2.1 Measures Of Economic Performance

Question 1

Measures of economic performance

Answer 1

• unemployment numbers
• rate of inflation
• rate of economic growth
• balance of payments position on current account (inflow and outflow of goods, services, investment incomes and transfer payments)
• government budget
• degree of inequality
• quality of environment

Question 2

Indexes

Answer 2

A technique for measuring and observing movements in variables that cannot be directly measured (inflation, confidence)

Index number for base period = 100

Question 3

Formula for index number

Answer 3

Index number = (raw number in period / raw number in base period) x 100

(round to 1 d.p)

Question 4

GDP (gross domestic product)

Answer 4

Measures quantity of goods & services produced in an economy

Question 5

How does GDP and economic growth relate

Answer 5

Economic growth occurs when there is a rise in the value of real GDP
Increase in national output = rise in economic growth

Income = output = expenditure
As GDP can be measured by expenditure method (consumer expenditure, investment, gov spending, net trade)
Or by income method (wages, interest, profits, rents)

Question 6

What does economic growth lead to

Answer 6

• higher living standards
• more employment opportunities

Question 7

Real GDP vs Nominal GDP

Answer 7

Real GDP: value of GDP adjusted for inflation (uses GDP deflator)

Nominal GDP: value of GDP (goods and services within an economy) without being adjusted for inflation

Question 8

Total GDP vs GDP per capita

Answer 8

Total GDP: total value of all goods & services produced within a country in a year

GDP per capita: value of total GDP / population of country (average output per person in economy) (easier to compare living standards amongst different countries)

Question 9

Volume of GDP vs Value of GDP

Answer 9

Volume of GDP: number of goods/services produced

Value of GDP: what goods/services produced are worth (volume x current price level)

(Important for trade, country may import more goods/services than export so trade surplus as value of exports exceed value of imports, but volume doesn’t)

Question 10

Gross national income (GNI) as another national income measure

Answer 10

GDP figure + net income paid into country from abroad including interest payments & dividends (& removed remittances sent home by migrant workers)

(GNI figure may be much lower than GDP in countries with large foreign populations as high remittances. Eg. Ireland has lots of MNCs due to low corporation tax rate

GNI increasing used instead of GDP due to growing size of remittances and aid)

GNI per capita more useful for comparisons

Question 11

Comparison of rates of growth between countries & over time

Answer 11

Use economic date to compare economic performance between different countries/ determine level of success caused by country’s policy decisions

• comparing GDP per capita more useful than GDP as takes into account population differences
• use real date rather than normal data as high inflation rate can artificially boost GDP growth rate but consumers real incomes may not have risen by much

Question 12

Limitations of using GDP to compare living standards between countries & over time

Answer 12

• doesnt include unofficial or unpaid work eg. Charity, childcare
• difficult to measure value of innovation (apps, free software/ improving quality of goods
• doesn’t include factors affecting / impacts on living standards (pollution, stress levels, national welfare, happiness) (increase in GDP often has negatives effects on standards of life)
• doesn’t take into account black markets (underground economy) as not registered (so countries with lots of black markets like Mexico have GDP underestimated)
• increase in real GDP may not be shared equally among economy’s population (doesn’t show how income is distributed, masks levels of inequality or true living standards of majority of population)

Question 13

Purchasing Power Parities (PPPs)

Answer 13

Help compare costs of living between countries

So gives more accurate comparison of different countries GDP rates

An exchange rate of one currency for another which compares how much a ​typical
basket of goods ​in the country costs compared to one in another country

§ The PPP exchange rate remains fairly constant year round, so it can be easily compared
§ Exchange rates will often get closer to the PPP as time passes
§ Knowing the PPP will allow you track and predict exchange rate relationships
§ PPP can help you examine the relative living conditions of different countries

Question 14

The use of PPP-adjusted figures in international comparisons

Answer 14

if basket of goods in UK equivalent of $400 (after pounds converted to dollars),
but basket of goods in America worth $800,
= purchasing power parity is 1:2.
So even if America has higher GDP per capita than UK, cost of living much higher so American citizens worse off

If GDP per capita in UK = $80,000 and GDP per capita in US = $100,000,
then UK GDP (PPP) = $80,000 and US GDP (PPP) = $50,000.
So when adjusted to PPP, UK has higher GDP per capita rate than America, suggesting higher living standards in UK

Question 15

National happiness (and UK national wellbeing stats)

Answer 15

National happiness index used alongside economic indicators to give better idea of standard of living between countries (to resolve limitations of GDP)

UK ranked 19th out of 156 nations in UN happiness report in 2018 using 6 key factors:

• GDP per capital (23rd)
• Generosity (6th)
• Absence of corruption (24th)
• social support (13th)
• perceived freedom (40th)
• healthy life expectancy (26th)

Question 16

Relationship between real incomes & subjective happiness

Answer 16

Easterlin paradox suggests life satisfaction rises with average incomes but only up to a certain point.

