4.2.3 Economic Performance

Question 1

Define Short run growth

Answer 1

Short run growth is the percentage increase in a country’s real GDP and it is usually measured annually. It is caused by increases in AD.

Question 2

Define long run growth

Answer 2

Long run economic growth occurs when the productive capacity of the economy is increasing and it refers to the trend rate of growth of real national output in an economy over time. It is caused by increases in AS.

The potential output of an economy is what the economy could produce if resources were fully employed.

Question 3

Define output gaps

Answer 3

An output gap occurs when there is a difference between the actual level of output and the potential level of output. It is measured as a percentage of national output.

Question 4

Outline a negative output gap in economic growth

Answer 4

A negative output gap occurs when the actual level of output is less than the potential level of output.
This puts downward pressure on inflation. It usually means there is the unemployment of resources in an economy, so labour and capital are not used to their full productive potential. This means there is a lot of spare capacity in the economy

Question 5

Outline a positive output gap in economic growth

Answer 5

A positive output gap occurs when the actual level of output is greater than the potential level of output.

It could be due to resources being used beyond the normal capacity, such as if labour works overtime. If productivity is growing, the output gap becomes positive. It puts upwards pressure on inflation.
Countries, such as China and India, which have high rates of inflation due to fast and increasing demand, are associated with positive output gaps.

Question 6

Describe how an output gap can be illustrated

Answer 6

Classical economists believe markets clear in the long run, so there is full employment. They believe there are output gaps in the short run. A negative output gap is between Ye and Y1, and a positive output gap is between Ye and Y2.

Question 7

Outline and describe a diagram or the business cycle

Answer 7

This refers to the stage of economic growth that the economy is in. The economy goes through periods of booms and busts.

Real output increases when there are periods of economic growth. This is the recovery stage.
* The boom is when economic growth is fast, and it could be inflationary or unsustainable.
* During recessions, the real output in the economy falls, and there is negative economic growth.
* During recessions, governments might increase spending to try and stimulate the economy. This could involve spending on welfare payments to help people who have lost their jobs, or cutting taxes.
* During periods of economic growth, governments may receive more tax revenue since consumers will be spending more and earning more. They may decide to spend less, since the economy does not need stimulating, and fewer people will be claiming benefits.

Question 8

Outline the characteristics of a boom

Answer 8

• High rates of economic growth
• Near full capacity or positive output gaps
• (Near) full employment
• Demand-pull inflation
• Consumers and firms have a lot of confidence, which leads to high rates of investment
• Government budgets improve, due to higher tax revenues and less spending on welfare payments

Question 9

Outline the characteristics of a recession

Answer 9

In the UK, a recession is defined as negative economic growth over two consecutive quarters.

The characteristics are:
* Negative economic growth
* Lots of spare capacity and negative output gaps
* Demand-deficient unemployment
* Low inflation rates
* Government budgets worsen due to more spending on welfare payments and lower tax revenues
* Less confidence amongst consumers and firms, which leads to less spending and investment

Question 10

Outline the costs and benefits for consumer of economic growth

Answer 10

Costs
1. Economic growth does not benefit everyone equally. Those on low and fixed incomes might feel worse off if there is high inflation and inequality could increase.
2. There is likely to be higher demand-pull inflation, due to higher levels of consumer spending.
3. Consumers could face more shoe leather costs, which means they have to spend more time and effort finding the best deal while prices are rising.
4. The benefits of more consumption might not last after the first few units, due to the law of diminishing returns, which states that the utility consumers derive from consuming a good diminishes as more of the good is consumed

Benefits
* The average consumer income increases as more people are in employment and wages increase.
* Consumers feel more confident in the economy, which increases consumption and leads to higher living standards.

Question 11

Outline the costs and benefits for Firms of economic growth

Answer 11

Costs
Firms could face more menu costs as a result of higher inflation. This means they have to keep changing their prices to meet inflation

Benefits
* Firms might make more profits, which might in turn increase investment. This is also driven by higher levels of business confidence.
* Higher levels of investment could develop new technologies to improve productivity and lower average costs in the long run.
* As firms grow, they can take advantages of the benefits of economies of scale.
* If there is more economic growth in export markets, firms might face more competition, which will make them more productive and efficient, but it will also give them more sales opportunities

Question 12

Outline the costs and benefits for The government of economic growth

Answer 12

Costs - Governments might increase their spending on healthcare if the consumption of demerit goods increases

Benefits- The government budget might improve, since
fewer people require welfare payments and more people will be paying tax.

