2.6 Flashcards
What is economic growth
Economic growth is a rise in the productive potential of an economy or a rise in goods/services produced,measured by a change in real GDP
Possible macroeconomic objectives
- Economic growth- UK=2.5%= sustainable economic growth,in developing tends to be faster rate
- Low unemployment=aim for full employment (aim=3%)
- Low/stable inflation= target is 2%
- Balance of payments equilibrium- equilibrium on current account
- Balance of gov budget-controls state borrowing=prevent national debt= borrow cheaply in LR if they need to and makes repayments easier
-Protection of environment= ensures less resource exploitation eg oil,gas so future can use= decrease excess pollution
- Greater income equality= Minimise gap between rich and poor= fairer society
Define demand side policies
Demand side policies are policies designed to manipulate consumer demand
Define monetary and fiscal policy
- Monetary policy- when central bank or regulatory authority attempts to control level of AD by altering base IR or amount of money in the economy
> Monetary policies= interest rates or quantitative easing, quantitative easing is when central banks buy assets in exchange for money in attempt to increase money supply
- Fiscal policy- use of borrowing,gov spending and taxation to manipulate levels of AD and improve macroeconomic performance
Expansionary- Increase AD to increase growth
Deflationary/Contractionary- Decreased AD to control inflation
How does a rise in IR affect AD
- High IR=increased cost of borrowing for ppl and businesses= decrease consumption/investment = Decreased AD
- High IR- higher ROI required to pay on loans and house mortgages and saving becomes more attractive due to high return
- Increased saving and less borrowing= decreases demand for assets eg shares, gov bonds = decreases prices for assets= consumers experience negative wealth effect=decreased confidence= decreased consumption
- High IR= investment falls as less abnormal profits made= decrease consumption nd investments = fall in AD
- High IR= decreases consumer and business confidence
- Increased mortgages= decreased disposable incomes= decrease C= decreased AD
- Increase IR= incentive for foreigners to hold £ due to high return= increase demand for £= increased imports and decreased exports as imports are cheaper and exports more expensive= fall in net trade= fall in AD
Problems of using demand side policies like rise in IR
- Cause worsen deficit
- Changes in IR take up to 2 years to have full effect and small change in IR doesnt effect decision making
- IR can already be low= cannot be decreased further to increase demand
- There are a range of interest rates not affect by Bank of England base rate
- Lack of confidence overall in economy= no matter how low IR, consumers and firms do not want to borrow and banks dont want to lend
- High IR in LR can decrease investment and shift LRAS left
Ways Quantitative easing increases AD
- QE has the effect of increasing consumption and investment= done by:
- Banks buy assets= increase demand= increased prices= positive wealth effect as assets eg houses worth more= increased confidence= increased spending= increased consumption
- Increased money supply= private sector companies receive more money which can be spent on goods/services or other assets= can lead to an increase in investment or consumption= increased AD
- Banks have higher reserves= increased confidence = increased lending to households/firms = increased consumption + investment as ppl can buy on credit
- Banks may reduce IR due to receiving so much money from BOE= able to offer lower IR deals to customers= reduces cost of borrowing and encourages it = increased investment and consumption
Problems with QE
- Very risky if not properly controlled as its hard to know correct money supply needed= increases inflation and even hyperinflation
- No guarantee high asset prices will increase consumption as confidence can sill remain low and consumers may psychologically feel worse off when they arent
- Can lead to geographical immobility by rising house prices eg 2013 rapid price rises = increases inequality as rich grow richer and poor poorer= contradicts objectives
- Countries can become to dependant on QE especially those in Eurozone
How can fiscal policy increase/decrease AD
- Decrease income tax = increase disposable income= increase MPC= increase consumption= increase AD
- Decrease corporation tax= increase firms profits= increase investment as firm has more money = increase investment as firm has more money= increase AD
- Gov spending is a component of AD= increases AD
Problems of fiscal policy
- Impacts LRAS which can hinder LR growth eg decrease spending on education= decrease quality = LRAS shifts left
- Increased tax or decreased spending can impact equality and can incentive firms consumers to spend- income inequality = decreases objectives as not met
- Political issues can occur eg vote gov out if right decision isn’t taken
- Depends on multiplier- if large = big impact on AD
EVAL for demand side policies
- Time lag between policies and seeing full effect
- Classical economists argue demand polcies will have no LR output effect so supply side policies should be used, they believed increased demand during depression only causes inflationary pressure
- Kengsiasn argue that it depend on trade cycle and where you operate in the economy. Full employment= increase AD= inflationary pressure
- Biggest issue= inflationary pressure= expansiaonry and contractionary policy = unemployment= gov cant bring able low and stable infaltion and unemployment and high growth= conflict of objectives