After this point, marginal gain in happiness derived from increases in income declines
so larger income increase needed to generate same increase in happiness as before the marginal happiness gain

Question 17

Economic Growth & how to calculate it

Answer 17

an increase in the amount of goods and services produced per head of the population over a period of time

= Calculate percentage change in GDP from 1 year to another

Question 18

How is inflation calculated

Answer 18

Percentage rate of change in prices over time

Question 19

The balance of payments

Answer 19

Record of all financial dealing over a period of time between economic agents of one country and all other countries

Question 20

What is the balance of payments account made up of

Answer 20

• the current account (records payments for purchase and sale of goods & services )
• the capital and financial account (records flows of money associated with saving, investment, speculation & currency stabilisation)

Question 21

What components is the current account split into?

Answer 21

• balance of trade in goods (difference between value of visible exports and visible imports)
• balance of trade in services (difference between value of invisible exports and invisible imports)
• income (remittances)
• transfers (payments eg. EU fees, aid contribution)

Question 22

Balance of trade in goods

Answer 22

Trade in raw materials, manufactured goods
(tangible)

• visible exports = inward flow of money = positive sign on balance of payments account
• visible imports = outward flow of money = negative sign on balance of payments

= value of visible exports - value of visible imports

Question 23

Balance of trade in services

Answer 23

Eg. Financial services, transport (intangible)

• invisible exports = inward flow of money = export credits in services (positive) on balance of payments accounts
• invisible imports = outward flow of money = export debits in services (negative) on balance on payments accounts

= value of invisible exports = value of invisible imports

Question 24

Primary income

Answer 24

Results from loan of factors of production abroad (interest profits & dividends on assets owned abroad)

Net income = income sent back to domestic country by workers abroad - income sent to foreign countries from workers in domestic country (remittances)

Question 25

Secondary income (transfers)

Answer 25

Range of mainly government transfers to and from overseas organisations (European Union)

Eg. EU fees or aid contribution

Question 26

What does the Trade of invisibles include?

Answer 26

• trade in services
• primary income
• secondary income (transfers)

Question 27

Current balance

Answer 27

Difference between value of exports and total imports

(Balance of trade in goods + balance of trade in services + income and current transfers (primary & secondary income))

Question 28

Current account surplus

Answer 28

Exports greater than imports (monies flowing into country greater than monies flowing out of country from all components of current account (net trade, income, transfers) )

= current balance (X-M) is positive

Question 29

Current account deficit

Answer 29

Imports greater than exports (monies flowing out of country greater than monies flowing into country from all components of current account (net trade, income, transfers) )

= current balance (X-M) is negative

Question 30

Inflation definition

Answer 30

An increase in the general price level of goods/services within an economy resulting in a decrease in the purchasing power of money

Question 31

Deflation definition

Answer 31

A decrease in the general price level of goods/services within an economy resulting in an increase in the purchasing power of money

Question 32

Disinflation definition

Answer 32

A decrease in the rate of inflation (the general price level is increasing, but at a slower rate than before)

Question 33

How to use the CPI to calculate the rate of inflation

Answer 33

• family expenditure survey for UK households (how much money spent on what goods/services)
• around 700 most popular household goods/services out into a basket of goods/services
• basket of goods has weighting system to indicate percentage of household income spent on each item
• base year is chosen (index = 100)
• index numbers calculated = gives measure of changes in rate of inflation

(new basket of goods made each year to keep up with changes in consumer spending)

Question 34

Consumer price index (CPI)

Answer 34

= UK gov’s preferred measure of inflation, measures changes in average cost of living for a representative household & is a weighted price index

Question 35

Retail price index (RPI)

Answer 35

= measure of inflation published monthly by Office for National Statistics, measures change in cost of representative sample of retail goods/services

Doesn’t meet international statistical standards, emphasises CPI instead

Question 36

Limitations of CPI in measuring rate of inflation

Answer 36

• basket of goods may not represent all consumers spending habits = may be inaccurate for some households
• different measurements of inflation used by different countries (eg. RPI or CPI) = difficult to compare
• prone to inaccuracy / errors as its data collection = inflation may be under/over valued
• difficult to compare to previous years as content of basket of goods/services keeps changing (less relevant/useful)
• consumption habits can change in less than a year = items in basket of goods can become outdated = less accurate representation

Question 37

Alternative measure of rate of inflation

How does it differ from CPI

Answer 37

= retail price index (RPI)

Unlike CPI, RPI takes into account housing costs = often higher than CPI as housing costs increase at higher rate

Question 38

Causes of inflation

Answer 38

• Demand pull inflation (caused by increase in components of AD)
• Cost push inflation (caused by decrease in AS & increase in firms cause of production)
• Growth of money supply

Question 39

Demand pull inflation (with graph)/ CAUSES:

Answer 39

• increase in AD (AD1 to AD2) causes increase in real GDP (Y1 to Y2) & increase in price level within economy (P1 to P2)
• moves economy closer to full employment = pressure on existing factors of production = prices rise (wage inflation due to harder work, scarce workers)
• consumers have more disposable income to spend on goods/services = increases inflation further

Any increase in components of AD (C, I, G, X-M) causes demand pull inflation

DEPRECIATION IN THE EXCHANGE RATE- Causes imports to become more expensive, whilst exports become cheaper, causes AD to rise.

