IB Economics OAFO -- MACRO

## 3.1 Measuring Economics Activity ### National Income Accounting **The output method**: measures the value of all finished goods and services in a country in a year (only the final product is measured) **The income method**: Measures the value of all incomes in the country in a year (Wages + Rent + Interest + Profit) **The expenditure method**: Measures the value of all spending in a country in a year (C + I + G + X - M) ### GDP & GNI $\text{GNI} = \text{GDP} + \text{Net Primary Income from Abroad}$ $\text{Real GDP/GNI} = \frac{\text{Nominal GDP/GNI}}{\text{Price Deflator}}$ Disadvantages of GDP and GNI - GDP and GNI don't accurately reflect the well-being of people in the country. China's GDP has multiplied by 40 in the last 30 years, but people are not 40 times happier. - They don't show the distribution of wealth in an economy. - Shadow economies or black markets don't count, which are huge parts (up to 50%) of economies in certain countries. - They do not account for negative externalities such as environmental costs. Alternative Measures: OECD Better Life Index, Happiness Index, The Happy Planet Index ## Business Cycle ![[Screenshot 20260111 at [email protected]]] ## 3.2 Aggregate Demand & Aggregate Supply AD: the total amount of demand for all goods and services in the economy in a specified time period AS: the total amount of goods and services that firms are willing and able to provide in an economy, in a certain time period **Neoclassicalists** believe the market will adjust itself automatically ![[Screenshot 20260111 at [email protected]]] **Keynesians**: Equilibrium can be at any point along AS. wages = sticky downward (workers rarely accept lower salaries) ![[Screenshot 20260111 at [email protected]]] **Shifts in LRAS / Keynesian AS** ![[Screenshot 20260111 at [email protected]]] ## 3.3 Macroeconomic Objectives **Economics Growth** (short-run vs long-run, actual vs potential) ![[Screenshot 20260111 at [email protected]]] **Unemployment**: people who are willing and able to work and looking for work are unable to find any. Natural Rate of Unemployment = Structural + Seasonal + Frictional **Inflation**: a sustained rise in the general price level demand-pull vs cost push ![[Screenshot 20260111 at [email protected]]] **Government debt**: the total amount of money owed by the government to lenders #### Potential Conflicts Between Macroeconomic Objectives Low Unemployment vs High Inflation: **Philips Curve** ![[Screenshot 20260111 at [email protected]]] ## 3.4 Inequality & Poverty ### Inequality Equity -- economic fairness Equality -- everyone earns the same amount Lorenz Curve & Gini Coefficient $\text{Gini coefficient} = \frac{A}{A+B}$ ![[Screenshot 20260111 at [email protected]]] ### Poverty - Absolute Poverty: When people are unable to access basic human needs such as food and shelter. - Relative poverty: When people are unable to reach a specified level of income, typically 50% of their countries' average earnings. ### Tax **Direct taxes**: imposed on income progressive -- The more you earn, the higher of a percentage you will pay as taxes **Indirect taxes**: imposed on expenditure affect poor people more, as they will need the same amount of groceries as a rich person, thereby paying the same amount of tax **Marginal & Average tax rate** Person A earns $35,000 a year 1. On their first $10,000, they pay 8%. 10,000 x 0.08 = 800 2. On their next $10,000, they pay 20%. 10,000 x 0.20 = 2000 3. On their last $15,000, they pay 30%. 15,000 x 0.30 = 4500 4. So in total, they pay 800 + 2000 + 4500 = $7,300 in taxes. This is the Total Tax. The exam might also ask you to find the "average tax rate". You do this by dividing the tax paid by the initial income. 6. They paid $7,300 in taxes on a $35,000 income. 7. 7300 / 35000 = 0.2086 = 20.86% is their Average Tax Rate. ## 3.5 Monetary Policy Monetary policy = central bank controlling interest rates and money supply ![[Screenshot 20260111 at [email protected]]] **Open Market Operations (OMOs)** ![[Screenshot 20260111 at [email protected]]] **Minimum Reserve Requirements (MRR)** **Central bank base rate** **Quantitative Easing** -- Sometimes the central bank base interest rate is so low it can't go lower; buying and selling of bonds, but on a larger scale (and more long-term) than OMOs Expansionary = decrease MMR, decrease base rate (usually not that effective), buy government bonds, buy corporate bonds (a.k.a quantitative easing) Contracitonary = all the opposite Money Multiplier = 1 / Reserve Ratio Real Interest Rate = Nominal Interest Rate - Inflation ### Effectiveness Strengths - Incremental, flexible, and easily reversible - Short time lags: central banks independent of the government's politics Weaknesses - The effectiveness of lowering interest rates decreases when close to 0 ## 3.6 Fiscal Policy Fiscal policy = government controlling taxation and government expenditure expansionary = cut tax, increase spending contractionary = increase tax, decrease spending The Keynesian multiplier $ \text{Keynesian Multiplier} = \frac{1}{1 - MPC} = \frac{1}{MPS + MPT + MPM} $ ### Effectiveness **Strengths** can target specific economic sectors automatic stabalizers -- naturally reduce fluctuations of the business cycle - Progressive taxes -- If people suddenly earn less in a recession, tax rates automatically decease as people go into lower tax brackets. - Unemployment benefits -- A form of transfer payments for the unemployed, ensuring they have enough money to cover their needs. This is given to every unemployed person and will therefore automatically adjust when more people lose their jobs. **Weaknesses** Political pressure Time lag Government debt **Crowding out** refers to a situation where **government spending reduces private sector spending** (through increasing interest rate), canceling out the effect ![[Screenshot 20260111 at [email protected]]] ## 3.7 Supply Side Policy Supply side policy = government actions done to increase the aggregate supply of the economy, by improving the quality and quantity of factors of production. ### Market-based Policies to Encourage Competition - Deregulation - Privatization - Trade liberalization - Anti-monopoly regulation Labor Market Policies - Reduce power of labor unions: - Reduce unemployment benefits - Abolish minimum wages ![[Screenshot 20260111 at [email protected]]] ### Interventionist 1. Facilitate education and training 2. Improve quality, quantity, and access to healthcare 3. Encourage research and development 4. Provide infrastructure 5. Implement industrial policies: Give tax cuts or grants to a certain industry so it can develop more, creating more supply. ### Effectiveness Strengths - Market-Based Supply-Side Policies: - No burden on the government budget - Improved resource allocation: Because private entities are generally better at determining equilibrium, resources will be allocated more efficiently in many markets. - Reduce unemployment: Its labor policies may reduce unemployment as work is incentivized more. - Interventionist Supply-Side Policies: - They can directly support sectors deemed important for growth: It is easy to target one industry and encourage R&D there, for example. - Education and training is effective in growing the productive capacity of an economy over time. Weaknesses - Market-Based Supply-Side Policies: - **Equity issues**: Market-based policies primarily aim to make markets run more efficiently, but does not consider well-being of people. Abolishing the minimum wage might reduce costs of production, but will not make the lives of the workers any better. It will, however, benefit the owners of the firms. - **Time lags**: It takes a significant amount of time for the economy to show any real impact of these policies. - **Environmental impact**: Deregulation may improve the market, but the creation of negative externalities will occur. This is partly why regulations existed in the first place. - Interventionist Supply-Side Policies: - **Costs**: They will take a toll on government budgets and may increase national debt. - **Time**: It takes a lot of time to see any change. If the government invests in education, it will take at least 12 years to see any meaningful change, for example. - **Inflation**: Increased government spending may raise inflation levels in the short run as AD shifts to the right, but could decrease in the long run as the supply effects kick in.