2.6.2 Demand side policies

Question 1

what are the two types of economic policies?

Answer 1

• demnd side policies (affect AD)
• supply side policies (affect AS)

aim to control the business cycle and acieve 7 macro objectives

Question 2

what are the side effects of demand side policies?

Answer 2

although intended to affect AD also affect AS
eg:

ALL policies have both supply side effects as well as demand side effect

Question 3

what are demand side policies?

Answer 3

goverment policies which aim to influence aggregate demand

Question 4

what are the two types of demand side policies?

who are they managed by

Answer 4

• fiscal policy (goverment )
• monentary policy (B of E )

Question 5

what two things do the central bank manipulate in monetary policy?

Answer 5

1. base intrest rate
2. money supply

in oreder to infulence AD

Question 6

what is the base intrest rate?

Answer 6

the intrest rate set by the central bank which impacts other commericial banks

infulences commerical intrest rates to consumers

Question 7

what is the central bank?

Answer 7

the bank of banks

Question 8

who are the monetary policy commitee?

Answer 8

a group of 8 economist and governer (9 total)
* job is to keep inflation rate at 2% goal
* every few weeks decide monetary policy

Question 9

what does is expansionary monetary policy

Answer 9

decrease base intrest rates (inflation is below target )
* consumers will be encouraged to spend more and save less
* consumption (60% ) will increase, increasing AD
* deand pull inflation

Question 10

what is contrationary monetary policy?

Answer 10

increase in base intrest rates ( inflation rate above target)
* consumers encourages to save more and spend less
* consumption (60%) will decrease, AD will decrease
* decrease in inflation

contracts the economy

Question 11

define monetary policy

Answer 11

when the central bank changes the base intrest rate or the money supply in order to influence aggregate demand

Question 12

define base intrest rate

Answer 12

the intrest rate set by the bank of england, showing the rate at which they will lend money to highstreet banks

Question 13

define expansionary monetary policy

Answer 13

decreasing the base intrest rate or increasing the money supply in order to increase aggregate demand and increase the rate of inflation

Question 14

define contractionary monetary policy

Answer 14

increasing the base intrest rate or decreasing the money supply in order to increase aggregate demand and decraese the rate of inflation

Question 15

what are the 4 things that base intrest rates affect?

Answer 15

• savings
• investment
• mortgage
• (net) exports
  SIME

Question 16

what are the effects of cutting the base intrest rates? (savings)

evaluation point

Answer 16

• discourage saving and encourage spending
  increase in (MPC), increase in consumption
• 1 in 6 people are pensioners who rely on return from their savings, less disposable income/ consumption

Question 17

what are the effects of increasing the base intrest rate? (savings)

evaluation point

Answer 17

• encouraged saving instead of spending , MPC decreases, MPS increases, AD decreases
• 1 in 6 are pensioners, rely on return from savings as income, so they will have more disposable income

Question 18

what are the effects of cutting the base intrest rates? (mortgages)

evaluation point

Answer 18

• mortagages become more affordable, more demand for housing, increased house prices, positive wealth affect , increased AD
  *

wealth affect 0 in european countries (evaluation)

Question 19

what is the effect of higher intrest rates on mortgages?

Answer 19

• less people can afford, demand for housing will decrease, house prices will decrease, negative wealth affect
• wealth affect neutral in european countries

increased price of borrowing, contractionary

Question 20

what is the effect of lower intrest rate on investment?(demand side effects and supply side effects)

Answer 20

• cost of borrowing has decreased
• incentive for firms to borrow money to invest in capital
• demand side effect: increase in AD as increase in investment
• supply side effect: increase in LRAS as an increase in productivity from new machinary

Question 21

what is an evaluation point to there being a cut in intrest rates and the effect of this on investment?

Answer 21

However, this may not happens as if animal spirits are low, then firms may be worried that they may not even be able to meet the small cost of borrowing and go bankrupt. Therefore, invesmtent will not necessiarily increase

Question 22

what is the effect on investment when there is a increase in intrest rates?

Answer 22

• increased cost of borrowing= decreased incentive for firms to take out loan and invest in capital, decraese in investment, decrease in AD, decrease in price level controlling inflation
• for firms that choose to invest, increased cost borrwoing, increase in firms costs, decreased SRAS passed down to consumers by an increase in prices, cost push inflation , against the point of the monetary contrationary policy

Question 23

what is the effect on the pound of increasing the base intrest rate?

Answer 23

since there is a higher return on savings
* an increase in demand foreign will increase the value of the pound (appreciate)

Question 24

what is the effect of increasing the base intrest rate on imports and exports?

