2.1 Flashcards
How can you measure economic performance ?
- Unemployment figure
- Rate of inflation
- Rate of economic growth
What is aggregate demand ?
- Aggregate demand is the total demand for goods and services in an economy
- C + I + G + (X-M)
What is economic growth ?
An increase in the productive potential of an economy
What is short run economic growth ?
The increase in real GDP over a certain period of time
What is long run economic growth ?
The expansion of the economy’s capacity to produce goods and services
What are index numbers ?
- Used to track each economic factor
- Used to observe how the economy is functioning
How do you work out the index number ?
Index number = (Raw number in current period ÷ Raw number in base period) × 100
What is a Real Value ?
- The quantities produced after having removed the effects of price changes. Before inflation.
- The base prices.
What is a Nominal value ?
- Measurements made using prices that are current, at the time a transaction takes place
- Current prices
What is Real GDP?
- The value of goods and services at base prices
- It is adjusted for inflation
What is Nominal GDP?
- The value of goods and services measured using current prices
- Does not adjust for inflation
What is the more useful GDP to measure standard of living, and why? (Real or Nominal)
- Real GDP
- Nominal GDP is always exaggerated, and it’s not a true reflection of the country’s GDP.
- Real GDP allows you to have an insight into a country’s living standards
What is the Price Index Formula?
( Nominal GDP / Real GDP ) x 100
How is the Price Index different to the CPI ?
- Price Index measures prices of purchases by consumers, government, and businesses.
- However, CPI measures prices of purchases by consumers only.
What is GDP?
- GDP (Gross Domestic Product) is the total output of a country in a given time period
- It gives us an indication of living standards
What is GNI?
- GDP plus or minus the net income from residents abroad
- It adds what a country earns from overseas and subtracts what foreigners earn in a country and send back home from the GDP
What is the preferred measure of economic growth ?
- GNI
- As it more closely reflects the incomes of the residents, including net flows of income between countries
What is GPI ?
- Genuine progress indicator
- Economic tool used to measure the health of a nation’s economy.
What does GPI incorporate ?
- It incorporates environmental and social factors
- Such as family structure, benefits from higher education, crime, and pollution, which are all not considered in the GDP.
What is the difference between GPI and GNI ?
GNI only incorporates economic factors whereas GPI incorporates factors such as pollution, value of labour and education
How do you Calculate Real GDP?
(Nominal GDP ÷ Price Index) × 100
How do you calculate the GDP growth rate ?
- (new - original) ÷ (original) × 100
- Measures actual economic growth
What is Meant by GDP Per Capita?
Income per Person
How do you Measure GDP Per Capita?
Country’s GDP / Country’s Population
What does GDP per capita allow ?
It allows the GDP of different nations to be more easily compared
What is Power Purchasing Parity ?
- An exchange rate of one currency for another
- It compares how much a typical basket of goods in one country costs compared to another country
What does power purchasing parity provide ?
An alternative to compare GDP using exchange rates
What does power purchasing parity take into account ?
Takes into account the cost of living and so helps us better compare living standards amongst different countries
What are the difficulties in measuring GDP ?
- Exclusion of real transactions; Only items which are purchased and sold through the market are included
- The value of leisure; The satisfaction we get from recreational activities and other uses of our leisure time are also not included in GDP
- The underground economy; This economy consists of transactions that are never reported to tax and other government authorities. It includes many illegal goods and services (drugs and prostitution)
- Zero price goods are excluded from GDP; Gifts that are given and received are excluded
- Difficult to measure the value of innovation; there is nothing approaching consensus on how to measure the value of innovation. It is getting more difficult to measure GDP as production is more in the tertiary sector and not secondary sector.
- Accounting for inflation; in order to make international comparisons and comparisons over time we need to compare real GDP, rather than nominal GDP
Who is Richard Easterlin ?
He argued that life satisfaction does rise with average incomes but only up to a point. Beyond that point, marginal gain in happiness declines.
What is the Easterlin paradox ?
An increase in consumption of material goods will increase happiness if basic needs aren’t met, but once these needs are met, an increase in consumption won’t increase long term happiness.
