DP Economics SL 3.3 Macroeconomic Objectives

DP Economics SL 3.3 Macroeconomic Objectives - Full notes

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DP Economics SL | 3.3 Macroeconomic Objectives

DP ECONOMICS · UNIT 3: MACROECONOMICS

3.3

Macroeconomic Objectives

Full notes for SL · IB-style

Contents

1	Economic growth
2	Low unemployment: measurement and types
3	The costs of unemployment
4	Low and stable inflation: measurement
5	Causes and costs of inflation
6	Deflation and disinflation
7	Equitable distribution of income and sustainable debt
8	Economic growth: calculations
9	Consequences of economic growth
10	Unemployment: measurement
11	Types of unemployment
12	Costs of unemployment
13	Inflation: measurement with a CPI
14	Limitations of CPI
15	Costs of inflation
16	Deflation
17	Real versus nominal values
18	Mixed review: worked problems
19	Additional exam-style practice
20	Conflicts between objectives
21	Common misconceptions and links
22	Exam-style question with markscheme
23	Check your understanding
24	Summary and topic map

These are full teaching notes. Read each section in order, try the Think about it question before you read on, and do every Quick check before moving to the next section.

Before you start

Rate yourself on each statement now, and again after you've worked through the notes. Shade R (not yet), A (getting there) or G (confident).

I can…	R	A	G
explain economic growth and its benefits and costs
calculate the unemployment rate and explain the difficulties of measuring it
explain cyclical, structural, frictional and seasonal unemployment and the natural rate
explain the economic and social costs of unemployment
construct and use a consumer price index and explain its limitations
explain demand-pull and cost-push inflation and their costs
explain the problems of deflation
explain why equity and sustainable debt are objectives

This booklet covers the SL syllabus for 3.3. The HL-only Phillips curve analysis is not included.

Guiding questions

What makes an economy 'healthy'? Why is unemployment so costly, for individuals and for society? Is inflation always bad, and is falling prices always good?

How this topic is examined

3.3 is the heart of macroeconomics. Paper 2 regularly asks you to calculate unemployment rates, price indices and inflation rates from data, and to explain the type of unemployment or inflation described in a text. Paper 1 essays ask you to explain the causes and consequences of unemployment or inflation and to evaluate policies to reduce them.

Precision with terms (cyclical vs structural, demand-pull vs cost-push, deflation vs disinflation) earns the definition and analysis marks.

Command term	What the examiner wants
Define	the precise meaning, ideally in the IB wording, in one or two sentences
Draw / Sketch	a fully labelled diagram with every axis, curve, equilibrium and change labelled
Explain	a causal chain linked to economic theory, usually supported by a diagram
Analyse	break a situation into its parts and trace the effects of each
Evaluate / Discuss	weigh up arguments, question assumptions and reach a justified conclusion using real-world examples
Calculate	construct index numbers and percentage changes step by step

How to use these notes

Each section teaches one part of the syllabus in full. You'll see these boxes throughout; each has one job:

Box	What it's for
Think about it	a question to get you thinking before a section; the answer comes in the section
Key point	the one idea you must not forget
Common mistake	an error examiners see every year, and how to avoid it
In the real world	where the economics shows up outside the classroom
Try this	something quick you can do yourself to test the idea
Worked example	full solutions with IB-style marks (M1 method, A1 answer, R1 reasoning)
Quick check	short questions to test yourself at the end of each section

1 Economic growth

Growth is an increase in real output over time.

Think about it

India's real GDP has grown by around 6% to 7% a year in many recent years. Roughly how long would it take for the economy to double in size at that rate?

Economic growth is an increase in real GDP over time. It is usually measured as the annual percentage change in real GDP. Short-term growth (actual growth) occurs when unused resources are brought into production, moving the economy towards its PPC or closing a negative output gap. Long-term growth (potential growth) occurs when productive capacity increases, shifting the PPC and LRAS outward.

A useful rule of thumb is the 'rule of 70': an economy growing at x% a year doubles in size in about 70 ÷ x years. At 7% growth, real GDP doubles in about 10 years; at 2%, it takes about 35 years.