Fiscal stimulus in the form of lower taxes or more government spending. This means consumers have more disposable income, so consumer spending increases. From higher spending incomes/ increased confidence

§ Increased confidence- higher consumer spending and business investment

§ Rising animal spirits due to positive wealth effect from rising house prices

§ Global economy experiencing faster growth in incomes and buying a lot of goods from the UK, causing UK exports and AD to rise quickly, causing demand – pull inflationary pressure

§ Lower interest rates makes saving less attractive and borrowing more attractive, so consumer spending increases. Lower IR, try to avoid deflation respiral

§ Lower income tax

§ Improved availability of credit/ affordable credit

§ Pre 2009, bank rate was 5% to avoid a deflation respiral, dropped the 5% rate to 0.5%

§ High growth in UK export markets means UK exports increase and AD increases.

Question 40

Cost push inflation (with graph)/ CAUSES

Answer 40

• decrease in AS (AS1 to AS2) causes decrease in real GDP (Y1 to Y2) & increase in price level within economy (P1 to P2)
• caused by supply side shocks (decrease in value of pound = imports more expensive = firms increase prices to compensate for increased costs)

Anything that causes decrease in AS & increase in firms cost of production causes cost push inflation (oil prices, wages, VAT, corporation tax)

Increase in raw material price; coal, oil, gas

§ Increase in wages, e.g. through trade unions if
consumers expect prices to rise, they may ask for higher wages to make up for this, and this could trigger more inflation

§ Increase in business taxes e.g. VAT

§ Increase in prices of importive of raw materials due to a weaker exchange rate, causes imports
to become more expensive, which pushes up the
price of raw materials.

§ Monopolies, using their dominant market position to exploit consumers with high prices.

A rise in the cost of imported raw materials:
§ If prices rise then in the short run producers will pay the higher cost and set higher prices. This is how price increases in the world commodity markets can lead to higher domestic inflation

§ If a country’s currency decreases in value then producers will have to pay more for the same imports.

A rise in indirect taxes:
§ If the government raises indirect taxes this will increase costs and in turn prices
§ If a good is price inelastic them more of the cost of the tax will be passed on to the customer

Question 41

Which type of inflation is worse & why/ EVAL

Answer 41

= cost push inflation if worst type of inflation for economy as real GDP is decreasing while inflation is increasing = results in stagnation, negative economic growth

Demand pull inflation is considered less harmful than cost push inflation because it is associated with increasing aggregate demand and improved living standards

Businesses may choose to use increased profit margins to invest in new capital, increasing productive capacity in the future

Cost – push inflation tends to be more harmful than demand pull inflation as it tends to be associated with falling output (AS) knows as stagflation.

INFLATION DEPENDS ON:

Rate at which inflation is rising- the higher the rate the more significant this will be

Whether inflation is stable or unstable- stability helps with forecasts and budgeting

Whether the current rate is one which has been expected- anticipated is better and firms/households can prepare

How UK inflation compares with other countries-effecting international competitiveness

The type of inflation- as mentioned above

Question 42

Growth of the money supply

Answer 42

Price level of goods/services within economy equal to money supply (if more money chasing same quantity of goods, price will rise to compensate)

Monetary policy of quantitive easing = increasing money supply (encourages banks to lend money to consumers / firms to increase spending to increase general price level of goods/services within economy)

Question 43

Effect of inflation on consumers

Answer 43

• reduction in purchasing power = weekly spending buys lower quantity of goods/services than before
• bigger impact on lower incomes as essentials increase in price (spend much higher percentage of weekly income on each item in basket of goods)

+ real value of debt/loan repayments will decrease (doesn’t align with inflation) = more disposable income to spend = consumption increases

Those on low and fixed incomes are hit hardest by inflation, due to its regressive effect, because the cost of necessities such as food and water becomes expensive. The purchasing powers of money falls, which affects those with high incomes the least.

§ If consumers have loans, the value of the repayment will be lower, because the amount owed does not increase with inflation, so the real value of debt decreases.

Question 44

Effect of inflation on firms

Answer 44

• results in increase in interest rate (to control inflation by deterring consumption) = upward pressure on prices, increase loan repayments for firms
• employees likely to ask for pay rise to compensate for reduction in purchasing power, increases costs of production,

+ but firms may be able to give wage increases to workers below rate of inflation = wage costs decrease & workers remain happy (still a pay increase)

• domestic firms less competitive globally as inflation increase price of exports relative to other countries = reduced demand for exports, & imports cheaper so domestic consumers demand increase for imported goods/services

With high inflation, interest rates are likely to be higher, so the cost of investing will be higher and firms are less likely to invest.