What does the Easterlin paradox concern ?
It concerns whether we are happier and more contented as our real living standards improve
What is the Relationship between Real Incomes, and Subjective Happiness?
Generally, the higher the GDP per capita, the higher the average life satisfaction score.
What is inflation ?
- Inflation is a sustained increase in the overall level of prices in an economy
- It is a measure of the cost of living
How can inflation be calculated ?
Inflation can be calculated as the percentage rate of change of prices over time
How do you calculate the inflation rate ?
- (( Change in CPI ) ÷ Previous year CPI )× 100
- Basically just percentage change
What is the UK’s target inflation rate ?
U.K.’s target inflation rate is 2%
What is disinflation ?
- Disinflation is a fall in the rate of inflation, but it is not sufficient enough to bring about deflation.
- Just a drop in the inflation rate e.g. 6% to 3%
- There is still inflation but its just less than before
What is deflation ?
Deflation is a persistent fall in the general price level of goods and services shown by a negative inflation rate e.g. -3%
Why is deflation different from disinflation ?
Deflation is a negative inflation rate whereas disinflation is a drop in the inflation rate, not necessarily negative
What is hyperinflation ?
Hyperinflation is very high inflation and usually accelerating rates of inflation
What does hyperinflation do ?
It rapidly erodes the real value of the local currency
What are the two measures of the price level in the UK ?
- Relative price index (RPI)
- Consumer price index (CPI)
What is the CPI ?
- The Consumer Price Index is the main measure of inflation used in the UK and the EU
- It is the price of a weighted average market basket of consumer goods and services purchased by households
- Changes in CPI track changes in prices over time
What are some of the limitations of CPI ?
- The CPI is not fully representative, it will be inaccurate for non-typical households
- Spending patterns are different; single people have different spending patterns compared to a married family
- New products are not included in the CPI
- It does not account for the regional differences in the cost of living
- Changing quality of goods and services
What is the basket of goods and services ?
A fixed set of consumer products and services whose price is evaluated on a regular basis, often monthly or annually.
What is the basket of goods and services used to track ?
It is used to track inflation in a specific market or economy
What is CPI used to index ?
CPI is used to index benefits, tax credits and public services pensions
What is RPI used to index ?
RPI is used to index government debt payments, most pay negotiations and most private sector pensions
What are the differences between RPI and CPI ?
- RPI and CPI use different methodologies for calculating averages. Mathematically, this means RPI will usually be higher than CPI.
- The CPI does not include council tax, mortgage interest payments and some other housing costs whereas RPI does
- RPI excludes top earners and those in state benefits
Why can CPI and RPI never be 100% accurate ?
- Basket not representative/ only a selection of products included and it is difficult to judge a typical household
- New technology enters the market and makes it difficult to calculate a change in price
- It doesn’t take into account the increasing quality of goods and services
- Shrinkflation - changing the size of products rather than the price
- Sampling errors
- Consumers may switch to relatively cheaper versions of some products meaning that the cost of living will not increase as much as CPI
Why does the RPI tend to be higher than CPI ?
- One reason is the method of calculating both indices.
- RPI uses an arithmetic mean
- CPI uses a geometric mean
What is the redistribution effect ?
Inflation redistributes income away from certain groups in the economy and towards other groups
When does the redistribution effect arise ?
It arises in situations where certain groups lose some purchasing power and become worse off, while other groups gain purchasing power and become better off
How do people who receive fixed incomes lose from inflation ?
When individuals receive an income or wage that is fixed or constant, as the general price level increases they become worse off
What kind of people receive fixed incomes ?
- Workers have wage contracts fixing their wages over a period of time
- Pensioners receive fixed pensions
- Landlords receive fixed rental income
- Individuals receive fixed welfare payments
How do people who receive income that increases less rapidly than the rate of inflation lose out ?
When individuals incomes do not keep up with a rising price level, a fall in their real incomes results and they therefore become worse off
How do holders of cash lose out from inflation ?