Benefits of growth	Costs of growth
higher incomes and living standards	environmental damage and resource depletion
more jobs; lower unemployment	inequality may rise if gains are uneven
more tax revenue for public services	inflation if growth is too fast (positive output gap)
less absolute poverty	loss of leisure, stress, urban congestion

Quick check

1. Distinguish short-term and long-term growth.

2. Roughly how long does an economy growing at 5% take to double?

Answers: 1. short-term: using spare capacity; long-term: capacity increases 2. about 14 years

2 Low unemployment: measurement and types

Not all unemployment has the same cause, so not all unemployment has the same cure.

2.1 Measuring unemployment

A person is unemployed if they are of working age, without work, actively seeking work and available to start. The labour force is everyone of working age who is either employed or unemployed. People not seeking work (students, retirees, full-time carers) are outside the labour force.

Unemployment rate = number unemployed ÷ labour force × 100

WORKED EXAMPLE 1 Unemployment rate

A country has 30 million employed and 2.4 million unemployed. Calculate the unemployment rate.

Solution

Labour force = 30 + 2.4 = 32.4 millionM1

Rate = 2.4 ÷ 32.4 × 100 = 7.4%A1

Unemployment figures can be misleading. Hidden unemployment includes discouraged workers who have stopped looking for work and so are not counted, and underemployment: people working part-time who want full-time work, or highly skilled workers in low-skilled jobs. The official rate also hides regional, age, gender and ethnic differences: youth unemployment is often two or three times the national average.

2.2 Types and causes of unemployment

Cyclical (demand-deficient) unemployment is caused by a fall in aggregate demand in a recession. Firms produce less and need fewer workers. It rises in downturns and falls in recoveries.

Structural unemployment is caused by a mismatch between the skills or location of workers and the available jobs. It results from long-term changes in the economy: the decline of industries (coal mining, steelmaking), new technology replacing workers, or changing patterns of demand. It can last for years, especially in regions dependent on a declining industry.

Frictional unemployment is the short-term unemployment of people moving between jobs or entering the labour force, while they search for a suitable job. Some frictional unemployment is inevitable and even healthy.

Seasonal unemployment occurs because demand for some workers varies at different times of year: tourism, agriculture, construction in cold climates.

The natural rate of unemployment (NRU) is the rate when the economy is at full employment output: it includes frictional and structural (and seasonal) unemployment, but not cyclical. 'Full employment' does not mean zero unemployment.

Type	Cause	Main policy response
Cyclical	fall in AD	expansionary fiscal or monetary policy
Structural	skills or location mismatch	education, training, mobility incentives
Frictional	searching between jobs	better job information, job centres
Seasonal	seasonal variation in demand	diversify local economy; retraining

Figure 1. Cyclical unemployment: a fall in AD reduces real output below Yf, so firms need fewer workers.

Common mistake

Calling every job loss 'structural'. If the job is lost because of a recession and will return when demand recovers, it is cyclical. Structural unemployment comes from long-term change in the economy.

Quick check

1. State the formula for the unemployment rate.

2. Who are discouraged workers?

3. What causes structural unemployment?

4. What does the natural rate include?

Answers: 1. unemployed ÷ labour force × 100 2. people who have given up looking for work 3. skills or location mismatch from long-term change 4. frictional and structural unemployment

3 The costs of unemployment

Unemployment wastes resources and harms people and society.

Economic costs. Unemployed workers produce nothing, so the economy operates inside its PPC: output is lost forever. Households lose income, so consumption falls. The government loses tax revenue and must spend more on unemployment benefits, increasing its budget deficit. Long spells of unemployment erode workers' skills (hysteresis), so they find it harder to get a job later.

Personal and social costs. Unemployment is linked to poverty, debt, stress, depression and poor health. It can lead to family breakdown, crime and social unrest, especially when concentrated among young people or in particular regions. Inequality tends to rise.

Quick check

1. Name two economic costs of unemployment.

2. What is hysteresis?

Answers: 1. lost output, lower tax revenue, higher benefit spending 2. long unemployment erodes skills and employability

4 Low and stable inflation: measurement

Inflation is a rise in the general price level, measured with a price index.

