REVISION IB DP ECONOMICSSection 2: Macroeconomics

The purpose of this section of the syllabus is to familiarise you with the working of the economy of individual countries. For this you will need to study the major macroeconomic issues which countries are facing such as economic growth/ development, unemployment, inflation and income distribution. In addition, you need to be aware of the differences between the two main views on economics: new classical (monetarist) and Keynesian. In this part of the syllabus you will also be introduced to a few (domestic) economic strategies available to governments to stabilise the macro-economy of a country and to create growth and development. In section 4 you will study more of these which may more relevant for low and (low) medium- income countries. The strategies discussed now are demand-side policies and supply-side policies. Later you will discuss interventionist and market-oriented policies and strategies which involve: domestic factors, international trade, FDI, aid and reducing debt.

2.1 The level of overall economic activity

What is the ‘circular flow of income’?A simplified model of the economy. It demonstrates the relationship between households and firms, and the flow of factors of production and payments in the economy.

Which four flows constitute the income flow in a circular flow of income?Expenditure on goods and services, payments (rent, profit, interest, wages), factors of production and goods and services.

This income flow is numerically equivalent to the following two flows: Investment (injection of income) and savings (leakage of circular flow model)

Give three examples of leakages (=’withdrawals’):Savings, imports and taxes

Give three examples of injections:Gvt spending, exports and investmentDraw a circular flow of income (between households and firms) in a closed economy with no government below:

Draw a circular flow of income in an open economy with government and financial markets, refer to leakages / withdrawals and injections in the description of your diagram: Explain how the size of the circular flow of income can change: When there is an imbalance in leakages and injections, the economy will move to a new equilibrium.

When is a circular flow of income in equilibrium in the following situations?• a two sector model (=households + firms)

• a four sector model (=also government and foreign trade): When leakages equal injections

Distinguish between GDP and GNP / GNI as a measure of economic activity:GDP: measures the total value of income earned in the economy regardless of who owns the assets. GNP is the total value of income earned in the economy regardless of where the assets are located.

Distinguish between the real and nominal value of GDP/GNP/GNI:Nominal value is the value at current prices, and real value is the nominal value adjusted for inflation.Distinguish between the total and per capita GDP/GNP/GNI:The total includes everyone in the economy, where as per capita is the GDP value divided by the amount of population. Or, output per person.List three different ways you could use national income statistics:1. government could use these statistics to evaluate their work2. they could evaluate the standards of living3. business could make predictions of future demandExplain what is meant with a green GDPGreen GDP = GDP-environmental costs of production, it takes into account the damage to the environment when producing.Which expenditures make up GDP?: expenditure on goods and servicesHow is the cyclical pattern called that economies typically go through: Business cycle: boom, recession, trough, recovery.

The long-term growth trend in the business cycle represents:The potential output

List the different phases of the business cycle: Business cycle: boom, recession, trough, recovery.

Distinguish between a decrease in GDP and a decrease in GDP growthA decrease in GDP means that the economy gets smaller, whereas a decrease in GDP growth means that the growth of the GDP slowed, but the economy is still growing, just at a slower pace.

Define ‘recession’:Two consecutive economic quarters of a negative GDP growth.

Illustrate the business cycle below:

2.2 Aggregate Demand and Aggregate Supply

Distinguish between microeconomic demand and macroeconomic AD: Total spending on all goods and services in an economy in a year at a given price level, it looks at the relationship between real output and average price level, and micro will look at the price of a single good or service and the quantity of output. It look at the relationship between price of one good and the quantity sold.Explain why the AD curve slopes downwards (has a negative slope):Because of the inverse relationship with price, as price raises, quantity demanded contracts.What are the four components of AD?Consumption, government spending, investment, net exportsDefine ‘aggregate demand’:Total spending on goods and services in a given time period at a given price level.

Changes in the components of AD will, ceteris paribus, change AD which can be shown as a shift of the AD curve. There are different reasons why for example consumption could change. List 5 of these:

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1. changes in income (domestic and foreign)

2. changes in wealth

3. changes in confidence of consumers and businesses

4. changes in interest rates and exchange rates

5. changes in household indebtness

List 5 different factors which can change investment:1. change in technology

2. change in business confidence

3. change in interest rates

4. change in exchange ratesGive two reasons why government spending could change in a country: Change in goals, market failures, reducing inflation, unemployment etc.