As the price level increases, the real value or purchasing power of any cash held falls
How do savers lose out from inflation ?
In general, savers who receive a rate of interest on their savings lower than the rate of inflation suffer a fall in the real value (or purchasing power) of their savings.
How do lenders lose out from inflation ?
In general, lending at a lower interest rate than the rate of inflation makes the lender worse off at the end of the loan period
How do borrowers gain from inflation ?
- In general, borrowing at a lower interest rate than the rate of inflation makes the borrower (debtor) better off at the end of the loan period
- This likely to happen when inflation occurs as you would have originally borrowed at a lower interest rate
How do payers of fixed incomes gain from inflation ?
The payers benefit as the real value of their payments to their workers falls due to inflation
How do payers of incomes that increase less rapidly than the rate of inflation gain from inflation ?
As long as incomes of any kind increase less rapidly that the rate of inflation, the payers of these incomes benefit due to the falling real value of their payments
What are menu costs ?
Menu costs are costs incurred by firms when they have to print new menus due to changes in prices
How are menu costs affected by inflation ?
The higher the rate of inflation, the more often firms have to change their prices and therefore, the higher the menu costs
What is the money illusion ?
It refers to the idea that some people feel better off when their nominal income increases, even though the price level may increase at the same rate and possibly even faster
What does the money illusion lead to ?
It has negative consequences as it leads to consumers to make wrong spending decisions
How does an increase in inflation affect international competitiveness ?
The country’s international competitiveness, or its ability to compete with foreign countries, is reduced.
What does an increase in inflation affecting international competitiveness lead to ?
The result is that the quantity of exports falls, and the quantity of imports increases. This in turn may create difficulties for the country’s balance of payments.
What can inflation result from ?
Inflation can result from demand side factors (demand pull inflation) or supply side factors from internal and external causes (cost pull inflation)
What is demand pull inflation caused by ?
- Caused by an increase in AD e.g. when the economy is in a boom phase.
- Demand-pull inflation is caused by excess demand in the economy.
When is demand pull inflation likely to occur ?
When aggregate or total demand rises and there is no increase in aggregate supply, then demand-pull inflation is likely to occur.
Why might demand pull inflation be caused ?
- Consumer spending may rise excessively.
- Consumer confidence could be rising because house prices are rising.
- Firms may substantially increase their spending on investment.
- The government might be increasing its spending substantially, or it could be cutting taxes.
- World demand for UK exports may be rising because of a boom in the world economy.
How can demand pull inflation be caused by money supply ?
- If banks increase their lending to customers, the money supply will grow.
- Customers are likely to spend the money they have borrowed.
- The result will be increased aggregate demand
- This can cause inflation
What can cause cost pull inflation ?
Anything that causes AS to decrease will lead to cost push inflation
Why does cost pull inflation occur ?
It occurs because of rising costs and it could occur because of changes in the supply side of the economy
What are the four major sources of increased costs ?
- Increases in wages
- Imports can cause a rise in price
This can also be caused by a depreciation in the exchange rate, WBIDEC - Profits can be increased by firms when they raise price to improve profit margins.
- Government can raise indirect tax rates or reduce subsidies, thus increasing prices
What will firms try to do when costs increase ?
They will try to pass on increases in their costs to customers
What might stop firms from passing on their costs to customers ?
- Competition in the market may mean that they find it difficult to pass on these price rises and maintain sales.
- However, if costs are rising over time, firms will have to increase their prices and this leads to inflation.
What is hyperinflation ?
When a country experiences a monthly inflation rate of 50 percent
What does hyperinflation cause ?
- It erodes wealth
- Wipes out peoples savings as they will have to spend that money
- People start to spend money as quickly as possible
What does extreme inflation make people do ?
Forces people to spend as quickly as possible
What does spending money very quickly lead to ?
Leads to no money being available to invest in businesses
What does an increase in the money supply mean ?
An increase in the money supply means that both outputs and prices increase
What does an increase in the money supply cause to begin ?
This is what initially causes inflation to begin
What happens when you print more money ?
The more money you print, the higher the rate of inflation
What does a fall of real GDP cause ?