Question 13

Outline the costs and benefits for Current and future
living standards of economic growth

Answer 13

Costs - High levels of growth could lead to damage to
the environment in the long run, due to increase negative externalities from the consumption and production of some goods and services.

Benefits- As consumer incomes increase, some people
might show more concern about the environment.
Also, economic growth could lead to the development of
technology to produce goods and services more
greenly. Higher average wages mean consumers can
enjoy more goods and services of a higher quality.
Public services improve, since governments have higher tax revenues, so they can afford to spend on improving services. This could increase life expectancy and education levels.

Question 14

Outline The sustainability of economic growth in the causes of cyclical instability

Answer 14

• Growth is sustainable when the rate of economic growth can be maintained in the long run, so future generations can enjoy the same rate of growth.
• Fast economic growth today could mean that natural resources, such as oil, might deplete, which would create environmental problems for future generations, and mean the future rate of growth might be weak.
• Unsustainable growth occurs around the boom and bust sections of the business cycle. These are essentially deviations from the trend rate of growth.
• If growth is excessive, there could be inflation in the average price level, wages and assets. There could be excessive credit, which is unsustainable in the long run, and the savings rate might be low and falling.

Question 15

Outline Excessive growth in credit and levels of debt in the causes of cyclical instability

Answer 15

Growth that is financed by public debt might not be sustainable. It might be difficult to pay it back in the future, and it does not contribute to improvements in
productivity. By being more productive, growth is likely to be more sustainable. This is since it increases the economy’s productive capacity, so there is more room to
grow.

Question 16

Outline Asset price bubbles in the causes of cyclical instability

Answer 16

A market bubble occurs when the price of an asset is predicted to rise significantly. This causes it to be traded more, and demand exceeds supply so the price rises
beyond the intrinsic value. The bubble then ‘bursts’ when the price steeply and suddenly falls to its ordinary level. This causes panic and investors try and sell their
assets. It results in a loss of confidence and it can lead to economic decline or a depression.

Question 17

Outline the two measures of unemployment

Answer 17

It is usually difficult to accurately measure unemployment. Some of those in employment might claim unemployment related benefits, whilst some of the
unemployed might not reveal this in a survey.

The two main measures of unemployment in the UK are:
The Claimant Count and The International Labour Organisation (ILO) and the UK Labour Force Survey (LFS)

Question 18

Outline The Claimant Count as a measure of unemployment and evaluate

Answer 18

The Claimant Count - This counts the number of people claiming unemployment related benefits, such as Job Seeker’s Allowance (JSA). They have to prove they are actively looking for work.

Evaluating the Claimant Count:
Not every unemployed person is eligible for, or bothers claiming JSA. Those with partners on high incomes will not be eligible for the benefit, even if they are
unemployed. Although there may be instances of people claiming the benefit whilst
they are employed, the method generally underestimated the level of unemployment.

Question 19

Outline The International Labour Organisation (ILO) and the UK Labour Force Survey (LFS) as a measurement of unemployment

Answer 19

The LFS is taken on by the ILO. It directly asks people if they meet the following criteria:
* Been out of work for 4 weeks
* Able and willing to start working within 2 weeks
* Workers should be available for 1 hour per week. Part time unemployment is included.

Since the part time unemployed are less likely to claim unemployment benefit, this method gives a higher unemployment figure than the Claimant Count.

Question 20

Outline the concepts of voluntary and involuntary unemployment

Answer 20

Voluntary unemployment occurs when someone chooses not to work at the current wage rate. This could be encouraged in welfare payments are generous relative to real wages. A high income tax rate might also discourage people from participating in the labour market.

A person is involuntarily unemployed when they are willing and able to work at the
current wage rate, but they cannot find work. It is usually cyclical, since it is caused
by a fall in AD. Moreover, it occurs when there is an excess supply of labour, which
‘sticky wages’ are unable to correct. When an economy experiences involuntary
unemployment, it is not operating at full employment.

