Graphs tend to correlate high unemployment with
Low GDP growth
Recession definition
output is declining, recession is over once the economy begins to grow again.
What does Okun’s law measure?
Measures the correlation between unemployment and GDP growth through regression analysis.
Two main reasons why unemployment rate responds only partially to changes in economy’s growth rate:
- labour hoarding where firms find it profitable to keep workers on payroll even when demand is too low for them all got be fully utilised
- Some people who take jobs in an upswing were not previously unemployed, they were inactive, when firms advertise more vacancies, benefits from job search rise and out of labour force yutes join employment. So OUTPUT rises but unemployment rate does not fall.
What is Okun’s law?
Change in unemployment rate,t = Okuns coefficient(GDP growth - normal growth rate)
Can model as a regression line, and calculate r-squared to measure the fit.
Fall in output leads to
Rise in unemployment rate = fall in wellbeing
GDP definition
Total output of all producers in a country
Alternate measures of GDP
- spending - total spent by households, firms, gov and foreign on export
- Production - value added by each industry - value of all outputs - value of inputs at each production stage
- Income - sum of all incomes/ profits received and taxes received by government
Percentage change in GDP formula
Sum of (%change of each component x weight of GDP)
Shortcomings of GDP as a measure
- does not take into consideration the impact on the environment
- Does not tell us individual spending power - distinction from GDP per capita
- Flawed measure of living standards
Responses to household shocks
- self insurance: households which encounter high income randomly, will save so when luck is gone they have savings.
- Co insurance: households which have been fortunate during a period might help a household which is struggling
Self and co insurance reflect important aspects of household preferences:
- people prefer a smooth pattern of consumption - so they will self insure
- Households are not wholly selfish - willing to provide support to each other to smooth good or bad luck periods
Economy wide shocks
- co insurance is less effective if bad shock hits everyone.
- But some say community survival depends on less badly hit households help the worst hit households
After an economic shock impact on path model
- individual must make judgement on if it is temporary or permanent
- If shock is permanent, should adjust red line above, up or down to reflect level of consumption individual adopts, consistent with forecast income
- If shock is temporary, little will change, wont have much effect on lifetime consumption plan, as only small difference to lifetime income.
Why consumption smoothing is not always possible
- credit constrained
- Weakness of will - cant carry out plans
- Limited co-insurance - low family or welfare system aid
What is consumption smoothing
Financial strategy to maintain relatively stable level of consumption over time.
Difference on path model for consumption constrained households
They cannot borrow money after hearing of a pay rise, and thus will have significantly lower until they receive pay rise
Impact on utility of credit constraints
If can borrow after shock, instead of y’ now, can consume at c’ and c’ later as debt has to be repaid, but this is good as it takes you to the highest possible indifference curve.
Being limited or credit excluded limits ur utility.
Impact on path model of weakness of will
- receive news about fall in future incomes, so should plan to save money to accommodate
- weakness of will means not saving, and thus can not smooth consumption
Volatility of investment
low expectations of future demand - low capacity utilisation and low profits - no incentive to incest or hire = little spending by firms or workers - cycle
Relationship between business confidence and investment
Very strong correlation
GDP deflation
Ratio of nominal GDP to real GDP
- takes into account prices of ALL g+s produced within borders of a country, regardless of where they end up
While CPI only looks at what’s been consumed by households, regardless of origin
What’s unit 13 about
Analysing key ideas on a National scale
Value added
Shirt sold for £100
- shirt industry buys cloth for £80
- who buys cotton from raw cotton industry for £50
- final GDP of this economy is £00 due to value of final sale.
- 50, 30, 20 are all value added = £100 as well