Define budget surplus and budget deficit
Budget surplus- gov receives more money than they spend
Budget deficit- gov spending is greater than gov income
Define direct and indirect tax and give examples
Direct tax- paid directly to gov by individual taxpayer eg income or corporation tax
(biggest source of gov revenue 25%)
Indirect tax- tax on consumer expenditure eg petrol,sugar ect
Role and operations of bank of england
- Control monetary policy
- Make decisions on QE and money supply
- Monetary policy committee- economists who meet monthly to set bank rates as well as other monetary instruments
- Aim= keep 2% inflation, if it goes above 3 or below BOE has to write a letter to chancellor of exchequer
Define supply side policy
Define market based
Define interventionist
Supply side policies- a policy designed to increase productive potential of the economy and shift LRAS to the right
Market based policies- policies designed to remove anything that prevents the free market system from working efficiently eg worker incentives to work,things that lead to inefficiently high prices or decreased risk taking eg priavtisation,deregulation
Interventionist- policies designed to correct market failure eg underprovision of education, encourage investment ect eg education,infrastructure,vocational training,housing
Market based and interventionists types
Market based policies
- Incentives for firms/employees
- Promote comp
- Reform labour market
Interventionist
- Increase skills and quality of labour market
- Improve infrastructure
One way to increase LRAS is to increase incentives, how can this be done
- Increase size of workforce= more produced
- Decrease benefits= increase opportunity cost of being out of work= people are better off working= increase size of workforce= increases productivity= increases LRAS. Also decreasing benefits decreases poverty trap where low income workers end up in the same or worst position after new job due to benefits lost
- Reduce NMW= incentive for firms to employ as decreased COP = increased size of WF= more produced
- Increase incentive for woman by offering free childcare and flexible hours
- Taxes on firms when employing eg national insurance contributions can be decrease = increases incentive to employ
- Decrease taxes on firms to take risks as they see higher ROI
EVAL- magnitude of change, decreased benefits = greater income inequality= conflict of objectives,decreased gov revenue = decreased spending
Increasing LRAS by promoting comp
- Privatisation- selling gov equity in nationalised industry to private sector= increases comp in market as its not one firms(monopoly) operating= decreased complacency= increased efficiency as firms have to lower offer price or better service= increase LRAS as first become more productive and less complacent= more produced
- Deregulation= less regulation and restrictions= less barriers to entry= increased comp as more firms flood market
EVAL
- can lead to poor quality service
- environmental damages if deregulation is seen in environment regulation= conflict of objectives
Increasing LRAS by reforming labour markets
- Increase retirement age = increases size of workforce= more productivity= increased goods/services produced
- Increase flexibility of workforce to respond to external factors eg demand, changing employment contracts,zero-hour contracts
- Weaken trade unions eg 14 day notice before strike= prevents them from pushing up wages which can lead to increased unemployment and decreased productivity. Weaken=prevents
- Increase mobility of labour eg increase info about job vacancies= increases occupational mobility. Decrease price of ousing through VAT cuts and planning relaxed laws = increases geoprahical mobility
- Decrease benefits
EVAL
- trade unions already weak= less power= little effect
- decreased benefits= decreased AD if ppl cant get job, high MPC by low income earners= big fall in multiplier effect as their incomes fall
- Increased flexibility= decreased quality and pay = income inequality
Increasing LRAS by improving skills and quality of labour
- Increase spending on education and training= more educated workforce= increased efficiency and ability to do more skilled jobs= increases productivity as mistakes are reduced
> can be done on primary,secondary and tertiary - Increase regulation for force firms to continuously train staff = prevent structural unemployment
- Increase high skilled migrants= increases quality
EVAL
- opportunity cost
- takes time to see full effect
- increase national debt
Increasing LRAS through infrastructure
- Increase tax incentives or subsidies on investment eg fewer tax if firms invest
- Increase gov spending on building better road links and railways = increase productivity as ppl can move quicker eg HS2
EVAL
- tax breaks/subsidies= decrease gov revenue
- opportunity cost
- sme may not invest and use as tax evasion
EVAL for all supply side policies
-Not all SSP increase supply and can cause conflicts
- Kengsian curve shows no impact if LRAS is elastic= demand side policies needed to fix SR problems
- Gov has to spend money or decreased tax= budget deficit
- Can have undesirable effect on AD eg can lead to increased unemployment or inflation
- Take long time to have effect on output
Conflicts and trade offs between objectives
- Economic growth vs environment- increased growth= more resources used due to increased demand for goods and services= destroy habitats,pollution eg China
- Economic growth vs balance of payments- growth= increased incomes= increased demand for imports= deficit
- Unemployment vs inflation= philips curve= firms employ but pass high wages in form of high prices
