11 - Economic Performance Flashcards
What is cost-push inflation?
Occurs when businesses respond to rising costs by increasing the costs of production to protect their profit margin.
What is Stagflation and an example?
Stagflation is a combination of slow growth and rising inflation.
Occurred during 1970’s oil prices rose dramatically and inflation in the UK rose nearly to 30%.
How is Cost-push inflation caused?
- Rising unit labour cost
- High global costs for components and raw materials.
- An increase in taxes (higher VAT and environmental tax).
- A depreciation in the external value of the exchange rate which causes a rise in imports prices.
What are the general theories for cost-push inflation in the UK?
1) Trade Unions bargaining for high wage rates.
2) Monopoly’s in the market for goods, like Russia with Gas, causing high global cost for raw materials.
What is inflation?
Inflation is a sustained rise is an economy’s general price level. This means that cost of living is rising.
This means that, on average, the prices of goods and services are going up over time.
What is Demand Pull Inflation?
Too much demand in the economy and too little supply, overheating, a rising price caused by an increase in demand.
What effect does Demand-Pull inflation and Cost-Push inflation have on the SRAS curve and AD curve?
DP Inflation : AD shift to the right
CP inflation : SRAS shift to the left
What is Deflation?
Deflation is a sustained period when the general price level for goods and services is falling. Goods and services becoming less expensive over time. (Negative Number)
What is Disinflation?
Disinflation is a fall in the rate of inflation but not sufficient to bring about price deflation.
During a period of disinflation, consumer prices are still rising but at a slower rate
For example a drop of inflation from 7% to 2%.
What is the difference between deflation and disinflation?
Deflation exists when the price level is falling , whereas disinflation is when the rate of inflation is falling.
What is the problem with inflation?
Living standards decrease and people become poorer.
What is the wage price spiral?
Where workers bid for higher wages because they have seen their real income eroded by fast-rising prices, this can lead to a further burst in cost-push inflation.
Happening now with nurses striking for higher wages.
What are the consequences of Inflation?
- Inequality
- Reduced international Competitiveness
- Cost of Borrowing
- Falling real incomes
- Business Uncertainty
Why is inequality a consequence of Inflation?
Inflation has regressive effects on lower-income families as most of their money wealth is in cash. Or families on fixed incomes like old age pensioners.
Why is reduced international business competitiveness a consequence of Inflation? and evaluate?
When inflation is higher than in competitor countries, exports increase in price so demand for exports will decrease for the country’s exports.
Eval - the rate of inflation of trading partners and competitor countries,
Why is the cost of borrowing increasing a consequence of Inflation? and evaluate?
High inflation may lead to higher interest rates for businesses and consumers with debts, like rising mortgages rates.
Eval - the extent that central banks is prepared to tolerate inflation before raising interest rates.
Why is business uncertainty a consequence of Inflation? and evaluate?
Higher inflation is not good for confidence, business are not sure what their prices and costs will be. Leads to a fall in CAPITAL INVESTMENT.
Eval - Whether uncertainty leads to a fall in domestic and foreign investment
Why is the falling real income a consequence of Inflation? and evaluate?
If wages lag behind price increases each year so people become poorer.
Eval - the power of trade unions and the wage bargaining power of workers in different industries. To increase their wages with inflation rises
What is the “Triple Lock” for pensions?
Rate at which pensioners incomes go up by each year, for the highest rate of either inflation, increase wages and 2.5%.
This is to reduce inequality.
What is the Cost-Push inflation graph?
The SRAS curve shifts to the left and up from SRAS1 to SRAS2. As there is an increase in production costs from the wages or increase raw materials. As a result of a shift the price level increase to P2
What is output gaps?
Is the difference between the actual level of GDP/ actual real output in the economy either higher or lower than the trend output level.
Draw an economic cycle diagram labelling the positive and negative output.
What is the difference between a negative and positive output gap?
Positive output gap - when real GDP is above the productive potential of the economy (above the trend line)
Negative output gap - real GDP is below the economy’s productive potential of the economy (Below the trend line)
What does an negative output gap show?
There is spare capacity in the economy.
That the country is not effectively distributing resources, resources under-utilised. Exp: some demand-deficient unemployment in the labour market.
Main problem is likely rising unemployment and possible deflation (spare capacity, excess supply.) Downward pressure on inflation.
What is fact about coronavirus on the UK economy?
Coronavirus caused the UK economy to shrink 11%, the largest drop in 300 years
Draw an AD/AS graph for positive output gap and explain it.
The economy is booming so demand has increase and the economy is overheating, resources are being overworked. (Worker working overtime). Producing at Y3 which larger than YP so the distance between this is positive out put gap. Producing above the potential (Y3 to YP)
Draw an AD/AS graph for negative output gap and explain it.
Less demand cause a negative output gap from YP to Y1 so spare capacity in the UK
Why does a positive output gap happen?
