Standard of living [SOL] → the quality of life enjoyed by individuals in a country, measured in ...

1. Types of economic growth (Actual, Potential, Sustainable, Inclusive) Economic growth: increase in G&S (quantitatively and/or qualitatively) that an economy produces - Occurs when the economy produces more G&S using its existing resources - If the growth rate of real GDP is still positive → Real GDP is increasing at a smaller rate & do not mean its falling (eg. 14.5% → 4.5%)

1.1. 1. ACTUAL economic growth Refers to an increase in output level or RNY over a period of time - NO change in productive capacity: no change in LRAS & no shift in PPC itself - Can be illustrated using 3 models: a. PPC. b. AD-AS c. Circular flow of income a. PPC - Movement of point towards the boundary of the PPC - Represents an increase in goods produced hence economic growth - Happens when there is increase employment of resources (same amt of resources available) b. AD-AS (increase in AD or AS) - If the country is not at full employment (verticle line), an increase in AD leads to an increase in RNY hence actual economic growth - Cost of production decrease → Increase in SRAS also leads to an increase in RNY hence actual economic growth Multiplier effect (AD-AS) - The initial investment of $100M by firms leads to an increase in AD from “I” component → increase in AD & RNY → firms must hire more labor for production → households to earn more (save some and spend some) and consume more due to higher income → further rounds of increased AD through “C” component → RNY would increase more than proportionately to the initial increase in “I” → country experiences stronger economic growth through multiplier - Successive increase in income become smaller and smaller in each round of the multiplier due to leakages from savings & tax. Hence, the process stops when total withdrawals from the economy are equal to the initial injection. - The lesser people save (the more spent) → the higher the size of multiplier → eventual increase in RNY is higher

1.2. 2. POTENTIAL economic growth The rate at which the economy could grow without causing inflation over a period of time - Refers to an improvement in productive capacity hence potential output given all its resources & technology - Dependant on LRAS factors 1. Quantity → capital, labor, land, entrepreneurship. (a country can produce or import in more capital goods for future production) 2. Quality → productivity of labour can be increased with better education 3. Technology → productivity of capital can be increased by tech improvements - Factors can be influenced by government & firms. (eg. to incentivize firms to train their workers, govt may provide training subsidies → increase QUALITY) - Can be illustrated using the a. PPC or b. AD-AS. Both illustrate that the economy is now capable of producing a higher level of potential output a. ppc - An outward shift of the PPC represents an increase in productive capacity - Have potential to produce more consumer goods and capital goods - Hence, potential economic growth b. AD-AS (Increase in LRAS) - Rightward shift of LRAS represents an increase in productive capacity - Results in an increase in full employment of RNY - Hence potential economic growth

1.3. 3. SUSTAINABLE economic growth Indicates a rate of growth that can be maintained without causing other significant economic problems (depleted resources & environmental problems) - A positive & stable economic growth over an extended period of time → allowing the population to enjoy a continuous increase in SOL - Must achieve potential growth to enable continuous actual growth, hence able to continuously produce more G&S, without creating economic issues Depleted resources → more scarce → firms compete for whatever resources left → COP increases → pass on cost to consumers → INFLATION 4. INCLUSIVE economic growth (BOTH broad-base & employment opportunities) Rate of economic growth that is broad-based across economic sectors & creates productive employment opportunities for the majority of the population - Implies economic growth that takes income distribution into account AND does not contribute to worsening income inequality

2. Stagflation - Economy faces BOTH 1. Raising SRAS & 2. Raising AD. - There is an increase in the pressure of rising cost and the weakening in DD for G&S. - Raising GPL & lower RNY