§ Workers might demand higher wages, which could increase the costs of production for firms. Firms may be less price competitive on a global scale if inflation is high. This depends on what happens in other countries, though.

§ Unpredictable inflation will reduce business confidence, since they are not aware of what their costs will be. This could mean there is less investment

Question 45

Effect of inflation on government

Answer 45

• increase cost of living for citizens = gov has to increase state pensions & welfare payments = increase in gov spending

+ helps to reduce national debt in real terms (requires smaller % of gov total tax revenue, easier to pay back)

Question 46

Effect of inflation on workers

Answer 46

+ wage increase likely to compensate for increase in cost of living

• but may lose out if wage increase is less than inflation rate
• higher wages may push workers into higher income tax bracket = may not gain wage increase by increased rate of tax
• increases costs of production for firms = redundancies made to reduce costs & maintain competition = unemployment within economy will increase

Question 47

Unemployment

Answer 47

Those who are willing, able and registered to work, but cannot find a job

Question 48

The measures of unemployment

Answer 48

• the claimant count
• the international labour organisation (ILO) & the uk labour force survey

Question 49

The claimant count

(Definition, negatives)

Answer 49

= measures no. of ppl claiming unemployment related benefits from the government, job seekers allowance.

• figure often lower than labour force survey as ppl who fit ILO not always eligible to claim job seekers allowance

ADVANTAGES:

Data is easy to obtain
No cost in collecting data as its already recorded when people apply for benefits
No administrative costs

DISADVANTAGES:

It excludes those people who are looking for work but aren’t eligible to claim benefits; not every1 claims JSA

§ Difficult to compare – not internationally recognised

§ Some people who claim aren’t actively seeking work

§ People working in the hidden economy or those who fraudulently claim benefits.

§ Partners on high incomes - not eligible for the benefit, even if they are u/e. Instances of ppl claiming the benefit whilst they are employed, the method generally underestimates the level of unemployment.

Question 50

The international labour organisation (ILO) & UK labour force survey

ILO definition of unemployment

(Definition, positives, negatives)

Answer 50

= labour force survey given to random sample of households within UK, makes unemployment statistic

ILO definition of unemployment = ready to work within 2 weeks & activity looked for work in past month, but cant find a job

+ labour force survey used worldwide, easy to compare internationally

• ## just a sample of houses = prone for sampling errors = figure may be inaccurate

Question 51

Difference between unemployment and under-employment

Answer 51

Unemployment = dont current have a job despite actively searching, willing & able to work

Underemployment = currently working, but overqualified for job, skill set isn’t fully utilised

Underemployment big issue in UK

Question 52

Significance of changes in rate of employment (what causes it)

Answer 52

• employment can increase (while unemployment increases) due to increased immigration = boost no. of ppl in workforce (evaluation)
• employment can decrease if no. of ppl not actively searching for job = aren’t in workforce

Question 53

Significance in changes in unemployment (what causes it)

Answer 53

• increase in unemployment (while employment increases) due to increase in no. of ppl economically inactive (not searching for work) = not in work, but not counted in unemployment figure

Question 54

Significance of changes in rate of inactivity (problems with economically inactive)

Answer 54

• roughly 9000 aged 16-64 in UK economically inactive (long term sickness, lack of motivation, dont find jobs in short term = unmotivated = drop out of workforce)
• economically inactive not counted in unemployment = doesn’t represent problems with increase in economically inactive = con of unemployment measures

Question 55

Types of unemployment

Answer 55

• structural unemployment
• frictional unemployment
• seasonal unemployment
• demand deficiency & cyclical unemployment
• real wage inflexibility

Question 56

Structural unemployment (definition, causes)

Answer 56

= when the demand for labour is less than its supply in an individual labour market in the economy (regional unemployment)

Serious form of unemployment as it is a long term decline in demand in an industry leading to reduction in employment - increasing international competition or technology.

§ Demand for labour is lower than the supply in an individual labour marke

Causes:

• geographical immobility (workers unwilling to move to find a job eg. Cost, family ties) - regional unemployment. Refers to barriers people moving from one area to another to find work.
• occupational immobility (workers have no skills, skills that are no longer needed) - sectoral unemployment

Question 57

Frictional unemployment
(definition, how to reduce it)

Answer 57

= short-term unemployment when workers lost their job and are searching for a new one

Always in a mixed economy

Reduce:
- educational & careers advice (better job info) = shorter time searching for job
- higher level of unemployment benefits = more time to search for better job, but may be over-reliant & never find new job

Generous welfare benefits will give people less incentive to look for a new job, or they can mean people can afford to take their time to look for a good job- so time spent between jobs may increase

Question 58

Seasonal unemployment

Answer 58

= some jobs only available in certain seasons, become unemployed when season changes (tourism, construction worker, ski instructor)

tends to rise in winter when some workers laid off, but falls in summer when they are taken on again