List 3 different reasons why net exports would change in an economy:1. change in domestic income and foreign income

2. change in interest rates and exchange rates

3. government policies quotes, subsidies, tariffs

Define ‘aggregate supply’: Total of all goods and services produced in a country at a given price level in a year.

Explain why the short-run aggregate supply curve (SRAS) would be upward sloping: Because of its positive relationship with the price level.

Give four factors which could change AS which is illustrated as a shift of the AS curve in the short-run (assuming ceteris paribus): these will shift the curve to the right as it means that employment can increase and potential output increases too.1. change in wages2. change in taxes and subsidies

3. change in cost of raw materials4. change in price of importsThere are alternative views of aggregate supply. These are:1. 2.

The LRAS is vertical because: The AS curve has three sections because: The classic economists believe that the market will always move to the full level of employment, without government intervention, based upon the quan and qual of goods and services and not on price.The AS curve has three sections: the first is perfectly elastic, because they can raise output without increasing costs, because of the spare capacity. Then the resources will become scarcer and the prices will increase. The last phase is where there is full level of employment, where fop’s can not be increased as well as the potential output unless the quan and qual improves.Factors leading to changes in the quantity and/or quality of factors of production will shift the LRAS curve. Four of these factors are:1. Decrease in natural unemployment

2. discovery of natural resources

3. training

4. immigrationIllustrate the determination of the short-run (macro-economic) equilibrium:

Illustrate the determination of the long-run (macro-economic) equilibrium:

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What do you always know about the level of output at the long-run equilibrium: The level of output is where AD equals LRAS.

Explain the impact of changes of the long-run equilibrium. Depends on the view. If there is an increase in the LRAS curve then it depends on the initial position on the curve with Keynesians. In Classicals the curve will shift to the right and price levels will fall.

Explain, using an appropriate diagram that in the new classical (new monetarist) approach there may be short-term fluctuations in output, but the economy will always return to the full employment level of output in the long-run. Please note that this will require multiple shifts:

When there is a shift in demand curve, shifting right, then we see on the diagram that there is an inflationary gap as full level of output is greater than full level of employment, forcing up costs for producers, who then decrease the supply, shifting that curve to the left, ending up again at the full level of employment but then at a higher price.Illustrate the different levels of output where according to Keynesian economists the economy may be in equilibrium:

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Could be anywhere.Explain when there is a deflationary (recessionary) gap in the Keynesian model: When demand contracts and shifts to the left, below the perfect inelastic curve. This shows that the economy is in equilibrium at the point of full output that is below the point of full employment level.

Compare and contrast (discuss) a deflationary (recessionary) gap in the Keynesian model and the monetarist / new classical equilibrium: Both show an equilibrium in which the full level of output is below the full level of employment. However, monetarists believe this is only possible in the SR, as market forces will force the market back to its full level of employment. But Keynesians believe this can happen in the LR as well, because of the existence of the spare capacity.

Illustrate when there is an inflationary gap in the Keynesian model:

Explain when an increase in AD will and will not be inflationary according to Keynesians:When the economy is operating below the full level of employment and experiences inflationary then the market does not experience inflationary gap as there are still unused capacity in the economy and thus costs do not increase. When all fop’s are used and capacity is up, then there will be inflationary gap.2.3 Macroeconomic objectives What are the five major macroeconomic objectives:1. low and stable rate of inflation2. increase of national output3. low level of unemployment4. balance in the account of payments5. income distributionLow unemployment

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Define’ demand for labour’: The demand for all labour in the economy that produces good and services.

Define ‘unemployment’: People of working age, without work, able to work and who are actively seeking for employment.

Explain how the unemployment rate is calculated: It is difficult to measure as there is hidden unemployment. But some countries measure it on the hand of demand for unemployment benefits such as Belgium. Internationally it is measured as a percentage of the total labour force.