2.1. Consequences of high inflation

2.1.1. 1. -ve effect on production and investments (producers/firms) ● High inflation raises production cost (workers DD for a higher wage) → falling profits → biz shutdown / relocate ● Inflation rate > interest rate from savings → discourage savings due to fall in future value of money → firms face with higher cost of borrowing → fall in “I” 2. Lower living standards (consumers/household) ● High inflation cases slowdown in economic growth and job loss(biz shutdown) → fall in household purchasing power → fall in SOL ● Group that is impacted most: fixed wages 3. Redistributive effects (consumer/household) ● Inflation has regressive effects on lower & fixed income families ● Workers with weak bargaining power → fail to get wage increment to compensate for price increase → decrease in real wage & PP ● Lenders lose out to borrowers → when debts are repaid, their real value will be less than the initial loans made 4. Economic growth and unemployment (government) ● High inflation lowers profits & creates uncertainties among households and firms → fall in C I (X-M) → fall in AD → fall in real GDP ● Erodes the country’s export competitiveness & makes purchasing imports from other countries more attractive → X drop, M rise ● Cause slowdown in economic growth & job losses → fall in PP & C ● Investors will not want to invest in counties with high inflation → fall in I 5. Depreciation of currency (government) ● High inflation relative to other countries result in reduction of value of its domestic currency ● It weakens SG export DD as price of exports more expensive to foreigners → good become less competitive → DD for SG exports fall → less SGD in demand for FOREX → weakening SGD value → depreciation of SGD ● Households and firms in SG find foreign imports relatively cheaper → increase in SS of SGD into FOREX → weakening SGD value ● Hence a country with high inflation exp fall in DD & rise in SS of its currency → fall in value of currency

2.2. Currency depreciation leads to

2.2.1. - Domestic dirms that rely on imported inputs will face rising COP while consumers find imported G&S more expensive - Depreciation may trigger further capital outflow by investors and speculators which can cause currency value to weaken further (downward spiral)

2.3. Consequences of high inflation

2.3.1. Producers / firms : -ve effects on production & investment - Higher inflation raises COP (eg. workers demand more wage/higher cost for raw material) → fall in profits → business shut down or relocation to other countries - When inflation rate rises to the point where it is more than the interest rate earned from savings → discourage savings due to fall in future value of money (consumer side) → firms faced with a higher cost of borrowing → falling investments (ie. firms lose money when lending out money due to inflation)

3. Deflation Deflation is where there is a sustained decrease in GPL of G&S - Only desirable if GPL is falling but one’s real disposable income can continue to increase

3.1. Deflation can be caused

3.1.1. 1. AD falling and further away from LRAS 2. Productive capacity LRAS expanding faster than the growth in AD

3.2. Pros

3.2.1. Price of G&S are falling → households can afford more quality & quantity G&S → material SOL increase

3.3. Cons

3.3.1. 1. Multiplied decrease in RNY - There is accretive to delay spending for G&S as consumers expect prices to be cheaper in the future - Fall in C → firms are less likely to expand, invest & hire - There is further fall in AD → GPL to fall further → deflationary spiral → adversely affecting other macroeconomic growth & aims 2. Effects on debtors - HH that are in debt might be forced to cut spendings to repay the debts (housing loan) - Applies to govt too: for govt that are spending on borrowed money, it might prompt them to cut down on govt spending (G) → Fall in AD - Causing a downward spiral of RNY & worsen unemployment 3. Wage trap - During times of deflation, firms are likely to give wage increment less than inflation rate (%wage increment < % i/r) - Falling GPL → fall in profit → hard for firms to pay wages + with workers who are resistant to wage cuts with strong unions → greater tendency for firms to have more lay offs - Hence rise in unemployment

3.4. Causes of deflation

3.4.1. 1. Undesirable economic conditions (recession) - Recession with falling AD may cause HH & biz to have pessimistic & weak economic sentiments - Causes the fall in C & I → AD falls → GPL falls further 2. Contractionary monetary policy - Eg. rising interest rates - Causes biz to borrow less → contributing to fall in AD → thus falling GPL to tackle inflation 3. Greater thrift - In some of the western capitalist countries, generations of ‘big-spenders’ are slowly being replaced by a gen who has begun to save fore retirement - Lower C → fall in AD → fall in GPL

