Short run is the period of time during which the nominal prices of resources, particularly the price of
labour – wages, do not change in response to changes in the price level therefore the prices are
constant.
Long run is the period of time in which the nominal prices of all resources including the price of labour
that is wages, change so as to reflect any change in the price level.
In the short run, prices of labour is constant because:
1. Labour contracts fix wage rates for certain periods of time that is a year or two years
2. Minimum wage legislation fixes the lowest legally permissible wage rate
3. Workers and labour unions resist wage cuts
4. Wage cuts have negative impact on workers morale
Aggregate supply is the total quantity of goods and services produced in an economy at different price
levels, ceteris paribus. It shows the relationship between the price level and the quantity of real GDP
produced by firms when resources prices do not change.
Reasons/Causes for shift of supply curve:
1. Change in wages
2. Change in non-labour resource prices
3. Changes in business taxes
4. Changes in subsidies
5. Supply shocks
The equilibrium level of real GDP occurs where aggregate demand is equal is aggregate supply. In short
run, it is shown the point of intersection of the aggregate demand curve and the short run aggregate
supply curve and determines the price level, the level of real GDP and the level of employment that
prevail when the economy is in short run equilibrium.
Solutions for structural unemployment
1. An Education system that trains people to be more occupationally flexible is important. This
system must make people able to learn the skills to adapt the rapidly changing economic
conditions.
2. Spending on the adult training programs to help people acquire necessary skills to match
available jobs
3. Give subsidies to provide training for the workers
4. If the job exists in other parts of the country, then the government should provide subsidies or
tax breaks to encourage people to move to those areas, which enhances geographic mobility.
Demand side policies (to reduce unemployment):
Through demand side policies, the government tries to increase the level of demand by giving the
incentive or raising the purchasing power of the people in order to increase the level of demand for
the commodities.
How does this happen?
1. By reducing taxes
2. Reducing Interest rates
3. Increasing the public expenditure
Distribution of Income
What to produce? How to produce? – resource allocation, For whom to produce? – problem of
distribution. How can the government solve this problem? Methods used to redistribute income and
outputs
1. Education
2. Taxation – Direct taxes are the taxes paid directly to the government tax authorities by the
taxpayer. The different types of direct taxes are personal income tax (is paid on the forms of
income like wages, rental income, interest income, dividends), corporate income tax, wealth tax.
Indirect taxes are the taxes on spending on goods and services; they are paid by the consumers
indirectly when they pay the prices of goods and services purchased.
3. Subsidized provision of merit goods - for example education facilities so people in the country
can vote.
4. Transfer Payments - are the payments made by the government to individuals specifically for
the purpose of redistributing income away from certain groups and towards other groups. The
government transfer s income from those who work and pay taxes towards those who need
assistance. Examples: Old age pensions, disability pensions, etc.
5. Public Expenditure
6. Government intervention in the market.
Proportional Taxes: As income increases, fraction of income paid as taxes remains constant. There is
constant tax rate.
Progressive Taxes: As income increases, the fraction of income paid as taxes increases. This is an
increase in the tax rate.
Regressive Tax: As income increases, the fraction of income paid as taxes decreases. This is a decrease
in the tax rate.
Laffer Curve : is a curve showing the relationship between income tax rates and the government
revenue. It indicates that there is a particular tax rate for which revenues are maximum, suggesting that
if actual tax rates are above this rate then cutting taxes will increase the government revenues.
The Phillips curve shows the relationship between unemployment and inflation. According to the
economist Phillip, there exists a long term inverse relationship between unemployment rate and the
rate of inflation; that is lower the rate of inflation, higher the unemployment and higher the rate of
unemployment, lower the rate of unemployment.