Answer 24

• stronger pound= imports cheaper
• increased import expenditure, decreased export income, net trade will decrease
• worsening current account balance

Question 25

evaluation point for increase in base intrest rate effects on imports and exports

Answer 25

the UK in a net importer of raw materials * reduction in cost for firms who import raw materials * lower prices make the firms internationally more competitive * incraesed demand for exports and increased export revenue * UK consumers may find it cheaper to buy dometic goods than international, decraesing import expenditure | improving the current account deficit

Question 26

what is the effect of decreasing the intrest rates on the value of the pound?

Answer 26

a decrease in the value of the pound, less return and so less demand from foreign investors

Question 27

what is the effect of decreasing the base interest rate on imports and exports?

Answer 27

* decreased value of the pound * decraesed import expenditure, increased export revenue * increased in net trade and AD, economic growth * improving the current account balance

Question 28

what is the evaluation point for the effect of decreasing the base intrest rate on imports and exports?

Answer 28

* However, the UK is a net importer of raw materials imports become more expensive so firms have to increase their prices * decreasing international competitivness, decrease in export revenue * less consumers would buy domestic goods over foreign goods as they are more expesnive, increase in import expediture * worsening the current acount deficit

Question 29

what is the zero lower bound?

Answer 29

intrest rates cannot be negative so lowest interest rate possible is 0 | when close to zero banks use quantitive easing

Question 30

what is quantitative easing?

Answer 30

1. the central bank makes electronic money 2. they then buy financial assets such as bonds from high street banks 3. this increases high street banks supply of money,increasing amount that they can lend | an expansion monetary policy

Question 31

what are the two effects of quantitative easing?

Answer 31

1. increase in AD from increase in consumption and investment 2. depreciation of pound, net trade will increase, increase in AD

Question 32

what are the negative consequences of quantitative easing?

Answer 32

* increase in AD, increase in price level = demand pull inflation * inflation effects may outweigh increase in real GDP

Question 33

what is fiscal policy?

Answer 33

changing tax and goverment spedning to influence the economy

Question 34

what is expansionary fiscal policy? | loose fiscal policy

Answer 34

when gov decrease taxes and increase government spending in order to increase AD | worsening the budget deficit

Question 35

what is contractionary fiscal policy?

Answer 35

when the government increases tax abd decreases government spending in order to decraese AD

Question 36

expansionary fiscal policy (chains of analysis)

Answer 36

(expansionary fiscal policy) 1. increase in government spending--> increase in injections 2. decrease in taxes ----> decrease in withdrawals 3. injections> withdrawals so the circular flow of income expands, expandning the economy 4. worsening the government budget deficit

Question 37

lower income tax (chains of analysis)

Answer 37

* higher dispoable income , increase in consumption increase in AD. Firms make more sales and profit, increase in investment, increase in AD * increase in corporation tax and VAT revenues will increase government spending, increase in AD * as firms expand, derived demand for labour increases, more jobs, more incomes and more spending ....

Question 38

lower income tax (evaluataion)

Answer 38

* cut in income tax, less revenue, less to spend on benefits, healthcare, education. Government spendning decraesimg will decrease AD

Question 39

higher income tax (chains of analysis)

Answer 39

(contractionary fiscal policy) * helps bring down the inflation rate * decraesed budget deficit * can spend on other things

Question 40

higher income tax (evaluation points)

Answer 40

* may decrease incentive to work, less hours worked, quanity of labour (LRAS) * migrate away to countries where income tax = 0%, no income tax at all * using clever accountants to avoid the income tax

Question 41

higher benefits (chains of analysis)

Answer 41

(expansionary fiscal policy) * increase C (not GS ) for low income workers--> economic growth * decrease in income inequality

Question 42

define benefits

Answer 42

payments or transfers made by the government to low income or unemployed workers

Question 43

higher benefits (evaluation)

Answer 43

* if benefits too high --> benefits trap: * reduced incentive for unemployed people to work, increase in unemployment

Question 44

what is the benefits trap?

Answer 44

when benefits get too high and unemployed workers are actually better off staying unemployed and claiming benefits than working

Question 45

lower benefits (chains of analysis)

Answer 45

(contractionary fiscal policy) * reduction in consumption--> lower inflation * decrease in budget defict * increased incentive to work --> lower unemployment

Question 46

lower benefits (evaluation)

Answer 46

* those who are poor get poorer--> increase in income inequality * decrease in consumption (not GS ) ---> decrease in economic growth

Question 47

higher corporation tax (chains of analysis)

Answer 47

(contractionary fiscal policy) * reduced government budget deficit * increased government spendning--> economic growth

Question 48

what is corporation tax?

Answer 48

tax paid on firms profits

Question 49

higher corporation tax (evaluation)

Answer 49

* decrease in I, decrease in AD * reduce investment in capital --> depreciation in qualit productivity--> less LRAS

Question 50

lower corporation tax (chains of analysis)

Answer 50

* (supply side) decrease in costs, SRAS shift to the right * increase in investment--> more productive capital --> LRAS shifts out * increase in investment, increase in AD