When real GDP falls for an extended period of time, the economy enters a depression
What are the three economic categories of employment ?
- The employed
- The unemployed
- Economically inactive
Define employment
The state of being paid to work for a company or organisation
Define unemployment
The state of being out of work while being willing and able to work
What is long term unemployment ?
- It accounts for people who have been out of work for at least one year
- The longer people are without a job, the harder it is for them to find their way back into paid work
What is the formula for unemployment rate ?
(Number of people unemployed ÷ labour force) × 100
What is cyclical unemployment ?
- Cyclical unemployment is caused by low levels of aggregate demand, reducing the demand for labour
- Cyclical unemployment can rise quickly in a recession, but it can increase in a period of slow growth.
What can cause cyclical unemployment ?
When aggregate demand falls, this will cause a contraction in real national output and some businesses may make workers redundant as a result.
What is frictional unemployment ?
Frictional unemployment is caused by workers seeking a better job or who are in-between jobs.
Why is there always frictional unemployment ?
This is mainly due to the fact that people will always be looking for work, not everyone will be employed
Who does frictional unemployment affect ?
- It affects those people who are new entrants to the labour market such as school and college leavers.
- It affects people who rely on short-term contracts and move between employers more frequently
How can frictional unemployment reduced ?
- Making information on jobs more widely available
- Making job search and applications more affordable
What is structural unemployment ?
- Mainly caused by lack of suitable skills for the jobs available
- Structural unemployment can happen because of other barriers to people finding work
What is the unemployment trap ?
This is a situation in which there is little financial incentive for someone who is unemployed to start working because the combined loss of benefits and a need for them to pay taxes may lead to them being worse off
How are the unemployment trap and structural unemployment related ?
People often remain unemployed because of disincentive effects such as the unemployment trap
When does real wage unemployment exist ?
Real wage unemployment exists when real wage rates are stuck at a level above that needed to reduce unemployment any further
What is one cause of real wage unemployment ?
- Minimum wages. Employers might be prepared to take on more workers but only if they could pay workers less than minimum wage
- However they can not do this which means that those unemployed workers can not get jobs
What is another cause of real wage unemployment ?
Unemployed workers refusing to take low paid jobs because they cane receive more in welfare benefits than working
Define economically inactive
Those who are of working age but are neither in work nor actively seeking work
What are the main reasons for economic inactivity ?
- Students remaining in full-time education
- Looking after family or home
- Being terminally sick
- Retired people
- Discouraged workers
What are discouraged workers ?
People who have failed to find work and have given up looking
What is underemployment ?
Those who would prefer to work longer hours or are in a job below their skill set, they are under-utilised
What is the effect of underemployment ?
Under-employment tends to make the official unemployment figure look better than it is.
What are the two measures of unemployment ?
- The Labour Force Survey (LFS) by the international labour organisation
- Claimant count measure
What is the Labour Force Survey ?
- The LFS identifies the number of people available for work, and seeking work, but without a job.
- It is generated from a survey of 60-70,000 households
Advantages of the labour force survey
- Allows for comparisons between countries as it is used internationally
- Provides a rich data set on many aspects of the labour market including regional labour market activity
Disadvantages of the labour force survey
- There will be sampling errors and will have a percentage margin of error as 60,000 people are being surveyed
- Costly and time consuming
- Only carried out quarterly so may not pick up changes in the labour market quickly
What is the claimant count measure ?
Counts the total number of recipients of JSA and UC
Advantages of the claimant count measure
- Accurate in the sense that an exact number of people who claim it can easily be calculated
- Easy to classify whether or not someone is actively seeking work
- Produced monthly so it provides a timely indicator of economic activity
Disadvantages of the claimant count measure
- There are lots of unemployed people who do not meet the criteria for collecting unemployment benefits
- People might be too proud to claim
- The claimant count measure tends to be weak at picking up the level of underemployment
What can AS and AD analysis be used for ?
It can be used to distinguish between demand side and supply side causes of unemployment
What happens when the LRAS curve is not at equilibrium ?