Question 59

Demand deficiency & cyclical unemployment (definition, why, graph)

Answer 59

= decease in AD (AD1 to AD2) = decrease in demand for goods/services = demand for labour falls = unemployment increases (firms need/can afford less labour to meet demand), causes real gdp to fall (Y1 to Y2) & price level to rise (P1 to P2)

Question 60

Real wage inflexibility / unemployment

Answer 60

= difference between demand for labour & supply for labour

Wages fixed above equilibrium rate (minimum wage) = supply of labour is more than demand for labour (excess supply), full unemployment cant be attained

Question 61

Significance of skills for employment & unemployment

Answer 61

• high levels of occupational immobility causes unemployment rate to be high (workforce has lack of relevant skills), created long term unemployment for workers who don’t get retrained
• skills brought in by migrants substitute skills in domestic market = domestic skilled workers are replaced
  + but some migrants have complementary skills = higher productivity levels = unemployment decreases

Question 62

Significance of migration for employment & unemployment/ HOW DOES IT IMPACT UNEMPLOYMENT

Answer 62

• migration = expansion in workforce (most of working age searching for work) = supply of labour increases = reduces domestic work wages
  (People most affected = low end of pay scale as migrants willing to earn less & replaced them)

+ increase in migrants increases demand for uk good/services = demand for labour increases = reduces excess labour supply

• skills brought in by migrants substitute skills in domestic market = domestic skilled workers are replaced,
  + but some migrants have complementary skills = higher productivity levels = unemployment decreases

Migration fills gaps in the economy, in certain sectors

§ Young, skilled, talented workers- positive multiplier effect as theres dervied demand for labour. They earn and spend money= Increase in AD & Real GDP- factor incomes and consumption

§ Increases labour force & productive capacity of the economy and potential output which should decrease unemployment as they fill skills gap- contribute to reducing the budget deficit.

§ Migrants bring high quality skills to the domestic workforce- increase productivity and increase skillet of the labour market= increase global competitiveness

HOW DOES IT IMPACT:

Depends upon the skillset, complementary or substitutes

§ Complementary- alleviate skills gap decrease u/e

§ Substitues- will not alleviate skill shortage and boost u/e

§ The skills of migrant labour could substitute those of the domestic market, so workers could be replaced. If the skills complement the domestic labour market, there could be a welfare gain through higher productivities.

§ Skills are substitutes = decreased pressure on wages, skills are complementary= increased pressure on wages

§ Migrant labour affects the wages of the lowest paid in the domestic labour market-bringing them down.

§ This is because migrants are usually from economies with lower average wages than the UK NMW.

§ However, this impact is only small.

§ For the medium and higher income households, it is hard to find evidence of worker displacement or depressed

Question 63

Effect of unemployment on consumers

Answer 63

• loss of income = fall in living standards, health issues (depression), reduction in self-esteem

Discouraged workers
Inequality

Hysteresis- workers uneployed for a long time, deskilled unmotivated and are less able to get new jobs, pool of available labour falls. MEANS MORE DIFFICULT TO GET WORK IN THE FUTURE

Question 64

Effect of unemployment on firms

Answer 64

• increase in consumers with no disposable income = reduced demand for goods/services = fall in firms revenue, may shut down

+ increases no. of workers searching for job = wider choice of skills for firms & workers willing to take pay cut (high skilled workers for cheaper labour = reduction in costs)

Question 65

Effect of unemployment on government

Answer 65

• reduction in tax revenue (fall in income tax & consumption = fall in VAT)= ad shifts left
• more gov spending on welfare payments = decrease gov budget & increase national debt

EXCHEQUER FOR ONE PERSON BEING UE IS £6243 a year in benefits and lost in tax revenue

Real GDP declines for economy, negative multiplier effect, reducer confidence

Question 66

Effect of unemployment on society

Answer 66

• increase in crime & unhappiness = negative externalities (vandalism) increases
• unhappy population = lack of motivation = increase in economically inactive

Question 67

Causes of a current account deficit

Answer 67

• strong domestic growth (increase in AS = increase in domestic income = demand for imported goods/services increases (majority from abroad) = trade deficit. Incomes are high and SOL, more willing to buy imports. Marginal propensity to import increases.
• overseas recession = reduction in income overseas = decrease in demand for domestic goods/services = reduction in revenue from exports = trade deficit
• strong exchange rate = cheaper imports, more expensive imports = domestic goods/services less competitive = demand for exports decreases & demand for imports increases = trade deficit
• high cost of production for domestic firms (low investment, low production, high unit labour cost) = rise in cost of domestic goods/services = rise in price of domestic goods/services = reduction in demand for domestic exports = trade deficit
• high relative inflation = increase in price of domestic goods/services compared to other countries = less competitive exports = reduction in export revenue = trade deficit
• poor quality goods = decrease in demand for domestic goods/services (less desirable) = export revenue low = trade deficit
• depletion of resources = domestic country may run out of resources (finite resources eg. Oil) they’re reliant on for export revenue = exports decrease = export revenue decreases = trade deficit

