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Economics AS > 2.6 > Flashcards

2.6 Flashcards

1
Q

What is Macroeconomics?

A

The performance of an economy as a whole

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2
Q

How many Macroeconomic Objectives are there?

A

Seven

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3
Q

What are the Macroeconomic Objectives?

A
  • Economic Growth
  • Low Unemployment
  • Low + Stable Inflation
  • Balance of Payments on the Current Account
  • Protection of the Environment
  • Greater Income Equality
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4
Q

What are the 4 Main Macroeconomic Objectives, and what do these aim to provide?

A
  • Economic Growth
  • Low + Stable Inflation
  • Low Unemployment
  • Balance of Payments Equilibrium on Current Account
  • These macroeconomic objectives aim to provide macro-stability.
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5
Q

What is Economic Growth as an objective?

A
  • In the UK, the long run trend of economic growth is about 2.5%.
  • Governments aim to have sustainable economic growth for the long run.
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6
Q

What is the definition of economic growth ?

A

Defined as the increase in real output over time

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7
Q

How is economic growth measured ?

A

Measured in the rate of change of real GDP per capita

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8
Q

What is Low Unemployment as an objective ?

A

Governments aim to have as near to full employment as possible, aiming for an unemployment rate of around 3%.

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9
Q

What is the definition of unemployment ?

A

Unemployment is when people who are economically active and willing to work are out of work

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10
Q

How is unemployment measured ?

A

Labour Force Survey or Claimant Count Measure

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11
Q

What does unemployment indicate ?

A

It indicates the under utilisation of resources

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12
Q

What is Low and Stable Inflation as an objective?

A
  • In the UK, the government inflation target is 2%, measured with CPI
  • This aims to provide price stability for firms and consumers, and will help them make decisions for the long run.
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13
Q

What is inflation ?

A

The sustained increase in the general price of goods and services over time

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14
Q

How is inflation measured ?

A

CPI

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15
Q

What is Balance of Payments Equilibrium as an objective?

A
  • Governments aim for the current account to be satisfactory, so there is not a large deficit. This is usually near to equilibrium.
  • Equilibrium on the current account means the country can sustainably finance the current account
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16
Q

What is the definition of Balance of Payments ?

A

The inflow and outflow of goods, services, investment, income and transfer payments from an economy

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17
Q

What does the balance of payments indicate ?

A

It is an indicator of a countries international competitiveness

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18
Q

What is Protection of the Environment as an objective?

A
  • The aim is to provide long run environmental stability

- It ensures resources are not exploited and that they are used sustainably

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19
Q

What is Greater Income equality as an objective?

A

Income and wealth should be distributed equitably

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20
Q

What are the stages of an economic cycle?

A
  • Boom
  • Downturn
  • Recession
  • Recovery
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21
Q

What is a boom ?

A

A period when the rate of growth of real GDP is fast and higher than the estimated long term trend

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22
Q

What is a downturn ?

A

A weakening of the rate of growth, real GDP is still rising but increasing at a slower rate.

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23
Q

What is a recession ?

A
  • A period of at least six months when an economy suffers a fall in AD
  • Real GDP contracts at least six months in a row.
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24
Q

What is a depression ?

A

A prolonged and persistent downturn, where a nations GDP falls by at least 10%

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25
Q

What is recovery ?

A

A phase after a recession where real GDP starts to increase from the low point and unemployment falls.

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26
Q

What is a negative output gap ?

A
  • The economy is not fully using its factor resource due to its large decline in demand in the economy.
  • Actual GDP is less than the potential GDP
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27
Q

What is a positive output gap ?

A
  • There is too much demand in the economy. Therefore they are overworking their factor resource. (e.g. workers overtime and using machines for longer).
  • Actual GDP is more than the potential GDP.
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28
Q

What does the government use to achieve their objectives ?

A

Monetary and fiscal policies

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29
Q

What is monetary policy ?

A

The manipulation by government of monetary variables

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30
Q

Give some examples of monetary variables

A
  • Interest rates

- Money supply

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31
Q

What is fiscal policy ?