Question 21

Explain how changes in the rates of Employment and Unemployment affect consumers

Answer 21

Consumers - If consumers are unemployed, they have less disposable income and their standard of living may fall as a result. There are also psychological consequences of losing a job, which could affect the mental health of workers.

Question 22

Explain how changes in the rates of Employment and Unemployment affect Firms

Answer 22

Firms - With a higher rate of unemployment, firms have a larger supply of labour to employ from. This causes wages to fall, which would help firms reduce their costs. However, with higher rates of unemployment, since consumers have less disposable income, consumer spending falls so firms may lose profits. Producers which sell inferior goods might see a rise in sales.
It might cost firms to retrain workers, especially if they have been out of work for a long time.

Question 23

Explain how changes in the rates of Employment and Unemployment affect Workers

Answer 23

Workers - With unemployment, there is a waste of workers’ resources. They could also lose their existing skills if they are not fully utilised

Question 24

Explain how changes in the rates of Employment and Unemployment affect The Government

Answer 24

If the unemployment rate increases, the government may have to spend more on JSA, which incurs an opportunity cost because the money could have been invested elsewhere.
The government would also receive less revenue from income tax, and from indirect taxes on expenditure, since the unemployed have less disposable income to spend.

Question 25

Explain how changes in the rates of Employment and Unemployment affect Society

Answer 25

There is an opportunity cost to society, since workers could have produced goods and services if they were employed.
There could be negative externalities in the form of crime and vandalism, if the unemployment rate increases

Question 26

Explain how changes in the rates of Employment and Unemployment affect Inactivity

Answer 26

Inactivity: The economically inactive are those who are not actively looking for jobs. These could include carers for the elderly, disabled or children, or
those who have retired. Some workers are discouraged from the labour market, since they have been out of work for so long that they have stopped
looking for work. If the number of the economically inactive increases, the size of the labour force may decrease, which means the productive potential
of the economy could fall.

Question 27

Outline Structural unemployment as a cause of unemployment and give a supporting diagram

Answer 27

This occurs with a long term decline in demand for the goods and services in an industry, which costs jobs. This is especially true of jobs in industries such as car
manufacturing, where labour is replaced by capital (this is also called technological unemployment). Moreover, the decline of the coal and ship building industries in the UK, led to a great deal of structural unemployment.

This type of unemployment is worsened by the geographical and occupational immobility of labour. If workers do not have the transferable skills to move to
another industry, or if it is not easy to move somewhere jobs are available, then those facing structural unemployment are likely to remain unemployed in the long run.

Question 28

Outline Frictional unemployment as a cause of unemployment

Answer 28

This is the time between leaving a job and looking for another job. It is common for there to always be some frictional unemployment, and it is not particularly damaging since it is only temporary.

For example, it could be the time between graduating from university and finding a job.

This is why it is rare to get 100% employment: there will always be people moving between jobs.

Question 29

Outline Seasonal unemployment as a cause of unemployment

Answer 29

This occurs during certain points in the year, usually around summer and winter. During the summer, more people will be employed in the tourist industry, when demand increases.

Question 30

Outline Demand deficiency (Cyclical unemployment) as a cause of unemployment

Answer 30

This is caused by a lack of demand for goods and services, and it usually occurs during periods of economic decline or recessions. It is linked to a negative output gap. Firms are either forced to close or make workers redundant, because their profits are falling due to decreased consumer spending, and they need to reduce their costs. This then causes output to fall in several industries.

This type of unemployment could actually be caused by increases in productivity, which means each worker can produce a higher output, and therefore fewer workers are needed to produce the same quantity of goods and services.

Question 31

Outline real wage unemployment as a cause of unemployment

Answer 31

Wages above the market equilibrium may cause unemployment. This is because the supply of labour exceeds demand. Classical economists argue that by letting wages
fall to the equilibrium level, there would be no unemployment.

In the diagram, the point at ‘minimum price’ reflects the NMW. This causes
unemployment of Q1 – Q3.If demand then shifts to the left, due to a fall in consumer spending for example, there would be more unemployment since wages are not able to adjust. Classical economists would argue that by letting wages be flexible, by removing trade union power and removing the NMW, wages could fall and unemployment
would fall to 0. However, cutting wages during times of weak consumer spending would cause
further falls in consumer spending, and there would be even lower economic growth. Moreover, the classical economist argument is made on the assumption of a perfectly competitive market, which is not true in reality.