Supply side causes more damaging than demand side causes (long term problems, cant be solved easily)

Question 68

4 main gov macroeconomic objectives

Answer 68

• low unemployment, achieving full employment
• low and stable inflation, avoiding deflation
• economic growth on a par with similar economies
• balance of payments equilibrium, including equilibrium on the current account

Question 69

What macroeconomic objectives are affected by a current account deficit

Answer 69

• stable economic growth
  = reduction in AD = negative economic growth
• low unemployment
  = less demand for goods / services = less demand for labour (derived) = increase in unemployment

Question 70

What macroeconomic objectives are affected by a current account surplus

Answer 70

• low & stable inflation
• balance of payments equilibrium

= increase in AD = increase in real GDP & price level = inflation increases past stable rate if price already high

Problems with high inflation:
- reduce purchasing power, consumers can’t buy as much, fall in living standards
- exports less competitive, current account surplus hard to maintain in long run

Question 71

Interconnectedness of economies through international trade (problems of international trade)

Answer 71

• country’s trade heavily relies on economic conditions of other country’s (one country’s exports is another countries imports)

(If one country experiences a recession, spending on imports will decrease so other countries exports will decrease, reduction of export revenue = contraction in AD = increase in unemployment)

Question 72

What are the benefits and cosst of inflation?

Answer 72

BENEFITS:

Economic Growth- if demand pull inflation increases then we can assume that disposable income has risen and therefore real GDP will increase. Increase inflation= increase in consumer spending= increase in consumption= increase output

Lower unemployment- if demand pull inflation occurs then we can assume disposable income has risen thus AD will shift to the right so unemployment may fall to meet demand. Workers with a strong wage bargaining power – can protect their incomes

Borrowers benefit- the value of money
that was borrowed is now worth less, in real terms they back less, erodes away value of debt

COSTS:

Decline of competitiveness- if inflation is high, prices will increase and the level of exports will decrease as unable to cope with foreign competitors

Administrative costs- adjusting accounts or budgets, estimating prices to change, negotiating wage rises

Inflationary noise: consumer choice is distorted, people cannot judge prices, markets fail to allocate resources effectively

Fixed incomes lose out: any worker on a fixed income is likely to suffer from real wage cuts leading to a decline in living standards

Fiscal drag- wages rise in line with inflation and you are dragged into a higher tax bracket therefore increasing government tax revenue without altering tax brackets

Shoe-leather cost: the cost attached to the time that people have to allocate to finding better ways of avoiding the inflation tax arising due to a falling purchasing power of money.

Menu cost: the cost to business enterprises of having to change the nominal prices of their products in response to inflation.

Question 73

What are the consequences of inflation?

Answer 73

Inflation will cause the standard of living on those on fixed incomes or near fixed incomes to fall. This will have the biggest impact on those in low income employment or welfare benefits.

Competitiveness is reduced by inflation as exports will cost more to buy and imports will be cheaper. Exp fall and imp rise could create a deficit in the balance of payments and increase unemployment

Discourages saving because the value falls= more attractive to spend (demand pull inflation)

Reluctance to save creates a shortage of funds for borrowing & investment. If interest rates increase to reduce inflation this will also reduce investment

Creates uncertainty as rising costs will reduce investment – harming future growth

Can cause shoe leather costs and menu costs

Extreme case is hyperinflation; often result of governments creating too much money

*Business competitiveness: A high relative rate of inflation can reduce competitiveness which will lower demand for the country’s exports.

*Business uncertainty: High and volatile inflation is not good for business confidence partly because they cannot be sure of what their costs and prices are likely to be. This uncertainty might lead to a lower level of capital investment spending.

Overall, a high and volatile rate of inflation is widely considered to be damaging for an economy that trades in international markets. In your analysis focus on the impact on Uncertainty / business and consumer confidence. Volatility in investment discourages inflation

Question 74

What is demand side deflation? And what are the causes

Answer 74

AD Shifts to the left:

prices fall because of a structural lack of demand
which creates huge excess capacity in an economic system.

If there is a slump in demand, companies go out of business and sack people, and hence demand falls again – the negative multiplier effect starts to have its effect.

Lower economic growth

Question 75

What is supply side deflation?

Answer 75

When SRAS shifts to the right:

If falling prices are caused by higher productivity then it can go hand in hand with robust
growth

On the other hand deflation reflects a slump in demand and persistent excess capacity,
dangerous triggering a downward spiral of demand and prices

If falling prices are a result of improving tech or managerial practises it’s okay

Question 76

What are the problems with deflation?