A

Fiscal policy is the use of taxes, government spending and government borrowing to achieve its objectives

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32
Q

What can the government control ?

A

The rate of interest and the amount of money circulating in the economy

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33
Q

What else can the government influence ?

A

The amount of borrowing or credit available from financial institutions like banks and building societies

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34
Q

What are the instruments of policy ?

A

The variables which the government is attempting to control

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35
Q

Give examples of the instruments of policy

A
  • Interest rates
  • Money supply
  • Tax rates
  • Government spending
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36
Q

What is the rate of interest ?

A

The rate of interest is the price of borrowing money

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37
Q

How does the rate of interest influence AD ?

A

The higher the rate of interest, the lower the level of AD

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38
Q

In what ways can interest rates affect AD ?

A
  • Consumer durables
  • Housing market
  • Wealth effect
  • Saving
  • Investment
  • The exchange rate
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39
Q

How does the rate of interest affect consumer durables ?

A

The higher the rate of interest, the greater the monthly repayments will have to be for any given sum borrowed

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40
Q

What do high interest rates lead to in relation to consumer durables ?

A

They lead to lower sales of durable goods and hence lower consumption expenditure

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41
Q

How does the rate of interest affect the housing market ?

A

The lower the rate of interest, the lower the mortgage repayments on a given sum borrowed. This makes houses more affordable

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42
Q

How do more affordable houses increase AD ?

A
  • increased demand leads to more houses being built which increases the investment part of AD
  • Moving houses stimulates the purchases of consumer durables which therefore increases consumption
43
Q

What effect does interest rates have on the wealth effect ?

A
  • A fall in rates of interest may increase asset prices
44
Q

Give an example of how the rate of interest causes the wealth effect

A
  • For instance, falling interest rates may lead to an increase in demand for housing, which in turn pushes up the price of houses.
  • If house prices rise, all homeowners are better off because their houses have increased in value. This may encourage them to increase their spending.
45
Q

Why does the government issue bonds ?

A

They issue bonds to finance their borrowing

46
Q

Who are bonds sold to ?

A

They are sold to individuals, assurance companies, pension funds etc

  • Others who receive interest on the money that they have loaned out to the government
47
Q

What can an increase in the price of bonds lead to ?

A
  • Rises in the price of bonds held by individuals or businesses will increase their financial wealth, which again may have a positive impact on consumer expenditure.
  • This will in turn increase AD
48
Q

How do interest rates affect saving ?

A
  • Higher interest rates make saving more attractive compared to spending
  • This may lead to a fall in AD at the present time
49
Q

How do interest rates affect investment ?

A
  • The lower the rate of interest, the more investment projects become profitable. Therefore the more investment and increase in AD
  • Equally, a rise in consumption which leads to a rise in income will lead, in turn, to a rise in investment and
50
Q

How does the rate of interest affect the exchange rate ?

A
  • A fall in the interest rate is likely to lead to a fall in the value of the domestic currency
  • This is because saving in the domestic economy becomes less attractive since there are lower returns on offer
  • As a result, demand for the domestic currency falls
  • WBIDEC
51
Q

What is the role of the bank of england ?

A

They operate monetary policy on an independent basis

52
Q

Who makes the most important decisions about monetary policy ?

A
  • The Monetary Policy Committee (MPC) of the bank of england
53
Q

What does the MPC do ?

A
  • They set the bank of england base rate at their regular meetings
  • They also decide how quantitative easing is managed
54
Q

What can the MPC do, assuming that the rate of inflation is under control ?

A

They can use monetary policy to achieve other government objectives, such as economic growth and employment

55
Q

What is Quantitative Easing (QE) ?

A

The introduction of new money into the national supply by a central bank

56
Q

What does QE involve ?

A

QE involves central bank purchases of financial assets from commercial banks and other financial institutions

57
Q

What is the financial asset of choice for central banks ?

A

Government bonds

58
Q

What is the basic outline of quantitative easing ?

