RI H1 Economics Lecture Notes 6 Factors Affecting Standard of Living

2019 Y6 H1 Economics Macroeconomics 16 RAFFLES INSTITUTION Year 6 H1 Economics 2019 Factors Affecting Standard Of Living Outline of Contents 1 Economic growth 1.1 Definition & types of economic growth 1.2 Benefits from economic growth 1.3 Costs of economic growth 1.4 Causes of weak/ negative economic growth 1.5 Consequences of weak/ negative economic growth 2 Inflation 2.1 Definition 2.2 Terms associated with inflation 2.3 Causes of inflation 2.3.1 Demand-pull inflation 2.3.2 Cost-push inflation 2.4 Benefits of Low inflation 2.5 Consequences of inflation 3 Unemployment 3.1 Definition 3.2 Unemployment rate 3.3 Causes (types) of unemployment 3.3.1 Frictional unemployment 3.3.2 Structural unemployment 3.3.3 Cyclical unemployment 3.3.4 Technological unemployment 3.3.5 Seasonal unemployment 3.4 Natural rate of unemployment 3.5 Consequences of unemployment Appendix: Lorenz Curve Reference Mankiw, Gregory N., Quah, Euston, & Wilson, Peter, Principles of Economics: An Asian Edition, Cengage Learning. Lecture Objectives At the end of the lecture series, you should be able to: Explain the meaning of undesirable rates of economic growth, high inflation, high unemployment and persistent or large balance of payments deficits. Analyse the causes and consequences of the macroeconomic problems. @dream

2019 Y6 H1 Economics Macroeconomics 17 OVERVIEW Key Economic Goals Economists identify the key goals that an economy or a government should seek to achieve under two major categories: Microeconomic Goals 1. Efficiency in resource allocation Scarce resources should be allocated with a view to attain economic efficiency in the country where the right mix of goods and services (allocative efficiency) are produced at the lowest possible average cost of production (productive efficiency). 2. Equitable income distribution Income distribution among the people should not be so unequal that many people cannot afford basic needs of shelter, food education and health care. Macroeconomic Goal: a high standard of living from 1. Economic growth This aims to achieve real increases in the output of goods and services. Ceteris paribus, economic growth ensures that on average, a resident can enjoy a higher standard of living, enjoy more choices and improve its well-being. 2. Full employment of resources The economy should aim to achieve full employment to ensure that scarce resources are fully utilized. 3. Low inflation Economic growth should be coupled with low inflation to ensure economic competitiveness, sustained economic growth and a higher quality of life. @dream

2019 Y6 H1 Economics Macroeconomics 18 1 ECONOMIC GROWTH 1.1 Definition AND TYPES OF ECONOMIC GROWTH Economic growth is defined as an increase in Gross Domestic Product. In order to achieve sustained economic growth, both actual and potential growth are required. It can be achieved by an increase in aggregate demand and/or aggregate supply. Actual growth is the increase in national output actually produced for a given period of time, commonly measured by the percentage increase in real GDP. Its major determinant is growth in aggregate demand. A rise in aggregate demand, say from a rise in consumer confidence, which increases consumption expenditure among households, will create shortages which stimulates firms to increase output and reduces the slack in the economy. This type of growth can be represented by a shift of the aggregate demand (AD) curve to the right as illustrated in Figure 1.1(a) or a movement of a point outwards from within the Production Possibility Curve (PPC) as illustrated in Figure 1.1(b). In Figure 1.1(a), real national income increases from Y1 to Y2 when AD increases, as represented by the shift in AD from AD1 to AD2. In Figure 1.1(b), more capital and consumer goods are being produced when the economy moves from point A to point B on the PPC. Actual growth can also result from an increase in aggregate supply due to a fall in production costs. This is represented by a downward shift of the AS curve as shown in Figure 1.1(c). In Figure 1.1(c), real national income increases from Y1 to Y2 when aggregate supply increases, as represented by the downward shift of AS1 to AS2 due to a fall in cost of production, mainly due to lower cost of labour or oil prices that encourages firms to expand output. Figure 1.1(b): Actual growth Figure 1.1(c): Actual growth due to an increase in AS Figure 1.1(a): Actual growth due to an increase in AD A Consumer Goods Capital Goods B @dream

2019 Y6 H1 Economics Macroeconomics 19 In contrast, potential growth is the increase in the productive capacity of the economy for a given period of time. An increase in the quantity of resources and/or an increase in efficiency or improvement in the quality of factors of production will contribute to potential economic growth. In other words, the determinant of potential growth is an increase in aggregate supply from increases or improvements in natural resources, capital (both physical and human) and technology. This type of growth can be represented by a shift of the aggregate supply (AS) curve to the right as illustrated in Figure 1.1(d) or an outward shift of the PPC as illustrated in Figure 1.1(e). A rapid rise in aggregate demand is not enough to ensure a continuing high level of economic growth over a number of years, without a simultaneous expansion of the productive capacity of the economy. As such, further increases in actual output will eventually diminish without an expansion of potential output. , Actual output will grow at the rate of potential output when labour and other resources are fully utilised as the economy reaches full employment or operates at full capacity. Therefore, in order to achieve sustained economic growth, actual growth must be accompanied by potential growth as shown in Figure 1.1(f), with rightward shifts of both the AD and AS curves. Figure 1.1(e): Potential growth Figure 1.1(d): Potential growth due to an increase in AS @dream

2019 Y6 H1 Economics Macroeconomics 20 WHAT IS SUSTAINABLE GROWTH? Sustainable growth refers to a rate of growth that can be maintained without creating other significant economic problems (such as depleted resources and environmental problems), particularly for future generations. It implies a positive and stable growth rate over an extended period of time. The Earth that supports the "sources" and "sinks" of our economic activities has not grown any larger since it was born 4.6 billion years ago. In other words, there is clearly a limit to its size. It is finite, and as such any economic activities that extract resources from this finite pool, and, to the extent that the waste is being absorbed by the Earth, cannot grow forever. This is because the Earth's sources and sinks are also finite. If the economy expands, at some point it is inevitable that we will encounter the Earth's limits. Over the past 50 years, the global economy grew by a factor of five. Accompanying that growth, world food production increased by a factor of about 2.5, the amount of water used by a factor of two, and the amount of timber logged for the production of pulp and paper increased by a factor of three. Presently, our economy is exceeding the limits that can be supported by the Earth and yet, we are still trying to produce beyond its capacity. Such growth is unsustainable. As one economist commented that “anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist”. Unsustainable economic growth has implications on standard of living. It reduces the ability of future generations to consum