Inflation is a sustained increase in the general (average) price level over time. It reduces the purchasing power of money: each dollar buys fewer goods. Most central banks target low and stable inflation, often about 2% a year.

Inflation is measured with a consumer price index (CPI). Statisticians select a representative basket of goods and services bought by a typical household, record their prices regularly, and calculate the cost of the basket. Each item is weighted by its share of household spending: housing and food carry more weight than matches. The cost of the basket in a chosen base year is set to 100, and later years are expressed relative to it.

Price index = cost of basket in year ÷ cost in base year × 100 Inflation rate = (index this year − index last year) ÷ index last year × 100

WORKED EXAMPLE 2 Constructing a price index

A basket costs $500 in the base year, $520 in year 2 and $546 in year 3. Calculate the price index for each year and the inflation rate in year 3.

Solution

Base year index = 100A1

Year 2: 520 ÷ 500 × 100 = 104; year 3: 546 ÷ 500 × 100 = 109.2A1 A1

Inflation in year 3 = (109.2 − 104) ÷ 104 × 100 = 5%M1 A1

WORKED EXAMPLE 3 A weighted index

A household spends 50% on food, 30% on housing and 20% on transport. Prices rise by 4%, 10% and −5% respectively. Calculate the weighted inflation rate.

Solution

0.5 × 4 + 0.3 × 10 + 0.2 × (−5)M1

= 2 + 3 − 1 = 4%A1

Limitations of the CPI. The basket reflects an average household, so it may not represent the elderly, the poor or rural households. It is slow to include new products. It may overstate inflation because it does not fully reflect quality improvements or consumers switching to cheaper substitutes. Weights become out of date as spending patterns change. Many countries also publish core inflation, which excludes volatile food and energy prices.

Quick check

1. Define inflation.

2. Why are items in the CPI weighted?

3. Give two limitations of the CPI.

Answers: 1. a sustained rise in the general price level 2. to reflect their share of household spending 3. unrepresentative basket, quality changes, new products, substitution

5 Causes and costs of inflation

Inflation comes from too much demand or rising costs.

5.1 Causes

Demand-pull inflation occurs when AD grows faster than the economy's productive capacity: 'too much money chasing too few goods'. As the economy approaches full employment, firms cannot increase output fast enough, so prices rise. Causes include rapid growth in consumer spending, expansionary fiscal or monetary policy, and booming exports.

Cost-push inflation occurs when firms' costs rise and they pass the increases on as higher prices. Causes include rising wages not matched by productivity, higher prices for imported raw materials and energy, a depreciation of the currency, and higher indirect taxes. SRAS shifts left, raising the price level and reducing output.

The two can interact in a wage-price spiral: rising prices lead workers to demand higher wages, which raise costs and prices further.

Figure 2. Cost-push inflation: SRAS shifts left, raising the price level and reducing output.

5.2 Costs of inflation

Loss of purchasing power, especially for people on fixed incomes such as pensioners, and for those whose wages rise more slowly than prices.

Redistribution. Unexpected inflation reduces the real value of savings and debts, so savers lose and borrowers gain.

Uncertainty. High and unpredictable inflation makes planning difficult, discouraging investment and long-term contracts.

Loss of international competitiveness. If domestic inflation is higher than abroad, exports become dearer and imports cheaper, worsening the current account.

Menu and shoe-leather costs. Firms must change prices frequently; people spend time managing their money to avoid losses.

Low, stable inflation is not harmful and may even help: it gives some flexibility to cut real wages and avoids the risks of deflation.

In the real world

Zimbabwe experienced hyperinflation in 2008, with monthly inflation estimated in the billions of percent. Prices doubled more than once a day, and the currency was eventually abandoned.

Quick check

1. Distinguish demand-pull and cost-push inflation.

2. Who gains from unexpected inflation?

3. Why does inflation discourage investment?

Answers: 1. demand-pull: AD grows faster than capacity; cost-push: rising costs shift SRAS left 2. borrowers 3. uncertainty about future costs and prices

6 Deflation and disinflation

Falling prices can be more dangerous than rising ones.