List three difficulties in correctly measuring / using the unemployment rate:1. hidden unemployment (illegal unemployment and work done by yourself such as painting the house)2. the national unemployment figure is not accurate as it does not accurately represent the unemployment differences in certain regions.3. it does not take into account people who have given up the search for work are who are over qualified for the current job they are doing.Explain the difference between hidden unemployment and underemployment: Hidden unemployment is the unemployment are the people who have given up the search for work, who are not able to work, and the illegal jobs there are by immigrants who not yet have received a permit to work.Underemployment is working fewer hours than they wish, or in a job they are over qualified for.

What is ‘full employment’? Where the market has used all its factors of production.

Give two methods (approaches) to measure unemployment:Information gathered from surveys of the populations and unemployment insurance records.

Unemployment can be divided into two main groups:A. Disequilibrium unemploymentB. Equilibrium unemploymentThere are two main examples of disequilibrium unemployment that you need to know (and you need to be able to give real-world examples):1. demand-deficient unemployment: recession in economy

2. real-wage unemploymentFor equilibrium unemployment you need to be familiar with 3 different types (and you need to be able to give real-world examples):1. structural: coal miners2. seasonal: ski instructor3. frictional: students looking for jobsDistinguish between the causes of the different types of unemployment: Demand-deficient: demand has contracted, causing demand for labor to contract. Real-wage: minimum wages have increased, contracting the demand for labor. Structural: changes in the economy due to an improvement in technology have permanently decreased the demand for labor for one particular labor. Seasonal: seasonal jobs like skiing contracts in summer in terms of demand for labor. Frictional: in between jobs, short run, supply of labor is looking for something more efficient. Define ‘cyclical’ (or ‘demand-deficient’) unemployment:When there is a temporarily fall in the aggregate demand of all the labor in an economy.Illustrate cyclical unemployment and clearly state the assumption made: wages are sticky and so there will be a shift of demand to the right but the wages will remain the same. This will result in excess supply of labor.

Illustrate the effect of a minimum wage: increases the supply of labor and decreases the demand for labor as costs will increase. This creates thus excess supply of labor and thus unemployment.

List different economic costs (individual and for society) of unemployment:1. individual: lower standard of living, stress, depression2. to society: vandalism, homelesness

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3. to society: government spending increases on unemployment benefits and thus decreases spending elsewhere, also gvt revenue decreases as a result of lower tax income.Illustrate structural unemployment:

Structural unemployment can have three main causes:1. change in technology2. change in consumer taste3. low cost labor foreign countriesMeasures to deal with unemployment could have adverse or unintended consequences on output and the economy. Explain the policies below and evaluate their spill over effects.• creating public sector employment:

• providing incentives to stimulate more individuals to work:lowering unemployment benefits, providing more information = but costly

• providing incentives to stimulate foreign companies to invest in the domestic economy:increasing interest rates = but increase savings, lower domestic spending

• lowering minimum wage:this will increase demand for labor but decrease standards of living

• lowering unemployment benefits:this will increase supply of labor• providing government subsidised job training:this will make sure that in a structural unemployment situation, workers can get another job faster. However, it is costly and requires an opportunity cost of the gvt to cut spending elsewhere or increase tax on some incomes.

• create job seekers agencies:

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this could increase the supply of labor but it is costly.

• stimulate infant industries in regions with high unemployment rates:by subsidizing or protectionism but this is costly.

The above should make clear that government policies to deal with unemployment will depend on the cause of unemployment. Different types of unemployment require different solutions. This is why it is likely that you will be asked to evaluate government policies to deal with the different types of unemployment. It could also be that the examiner already picks one particular solution (usually demand or supply-side policies) and will ask you to evaluate the likely effectiveness of these solutions. Again make sure that you know of real-world examples: what is done in South-Africa to bring down high youth unemployment, why is the Danish model often praised, ask Renana who wrote her EE on unemployment which policies the Netherlands implements. Low and stable rate of inflationDistinguish between inflation, disinflation and deflation: Inflation: a persistent increase in the average price levelDeflation: a persistent decrease in the average price levelDisinflation: a decrease in the growth of the average price level

What is a consumer price index? It is a basket that represent the value of the typical goods and services consumed by the average household to measure inflation.Explain how different income groups may experience a different rate of inflation: Because the CPI measures the average household to set up a basis wage. But, not everyone has children, some have none and some have more than others. This means some households will experience more inflation than others.

