Understanding Key Economic Concepts: Fiscal Policy, Unemployment, and More
Key Economic Concepts Explained
Restrictive Fiscal Policies: A tight fiscal policy aims to cool down the economy by reducing public spending and/or increasing taxes. This leads to lower aggregate demand and reduces pressure on prices. With restrictive policies, lower public spending and higher taxes decrease aggregate demand, thereby lowering production, employment, and prices.
Expansionary Fiscal Policy: This involves reducing taxes, increasing financial expenses, or transfers to increase production and employment levels. Therefore, in expansionary fiscal policy, rising costs and tax cuts cause aggregate demand to rise, which in turn increases production, employment, and prices.
Unemployment Types
Frictional Unemployment: This is a temporary situation motivated by the job search process. It occurs when workers leave their positions to seek better opportunities and take time to find them.
Structural Unemployment: This is caused by imbalances in the location of supply and demand between the qualifications offered and those demanded. Newly created jobs may require skills that some workers lack, leading to continued unemployment.
Automatic Stabilizers and Production Potential
Automatic Stabilizers: These are elements of the economic system that automatically reduce the force of recessions and/or expansions of demand, without requiring discretionary economic policy. An example is retirement pensions.
Production Potential: This refers to the total goods and services an economy can produce with its available machines, workers, technological expertise, and resources.
Consumer Price Index (CPI)
The CPI is a statistical measure of the average change over time in the prices of goods and services consumed by a population. It is calculated based on a survey of households. The CPI considers variations in hundreds of items.
Two key issues for the CPI are:
- Groups of Prices: The CPI includes the prices of goods and services that consumers typically purchase. Changes in the CPI measure the change in costs for households.
- Balance of Prices: These proportions become the weights attached to each price when calculating the CPI.
Thus, the CPI gives relatively high weight to the most significant assets and a relatively small weight to goods that barely affect household spending.
Inflation Rate: Calculated as [(CPI2 – CPI1) / CPI1] x 100; representing the percentage increase in the CPI.
Business Cycle Phases
The economic cycle has four phases:
- Recession: A decline in the pace of economic activity. A severe and prolonged recession is often called a depression.
- Trough: Characterized by high unemployment and low demand relative to the productive capacity of economic activity.
- Recovery: Begins when expectations for improved economic climate arise.
- Rise (Boom): The high point of a recovery cycle, where capacity is almost fully utilized.
Active Population and Unemployment Rate
Active Population: The group of individuals in a society who are of working age (from 16) and trained to work, have, or want a paid job.
Activity Rate: (Active population / total population) x 100
Unemployment Rate: The proportion of unemployed workers with respect to the total working population. Calculated as (unemployed / labor force) x 100.