Deflation is a sustained fall in the general price level: the inflation rate is negative. Disinflation is a fall in the rate of inflation: prices are still rising, but more slowly (for example from 6% to 3%).

Bad (malign) deflation is caused by a fall in AD. It is dangerous because consumers delay purchases, expecting lower prices; firms cut output and jobs; the real value of debt rises, so borrowers cut spending; and profits fall. This can create a deflationary spiral of falling demand, prices and output. Central banks find it hard to respond because interest rates cannot easily go below zero.

Good (benign) deflation is caused by an increase in SRAS, such as technological progress lowering costs. It comes with rising output and is much less harmful.

Japan experienced long periods of mild deflation from the late 1990s, with weak growth and very low interest rates.

Common mistake

Calling a fall in inflation from 5% to 2% 'deflation'. Prices are still rising: that is disinflation.

Quick check

1. Distinguish deflation and disinflation.

2. Why can deflation cause a spiral?

Answers: 1. deflation: falling prices; disinflation: prices rising more slowly 2. people delay spending, firms cut output, real debt rises

7 Equitable distribution of income and sustainable debt

Governments also aim for fairness and for public finances that can last.

An equitable distribution of income is a macroeconomic objective because high inequality can reduce well-being, social cohesion and even growth. It is measured with Lorenz curves and the Gini coefficient (3.4).

A sustainable level of government debt means that the government can meet its debt payments without needing to make drastic cuts or tax rises, or defaulting. High debt means high interest payments, which have an opportunity cost, and can raise borrowing costs if lenders lose confidence. Debt is usually measured as a percentage of GDP: what matters is whether the debt can be serviced from the economy's income.

WORKED EXAMPLE 4 Debt ratio

Government debt is $900 bn and GDP is $1 500 bn. Calculate the debt-to-GDP ratio.

Solution

900 ÷ 1 500 × 100 = 60%A1

Governments face conflicts between objectives. Expansionary policies to reduce unemployment may raise inflation; policies to reduce inflation may raise unemployment; rapid growth may harm the environment and worsen the current account; and reducing debt may require spending cuts that slow growth.

8 Economic growth: calculations

Percentage change in real GDP.

Economic growth rate = (real GDP this year − real GDP last year)/real GDP last year × 100. Positive growth with a falling rate is still growth (output increasing more slowly).

WORKED EXAMPLE 5 Growth (standard)

Real GDP rises from $640 bn to $662 bn. Calculate the growth rate.

Solution

22/640 × 100M1

= 3.4%A1

Common mistake

Saying the economy is shrinking when growth falls from 4% to 2%. Output is still rising, just more slowly.

Quick check

1. Real GDP growth is 2%, 1.5% and 0.5% in three years. Is output falling?

Answers: 1. no: output is rising each year, but more slowly

9 Consequences of economic growth

Benefits and costs.

Benefits: higher incomes and living standards, more tax revenue, lower unemployment. Costs: inflation if too rapid, environmental damage, inequality, resource depletion, current account deficits.

WORKED EXAMPLE 6 Evaluation (exam level)

Evaluate the consequences of rapid economic growth.

Solution

Higher living standards and employment; more tax revenueR1

Environmental costs, inequality, inflation riskR1

10 Unemployment: measurement

The unemployment rate.

Unemployment rate = number unemployed/labour force × 100. The labour force includes employed and unemployed people who are actively seeking work. Measurement problems: hidden unemployment (discouraged workers), underemployment, informal work.

WORKED EXAMPLE 7 Rate (standard)

A country has 28 million employed and 2 million unemployed. Calculate the unemployment rate.

Solution

2/30 × 100M1

= 6.7%A1

Quick check

1. Explain hidden unemployment.

Answers: 1. people who want work but have stopped looking are not counted

11 Types of unemployment

Causes and remedies.

Type	Cause	Remedy
frictional	between jobs	better job information
structural	mismatch of skills or location	retraining, mobility support
seasonal	seasonal demand	diversification
cyclical (demand-deficient)	fall in AD (recession)	expansionary policy

12 Costs of unemployment

Economic and social.