Answer 76

Holding back on spending: Consumers may postpone demand if they expect prices to fail in the future

Debts increase: the real value of debt rises with deflation and higher real debts can be a big drag on consumer confidence

The real cost of browning increase: real inserts rates will rise if nominal rates of interest do not fall in line with pries

Lower profit margins: lower prices can mean reduced revenues and profits for businesses- can then lead to higher unemployment as firms seek to reduce costs by shedding labour

Confidence and saving- falling asset prices such as price deflation in the housing market hits personal sector wealth and confidence

Income distribution- deflation leads to a redistribution of income from debts to creditors- but debtors may then default on loans

Deflation can make exports more competitive eventually- but this often comes at a cost i.e higher unemployment in short term

Question 77

Does immigration push down wages?

Answer 77

From one perspective an increase in the labour supply may push down wages.

§ This is especially true if migrants are keen to accept lower wages (e.g. willing to bypass traditional union bargaining).

§ However, again, net migration doesn’t have to push down wages

Increased migration, will also affect demand for labour due to higher spending in the economy. Immigration increases labour supply – but also increased labour demand.

§ However, particular labour markets may notice lower wages if there is a concentration of immigrants willing to work. For example, if wages are high in a particular agricultural market, migration from a low-income country may lead to falling wages in these specific markets.

§ Also, some migrants may be more vulnerable and more willing to work in the black market (e.g. accept a wage below the equilibrium).

Bank of England - rise in immigration, tiny impact on overall wages – with a 10% increase in immigration – wages fall by 0.31%. However, the negative effect was greater for semi/unskilled workers in the service sector, with a 10% rise in immigration reducing wages the equivalent of 2%.

Question 78

What are the evaluation points for migration?

Answer 78

The skills and qualifications of migrants.

§ How easy do migrant find it to assimilate in the destined country

§ Age profile of migrants. If a high % are young workers, then this can help reduce the dependency ratio – a crucial issue for the government budget.

§ The current economic climate. In a recession, migrants will find it harder to gain employment.

§ Low skilled migrants are more likely to be structurally unemployed.

§ A source of foreign income, e.g. tuition fees from foreign students. However, migrants may also send a substantial portion of their earnings to relatives abroad – reducing the wealth of UK.

§ Can the Economy absorb a greater population? For example, what are the impact on public services, levels of congestion, and housing?

Migration on employment and U/E - Evaluation
§ Skill set is complementary or substitute this may have a negative impact on unemployment. If their skill set are substitute then this will not alleviate issues of unemployment and can also increase pressure on wages. Migration can be expected to increase competition in the labour market and drive down wages in the short run. The closer the substitute, the greater the adverse wage effects will be.

May be transferred via remittances which do not stimulate the UK’s economy. Decreases the wealth of the UK
and government spending which could reduce spending on public services. In this case, unemployment is made
higher as there isn’t a boost in employment especially in the short term as migrants will be studying – they
don’t have an impact on employment and they may also return back

Question 79

What are the consequences of a current account deficit?

Answer 79

(x-m) is negative AD must be falling.

§ Diagram- AD shifts left, leads to a reduction in growth. Might see some benefit from demand pull inflation. A reduction in growth and unemployment – less demand for labour, less output being produced.

§ Good consequence - A current account deficit might be an indicator of a strong growing economy- if it’s caused by demand side. Also, we finance the current account through the financial account surplus

Evaluation point- It depends on the size of deficit. The UK and US Gov argues this as it doesn’t have much of an impact on the economy.

§ Buying raw materials- export led growth in the L/R import substitution. Converted into finished goods – exported

§ Depends on demand or supply side factors, supply side (L/T). Deficit- counteracted by surplus in income & tfrs

§ What if is other factor of the account causing the current account to be pushed into a deficit like transfer

§ Cause may be cyclical factor e.g. exchange rate or income level fluctuations which are likely to be self correcting

Question 80

Is a current account deficit a concern?

Answer 80

If a deficit is because of capital goods imports, then it is likely to be good for future productivity and future growth

If a deficit is because of purchase of current goods it will be good for short term standards of living

If the deficit is a high percentage of gdp and is getting worse, this may be worrying

If nobody wants to buy a country’s exports, then this may be concerning

Question 81

What impacts do changes in the current account have on the economy?

Answer 81

If imported raw materials are expensive, COULD be cost – push inflation in the domestic economy, since firms face higher production costs

§ Could be difficult to attract sufficient financial flows in order to finance a current account deficit- unsustainable in L/R

§ Possibly loss of AD and slower growth/ lack of competitiveness

§ By selling more exports to foreign countries, the UK will have a greater inflow of money into the circular flow of income. This will increase AD and improve the rate of economic growth. In the UK, during periods of economic decline or recessions, the current account deficit falls- because consumer spending falls.

Question 82

What are measures to reduce a country’s imbalance on the current account?

Answer 82

§ If there’s a deficit on the CA, income tax could be increased. Will reduce the amount of disposable income consumers have, reduce the quantity of imports. But might also impact domestic growth, since consumers will also spend less on domestic goods. Governments could also reduce their spending. Reduces AD and lead to less imports. It forces domestic firms into increasing exports, which helps improve the disequilibrium.