List two limitations of the use of CPI figures:1. Not everyone has an average household2. in terms of internationally comparing, every economy has slight differences so comparing is hard3. it is impossible to take into account all the changing prices of all goods and services.The core or underlying rate of inflation is used as a more stable rate of inflation, because:

Explain how a producer price index may be useful in predicting future inflation:

If you measure the price of factors of production and see the prices of these have increased, you can predict future inflation as these are needed produce goods and services.

While a high rate of inflation is undesirable, it is highly likely that deflation is even more undesirable. List the two major consequences of deflation: Consumers don’t spend money as they are waiting for prices to fall even further, which decreases AD further. Firms will fire workers as their demand for labor decreases, and thus creates unemployment. This unemployment further decreases AD. This is a deflationary cycle and very harmful. In general there are two causes of inflation you need to know:1. increase in AD2. increase in money supplyIllustrate demand-pull inflation below and state the cause of this type of inflation: due to an increase in gvt spending, incomes, consumer confidence, foreign income goes up and spend more on exports.

Illustrate cost-push inflation below and state the cause of this type of inflation: prices of raw materials go up, or imports become more expensive due a fall in exchange rate or inflation in foreign countries, this will increase the cost of producers and thus shift the curve to the left.

Be aware that a popular macroeconomic essay question in that past has been to evaluate government policies to deal with the different types of inflation. As the two types have different causes, you have to be aware of this in your answer. As with the unemployment policies, you need to be able to judge whether demand or supply-side policies would be the most suitable policies. If the inflation is due to demand-push: use

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demand side policies such as fiscal policy and increase taxes, cut spending (not so efficient). This is rather unpopular since a government has goals to achieve through its spending and increasing taxes is never popular. So in this case a monetary policy should be better since it is operating by the independent central bank who does not need any elections to win; increase interest rates and reduce the money supply. If the inflation is due to cost-push inflation, then the government should use supply side policies such as deregulation, decreasing minimum wages etc,

Illustrate using a PPC the different types of economic growth: at a level of decreased prices and where there is no price change1. 2.

This growth is caused by: The growth is caused by:1. improvement of fop(factors of production) (quan + qual)1. An increasein AD and AS2. advances in technology 2. Rise in income and discovery resourcesDescribe using an AD / AS diagram, potential economic growth:

When in a deflationary gap, the economy is operating below its point of potential growth. This can be solved by demand side policies.

Investment in different ‘types’ of ‘capital’ can occur. List the 3 main ones:1. replacing old capital with new capital 2. Invest in factors of production 3.Explain why investment is important for economic growth, refer to the above types:

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By replacing old capital and investing on factors of production a firm can keep up with the increasing demand, and thus as AD increases, AS can increase as well so there will be no excess demand and inflationary pressure.

Explain the importance of improved productivity for economic growth:If a firm does not improve its productivity, and AD demand only increases, excess demand is created which results in inflationary pressure.

Economic growth has many impacts. Explain the consequences on the following:Standard of living: improves as incomes go up, more people are employed, technology improves so standard living will go up, higher competitiveness so qual and quan increase standard of living goes up

Unemployment: As the economy grows there is more productivity and AD, and firms need more employment to meet the increased demand and increased output.

Inflation: If the economy grows and the LRAS curve shifts to the right, then there will be downward pressure on inflation. Inflation only happens if the AD grows faster and more than the output.

Distribution of income: Due to economic growth there can be structural chances and an increase in unemployment. This means that not everyone will benefit from the economic growth and there will be an increase in inequality of income.

Current account (BOP):Since incomes increase, demand for imports will increase too. This may result in current account deficits.

Sustainability: Economic growth means there is a lot of production going on, meaning a lot of pollution, resource depletion etc.

Equity in the distribution of incomeExplain the difference between equity and equality in distribution of income: Equity means fairness and equality means everyone having the same income.

Give a main reason for distribution of income not being equitable: some have more income than others, and thus those with lowers incomes have a lower standard of living, which is not fair.