Costs include lost output (operating inside the PPC), lower tax revenue, higher benefit spending, loss of skills (hysteresis), poverty, mental health problems, and social tensions.

WORKED EXAMPLE 8 Hysteresis (exam level)

Explain how long-term unemployment can reduce potential output.

Solution

Workers lose skills and motivationR1

Become less employable; LRAS fallsR1

13 Inflation: measurement with a CPI

Weighted price index.

The consumer price index tracks the price of a representative basket of goods, weighted by their share of household spending. Inflation rate = (CPI this year − CPI last year)/CPI last year × 100.

Item	Weight	Price index (year 2)
food	0.3	110
housing	0.4	105
transport	0.2	120
other	0.1	100

WORKED EXAMPLE 9 Weighted index (exam level)

Calculate the weighted price index for year 2 (base year 100) and the inflation rate.

Solution

0.3(110) + 0.4(105) + 0.2(120) + 0.1(100)M1

= 33 + 42 + 24 + 10 = 109: inflation 9%A1 A1

14 Limitations of CPI

Imperfect measure.

The CPI may not reflect individual households' spending, may lag changes in consumption patterns, struggles to account for quality improvements and new products, and may not capture substitution when prices change.

Quick check

1. Why might pensioners experience a different inflation rate from the CPI?

Answers: 1. their spending patterns differ (more on heating, healthcare)

15 Costs of inflation

Who loses?

High inflation reduces purchasing power (especially fixed incomes), creates uncertainty that discourages investment, redistributes from savers and lenders to borrowers, reduces export competitiveness, and creates menu and shoe-leather costs.

WORKED EXAMPLE 10 Redistribution (standard)

Explain why unexpected inflation benefits borrowers.

Solution

The real value of debt fallsR1

Repayments are worth less in real termsR1

16 Deflation

Falling prices.

Deflation (a sustained fall in the price level) can be good (from productivity growth) or bad (from falling AD). Bad deflation leads to delayed spending, higher real debt burdens and falling profits, possibly a deflationary spiral.

In the real world

Japan experienced long periods of mild deflation from the late 1990s to the 2010s, associated with weak demand and slow growth.

Quick check

1. Why might consumers delay purchases during deflation?

Answers: 1. they expect prices to be lower in future

17 Real versus nominal values

Adjusting for inflation.

Real wage growth ≈ nominal wage growth − inflation. Real interest rate ≈ nominal interest rate − inflation.

WORKED EXAMPLE 11 Real wages (standard)

Nominal wages rise 4% while inflation is 6%. What happens to real wages?

Solution

4 − 6 = −2%: real wages fallA1

18 Mixed review: worked problems

Bringing the ideas together.

WORKED EXAMPLE 12 Mixed problem (exam level)

CPI rises from 120 to 126. Nominal wages rise from $500 to $520 a week. Calculate inflation and the change in real wages.

Solution

Inflation = 5%A1

Nominal wage growth = 4%: real wages fall about 1%M1 A1

19 Additional exam-style practice

Paper 1 and Paper 3.

WORKED EXAMPLE 13 Paper 1 part (b) (exam level)

Evaluate the view that low unemployment should be the government's main macroeconomic objective. [15]

Solution

Costs of unemployment; benefits of low unemploymentR1 R1

Conflicts with inflation (Phillips curve), sustainabilityR1

Other objectives; judgementR1 R1

20 Conflicts between objectives

Trade-offs.

Rapid growth may cause inflation and current account deficits; low unemployment may conflict with low inflation; growth may conflict with environmental sustainability and equity. Governments must prioritize.

Quick check

1. Explain one conflict between macroeconomic objectives.

Answers: 1. low unemployment vs low inflation (demand-pull pressure)

21 Common misconceptions and links

Students often think…	Actually…
full employment means zero unemployment	it means unemployment at the natural rate
deflation means falling inflation	it means falling prices; falling inflation is disinflation
all inflation is caused by demand	cost-push inflation comes from rising costs
every job loss is structural	recession job losses are cyclical

How 3.3 connects to the rest of the course

Topic	Connection
3.1 Measuring activity	real GDP and the business cycle
3.2 AD/AS	causes of unemployment and inflation
3.4 Inequality	equitable distribution
3.5 to 3.7 Policies	how governments pursue the objectives

22 Exam-style question with markscheme

Try this under exam conditions (about 18 minutes) before reading the markscheme.