A
  • Central bank digitally creates money and adds it to its balance sheet.
  • Central bank purchases financial assets from banks and other financial institutions
  • Financial institutions have more money. The increased demand for bonds and other financial assets causes their value to rise. The wealth of the owners of these assets therefore increases.
59
Q

In what two ways is QE intended to increase aggregate demand ?

A
  • Greater lending by banks

- Wealth effects —> Higher consumption

60
Q

How does QE cause greater lending by banks to increase AD ?

A
  • QE involves central banks buying up government bonds
  • Consequently, financial institutions have more money.
  • It is hoped that this money will then be lent to consumers and firms to finance consumption and investment. This will then increase AD.
61
Q

How does QE cause the wealth effect ?

A
  • The effect of asset purchases is that the prices of existing assets rise, while yields, the interest on them, adjust downwards.
  • This encourages banks and other investors to look to rebalance their portfolios by investing in other assets with a higher yield, such as corporate bonds and shares (equities).
  • As new investment occurs, the new liquidity is re-directed towards sellers of bonds and shares.
  • In addition, lower yields push down borrowing costs for business, which can act as a stimulus to borrowing and spending.
62
Q

What do asset purchases cause ?

A

It creates a wealth effect with holders of assets experiencing an increase in their wealth, raising confidence and also stimulating spending

63
Q

What does QE hope to do ?

A
  • Bank lending starts to flow again, leading to increased household and corporate spending.
  • Confidence rises as lending and spending increase.
  • Aggregate demand increases and the economy moves out of recession.
  • The inflation target (2%) is achieved – rather than fall below target as might happen in a recession or periods of low growth and poor expectations.
64
Q

What are the main areas of public spending ?

A

The main areas of public spending are the National Health Service, defence, education and roads

65
Q

What finances public spending ?

A

Taxes, such as income tax and VAT.

66
Q

What is private sector net borrowing (PSNB) ?

A

The borrowing of the public sector (central government, local government and other state bodies such as nationalised industries) over a period of time

67
Q

How is a budget surplus beneficial ?

A

It allows the government to pay off part of its accumulated debt

68
Q

What is the government debt called ?

A

It is called the national debt and it dates back to the founding of England in 1694

69
Q

What is a balanced budget ?

A

Government receipts are equal to government spending

70
Q

What is a direct tax ?

A

A tax levied directly on an individual or an organisation

71
Q

Give an example of a direct tax

A

Income tax and national insurance

72
Q

What is an indirect tax ?

A

An indirect tax is a tax levied on a good or service

73
Q

Give an example of an indirect tax

A

VAT or Excise duties

74
Q

What main policies can affect AD ?

A

Fiscal and monetary policy

75
Q

What would happen if the government cuts income tax ?

A

The disposable income of households will increase which will lead to an increase in consumption, although there will also be a rise in imports

76
Q

What would happen if the government cuts VAT or excise duties ?

A

Prices of consumer goods should fall again, leading to a rise in consumption

77
Q

What would happen if the government cuts taxes on company profits ?

A

This might encourage firms to increase investment.

78
Q

What would the diagram for expansionary demand-side policy look like ?

A

An increase in aggregate demand

79
Q

What would the diagram for contractionary demand-side policy look like ?

A

A decrease in aggregate demand

80
Q

What is a rise in the budget deficit/fall in the budget surplus likely to do ?

A

It is likely to increase AD

81
Q

When is there expansionary fiscal policy ?

A
  • When there is a rise in the budget deficit or a fall in the budget surplus
82
Q

What is a decrease in the budget deficit/rise in the budget surplus likely to do ?

A

Decrease in AD

83
Q

When is there contractionary fiscal policy ?

A
  • Occurs when there is a fall in the budget deficit or a rise in the budget surplus
  • Fiscal policy is said to tighten as a result
84
Q

When is there neutral fiscal policy ?

A

When changes to government spending and taxation leave the overall budget surplus or deficit unchanged and have no effect on aggregate demand.

85
Q

What can monetary policy be used to influence ?

