THE ECONOMICS OF HOUSEHOLD SAVINGS

1
Money, money, money
Conflicting objectives?
2
Whats the relationship here?
3
Aims

• To understand the consequences of unemployment
  and inflation
• To be aware of the concept of the Phillips Curve.

4
What are the consequences of falling unemployment?
5
Consequence of falling unemployment on

• .the circular flow of income?
• 1st draw me a circular flow diagram!

• What are the 2 main sectors?
• Whos at the top?
• Whos at the bottom?
• What are the initial flow of incomes?
• What else happens?

6
So what would happen if there was a fall in
unemployment?
What would be the negative consequences?
What would be the positive consequences?
7
What are the consequences of falling unemployment?

• On circular flow of income?
• On balance of payments?
• On govt finances?
• On inflation?

• Did we cover these groups and issues?

8
Consequences of falling unemployment

• The circular flow and the multiplier
• Incomes flowing into households will grow
• Falling unemployment adds to demand and creates a
  positive multiplier effect on incomes, demand and
  output.
• The balance of payments
• When incomes and spending are growing, there is
  an increase in the demand for imports. Unless
  this is matched by a rise in export sales, the
  trade balance in goods and services will worsen

9
Consequences of falling unemployment

• Government finances
• With more people in work paying income tax,
  national insurance and value added tax, the
  government can expect a large rise in tax
  revenues and a reduction in social security
  benefits
• Inflationary effects
• Falling unemployment can also create a rise in
  inflationary pressure particularly when the
  economy moves close to operating at full capacity
• However this is not really a risk when the
  economy is coming out of recession, since
  aggregate supply is likely to be highly elastic
  because of a high level of spare capacity

10
Is there a trade off between.

• Unemployment Inflation?

11
Give me a policy that Govt could use to reduce
unemployment?
12
Give me a policy that Govt could use to reduce
unemployment?
How do each of these effect inflation?

• Stimulate an improvement in the human capital of
  the workforce training, education, skills
• Improve incentives for people to search and then
  accept paid work this may require reforms of
  the tax and benefits system for example a
  reduction in the starting rate of income tax (an
  incentive for people in lower paid jobs).
• Employment subsidies Government subsidies for
  those firms that take on the long-term unemployed
  will create an incentive for businesses to
  increase the size of their workforce.
• Achieve a sustained period of economic growth
  this requires that aggregate demand is
  sufficiently high for businesses to be looking to
  expand their workforce.

13
Give me a policy that Govt could use to reduce
unemployment?

• Stimulate an improvement in the human capital of
  the workforce training, education, skills
• Improve incentives for people to search and then
  accept paid work this may require reforms of
  the tax and benefits system for example a
  reduction in the starting rate of income tax (an
  incentive for people in lower paid jobs).
• Employment subsidies Government subsidies for
  those firms that take on the long-term unemployed
  will create an incentive for businesses to
  increase the size of their workforce.
• Achieve a sustained period of economic growth
  this requires that aggregate demand is
  sufficiently high for businesses to be looking to
  expand their workforce.

14
Demand Pull Inflation
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Reducing unemploymentin the short run
Trade off between falling unemployment
inflation?
Price Level
SRAS
Known as DEMAND PULL INFLATION
AD1
AD
0
Y2
Y1
Real National Output
16
Draw a Classical AD/AS diagram
LRAS
Price Level
SRAS
In the SR the economy can work overtime, at a
slightly higher cost (overtime)
AD1
AD
0
Y2
Real National Output
Y1
17
Demand Pull Inflation
SRAS2
LRAS
Price Level
SRAS
In the LR, workers are not willing to sacrifice
Leisure time for more overtime. But still have
high wage expectations. demand pull inflation
AD1
AD
Known as DEMAND PULL INFLATION
0
Y2
Real National Output
Y1
18
Cost push inflation
19
Cost Push Inflation

• Occurs when costs of production are increasing
• Causes
• External shocks (commodity price fluctuations)
• A depreciation in the exchange rate
• Acceleration in wages
• Leads to inward shift in SRAS curve
• Firms raise prices to protect their profit
  margins better able to do this when market
  demand is price inelastic
• Wages often follow prices
• A rise in inflation can lead to rising
  inflationary expectations

20
Draw an Classical AD/AS diagram
LRAS
SRAS2
Price Level
SRAS1
What would happen if there was an inward shift of
the SRAS?
AD
0
Y2
Real National Output
Y1
21
The Phillips Curve.

• Old theory!!!

22
The Phillips Curve
23
Old data
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• In 1958 AW Phillips plotted 95 years of data of
  UK wage inflation against unemployment. It seemed
  to suggest a short-run trade-off between
  unemployment and inflation. The theory behind
  this was fairly straightforward. Falling
  unemployment might cause rising inflation and a
  fall in inflation might only be possible by
  allowing unemployment to rise.
• HOW CAN GOVT INCREASE AD? (AD C I G (X-M))
• If the Government wanted to reduce the
  unemployment rate, it could increase aggregate
  demand but, although this might temporarily
  increase employment, it could also have
  inflationary implications in both the labour and
  the product markets.

25
In the long run if its a supply side policy to
reduce unemployment?
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Non-inflationary growth
LRAS
LRAS2
Price Level
Yfc1
Yfc2
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Non-inflationary growth
LRAS
LRAS2
Vital diagram What govt wants to achieve!
Price Level
AD2
AD1
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The inverse relationship has now gone! (A2 Ec
theory!)
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Homework

• Read Grazia article
• Impact of credit crunch recession women in
  unemployment.