It could be due to resources being used beyond the normal capacity, such as if labour works overtime. If productivity is growing, the output gap becomes positive. It puts upwards pressure on inflation.
Main problems is rising demand-pull and cost-push inflationary pressures. Because demand will excess supply so price will rise. Countries, such as China and India, which have high rates of inflation due to fast and increasing demand, are associated with positive output gaps.
Show with graph how supply can shift if demand increase on a output gap diagram.
Demand is in excess of supply so supply will shift causing for price to increase therefore decreasing output of the economy.
What is the quantity of theory of Money?
States that there is inflation if the money supply increases at a faster rate than nominal income, persistant increase in supply of money.
The quantity theory of money states that there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold.
What is Fishers equation?
MV = PQ
Money Supply (stock of money) x Velocity of circulation of Money = Price Level x Quantity of Output
What are Monetarists?
Economists who argue that a prior increase in the money supply is the cause of inflation.
What is narrow monetarism?
Narrow monetarism centres on increases in the money supply as the prime cause of inflation
What is broad monetarism?
Broader monetarism focuses on the virtues of free markets in resource allocation
Why can the fisher equation MV=PQ also be written as MV=PT?
Everything is the same other than the T which stands for total transactions taking place in the economy but this is more difficult to measure than quantity of output.
How does the fisher equation MV=PQ argue that increasing the money supply causes inflation? (IMPORTANT)
- When the money supply increases, consumers have more money to spend. This causes AD to shift to the right. Firms then increase supply in the short run. A positive output gap occurs, which is inflationary
- As a result, more workers are employed, so wages increase meaning costs increase for firms, so they put prices up
- This inflationary pressure means the real value of money falls. Since money can buy less, there is a contraction in demand
- Workers demand higher wages to make up for the increase in inflation. This leads to a left shift in the SRAS curve
- The output in the economy returns to equilibrium, but the price level is higher
What are the main Macro Economic Objectives?
- Economic Growth
- Low Inflation (price stability)
- Low Unemployment
- Reduce Inequalities
- Balance of Payments
- Lower Government Borrowing (debt)
How does economic growth and inflation experience conflict when trying to achieve both?
A growing economy is likely to experience inflationary pressures on the average price level. This especially true when there is a positive gap and AD increases faster than AS.
What are the Possible Macro-Economic Conflicts?
A vs B
Economic Growth vs Inflation
Unemployment vs Inflation
Economic Growth vs Current account balance of payments
Budget deficit vs Economic growth
Economic growth vs Environment
What are the two ways of measuring unemployment?
- The Claimant Count
2.UK Labour Force Survey
How does the Claimant Count measure unemployment?
This counts the number of people claiming unemployment related benefits, such as Job Seeker’s Allowance (JSA). They have to prove they are actively looking for work.
What is the problem with the Claimant Count for measuring unemployment?
- Not every unemployed person is eligible for, or bothers claiming JSA
- Those with partners on high incomes will not be eligible for the benefit, even if they are unemployed
- Although there may be instances of people claiming the benefit whilst they are employed, the method generally underestimated the level of unemployment.
How does the UK Labour Force Survey measure unemployment?
- Been out of work for 4 weeks
- Able and willing to start working within 2 weeks
- Workers should be available for 1 hour per week. Part time unemployment is included.
Usually gives a higher unemployment rate as part-time unemployment are less likely to claim unemployment benefits.
What is the UK employment rate and unemployment rate currently?
Unemployment rate - 3.8%
What is voluntary unemployment, and what encourages this?
Voluntary unemployment occurs when someone chooses not to work at the current wage rate. This could be encouraged in welfare payments are generous relative to real wages. A high income tax rate might also discourage people from participating in the labour market.
What is involuntary unemployment?
Occurs when workers are willing to work at current market wage rates but there are no jobs available.
What is frictional unemployment?
With example
This is the time between leaving a job and looking for another job. It is common for there to always be some frictional unemployment, and it is not particularly damaging since it is only temporary. Frictional unemployment is caused due to geographical immobility, people do not want to move have family ties, and occupational immobility, need to learn skills first.
For example, it could be the time between graduating from university and finding a job
What is structural unemployment?
This occurs with a long term decline in demand for the goods and services in an industry, which costs jobs. This is especially true of jobs in industries such as car manufacturing, where labour is replaced by capital (this is also called technological unemployment).
Moreover, the decline of the coal and ship building industries in the UK, led to a great deal of structural unemployment.
Why is employment never able to be at 100%?
This is why it is rare to get 100% employment: there will always be people moving between jobs
What is Short Run Economic growth?
Short run growth is the percentage increase in a country’s real GDP and it is usually measured annually. It is caused by increases in AD.
What is Long Run Economic growth?
Long run economic growth occurs when the productive capacity of the economy is increasing and it refers to the trend rate of growth of real national output in an economy over time. It is caused by increases in AS.