Question 32

How changes in the rest of the world affect employment and
unemployment in the UK

Answer 32

Globalisation also contributes to structural unemployment, since production in the manufacturing sectors, such as in clothing or motor cars, moves abroad to countries with lower labour costs. This means that workers trained for these jobs will become unemployed, because the industry has declined in size or has been removed from
the economy.

Migrants are usually of working age, so the supply of labour at all wage rates tends to increase with more migration. There could be more competition to get a job due to the rise in the size of the working population. Migrants tend to be of working age, and many are looking for a job. Migrants tend to bring high quality skills to the domestic workforce, which can increase productivity and increase the skillset of the labour market. This could increase global competitiveness.

Question 33

Outline the consequences of unemployment

Answer 33

• If consumers are unemployed, they have less disposable income and their standard of living may fall as a result.
• There are also psychological consequences of losing a job, which could affect the mental health of workers.
• With a higher rate of unemployment, firms have a larger supply of labour to employ from. This causes wages to fall, which would help firms reduce their costs.
• However, with higher rates of unemployment, since consumers have less disposable income, consumer spending falls so firms may lose profits. Producers which sell inferior goods might see a rise in sales.
• It might cost firms to retrain workers, especially if they have been out of work for a long time.
• With unemployment, there is a waste of workers’ resources. They could also lose their existing skills if they are not fully utilised.
• If the unemployment rate increases, the government may have to spend more on JSA, which incurs an opportunity cost because the money could have been invested elsewhere.
• The government would also receive less revenue from income tax, and from indirect taxes on expenditure, since the unemployed have less disposable income to spend.
• There is an opportunity cost to society, since workers could have produced goods and services if they were employed.
• There could be negative externalities in the form of crime and vandalism, if the unemployment rate increases.

Question 34

Define Inflation

Answer 34

Inflation is the sustained rise in the general price level over time. This means that the cost of living increases and the purchasing power of money decreases.

Question 35

Define Deflation

Answer 35

Deflation is the opposite, where the average price level in the economy falls. There is a negative inflation rate.

Question 36

Define disinflation

Answer 36

Disinflation is the falling rate of inflation. This is when the average price level is still rising, but to a slower extent. This means goods and services are relatively cheaper now than a year ago, and the purchasing power of money has increased.

Question 37

What is the current rate of inflation

Answer 37

3.2%

Question 38

Outline demand pull as a cause of inflation and give a diagram to support

Answer 38

This is from the demand side of the economy. When aggregate
demand is growing unsustainably, there is pressure on resources. Producers increase their prices and earn more profits. It usually occurs when resourcesare fully employed.

The main triggers for demand pull inflation are:
- A depreciation in the exchange rate, which causes imports to become more expensive, whilst exports become cheaper. This 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.
- Lower interest rates makes saving less attractive and borrowing more attractive, so consumer spending increases.
- High growth in UK export markets means UK exports increase and AD increases.

Question 39

Outline cost push as a cause of inflation and give a supporting diagram

Answer 39

This is from the supply side of the economy, and occurs when
firms face rising costs. This occurs when:

Changes in world commodity prices can affect domestic inflation. For example, raw materials might become more expensive if oil prices rise. This increases costs of production.

Labour becomes more expensive. This could be through trade unions, for example.
Expectations of inflation- if consumers expect prices to rise, they may ask for higher wages to make up for this, and this could trigger more inflation.
Indirect taxes could increase the cost of goods such as cigarettes or fuel, if producers choose to pass the costs onto the consumer.
Depreciation in the exchange rate, which causes imports to become more expensive and pushes up the price of raw materials.
Monopolies, using their dominant market position to exploit
consumers with high prices.

Question 40

The effects of inflation on consumers

Answer 40

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 power 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 41

The effects of inflation on firms

Answer 41

• Low interest rates means borrowing and investing is more attractive than saving profits. 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 42

Outline the effects of inflation on the government

Answer 42

The government will have to increase the value of the state pension and welfare payments, because the cost of living is increasing.

Question 43

Outline the effects of inflation on Workers

Answer 43

Real incomes fall with inflation, so workers will have less disposable income.
If firms face higher costs, there could be more redundancies when firms try and cut their costs.