4. Material → amount & quality of G&S the individual in a country enjoys Non-material → access to education, healthcare, and environmental conditions

4.1. Indicator 1 (material) : GDP - GDP: monetary value of all final G&S produced by residents within a geographical boundary of a country in a given time period, regardless of the ownership of FOP GDP → measures value of G&S produced → generates income (firm profit & workers wages) → more disposable income → consume more G&S → material SOL improve - BUT GDP generated may not fully belong to the domestic economy where there is a large concentration of foreigners & foreign-own firms → might send money back to their country - GDP may overestimate citizen’s SOL

4.2. Indicator 2 (material) : GNP - GNP: monetary value of all final G&S produced by nationals of the country, irrespective of the location of production in a given time period GNP = GDP + Net Factor Income NFI = income earned by nationals overseas - income paid to foreign firms/individuals from located domestically

4.3. Indicator 3 & 4 Comparing material SOL across time: real GDP & real GDP per capita - Nominal: using prices from the same year - Real GDP is a more accurate measurement as it removes the effect of price changes over time - Comparing nominal GDP instead of real GDP over different years may be misleading when determining changes in living standards - When real GDP increases, material SOL increases - The population size of the country may also change → hence use real GDP per capita

4.3.1. How to calculate REAL GDP 1. Identify a base year (price index of base year = 100) 2. Calculate the x% change price from year to year 3. Calculate price index of the other year = (100+x) x 100 4. Use formula

4.4. Indicator 5 & 6 Comparing GDP across space: Common currency & PPP (best) - To compare material SOL of different countries → convert the real GDP value of each country into a common currency - Use it to calculate real GDP per capita to account for differences in population size - The higher real GDP per capita in common currency, the higher material SOL when comparing between countries PPP → amount of foreign currencies needed to buy the same basket of G&S in 2 countries - PPP exchange rate equalizes the purchasing power of different currencies by removing the difference in price level

4.4.1. How to calculate the PPP adjusted real GDP 1. Find out real GDP for each country 2. Convert both real GDP to USD (common currency) 3. Convert the same basket of G&S to USD 4. Step 2 divide by Step 3 5. Compare which value in step 4 is higher

4.5. Indicator 7: Human Development Index (HDI) - For a more comprehensive measure of SOL, HDI is used to measure non-material SOL - It is a good indicator of SOL as it takes into account material AND non-material - Measures average achievement in 3 dimensions 1. Healthcare availability → life expectancy 2. Education opportunities → adult literacy rate 3. Decent SOL → GNP per capita (in PPP)

4.6. Indicator 8: Lorenz curve & Gini Coefficient - An important determinant of a countries SOL is the distribution of national income among the population - Helps to measure the inclusiveness and reliability of measure in terms of representing SOL Lorenz curve: the proportion of national income earned by any given percentage of the population - If income were distributed totally equally → Lorenz curve is a straight 45° line → the closer the curve is to 45°, the more equal income is Gini Coefficient: a precise way of measuring the position of the Lorenz curve - It is the ratio of the area between the Lorenz curve and the 45° line to the whole area between the 45°line - 0 = total inequality 1= total equality - Gini Coefficient can be reduced by government intervention via government transfer & taxes

5. Limitations of measuring and comparing material SOL using National income statistics

5.1. 1. Using Real GDP - Using CPI to derive real income figures introduces statistical accuracy 2. Converting GDP to a common currency using market exchange rate - Leads to statistical distortions due to fluctuations & inaccuracies in currency valuation - Market exchange rates are inaccurate because it is influenced by: 1. Speculations by currency traders 2. Government intervention 3. Changes in other DD&SS factors in the currency market 3. Converting GDP using PPP - The qualitative difference in products in different countries are not taken into account - Hence a country with a lower GDP based on PPP could still have comparable material SOL if the quality of G&S is higher - The difference in the basket of G&S consumed - Countries in differ in climate, cultures and social norms. Having to satisfy different needs meant that different countries differ in composition of basket of G&S * PPP adjusted GDP are still preferable > exchange rate adjusted GDP → as it reflects domestic prices of G&S in different countries