What are ‘deciles’ and ‘quintiles’? deciles: divides distribution into tenths and quintiles into fifths.Draw a Lorenz curve and explain when to use this diagram: to show a graphical representation of a country’s income distribution to compare it to the line of absolute poverty and decide whether or not that country has an equal or an unequal distribution of income.

Explain how the Gini coefficient is derived and interpreted: The gini coefficient is derived from the Lorenz curve, it is the area under the line of absolute equality between the line of a country’s Lorenz curve, the higher the gini index, the more unequal distribution of income.Distinguish between absolute and relative poverty. Absolute poverty is when one does not have the necessary income to provide for basic goods and services, whereas relative poverty is when one has income that is below the line of an average and is in comparison to others poor, but still can provide for the basic necessities in their lives.List three main causes of poverty:1. poor health care2. no (proper) education3. born into a family that is poorGive two main consequences of poverty for individuals:1. low living standards2. no education, no health care, no income, continue living in povertyDistinguish between direct and indirect taxes: Direct taxes: unavoidable, on incomeIndirect taxes: avoidable, on goods and services

Distinguish between progressive, regressive and proportional taxation: Progressive: the higher the income, the more tax is placed on the incomeRegressive: the higher the income, proportionally less income is paid to taxes (indirect taxes)Proportional: everyone pays the same proportion of their income to taxes.

List four different ways in which a government could promote equity:1. provide health care and education2. transfer payments3. proportional taxes4. expenditure on goods and servicesDefine ‘transfer payments’ and give examples:Direct payment of the government to those who need an increase in income; child care, pensions, disabled peopleEvaluate government policies to promote equity by looking at advantages & disadvantages: Progressive (direct) taxes: as income increases, income is taxed at a higher rate+ it will tax those who already have a solid income, and reduces the gap between rich and poor- it is a disincentive to work hardGovernment expenditure to directly provide socially desirable goods and services:+ gvt will use tax revenues received to subsidize or to provide health care etc to the poor to increase their standards of living- opportunity cost and taxesGovernment expenditure to subsidise health care, education and infrastructure:+ it will ensure that the poor have essential goods and services to lead to economic development- opportunity cost and taxesTransfer payments and providing a social safety net:+ helps those who need a better standard of living and the poor who don’t have an income- disincentive to find work and opportunity cost of the government to spend elsewhere and it needs taxes2.4 Fiscal PolicyList the three different sources of government revenue (ways governments earn revenues):1. direct taxes2. indirect taxes3. selling of state owned enterprisesList the three different types of government expenditures and be able to give examples:1. subsidies on health care and to firms to offer training2. transfer payments like pensions and unemployment benefits3. infrastructureDistinguish between a budget deficit and a balanced budget:

A budget deficit is where the government’s spending is greater than the revenue they have.

What is the opposite of a budget deficit? A budget surplus

Distinguish between a budget deficit and budget surplus:A budget deficit is where spending exceeds revenues and surplus is where revenues exceed spending

Explain the relationship between budget deficits / surpluses and the public (government) debt:Deficits: means the government has to borrow from other countries and thus their debt increases. When they have surplus they can pay off their debts.

Define ‘fiscal policy’: Fiscal policy is a demand side policy in which governments use taxes and government spending to alter AD.

Using an appropriate diagram, explain how expansionary fiscal policy can help an economy close a deflationary gap:

Increasing AD will shift the AD curve to the right towards the point of full employment.

The successfulness of fiscal policy in closing a deflationary or inflationary gap depends on the shape of the aggregate supply curve. Explain this statement: If the shape is perfectly elastic (like in the Keynesian’s case), and the AS curve shift to the right, it can still be below the full level of employment. If the shape is perfectly inelastic, like in the classics case, then when a deflationary gap closed up, it will move towards the full level of employment.

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Using an appropriate diagram, explain how contractionary fiscal policy can help an economy to close an inflationary gap:

Define ‘automatic stabilisers’:

Give two main examples of ‘automatic stabilisers’: 1.2.Fiscal policy is often associated with short-term demand management (impacting AD to stabilise the macro economy. Still fiscal policy could also promote long-term economic growth (increase potential output). List three different ways how this could happen:1.2.3. You need to be able to evaluate the effectiveness of fiscal policy. In general there are different advantages and disadvantages of the use of this kind of policy. Two major advantages are:1.2.However, there are also 5 factors which could limit the success of fiscal policy:1.2.3.4.5. 2.5 Monetary policyWhich two main roles do central banks have?1.2.Which two tools could central banks have to achieve macroeconomic objectives?1.