§ Fiscal policy could be effective in the short term, not much in the L/T. As soon as the policy measures end, household likely to revert their expenditure back on imports.

§ If taxes are imposed on trading partners, there is the risk of retaliation, which could reduce demand for exports, too.

§ Governments might have imperfect information about the economy, so it could lead to Gov failure.

§ If ‘green taxes’ are implemented, such as carbon taxes, or if there are minimum prices on pollution permits, the competitiveness of domestic firms could be compromised. Could reduce exports from domestic firms.

§ If there is a CA deficit, the bank might lower interest rates to cause depreciation in the currency. This causes exports to become cheaper, but it could be inflationary for the domestic economy. Moreover, hot money might flow out of the country, since investors are not receiving a high return on their investment- HARD to control the supply of money in reality. Moreover, there is a significant time lag with changing the interest rate and seeing an effect.

§ Supply-side policies could help increase productivity with increased spending on education and training, which could result in the country becoming more internationally competitive. This could lead to a rise in exports. However, this incurs a significant time lag, so it is not effective as an immediate measure. In the long term, this can be an effective policy. Supply-side policies could also help make the domestic economy attractive to investors.

§ The domestic economy could be made more competitive through deregulation and privatisation, which will force firms to lower their average costs. However, privatisation could result in monopolies being formed, which will not increase efficiency

§ If governments provide subsidies to some industries to encourage production, there could be retaliation from foreign countries that see this as an unfair protectionist policy

Question 83

What is the significance of global trade imbalances?

Answer 83

International trade has meant countries have become interdependent. Therefore, the economic conditions in one country affect another country, since the quantity they export or import will change. A surplus or deficit on the current account could indicate an unbalanced economy, and it could mean the country is too reliant on other economies for their own growth. It could be difficult to attract sufficient financial flows in order to finance a current account deficit. This could make it unsustainable in the long run.

§ Imbalance suggests that the UK is reliant on the performance of other countries. If export markets, such as the EU, become weak, UK economic performance will be affected- seen during the 2008 financial crisis.

§ It could become difficult to finance the deficit in the long run. In the US, the current account deficit is financed by Chinese investors buying US securities at low interest rates. If they lose confidence in the US economy, they would stop buying US debt. The interest rates would then have to be increased to encourage investors to buy the debt. This would be damaging to US consumers who have a lot of debt, since repayments would increase, and they would have less disposable income as a result.

§ In the Eurozone, current account deficits are of greater concern because the countries have a fixed exchange rate. This means they cannot devalue the currency to restore their level of international competitiveness.

§ Since 2006, the US deficit with China narrowed and China’s surplus also fell. A surplus indicates low consumer spending and a low savings ratio, which puts China at the risk of having unsustainable economic growth. However, the government now aims to grow the economy using domestic spending, rather than exports.

§ China made their exports more competitive by undervaluing their currency. This makes their imports more expensive, however, so it could be inflationary and cause a boom or bust. A stronger Yuan causes lower growth, lower inflation and reduces the current account surplus. The US would prefer a stronger Yuan since it makes their domestic industries more competitive.

Question 84

Explain how an economic boom can cause an external deficit?

Answer 84

§ An economic boom occurs when demand, real incomes and national output (real GDP) are all rising at above trend rates.

§ One effect of this is often strong rise in consumer spending for goods and series which have income elasticity of demand.

§ A large percentage of consumer durables such as new cars and household appliances’ tend to be imported.

§ Thus a rise in consumer spending a reduction in household savings can cause the volume of imports to rise at a fast pace.

§ If the domestic economy is booming there might be limited spare capacity in general and in export industries.

§ Thus higher imports and a slowdown in exports might lead to a widening of a country’s trade deficit on the current account.

Question 85

Explain how a strong currrency can cause an external deficit

Answer 85

When a currency appreciates the foreign price of a country’s exports increases.

§ This can lead to exports becoming less prices competitive overseas causing substitution effect leading to weaker demand.

§ A fall in the value of exports can then lead to a higher trade deficit since net trade = X-M.

§ A stronger currency also leads to cheaper prices for imported products such as finished manufactured products.

§ This might cause domestic consumers to switch demand and spending towards goods and services produces overseas.

§ A rise in spending on imports (ceteris paribus) will lead to a higher trade deficit esp if demand for imports has a high coefficient of PED.

Question 86

Explain how low productivity can cause an external deficit?

Answer 86

Labour productivity measures output per worker.

§ Relatively low productivity means that efficiency in the UK is below that of other major trading competitor nations.

§ If labour productivity is low, then for a given level of wages the unit labour cost of production will be higher.

§ As a result, exporting firms with low productivity may find themselves at a price and cost disadvantage in overseas markets.

§ This might cause a slowdown in exports as foreign consumers look for relatively cheaper substitutes.

§ Also, it may cause a rise in import penetration into a domestic economy as consumers prefer to buy cheaper goods/ services.