assume X=0 (closed economy), then Y= C + I + G
PUBLIC SAVING
Government
Investment and capital formation
National saving provides resources for investment
Investment is the purchase of new capital goods
Influences on the level of investment
Crowding Out
Increase in government budget deficit will educe private investment spending
UNEMPLOYMENT AND THE LABOUR MARKET
DEMAND FOR LABOUR
MARGINAL PRODUCT OF LABOUR
A firm combines workers with a given amount of capital (machines and buildings) to produce
computers
As the firm employs more labour its output rises
Marginal product of labouradditional output generated by each additional worker
Diminishing Marginal Product
-The Nature of the production technology is such that each additional worker produces less
output than the existing workers
COMPETITIVE MARKETS
Assume that firm operates in a competitive market
It cannot set the wage it pays workers
It cannot set the price it receives for its product
Willing to employ labour until P x MPL= W (Value of MPL= Wage)
Or
MPL= W/P (Marginal Product of labour =real wage)
Since the MPL decreases as the firm employs more
workers, it must be the case that the real wage also has to
fall
TYPES OF UNEMPLOYMENT
Labour Force=Employed+Unemployed
Working populationtotal population 15 years or older
EMPLOYED: Person worked full time or part time during past week
UNEMPLOYED: Person did not work during preceding week and made some effort to find work
NOT IN LABOUR FORCE: Person did not work in past week and was not actively seeking work
DISCOURAGED WORKERS: People who have given up looking for work and not so are not
counted as unemployed
LABOUR UNIONS
Workers may negotiate on an individual basis with a firm over wages and conditions
Alternatively workers may form labour unions to bargain collectively with a firm.
Presence of unions tends to produce a wage outcome that is above the market-clearing wage.
Minimum wage can be re-interpreted as the outcome for a unionised industry, where
Wmin = Wunion
UNEMPLOYMENT BENEFITS
Government transfer payment paid to the unemployed.
Provides a basic income to workers who are unemployed and searching for work.
Can have a disincentive effect on a workers search effort
Potential output= y*
(potential out put is not the same as maximum output)
OUTPUT GAP
Actual output doesnt always equal potential output (Difference is called output gap)
Assumptions:
No government sector (G=T=0)
No foreign sector (Closed economy) (X=M=0)
Consumption function
THE MULTIPLIER
Y caused by the changes in PAE
An additional dollar of
exogenous PAE generates more
than a dollars worth of GDP
Taxes and transfer payments affect the level of disposable income (Y-T) received by the private
sector
Exogenous changes in taxes and transfers only have an indirect effect on PAE
(Initial) BS = T G
BS = (T+100) (G+100)
(No change on initial value)
AUTOMATIC STABILISERS
System of taxes and transfer payments that act as automatic stabilisers for the economy
As GDP declines, the level of taxes paid falls and the level of transfer payments made increase.
T T ( GDP) implies decline in budget surplus
This happens automatically (without any government action) and makes contractions and expansions in
GDP smaller than they would have been otherwise.
Public debt equals the sum of all past deficits less any surpluses.
Intergenerational Equity: Borrowing because of deficit budgets cant be sustained forever, and eventually
surpluses would be required to reduce debt.
BENEFITS OF PUBLIC DEBT
One use of public debt is to finance the provision of public infrastructure. Where infrastructure has the
characteristics of a public good it will be undersupplied by the private sector.
Public debt may have a net benefit for the economy, even when allowing for crowding out and
intergenerational equity effects
BONDS
Legally enforceable promise to repay a debt
Principal = amount that is originally borrowed on the bond
Term of bond = length of time before bond has to be repaid (terms can range from 24 hours to 30 years)
(Maturation date)
Coupon payment = regular dollar payment of interest on the bond
MONEY
Medium of exchange
Double coincidence of wants; Sell goods for MOE and use MOE to buy goods they want
Unit of account
Good that is used to compare the value of all other goods and services
Store value
Good or asset that serves as a means of holding (or transferring) wealth over time (e.g. land, bonds,
stocks)
Money measures
Currency = notes and coin on issue (less what is held by RBA and banks)
M1 = Currency + Current deposits at banks
M3 = M1 + all other bank deposits of non-bank private sector
Broad Money = M3 + borrowings from private sector by non-bank depository corporations (less
what these non-banks hold with banks)
Deposit Multiplier
Quantity Equation
ROLE OF ESAs
Banks use ESA to clear debts (or credits) with other banks
Re-discount rate
Banks can, at any time, borrow cash (using bonds as security) from the RBA at a rate that is 0.25%
above the target cash rate (at present this would be 2.75%). Upper bound for cash rate
SUPPLY OF BILLS
Borrow more when interest rates on bills is low
OR
Supply more when price of bills is high
This occurs because some banks will leave the Bill market in favour of the higher returns in the
overnight cash market.
ARBITRAGE
While RBA targets a very short interest rate, changes in cash rate eventually lead to changes in longer-
term interest rates.
Market Rates = Cash Rate + Premium
DERIVE AD CURVE
Why does AD Curve slope downwards?
When inflation is high, the RBA will raise
the real interest rate. The increase in r
reduces consumption and investment
(i.e. PAE) and this produces a fall in
equilibrium output.
Rise in the real exchange rate implies that domestic goods are becoming more expensive
INTERNATIONAL RESERVES
To maintain fixed value for exchange rate, country needs sufficient level of international
reserves of foreign currency to purchase excess supply of domestic currency
Balance of payments deficit: net decline in a countrys stock of international reserves
Balance of payments surplus: net increase in a countrys stock of international reserves
Speculative Attack: massive selling of domestic currency assets by financial investors
Balance of Payments
Record of transactions between residents of a country and non-residents
Current Account
Transactions leading to a change of ownership of commodities or a direct flow of income
Capital Account
Transactions involving the purchase or sale of assets