6. Challenges and limitations of using GDP values to measure material SOL

6.1. 1. Measurement problems - National income figures do not give an accurate measurement of the level of production because some data may be omitted in statistical coverage - Due to under-declaration of tax returns by firms/individuals - Existence of “shadow economy” in some countries → activities generating income are not reported → drug production, distribution, prostitution - Many countries in sub-Saharan Africa do not accurately record economic activities → mostly counties with large farming landscapes → unrecorded in GDP - Poor administrative capacity to collect data → due to insufficient resources to find official statistics office 2. Difference in the composition of output - N.I.S may be a poor indicator of consumption level by residents (since it measures production level only) - Countries output includes both consumption and investment goods - Current SOL depends only on consumption goods - Rise in investment goods will not raise current SOL, but might increase future consumption and future SOL - An increase in GDP due to (i) govt expenditure on war & (ii) increase in exports, does not imply a rise in SOL Appropriateness of National income statistics as a measure of SOL - The 2 concepts of SOL and national income are not identical - There are material & non-material aspects of SOL to consider - N.I.S at best reflect the material SOL → measured by the amount of G&S that individuals within the country have available for consumption - Non-material aspects of SOL [eg. life expectancy, the standard of education]

7. Undesirable rates of economic growth (slower/negative growth rate)

7.1. - Real GDP is increasing at a very small rate or decreasing - Recession: period of 2 consecutive quarters of negative economic growth - Excessively high growth rates due to excessive increase in AD relative to AS is also undesirable as it causes demand-pull inflation

7.2. 4 phases of the business cycle (not very important)

7.2.1. 1. upturn - A contracting/stagnant economy begins to recover. - AD is increasing at a faster rate than before → growth in actual output - Economy growth rate increasing: from -ve to very low +ve

7.2.2. 2. expansion - Rapid economic growth - AD is increasing and moving closer to LRAS. fuller use of resources has been made and gap between actual and potential output narrows - High economic growth rate

7.2.3. 3. Peaking out - Growth is at its maximum and starting to slow down as gap between actual and potential narrows even further - AD is increasing at a slower rate than before (close to LRAS) - Actual output increases at a decreasing rate → economic growth rate is still +ve but decreasing

7.2.4. 4. recession - Decline in output - AD starts to decrease → -ve economic growth rate

7.3. Causes of undesirable rates of economic growth

7.3.1. 1. Weak AD (or falling) - Any component of CIG(X-M) that is falling → AD falls - Can be both internal and external - Internal factors: rising interest rates, weakening economic confidence - External factors: foreign trade policies of taxes/ recession in another country

7.3.2. 2. Weak LRAS/SRAS (or falling) - Limits both potential and actual growth - Can be both external and internal - Internal: rising wages, tightening of immigration policies - External: increased prices of imported commodity (oil, coal)

7.4. Consequences of undesirable rates of economic growth

7.4.1. Low/Negative growth 1. Producers/firms - closure/downsize/retrench: fall in DD of G&S → profits decreases → adopt cost-cutting measures - Falling investments: no confidence in the economy for the present and future → cancel or postpone investment plans 2. consumers/households - Lower SOL: falling income and job loss → fall in purchasing power → material SOL decreases - And other consequences following unemployment 3. government/whole economy - Smaller tax revenue to fund government projects - Worsening macroeconomic aims: rising unemployment, lower RNY, inflation