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2.Using a demand and supply of money diagram, explain how equilibrium interest rates are determined. In your answer outline the role of the central bank in influencing the supply.

Explain how changes in interest rates can influence the level of AD in an economy:

Using an appropriate diagram, describe the mechanism through which easy monetary policy can help an economy close a deflationary gap below:

Using an appropriate diagram, describe the mechanism through which tight monetary policy can help an economy close an inflationary gap below:

You need to be able to evaluate the effectiveness of monetary policy too. Three major advantages are:1.

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2.3.However, there are also 3 factors which could limit the success of such a policy:1.2.3.2.5 Supply-side policiesDefine ‘supply-side policy’:

Describe what is meant by the ‘institutional framework’ of an economy:

Illustrate the impact of a supply-side policy:

There are two types of supply-side policies:1.

2.

Give four examples of interventionist supply-side policies:1.

2.

3.

4.

Investment in human capital / new technology / infrastructure / industrial policies will have two impacts:

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short-term:

long-term:

Governments can use industrial policies to target specific industries. These policies include:1. tax cuts 2. tax allowances 3. subsidised lending

Market-based supply-side policies can be divided into three groups:1.

2.

3.

Give examples of policies which encourage competition:1.

2.

3.

4.

Give examples of policies which make the labour market more flexible:1.

2.

3.Incentive-related policies relate to factors which increase the incentive to work or invest.

Governments can influence this through the following taxes:

Using supply-side policies will have strengths and weaknesses. In general, what are the three main advantages of supply-side policies?1.

2.

3.

Which factors could limit the effectiveness of supply-side policies?1.

2.

3.

4.

GLOSSARY MOST ESSENTIAL TERMS

Circular flow of income - a simplified model of the economy that shows the flow of income through the economy and injection and leakages from this economy. Gross national product – the total money value of all final goods and services produced in an economy in one year, plus net property income from abroad (interest, rent, dividends and profit). Net national product – GNP [the total money value of all final goods and services produced in an economy in one year, plus net property income from abroad (interest, rent, dividends and profit)] minus depreciation (capital consumption). Nominal GDP - the total money value of all final goods and services produced in an economy in one year, not adjusted for inflation. Real GDP - the total money value of all final goods and services produced in an economy in one year, adjusted for inflation. Per capita GDP - the total money value of all final goods and services produced in an economy in one year per head of the population.   Economic growth - the (percentage) increase of the value of real output in an economy over time.  Usually measured as growth in real GDP. Economic development - it is a broad concept involving improvement in the overall standard of living, reduction in poverty, improved health and education, but also increased freedom and choice.Human development index [HDI] – a composite index that weights the life expectancy at birth, school enrolment rate/ literacy rate and GDP per capita [PPP US$]) in order to attempt to measure relative human development.

Aggregate demand - the total value of spending in an economy over a certain period of time consisting of consumption, domestic investment, government expenditure and net exports. Consumption - spending by households on consumer goods and services impacted by disposable income. Investment - the addition of capital stock to the economy or expenditure by firms on capital goods with the aim of increasing the production capacity or replacing worn out capital goods. Injection into the circular flow of income. Inflationary gap – situation where the total value of spending (aggregate demand) is greater than the full employment level of output, thus causing inflation and shortages in the economy. Deflationary gap - situation where total spending (aggregate demand) is less than the full employment level of output, thus causing unemployment and underuse of the production capacity (also less pressure on the price level to increase). Business cycle (trade cycle) – diagram illustrating fluctuations in the level of economic activity in an economy over time around the trend growth. These changes are assumed to be repetitive and to follow a pattern of different stages: slump (recession / depression), trough, upturn, recovery, boom, peak and recession, etc.   3.4 Demand-side policy – any government policy designed to influence the aggregate demand in the economy, thus affecting the average price level and real national output. Examples are fiscal policy, monetary policy and exchange rate manipulation. Fiscal policy – a demand-side policy using changes in government spending and/or direct taxation to achieve economic objectives relating to inflation and unemployment. Monetary policy - a demand-side policy using changes in the money supply or interest rates to achieve economic objectives relating to inflation and unemployment. Aggregate supply - the total value of domestic goods and services supplied by firms and the government, including consumer goods and capital goods.