- Then there must be cyclical or demand-deficient unemployment
- The economy is in a recession
How can the LRAS not being at equilibrium be resolved ?
If there is an increase in AD full employment can be restored
What can lead to a shift right of the LRAS ?
- If through training workers acquire new skills and get jobs
- A fall in the frictional, seasonal and structural unemployment
What would a shift right of the LRAS then lead to ?
A decrease in the price level
What are some supply side causes of unemployment ?
Supply-side causes of unemployment include frictional, seasonal and structural unemployment.
What does the trend rate of growth assume ?
- It assumes there will be supply side improvements to the economy over time
- This may or may not include supply-side improvements which reduce frictional, seasonal or structural unemployment.
- However, past evidence would suggest that existing structural unemployment tends to fall over time
How can we tell the trend rate of growth assumes this ?
If the long-run trend rate of growth is 2.5 per cent, then in the diagram for trend rate of growth, the LRAS curve is shifting to the right by 2.5 per cent per year on average.
What would happen if the trend rate of growth increased over time ?
If the long run trend rate of growth could be raised, say from 2.5 percent to 3 percent, there is a greater likelihood that structural unemployment will fall
What effect does migration have on employment and unemployment ?
Studies show that immigrants to the UK are more likely to be employed and less likely to claim benefits than the existing population
What does migration of workers lead to ?
- Due to the circular flow of income, the spending of these workers creates further jobs in the UK
- Total UK employment increases without an increase in unemployment
What can be said to happen due to net inward migration ?
- It depresses wage rates, in particular low wages
- The ability of UK firms to recruit foreign workers means that the supply side of labour is increased, reducing the equilibrium price of labour, the wage rate
Who is most affected by net inward migration ?
It can be argued that workers with fewer skills are most effected
Why are workers with fewer skills affected by net inward migration ?
This is because they are competing in the job market with migrants have work skills and are prepared to work for low wages.
What does the UK have to do to maintain its employment levels ?
It has to increase the skills of its workforce over time
What are the Balance of Payment accounts ?
The balance of payment accounts record all financial transactions between residents of a country and the rest of the world over a time period
What three accounts does the the balance of payments have ?
- Current account
- Capital account
- Financial account
What is the only account that we need to know ?
Current account
What is the balance of trade ?
- The difference between the value of visible exports and visible imports
- visible exports - visible imports
What is the current balance ?
- Difference between the value of total exports and total imports
- Can be calculated by adding the balance of trade in goods with that of services, income and current transfers
What is the current account ?
- It records money flow between the UK and the rest of the world arising from trade in goods and services, income from owning overseas assets and overseas transfers
What 4 categories does the current account include ?
- Exports
- Imports
- Net income from investment
- Net transfers from abroad
What are trade in goods ? ( visibles )
- Known as visibles because you can physically see them
- e.g. raw materials or finished goods
What are trade in services ? ( invisibles )
- These are services traded in or out of the country, known as invisibles.
- e.g. holidays
What are trade in goods and services a form of ?
Exports and imports
What are exports ?
- Goods and services sold to foreigners by UK firms
- A positive on the current account
- The money received will enter the UK
Examples of visible exports
Cars, mobile phones, unfinished goods etc
Example of an invisible export
A Japanese firm buying insurance from a city of london firm is an invisible export as money enters the UK
What are imports ?
- Goods and services bought by UK residents and firms from foreigners
- Imports are a negative on the current account
- The money paid will leave the UK and go into the foreign country
Examples of visible imports
Cars, mobile phones, unfinished goods etc
Examples of an invisible import
A holiday to spain is an invisible import as money leaves the country and goes to spain
How do you measure the value of imports and exports ?
- Price x Quantity, determines the value of exports and imports
- You do not use the quantity of exports and imports, instead you calculate their value
What is a current account surplus ?
When there are more inflows than outflows
What is a current account deficit ?
When there are more outflows than inflows
What is primary income ?
- Results from the loan of factors of production abroad
- Interest, profits and dividends from abroad
What is secondary income ?
A range of mainly government transfers to and from overseas organisations