Question 44

Outline the effects of deflation

Answer 44

• Deflation discourages spending because it makes goods and services cheaper in the future. Consumers believe that, if goods are cheaper tomorrow, it is not worthwhile buying them today. This can result in economic decline and increasing rates of unemployment.
• Deflation can worsen the effects of economic stagnation.
• Deflation makes the real value of debt higher. This means that consumers with high levels of debt find it harder to pay it off, since a larger proportion of their income will be used to make repayments.
• Since consumers have less disposable income, the level of spending in the economy falls, which worsens the effects of a recession. Wages are also likely to fall, since firms make lower profits. There could be even lower growth and worse rates of unemployment if the real interest rate increases.
• If the interest rate is 0% and the deflation rate is 5%, the real interest rate is 5%. This means that saving is encouraged, because the rate of return is higher

Question 45

Fisher’s equation of exchange

Answer 45

Fisher’s equation of exchange is MV = PQ. T can be used instead of Q, although using Q means that PQ is nominal national income and overcomes the difficulties
associated with the inclusion of intermediate transactions

M refers to the supply of money, V is the velocity of circulation, P is the price level and Q is the quantity of real goods sold (real GDP). T represents transactions.
However, it is difficult to measure T. Therefore, the value of expenditure on goods equals the value of total output
(MV=PQ).

Question 46

The Quantity Theory of Money

Answer 46

states that there is inflation if the money supply increases at a faster rate than national income

Question 47

Outline a negative output gap

Answer 47

A negative output gap occurs when the actual level of output is less than the potential level of output. This puts downward pressure on inflation. It usually means there is the unemployment of resources in an economy, so labour and capital are not used to their full productive potential. This means there is a lot of spare capacity
in the economy.

Question 48

Outline a positive output gap

Answer 48

A positive output gap occurs when the actual level of output is greater than the potential level of output. It could be due to resources being used beyond the normal
capacity, such as if labour works overtime. If productivity is growing, the output gap becomes positive. It puts upwards pressure on inflation. Countries, such as China
and India, which have high rates of inflation due to fast and increasing demand, are associated with positive output gaps.

Question 49

Outline the Economic growth vs the current account:.

Answer 49

During periods of economic growth, consumers have high levels of spending. In the UK, consumers have a high marginal propensity to import, so there is likely to be
more spending on imports. This leads to a worsening of the current account deficit. However, export-led growth, such as that of China and Germany, means a country
can run a current account surplus and have high levels of economic growth.

Question 50

Outline Economic growth vs the government budget deficit

Answer 50

Reducing a budget deficit requires less expenditure and more tax revenue. This would lead to a fall in AD, however, and as a result there will be less economic growth.

Question 51

Outline Economic growth vs the environment:

Answer 51

High rates of economic growth are likely to result in high levels of negative externalities, such as pollution and the usage of non-renewable resources. This is because of more manufacturing, which is associated with higher levels of carbon dioxide emissions.

Question 52

Outline unemployment vs inflation

Answer 52

In the short run, there is a trade-off between the level of unemployment and the inflation rate. This is illustrated with a Phillips curve. As economic growth increases, unemployment falls due to more jobs being created.
However, this causes wages to increase, which can lead to more consumer spending and an increase in the average price level.

The extent of this trade off can be limited if supply side policies are used to reduce structural unemployment, which will not increase average wages.

Question 53

Outline the Phillips curve as as possible conflict between macroeconomic policy objectives

Answer 53

The short-run Phillips curve represents the trade-off between unemployment and inflation. In the short run, the Phillips curve is roughly L-shaped, which shows how as unemployment increases, inflation decreases. The above Phillips curve is for the short run.

The long run Phillips curve is L-shaped. It is also known as the vertical long-run Phillips curve (shown below). It is at the natural rate of unemployment, and there is no trade-off between unemployment and inflation. The two variables are unrelated

Question 54

The implications of the short-run Phillips curve and the long-run, L-shaped Phillips curve for economic policy

Answer 54

If the government tries to lower unemployment in the short run, there could be inflationary pressure on the price level. In the short run, the economy suffers from
demand-deficient unemployment. This might encourage the use of demand-side policies to tackle unemployment.
In the long run, changes in the unemployment rate do not affect the inflation rate. Therefore, policies can be more flexible. Since there is no demand-deficient
unemployment in the long run, supply-side policies are more likely to be used