7.4.2. Excessive growth - Better than -ve economic growth as it still raises SOL and boosts economic sentiment for consumption and investment. BUT will cause: 1. High level of inflation - Excessive high GDP growth → overheating with shortages & bottlenecks in factor input → rapid rise in inflation - DD-pull inflation occurs → rising business cost and loss of international competitiveness → dampening investment expenditure and export revenue 2. Negative externalities & lack of sustainability - As income rises → people consume more normal goods (eg. meat) - Consumption of such G&S could bring about negative externalities → high environmental cost to society - Resources are also depleted at a faster rate as they are used for production of the increased G&S demanded

8. Inflation

8.1. - A sustained increase in the General Price Level (GPL) of G&S in a country - Measured by the percentage change in consumer price index (CPI) - CPI → measures how prices of a basket of G&S have changed from one period to another - Low inflation rate → small increase in GPL → stability of GPL → key to sustainable economic growth and material SOL - It keeps the purchasing power of household income stable

8.2. DISflation → falling inflation rates BUT still positive. (CPI increasing a smaller rate) DEflation → negative inflation rate

8.3. Demand-pull inflation - Rapid growth of AD relative to AS - AD has gone very close to or beyond what the current potential output can support - Economy operating AT/OR NEAR full employment - Leads to shortages and bottlenecks in both product and factor markets → raising COP → increase in consumer price

8.4. Rigidity in LRAS (NOT just AD increase but because LRAS not increasing) - LRAS (productive capacity) not rising fast enough to match rising AD - Might be due to: 1. Lack of labor supply (sectors facing high DD [eg. digital]) 2. Lack of infrastructure (digital & physical ones) 3. Shortage of essential raw materials 4. Depletion of natural resources

8.5. When the country has NOT attained full employment - When output/employment is at low levels, increase in AD (AD1 to AD2) results in expansion of RNY (Y1 to Y2) and higher employment rate with zero inflation - As AD increases further and goes closer to productive capacity, GPL is pulled upwards (P2 to P3). The increase in RNY(Y2 to Y3) is less than the initial stages of production as there is less idle resources available

8.6. When country IS AT full employment - Further increase in AD (>AD4) → DD-pull inflation - All available resources are already fully employed and real GDP is already at max lvl - Competing DD for FOP(labour, inputs) → firms bid up prices of FOP to increase production → wages usually increase → rising income → consumers are willing to pay more (low u/e & more confidence) - An increase in AD from AD4 to AD5 will cause GDP to rise to P5 with NO increase in output - Nominal national income rises but REAL national income is constant

8.7. Cost-push inflation

8.7.1. - Sustained increase in input cost - Stems from SS of the economy and not associated with AD - Triggered by the increase critical input prices → labour, oil, imported raw materials - Only SRAS curve shifts → does not reduce a country’s productive capacity - Causes shrinkage in domestic production & RNY - Rate of inflation is higher if economy is close to full employment → strong AD causes DD to be inelastic → easier for firms to pass cost increase to consumer - When COP increase, SRAS shifts left from SRAS1 to SRAS2 → resulting in higher GPL (P1 to P2) - Producers faced with rising production costs pass the increase in cost to the consumers in the form of higher prices to protect their profit margin - Wage-Price Spiral: Workers ask for higher wages to protect their real income → COP increases even more → producers pass to consumers by pushing up prices again

8.7.2. Causes of cost-push inflation 1. Wage-push inflation: - Occurs when wages increase more than productivity - Unit labor cost (cost of labor per unit output) will rise → rising COP - Occur when there is a strong union to bargain for higher wages for workers

8.7.3. 2. Imported inflation - When inflation is transmitted from one country to another due to shortages of essential raw materials - Price of raw materials: energy production unable to cope with DD for it - Food inflation: eg. droughts in grain-producing countries - Currency depreciation: of domestic currency → prices of imports rises (esp raw materials) → COP rises → loss of price competitiveness for local firms Interaction of DD-pull and Cost-push : Inflationary Spiral Excessive growth in AD → higher DD for factor inputs (to produce more) → factor prices increases → higher price for G&S as firms seek to protect their profit margin → workers DD more pay to cope with the cost of living