Figure 3. Unemployment and inflation in an economy.

Text A. Unemployment jumped in 2020 when the pandemic hit. In 2022 inflation reached 8% as energy and food prices soared after a war disrupted supplies, while consumer spending recovered strongly.

(a) The labour force is 32 million. Calculate the number unemployed in 2020. [2]

(b) Explain the type of unemployment that most likely increased in 2020. [3]

(d) Explain one cost of high inflation. [2]

Markscheme

Part	Answer	Marks
(a)	8.1% × 32 m	M1
	= 2.59 million	A1
(b)	cyclical (demand-deficient)	A1
	AD fell sharply in the pandemic	R1
	firms cut output and jobs	R1
(c)	cost-push: energy and food prices rose	R1
	explanation (SRAS left)	R1
	demand-pull: strong recovery in spending	R1
	explanation (AD right)	R1
(d)	e.g. loss of purchasing power for fixed incomes	A1
	explanation	R1

Examiner's comments. In (c), the best answers separated a cost-push cause and a demand-pull cause from the text.

23 Check your understanding

Section A: multiple choice

1. The unemployment rate is

A. unemployed as a percentage of the labour force B. unemployed as a percentage of population C. the number of jobs D. people not working

2. Cyclical unemployment is caused by

A. changes in the structure of industry B. people moving between jobs C. a fall in aggregate demand D. seasonal factors

3. Structural unemployment results from

A. a fall in AD B. a mismatch between skills and jobs C. people changing jobs D. the weather

4. Inflation is

A. a rise in one price B. a fall in prices C. an increase in GDP D. a sustained increase in the general price level

5. Deflation is

A. a fall in the inflation rate B. a sustained fall in the general price level C. a recession D. a fall in GDP

6. A price index rises from 120 to 126. The inflation rate is

A. 5% B. 6% C. 4.8% D. 126%

7. Which group loses from unexpected inflation?

A. borrowers B. property owners C. firms with debt D. savers with fixed-interest deposits

8. Cost-push inflation results from

A. a rightward shift of AD B. a rightward shift of LRAS C. a leftward shift of SRAS D. lower costs

Section B: structured

9. Distinguish between cyclical and structural unemployment, with examples. [4]

10. A basket costs $800, $840 and $882 in three years. Calculate the inflation rate in years 2 and 3. [3]

11. Explain why deflation can be harmful. [4]

12. Explain two costs of unemployment. [4]

Answers

1. A 2. C 3. B 4. D 5. B 6. A 7. D 8. C

9. Cyclical: fall in AD (recession job losses); structural: skills mismatch (decline of coal mining).

10. Index 100, 105, 110.25; inflation 5% and 5%.

11. Delayed spending, rising real debt, falling profits and jobs, deflationary spiral.

12. Lost output; lower tax revenue / higher benefits; personal and social costs.

24 Summary and topic map

Idea	Remember
Growth	rise in real GDP; benefits and costs
Unemployment rate	unemployed ÷ labour force × 100
Types	cyclical, structural, frictional, seasonal; NRU
CPI	weighted basket; base year = 100
Inflation causes	demand-pull (AD), cost-push (SRAS)
Inflation costs	purchasing power, redistribution, uncertainty, competitiveness
Deflation	falling prices; spiral risk
Other objectives	equity; sustainable debt

Before the exam, make sure you…

•calculate rates using the labour force, not the population
•match each type of unemployment to a cause and a policy
•build price indices step by step
•separate deflation from disinflation
•explain conflicts between objectives

Macroeconomic Objectives on one page

Cover this page with a sheet of paper and try to rebuild it from memory. Whatever you can't recall is what to revise next.

Figure 4. Topic map for Macroeconomic Objectives.

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