A

Used to influence AD

86
Q

How does expansionary monetary policy work ?

A
  • Or a loosening of monetary policy works, for example, through lowering interest rates or increasing quantitative easing
  • Leads to an increase in AD
87
Q

How does contractionary monetary policy work ?

A
  • Or a tightening of monetary policy works, for example, through raising interest rates or reducing quantitative easing.
  • Leads to a decrease in AD
88
Q

What type of policies do keynesian economists prefer ?

A

Keynesian economists tend to favour the use of both fiscal and monetary demand-side policies when the economy is in recession or is growing so fast that inflation begins to increase

89
Q

What type of policies do classical economists prefer ?

A

Classical economists tend to argue that fiscal policies are ineffective and governments should rely solely on monetary policy to influence aggregate demand, if at all.

90
Q

What do keynesian economists say about how quickly an economy can revert to long-run equilibrium ?

A
  • Keynesian economists tend to argue that an economy could be in short-run disequilibrium for years and even decades because of a lack of demand.
  • If consumers, firms and governments all spend less than is needed to get the economy to full employment, then the economy can remain depressed for a long time.
91
Q

What do classical economists say about how quickly an economy can revert to long-run equilibrium ?

A
  • Classical economists tend to argue that economies adjust very quickly.
  • If there is long-term unemployment, for example, with no economic growth, this is not because there is recession in the economy. It is because there are supply-side problems in the economy.
  • Using demand-side policies to get a stagnant economy moving again will have no effect.
92
Q

What do keynesian economists say they should do to get out of a recession ?

A

Keynesian economists would argue that governments should use both expansionary fiscal and monetary policies to get the economy back to growth

93
Q

What do some right wing economists argue about how to get out of a recession?

A

Fiscal policy should be contractionary, whilst monetary policy should be expansionary.

This is because they argue that the costs of increasing the National Debt from expansionary fiscal policy are greater than any benefits to aggregate demand that might result

94
Q

How can expansionary fiscal policy be used in a recession ?

A
  • They can be used as a demand-side policy to increase aggregate demand.
  • However, it will increase the size of the national debt
95
Q

What do some economists argue about using expansionary fiscal policy to get the economy out of a recession ?

A

Some economists argue that the benefit of increased aggregate demand in the short term is outweighed by the negative impact of increasing the National Debt

96
Q

What do keynesian economists argue about using expansionary fiscal policy to get the economy out of a recession ?

A
  • They argue the opposite
  • So long as a government can print money to finance its deficit without fuelling inflation or borrow money from the financial markets, then the National Debt is not a problem in the short term.
97
Q

What do all economists say about the National Debt ?

A

They say in the long term it can be large problem, especially if it is financed by the borrowing of money from foreigners

98
Q

What do economists say banks should do in a recession ?

A

They say that the central bank should cut interest rates to stimulate aggregate demand

99
Q

What could be used instead of cutting interest rates in a recession ?

A

QE, would have a greater effect

100
Q

What is crowding out ?

A

When government spending is discouraging firms from making further investment in the economy

101
Q

What do classical economists say about the size of the multiplier ?

A
  • Classical economists tend to argue that it is virtually zero even in the short term.
  • They argue that extra government spending crowds out (or forces out) private sector spending.
  • Cuts in tax financed by government borrowing mean that the private sector can borrow less money.
  • An increase in the budget deficit financed by printing money only leads to inflation, not extra output.
102
Q

What do keynesian economists say about the size of the multiplier ?

A

Keynesian economists argue that the multiplier is positive and can be large if government spending and tax charges are carefully targeted

103
Q

Give two ways that firms have less money for investment

A
  • Government sells its bonds to firms - firms that buy the bonds will have less money for investments
  • Government spending increase = higher corporate tax = firms having less retained profit = less funding for investment
104
Q

What do economists say about fine tuning now ?

A
  • They say that fine tuning is almost impossible
  • There are too many small, or indeed large, random shocks to the economic system and too little precision about the tools of demand-side policy for this to work.

Economics AS (11 decks)

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