Short run aggregate supply (SRAS) – total output at a given price level, in a given time period, assuming costs such as wage rates, oil prices and components remain constant, resulting in an increase / decrease of SRAS and thus a shift of the curve when there are changes in for example the costs of factors of production. Long run aggregate supply (LRAS) – the output possible using all the available resources in the economy and that can only be increased by improvements in the quantity and/or quality of factors of production. (could also be shown on a PPC). Supply-side policy – government policies designed to increase production capacity and thus illustrated as a shift of the long run aggregate supply curve to the right.

Unemployment - the number of people able and willing to work of working age without a job but who are actively seeking work. Unemployment rate – the percentage of the economically active population without a job. The number of unemployed workers expressed as a percentage of the total workforce. Underemployment – exists when workers are carrying out jobs for which they are over-qualified, i.e. they are not using their full skills and abilities or when workers are employed part-time, even though they are available for full time employment or when workers in a planned economy are undertaking jobs that would not exist in a free market. Full employment – exists when the number of jobs available in an economy is equal to or greater than the number of people actively seeking work. Structural unemployment –type of equilibrium unemployment that exists when in the long-term the pattern of demand and production methods change and there is a permanent fall in the demand for a particular type of labour.  There is a mismatch between skills and the jobs available. Frictional unemployment –type of equilibrium unemployment that exists when workers have left a job and are in between jobs and searching for another job. Seasonal unemployment –type of equilibrium unemployment that exists when people are out of work because their usual job is out of season, e.g. a ski instructor in the off-season. Demand deficient / cyclical unemployment – type of disequilibrium unemployment that exists when there is insufficient aggregate demand in the economy and wages do not fall to compensate for this (sticky downwards wages). Real wage unemployment – type of disequilibrium unemployment that exists when wages in the economy are held above the equilibrium wage rate, either by the government or by trade unions. Inflation - a sustained increase in the general or average level of prices and a fall in the value of money reducing purchasing power of fixed income and savings. Demand-pull inflation – type of inflation that is caused by increasing aggregate demand (relatively faster than AS could cope with) in an economy, i.e. illustrated as a shift of the AD curve to the right. Cost-push inflation - inflation that is caused by an increase in the costs of production in an economy, i.e. illustrated as a shift of the SRAS curve to the left. Deflation – situation in an economy where there is a persistent fall in the average level of prices. This may be caused by a larger production capacity or a fall in aggregate demand. Direct taxation – payment to the government imposed on people’s income or wealth, and on firms’ profits. (It is sometimes known as unavoidable tax) Indirect taxation - tax on expenditure added to the selling price of a good or service (e.g. VAT). (It is sometimes known as avoidable tax) Progressive taxation – a system of direct taxation where tax is levied at an increasing rate for successive bands of income.  The marginal tax rate is higher than the average tax rate. This way of taxing aims at reducing income differences. Regressive taxation – a system of taxation in which tax is levied at a decreasing average rate as income rises. This form of taxation takes a greater proportion of tax from the low-income

taxpayer than from the high-income taxpayer and will therefore increase the post-tax income differences.  Proportional taxation – a system of taxation in which tax is levied at a constant rate as income rises, Transfer payments – a payment received for which no good or service is exchanged, e.g. pension. Lorenz Curve - a curve showing which percentage of the population earns which percentage of the total income in the economy.  It is calculated in cumulative terms.  The further the curve is from the line of absolute equality (45 degree line), the more unequal is the distribution of income. Gini coefficient (HL only) – a ratio between the area between a Lorenz curve and the line of absolute equality to the total area under the line of equality. The higher the figure, the more unequal is the distribution as the Lorenz curve will be very close to the horizontal axis and thus be almost equal to the total area below the line of perfect equality.