2016 AS paper Flashcards
define ‘national income’
total spending on goods and services
define ‘circular flow of income’
Money flows around the economy between
consumers/households and firms.
withdrawals from the circular flow: savings, tax (TP), imports
Injections: government spending, exports, investment
Consumption and income flows as financial flows for factors of production and goods and services.
g/s to households, consumption expenditure to firms
FOP to firms, income (rent, wages, interest, profit) to households
define ‘purchasing power parities’
The rate at which the currency of one country
would have to be converted into that of another country to buy the same amount of goods and services in each country
Comparison between countries, taking into account different cost of living.
define ‘claimant count’
number of people claiming unemployment/jobseekers allowance
cause a reduction in the claimant count
compulsory weekly interview for every claimant
likely reason for the reduction in total UK trade deficit in Jan 2015
Knowledge
Falling oil price reducing cost of imports
Relatively lower inflation in UK makes exports more competitive
Improvement in quality of UK exports increases demand for them
Depreciation of the exchange rate.
Application
trade deficit was approx. £1 billion in January 2015
Analysis
Fall in the value of the pound makes exports
cheaper and imports more expensive.
explain ‘real income’
Knowledge
Income is money received as payment for work
Real means adjusted for inflation/purchasing power of income
Application
Real income has fallen
From approximately £675 in 2008 to £615 in 2013
likely impact of falling real incomes on UK consumers (KAA)
Lower incomes means lower consumption
Consumer confidence falls
Aggregate demand therefore falls
Fall in standard of living
Falling demand for firms means lower profits; rising unemployment
Less ability to save & possible consequences of this, e.g. mortgage deposit; confidence
AD/AS diagram showing AD decreasing
likely impact of falling real incomes on UK consumers (Ev)
Depends on other factors in the economy, such as government spending or demand for exports
Changes in benefits and/or tax allowances may offset fall in real income
Only short-term fall (Figure 1 shows slight increase in 2013)
Inflation falling recently, improving likelihood of real income rises
Could be due to firms keeping wages low rather than making redundancies, thus people’s standard of living higher than it would be if they lost their job
likely effect of a rise in the value of the pound on AD
Knowledge/understanding
Definition of aggregate demand (total spending on g/s in the economy)
Understanding of a rise in value of the pound
Application
Aggregate demand will fall
Lagged effect
Declining imported food and commodity prices
Analysis
Imports become cheaper so aggregate demand
falls
Exports become expensive so aggregate demand falls
likely reasons for the UK’s falling inflation rate
1. fall in AD 2. rightward AS Knowledge Falling energy prices Falling telecommunication prices Falling shipping costs Falling non-energy industrial goods prices Slowdown in world economic growth Slowdown in consumer spending Slowdown in house construction
Application
2 relevant pieces of application from Extract B
inflation at 0.3%
Analysis
falling oil prices makes transport of goods cheaper
inflation
- situation of a sustained increase in the general price level in an economy. Inflation means an increase in the cost of living as the price of goods and services rise.
- rate at which the average price level of a basket of selected goods and services in an economy increases over a period of time
- inflation indicates a decrease in the purchasing power of a nation’s currency
calculating CPI
- measures the average household cost of living, excluding housing costs and is used as the target for monetary policy
1. assign weights to different categories of consumer spending - uses “national accounts” to assign weights, cross check against Family Expenditure Survey, annually checked and trade for new trends
2. price collection - every month, regionally, over 100,000 prices collected
3. calculate price indices for each category - base year, compare the month’s data with the previous year
4. calculate CPI - multiply each index number by its weighting, sum to give CPI
MPC should be concerned about risk of deflation in UK economy
Risk of deflationary spiral; hard to ‘escape’ from such a situation
Example of Japan (the root cause of deflation was slow growth and a high level of spare capacity that was driving prices lower.)
Consumer expectations of very low/falling prices
become embedded
Limited ability of the MPC to get the economy out of
deflation (interest rates already only 0.5%)
Harder for MPC to react to/influence supply-side
factors such as falling oil prices
MPC should not be concerned about risk of deflation in UK economy
Likely to be only short-term/caused by one-off factors that will disappear from the statistics after one year
Caused by supply-side factors rather than demand-side, so less of a problem for the UK economy
Caused by falls in just a few significant items (e.g. oil), fall in prices not widespread across the whole economy
Economic growth and incomes are still rising in the UK economy, suggesting inflation is not affecting consumer demand
May benefit economy as it leads to increasing AS due to falling commodity prices, rather than being caused by falling AD
deflation
persistent fall in the general price level of g/s - the rate of inflation becomes negative
causes of deflation - demand-side
- deep fall in AD causing a persistent recession/depression (a more severe recession, e.g. decline in output for over 2 years, drop in output of 10% or greater, unemployment rate touch 20% rather than 10% with a recession
- large negative output gap (high level of spare capacity)
causes of deflation - supply-side
- improved productivity
- technological advances
- significant fall in wage rates
- high exchange rate causing import prices to fall
why deflation is damaging for an economy
- consumers holding back on spending
- real value of debt rises (higher real debts big drag on consumer confidence)
- real cost of borrowing increases (real interest rates will rise if nominal rates of interest don’t fall in line with prices)
- lower profit margins (lower prices -> reduced revenue & profits -> higher u/e as seek to reduce costs
- confidence/saving (falling asset prices such as price deflation in housing market hits personal sector wealth and confidence
- income distribution (redistribution from debtors to creditors)
- deflation can make exporters more competitive eventually (but often comes at a cost, i.e. higher u/e in shot term)
MPC has been successful in controlling the UK’s inflation rate since 2011
Changing interest rates and quantitative easing/asset purchases to influence money supply as monetary policies
AD/AS diagram could be used to aid effective analysis
MPC has been successful at controlling inflation:
According to Figure 2 highest inflation rate was only just over 5%, good by historical standards
Independent of government
Regular monthly MPC meetings implies flexibility
Willingness to use other unorthodox tools such as
QE and forward guidance to additionally control
inflation
QE helped to avoid risk of deflation during global
economic crisis
Powerful transmission mechanisms
Contrast with Japan.
MPC has not been successful in controlling the UK’s inflation rate since 2011
Figure 1 shows inflation has often been outside of
range of +/- 1% from the 2% target
MPC struggles to respond to supply-side factors, e.g. rising food/commodity prices in 2008/9 and
now falling prices in 2014
Interest rates have stayed at 0.5% for a long
time so there is limited scope to reduce further in
response to falling inflation/risk of deflation
Banking failure
In the period shown, interest rates have been
0.5% but inflation has continued to fall
evaluate demand-side policy responses to the Global Financial Crisis of 2008 (KAA)
Understanding of demand-side policies to include monetary and/or fiscal policy
Understanding of Global Financial Crisis of 2008 in UK and/or other countries
AD/AS diagram may be used to aid effective analysis
Examples of demand-side policies:
Reduction of interest rates to boost aggregate demand in a recession.
Quantitative easing to increase liquidity
Bailout of banks
Increase in government spending e.g. infrastructure
Cut in taxation
evaluate demand-side policy responses to the Global Financial Crisis of 2008 (Ev)
Short run/long run issues, e.g. interest rates take at least a year to have a full effect
Interest rates cannot be cut much further; relative interest rates are important
The uncertainty of the impact of QE, e.g. do banks pass on the credit, is it inflationary?
Size of the multiplier
Problems in financing government deficit/fiscal
austerity issues
Impact of different tax cuts, e.g. income tax vs. VAT
Relative success of US or other country’s policies
in response to the crisis compared to the UK
demand-side policy
policy that stimulates AD