Draw Production Possibility Frontier (PPF) Curve?
What determines short run growth?
Demand sides which relates to the changes in AD on the economy. Increase in any C + I + G or X and decrease in M.
Also sometimes supply side shifting SRAS curve to the right. However the main impact of supply side policies is long-term.
Explain this diagram
What is economic growth?
An increase in the production of economic goods and services in one of time compared with a previous period.
What are costs of economic growth?
- Economic Growth uses up finite resources, oil and minerals, that can’t be replaced.
- Leads to pollution and destroying environment, where the Earth can’t recover.
- Growth can destroy local cultures and communities and widen inequalities in income and wealth.
- Growth leads to urbanisation, big cities, swallowing up agriculture land.
- Rapid population growth, more mouths to feed more poor people.
- Inflation
What is key impact of economic growth on individuals?
- Some individuals, mostly the rich and many of the less well-offs benefit from higher welfare and incomes, and better prospects for the future that growth brings about
- However, others ,including many of the poor, can suffer from the loss of jobs and increased inequality that can also result from economic growth
- E.g. Increased automation brought about by faster economic growth may reduce overall demand for labour
Explain this diagram?
Real output increases when there are periods of economic growth. This is the recovery stage.
The boom is when economic growth is fast, and it could be inflationary or unsustainable.
During recessions, the real output in the economy falls, and there is negative economic growth.
During recessions, governments might increase spending to try and stimulate the economy. This could involve spending on welfare payments to help people who have lost their jobs, or cutting taxes.
During periods of economic growth, governments may receive more tax revenue since consumers will be spending more and earning more. They may decide to spend less, since the economy does not need stimulating, and fewer people will be claiming benefits.
How does external shocks causes change in the phases of the economic cycle (cyclical instability)?
- Demand shocks affect AD and supply shocks impact on AS
- In some cases, an outside shock hitting the economy may affect both AD and AS
- E.g. the effect on other countries of a war in the Middle East. The war might not only affect business confidence in a country such as the UK (a demand shock), but also lead to an oil shortage which increases businesses’ costs of production. This would be a supply shock
Draw a diagram for cyclical unemployment.
Explain this cyclical unemployment graph, the Keynesian and Free-Market opinion.
Draw a diagram showing real wage unemployment.
Explain this real wage unemployment diagram.
What is the natural rate unemployment diagram?
Explain this natural rate of unemployment diagram.
How does governement policies improving geographical mobility of labour reduce unemployment?
How does governement policies improving the occupational mobility of labour reduce unemployment?
How does governement policies reducing employment search periods reduce unemployment?
How does governement supply side policies reduce unemployment?
(More in detail in chapter 13)
Explain this cost-push inflation graph.
Equilibrium of national income,e is at point X, with real output and the price level at Y1 and P1
The SRAS curve shifts to the left and up from SRAS1 to SRAS2. As there is an increase in production costs from the wages or increase raw materials. As a result of a shift the price level increase to P2.
Higher production costs have reduced the equilibrium level of output that firms are willing to produce to Y2. The new equilibrium national income is at point Z.
Draw a demand-pull inflation diagram?
How is distributional effects a disadvantage of inflation?
How is distortion of normal economic behaviour a disadvantage of inflation?
How is the breakdown in the functions of money a disadvantage of inflation?
How is reduced international uncompetitveness disadvantage of inflation?
How is ‘shoe leather and menu costs’ a disadvantage of inflation?
Draw diagram for demand-side (Bad) deflation?
Draw diagram for supply-side (Good) deflation?
Explain supply side (good) deflation? Using this diagram
Supply-side/Good deflation results from improve,ents in the economy’s supply side, which reduces businesses costs of production. SRAS and LRAS shift to the right and AD stays the same so the price level falls, but employment and output increases.
Mainly short term.
Explain demand side (bad) deflation? Using this diagram
Caused by a collapse of aggregate demand causing a persistant recession. Large negative output gap - high level of spare capacity, possible credit crunch.
Draw the short run Phillips curve?
Draw the long-run Phillips curve.
Un = natural rate of unemployment
Explain this Short Run Phillips Curve diagram.
Explain the Long Run Phillips Curve.
Neo-classical economists believe that in the long output always returns to a long run equilibrium path
They also argue that an economy will tend to revert to a level of output where unemployment returns to the natural rate of unemployment made up of frictional and structural Unemployment.
The Long Run Phillips Curve is drawn as vertical i.e. it is assumed to be independent of the level of short run demand/output and the general price level
What is this diagram showing?
Successful supply side policies like:
Improve the occupational mobility of labour force
Attract more people into an active search for work
Lift labour productivity
These policies can lead to a fall in the natural rate of unemployment (frictional + structural unemployment). This causes the long run Phillips Curve to shift to the left
